Individual Investors’ Dividend Tax and Corporate Payout Policies – Evidence from a Reform that Ties the Dividend Tax Rate to Share Holding Period

Abstract

The 2012 Dividend Tax Reform in China uniquely ties individual investors’ dividend tax rates to the length of their share holding period. We find that firms facing a reduction in their individual investors’ dividend tax rate are more likely to increase dividend payout, initiate dividends, and are less likely to omit dividends, compared with firms facing an increase in their individual investors’ dividend tax rate. Such an effect is concentrated in firms with a low level of agency cost. In addition, investors respond to this tax law change by reducing trading activities before the cum-dividend day to avoid entering into a higher dividend tax bracket. Further, stock return patterns on the ex-dividend day suggest that reduced trading activities lower the marginal investor’s dividend tax penalty. Overall, our evidence enhances the notion that individual investors’ tax profiles shape firms’ payout policies.

Keywords: individual investor, dividend tax, payout policy, agency cost

JEL Classification: G30, G35, H20