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The Effects of Taxes on Market Responses to Dividend Announcements and Payments: What Can we Learn from the 2003 Dividend Tax Cut?

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  • Raj Chetty
  • Joseph Rosenberg
  • Emmanuel Saez

Abstract

This paper investigates the effects of capital gains and dividend taxes on excess returns around announcements of dividend increases and ex-dividend days for U.S. corporations. Consistent with standard no-arbitrage conditions, we find that the ex-dividend day premium increased from 2002 to 2004 when the dividend tax rate was cut. Consistent with the signalling theory of dividends, we also find that the excess return for dividend increase announcements went down from 2002 to 2004. However, these findings are very sensitive to the years chosen for the pre-reform control period. Semi-parametric graphical analysis using data since 1962 shows that the relationship between tax rates and ex-day and announcement day premia is very fragile and sensitive to sample period choices. Strong year-to-year fluctuations in the ex-day and announcement day premia greatly reduce statistical power, making it impossible to credibly detect responses even around large tax reforms. The important non-tax factors affecting these premia must therefore be understood before progress can be made in evaluating the role of taxation in market responses.

Suggested Citation

  • Raj Chetty & Joseph Rosenberg & Emmanuel Saez, 2005. "The Effects of Taxes on Market Responses to Dividend Announcements and Payments: What Can we Learn from the 2003 Dividend Tax Cut?," NBER Working Papers 11452, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:11452
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    Cited by:

    1. Khamis Al Yahyaee & Toan Pham & Terry Walter, 2008. "Ex‐Dividend Day Behavior in the Absence of Taxes and Price Discreteness," International Review of Finance, International Review of Finance Ltd., vol. 8(3‐4), pages 103-123, September.

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    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents

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