Why do stock prices drop by less than the value of the dividend?
Evidence from a country without taxes (1998).
Frank, M., & Jagannathan, R.
, Main Idea
Stock prices drop by less than the dividend amount on the ex-dividend day even in a country with no taxes
(Hong Kong).
Because there are no taxes on dividends or capital gains in Hong Kong, taxes cannot be the main explanation for
this price behavior.
If prices still do not drop by the full dividend amount, something else must be driving the effect.
The authors argue that this “something else” is market microstructure, such as:
bid–ask spreads,
trading behavior of buyers and sellers,
and discrete price ticks.
This paper is a direct attack on the classical tax-based interpretation (Elton & Gruber, 1970), which explains ex-
dividend price drops mainly by investor taxes.
, Motivation
A classic paper, Elton & Gruber (1970), says: the ex-dividend price drop can be used to test tax
effects (tax clienteles).
Why the tax explanation is hard to prove?
The U.S. tax system is very complicated, so it is hard to test the tax story clearly.
Investors are not all the same (different tax situations, different trading costs), so the ex-
dividend price drop is hard to interpret.
Transaction costs can make “tax arbitrage” trades too expensive, so the clean tax prediction
may fail.
So even in the U.S., it is hard to prove that taxes are the real reason.
Evidence from a country without taxes (1998).
Frank, M., & Jagannathan, R.
, Main Idea
Stock prices drop by less than the dividend amount on the ex-dividend day even in a country with no taxes
(Hong Kong).
Because there are no taxes on dividends or capital gains in Hong Kong, taxes cannot be the main explanation for
this price behavior.
If prices still do not drop by the full dividend amount, something else must be driving the effect.
The authors argue that this “something else” is market microstructure, such as:
bid–ask spreads,
trading behavior of buyers and sellers,
and discrete price ticks.
This paper is a direct attack on the classical tax-based interpretation (Elton & Gruber, 1970), which explains ex-
dividend price drops mainly by investor taxes.
, Motivation
A classic paper, Elton & Gruber (1970), says: the ex-dividend price drop can be used to test tax
effects (tax clienteles).
Why the tax explanation is hard to prove?
The U.S. tax system is very complicated, so it is hard to test the tax story clearly.
Investors are not all the same (different tax situations, different trading costs), so the ex-
dividend price drop is hard to interpret.
Transaction costs can make “tax arbitrage” trades too expensive, so the clean tax prediction
may fail.
So even in the U.S., it is hard to prove that taxes are the real reason.
