Taxes, Volatility and the Cost of Equity Capital: An Analysis of the Jobs & Growth Tax Relief Reconciliation Act of 2003

35 Pages Posted: 5 Aug 2011 Last revised: 26 Aug 2011

See all articles by Derek W. Dalton

Derek W. Dalton

Texas Tech University - Rawls College of Business

Teresa Lightner

affiliation not provided to SSRN

Robert C. Ricketts

Texas Tech University

Mark E. Riley

affiliation not provided to SSRN

Abstract

We hypothesize that the 2003 decrease in individual tax rates on dividends and capital gains should have been followed by a decline in the cost of capital and increased volatility, especially for dividend paying firms. We observe a significantly positive increase in the volatility of daily returns which is larger for dividend than non-dividend-paying firms, and is positively associated with dividend yield. We find that the increase in volatility dampened the cost of capital reduction brought about by the tax reduction. We also analyze changes in ERCs as a proxy for changes in firm cost of capital. The heightened investor response to unexpected earnings information is larger for dividend-paying firms overall, but is not positively associated with dividend yield. These results suggest that as dividend yields increase, the initial effect of the tax rate changes on cost of capital is offset by increased return volatility from those same rate changes.

Suggested Citation

Dalton, Derek W. and Lightner, Teresa and Ricketts, Robert C. and Riley, Mark E., Taxes, Volatility and the Cost of Equity Capital: An Analysis of the Jobs & Growth Tax Relief Reconciliation Act of 2003. 2011 American Accounting Association Annual Meeting - Tax Concurrent Sessions, Available at SSRN: https://ssrn.com/abstract=1905112 or http://dx.doi.org/10.2139/ssrn.1905112

Derek W. Dalton

Texas Tech University - Rawls College of Business ( email )

P.O. Box 42101
Lubbock, TX 79409
United States
806-742-3298 (Phone)
806-742-3182 (Fax)

Teresa Lightner (Contact Author)

affiliation not provided to SSRN ( email )

Robert C. Ricketts

Texas Tech University ( email )

2500 Broadway
Lubbock, TX 79409
United States

Mark E. Riley

affiliation not provided to SSRN ( email )

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