JOSEF LAKONISHOK, THEO VERMAELEN
TAX-INDUCED TRADING
AROUND EX-DIVIDEND DAYS
(1986)
, WHAT IS TAX-INDUCED TRADING?
Some investors face much lower taxes on dividends than others.
In particular, U.S. corporations benefit from the Dividend Received Deduction, which means that only about
15% of dividend income is taxable.
Because of this tax advantage, corporations may use the following strategy (tax arbitrage):
• Buy the stock before the ex-dividend day.
• Receive the dividend payment.
• Sell the stock after the ex-dividend day.
When the stock goes ex-dividend, the price typically falls by approximately the dividend amount. This price
decline generates a capital loss.
This creates incentives for short-term trading around the ex-dividend day, which is known as tax-induced trading.
, MAIN IDEA
The main idea of the paper is that stock price behavior around the ex-dividend day cannot be explained
solely by the tax rate of a passive representative investor. The authors show that there is active short-term
trading around the ex-dividend day that is driven by tax incentives. This trading affects not only stock
prices but also trading volume.
In other words, if investors actively trade around the ex-dividend day in order to capture tax advantages
associated with dividends, then the observed price behavior does not simply reflect the tax preferences of a
stable dividend clientele. Instead, it also reflects strategic short-term trading motivated by tax
considerations.
This effect is particularly pronounced for taxable distributions such as cash dividends. In contrast, for non-
taxable distributions such as stock splits and stock dividends, the pattern is very different.
TAX-INDUCED TRADING
AROUND EX-DIVIDEND DAYS
(1986)
, WHAT IS TAX-INDUCED TRADING?
Some investors face much lower taxes on dividends than others.
In particular, U.S. corporations benefit from the Dividend Received Deduction, which means that only about
15% of dividend income is taxable.
Because of this tax advantage, corporations may use the following strategy (tax arbitrage):
• Buy the stock before the ex-dividend day.
• Receive the dividend payment.
• Sell the stock after the ex-dividend day.
When the stock goes ex-dividend, the price typically falls by approximately the dividend amount. This price
decline generates a capital loss.
This creates incentives for short-term trading around the ex-dividend day, which is known as tax-induced trading.
, MAIN IDEA
The main idea of the paper is that stock price behavior around the ex-dividend day cannot be explained
solely by the tax rate of a passive representative investor. The authors show that there is active short-term
trading around the ex-dividend day that is driven by tax incentives. This trading affects not only stock
prices but also trading volume.
In other words, if investors actively trade around the ex-dividend day in order to capture tax advantages
associated with dividends, then the observed price behavior does not simply reflect the tax preferences of a
stable dividend clientele. Instead, it also reflects strategic short-term trading motivated by tax
considerations.
This effect is particularly pronounced for taxable distributions such as cash dividends. In contrast, for non-
taxable distributions such as stock splits and stock dividends, the pattern is very different.
