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New Evidence that Taxes Affect the Valuation of Dividends

  • James M. Poterba
  • Lawrence A. Summers

This paper uses British data to examine the effects of dividend taxes on investors' relative valuation of dividends and capital gains. British data offer great potential to illuminate the dividends and taxes question, since there have been two radical changes and several minor reforms in British dividend tax policy during the last twenty-five years. Studying the relationship between dividends and stockprice movements during different tax regimes offers an ideal controlled experiment for assessing the effects of taxes on investors' valuation of dividends. Using daily data on a small sample of firms, and monthly data on a much broader sample, we find clear evidence that taxes change equilibrium relationships between dividend yields and market returns. These findings suggest that taxes are important determinants of security market equilibrium, and deepen the puzzle of why firms pay dividends.

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Paper provided by Massachusetts Institute of Technology (MIT), Department of Economics in its series Working papers with number 338.

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Date of creation: Mar 1984
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Handle: RePEc:mit:worpap:338
Contact details of provider: Postal: MASSACHUSETTS INSTITUTE OF TECHNOLOGY (MIT), DEPARTMENT OF ECONOMICS, 50 MEMORIAL DRIVE CAMBRIDGE MASSACHUSETTS 02142 USA
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Web page: http://econ-www.mit.edu/

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  1. Feenberg, Daniel, 1981. "Does the investment interest limitation explain the existence of dividends?," Journal of Financial Economics, Elsevier, vol. 9(3), pages 265-269, September.
  2. Litzenberger, Robert H & Ramaswamy, Krishna, 1982. " The Effects of Dividends on Common Stock Prices: Tax Effects or Information Effects?," Journal of Finance, American Finance Association, vol. 37(2), pages 429-43, May.
  3. Elton, Edwin & Gruber, Martin & Rentzler, Joel, 1983. "A simple examination of the empirical relationship between dividend yields and deviations from the CAPM," Journal of Banking & Finance, Elsevier, vol. 7(1), pages 135-146, March.
  4. Lakonishok, Josef & Vermaelen, Theo, 1983. " Tax Reform and Ex-Dividend Day Behavior," Journal of Finance, American Finance Association, vol. 38(4), pages 1157-79, September.
  5. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-75, May.
  6. Hausman, Jerry A., 1983. "Specification and estimation of simultaneous equation models," Handbook of Econometrics, in: Z. Griliches† & M. D. Intriligator (ed.), Handbook of Econometrics, edition 1, volume 1, chapter 7, pages 391-448 Elsevier.
  7. Feldstein, Martin & Dicks-Mireaux, Louis & Poterba, James, 1983. "The effective tax rate and the pretax rate of return," Journal of Public Economics, Elsevier, vol. 21(2), pages 129-158, July.
  8. Hess, Patrick J, 1982. " The Ex-Dividend Day Behavior of Stock Returns: Further Evidence on Tax Effects," Journal of Finance, American Finance Association, vol. 37(2), pages 445-56, May.
  9. Roger H. Gordon & David F. Bradford, 1980. "Taxation and the stock market valuation of capital gains and dividends : Theory and emphirical results," NBER Chapters, in: Econometric Studies in Public Finance, pages 109-136 National Bureau of Economic Research, Inc.
  10. Miller, Merton H. & Scholes, Myron S., 1978. "Dividends and taxes," Journal of Financial Economics, Elsevier, vol. 6(4), pages 333-364, December.
  11. Litzenberger, Robert H & Ramaswamy, Krishna, 1980. " Dividends, Short Selling Restrictions, Tax-Induced Investor Clienteles and Market Equilibrium," Journal of Finance, American Finance Association, vol. 35(2), pages 469-82, May.
  12. Hess, Patrick J, 1983. "Test for Tax Effects in the Pricing of Financial Assets," The Journal of Business, University of Chicago Press, vol. 56(4), pages 537-54, October.
  13. Auerbach, Alan J., 1983. "Stockholder tax rates and firm attributes," Journal of Public Economics, Elsevier, vol. 21(2), pages 107-127, July.
  14. James M. Poterba & Lawrence H. Summers, 1984. "The Economic Effects of Dividend Taxation," Working papers 343, Massachusetts Institute of Technology (MIT), Department of Economics.
  15. Merton H. Miller & Franco Modigliani, 1961. "Dividend Policy, Growth, and the Valuation of Shares," The Journal of Business, University of Chicago Press, vol. 34, pages 411.
  16. Elton, Edwin J & Gruber, Martin J, 1970. "Marginal Stockholder Tax Rates and the Clientele Effect," The Review of Economics and Statistics, MIT Press, vol. 52(1), pages 68-74, February.
  17. Jerry R. Green, 1980. "Taxation and the Ex-Dividend Day Behavior of Common Stock Prices," NBER Working Papers 0496, National Bureau of Economic Research, Inc.
  18. Litzenberger, Robert H. & Ramaswamy, Krishna, 1979. "The effect of personal taxes and dividends on capital asset prices : Theory and empirical evidence," Journal of Financial Economics, Elsevier, vol. 7(2), pages 163-195, June.
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