Taxes and Valuation: Evidence from Dividend Change Announcements
55 Pages Posted: 28 Jul 2005
Date Written: July 2005
I test whether and how shareholder income taxes affect the market response to dividend surprises. Under the US tax system, dividends are historically taxed at a higher rate than capital gains and thus receive a tax-related penalty. I provide evidence that the dividend tax penalty partially offsets the positive signaling and agency cost effects of dividends, and that the presence of tax advantaged institutional investors, proxied for by institutional ownership and the frequency of institutional trading, mitigates the negative dividend tax effect. My results support the notion that taxes impact valuation. I contribute to the literature by separating dividends' negative tax effect from their positive signaling and agency cost effects. My analysis also suggests that in event study settings, the frequency of institutional trading may be a more reliable proxy for investor tax attributes than institutional ownership.
Keywords: Tax, Dividend tax capitalization, Institutional investors, Tax regime change
JEL Classification: H24, G35, G12, G34
Suggested Citation: Suggested Citation