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How did the 2003 dividend tax cut affect stock prices?

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  • Gene Amromin
  • Paul Harrison
  • Steven Sharpe

Abstract

We test the hypothesis that the 2003 dividend tax cut boosted U.S. stock prices and thus lowered the cost of equity. Using an event-study methodology, we attempt to identify an aggregate stock market effect by comparing the behavior of U.S. common stock prices to that of European stocks and real estate investment trusts. We also examine the relative cross-sectional response of stock prices for high-dividend and low-dividend stocks. We find that U.S. large-cap and small-cap indexes do not outperform their European counterparts, nor REIT stocks, over the event windows, suggesting the absence of a notable aggregate stock market effect. Second, high-dividend-yield stocks outperformed low-dividend-yield stocks by a few percentage points over the event windows, consistent with the hypothesis that investors heavily discounted future dividends, though this outperformance appears to dissipate in subsequent weeks. Finally, non-dividend paying stocks are found to have outperformed the overall market by a small margin, but this result does not appear to be tied to tax-cut news, suggesting that non-tax factors were at play.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2005-61.

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Date of creation: 2005
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Handle: RePEc:fip:fedgfe:2005-61

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Keywords: Stock - Prices ; Taxation;

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References

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  1. Clemens Sialm, 2005. "Tax Changes and Asset Pricing: Time-Series Evidence," NBER Working Papers 11756, National Bureau of Economic Research, Inc.
  2. John R. Graham & Roni Michaely & Michael R. Roberts, 2003. "Do Price Discreteness and Transactions Costs Affect Stock Returns? Comparing Ex-Dividend Pricing before and after Decimalization," Journal of Finance, American Finance Association, vol. 58(6), pages 2611-2636, December.
  3. Auerbach, Alan J. & Hassett, Kevin A., 2006. "Dividend Taxes and Firm Valuation: New Evidence," Berkeley Olin Program in Law & Economics, Working Paper Series qt2nt4k6vj, Berkeley Olin Program in Law & Economics.
  4. Auerbach, Alan J., 2002. "Taxation and corporate financial policy," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 19, pages 1251-1292 Elsevier.
  5. James Poterba, 2004. "Taxation and Corporate Payout Policy," NBER Working Papers 10321, National Bureau of Economic Research, Inc.
  6. Auerbach, Alan J. & Hassett, Kevin A., 2003. "On the marginal source of investment funds," Journal of Public Economics, Elsevier, vol. 87(1), pages 205-232, January.
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Citations

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Cited by:
  1. Alan J. Auerbach & Kevin A. Hassett, 2006. "Dividend Taxes and Firm Valuation: New Evidence," NBER Working Papers 11959, National Bureau of Economic Research, Inc.
  2. Jeffrey R. Brown & Nellie Liang & Scott Weisbenner, 2007. "Executive Financial Incentives and Payout Policy: Firm Responses to the 2003 Dividend Tax Cut," Journal of Finance, American Finance Association, vol. 62(4), pages 1935-1965, 08.
  3. Jesse Edgerton, 2010. "Effects of the 2003 dividend tax cut: evidence from real estate investment trusts," Finance and Economics Discussion Series 2010-34, Board of Governors of the Federal Reserve System (U.S.).
  4. Josef García Blandón & M?nica Martínez Blasco & Josef Argiles Bosch, 2011. "Ex-Dividend Day Returns when Dividend and Capital Gains are Taxed at the Same Rate," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 61(2), pages 140-152, June.
  5. Jesse Edgerton, 2013. "Four facts about dividend payouts and the 2003 tax cut," International Tax and Public Finance, Springer, vol. 20(5), pages 769-784, October.
  6. Clemens Sialm, 2006. "Investment Taxes and Equity Returns," NBER Working Papers 12146, National Bureau of Economic Research, Inc.
  7. Lin, Leming & Flannery, Mark J., 2013. "Do personal taxes affect capital structure? Evidence from the 2003 tax cut," Journal of Financial Economics, Elsevier, vol. 109(2), pages 549-565.

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