Ex-dividend day price and volume: the case of 2003 dividend tax cut.

Next we turn our focus to Table 2, Panel A where we present descriptive statistics for the ex-dividend day PDR for each of the four years around the 2003 Act. Unless otherwise noted, all results reported for the PDR are based on the winsorized data to reduce the effect of outliers caused by the large variation in the PDR that arises from a large price change or a tiny dividend. First we note that there are 4,318 and 4,713 dividend distribution events in 2001 and 2002, respectively, while the number of payouts is 4,772 and 4,677 in 2004 and 2005, respectively. Although we restrict the analysis to 1,278 firms that pay dividends in all four years, our dividend distribution sample sizes are not equal for several reasons. First, we only capture 11 months of distributions in 2001 due to decimalization. Second, firms may increase or reduce the frequency of payment over the four-year period.

As shown in Panel A of Table 2, the mean PDR is significantly lower than one before the tax cut: 0.653 for 2001 and 0.645 for 2002. After the 2003 Act the mean PDR increases to 0.857 in 2004 and 0.870 in 2005. Analyzing the medians generates similar results. The median PDR increases from 0.510 in 2001 and 0.613 in 2002 to 0.763 in 2004 and 0.757 in 2005. (16) Despite the significant increase in the PDR from 2002 to 2004, the PDR remains significantly less than one. This phenomenon may result from individual investors' ability to defer capital gains which causes capital gains tax rates to remain lower than dividend tax rates for individual investors even after the 2003 Act. Alternatively, a PDR that is less than one is also consistent with the dynamic trading model of Michaely and Vila (1995). Even when the average relative tax rate is one, the risk involved in the ex-dividend day trading results in a PDR that is less than one (see, for example, equation [4]).

We also test the structural change in the PDR by dividing the sample into pre- and post-Act periods, as presented in Panel B of Table 2. The median (mean) PDR increases after the 2003 Act from 0.562 (0.648) to 0.759 (0.864), respectively. The increase in both the median and mean PDR from the pre- to post-Act period is statistically significant at the one percent level. Furthermore there is no significant shift in the mean PDR between 2001 and 2002 or between 2004 and 2005. These results suggest a structural change between the pre- and post-Act periods, thus lending support to our first hypothesis. Absent any shift in the market microstructure such as price discreteness or bid-ask bounce, the structural change in the PDR is associated with the dividend tax cut. Therefore, our data support the tax-based theory on the ex-dividend day price behavior. The relative taxation of dividends and capital gains does affect the ex-dividend day price behavior of stocks.

One potential limitation to our analysis is that we analyze a short-window around the reform. Chetty et al. (2007) perform a similar analysis of the PDR around the 2003 Act and find that although the PDR does rise significantly after the Act, the magnitude of the increase is in large part due to the unusually low value of the PDR during the 2000-2002 period. They argue that there is a time series pattern in the PDR that appears to be unrelated to taxes. To address this concern, we calculate the PDR for 1998 and 1999 since this period captures a similar dividend tax regime as in the 2001 and 2002 period. In results not shown, we calculate the full sample winsorized mean (median) PDR to be 0.754 (0.647) and 0.707 (0.629) for 1998 and 1999, respectively. In 2001 and 2002, we calculate the mean (median) PDR for the full sample to be 0.698 (0.475) and 0.671 (0.558), respectively. We do not restrict the sample to dividend payers for the five-year period between 2001 and 2005 since this would impose an additional survivorship bias on the sample if we extend this requirement back to 1998. Consistent with the findings of Chetty et al. (2007) and Graham et al. (2003), we note that the mean and median PDRs in 1998 and 1999 are higher than the PDRs in 2001 and 2002. However, in our sample of firms, the mean and median PDR after the 2003 Act remains significantly higher than the respective PDRs of 1998 and 1999. Although it appears that the PDR in 2001 and 2002 is unusually low relative to other time periods, our conclusion that taxes have a significant effect on the PDR appears robust to the choice of alternative pre-Act periods.

Similarly, Table 3 presents the excess returns for ten days surrounding the ex-dividend day for our four year sample period. Consistent with the PDR results, ex-dividend day excess returns are significantly positive. The ex-dividend day excess return is 0.319 percent in 2001 and 0.283 percent in 2002, and it decreases to 0.108 percent in 2004 and 0.119 percent in 2005. Consistent with Eades et al. (1984) and other studies, we find excess returns are not unique for the ex-dividend day. The five trading days before the ex-dividend day generally have positive excess returns while the five trading days after the ex-dividend day generally have negative excess returns or excess returns insignificantly different from zero. But the excess returns of the ex-dividend day are much larger in magnitude compared to other trading days. These patterns can be seen from Figure 1. Figure I also illustrates that excess returns for days surrounding the ex-day in the post-Act period are smaller and less volatile than those in the pre-Act period.

To examine the relation between the dividend yield and the PDR, we perform regressions where PDR is our dependent variable, as shown in Table 4, Panel A. Consistent with the predictions of the dividend clientele theory, regression (1) shows that there is a positive and significant relation between dividend yield and PDR in both the pre- and post-Act periods. The coefficient on the dividend yield in the post-Act period is much smaller than that in the pre-Act period, indicating the weakening of the dividend yield effect. Based on the dynamic trading clientele theory, we include a proxy for risk ([[sigma].sup.2.sub.i] / [[sigma].sup.2.sub.m]) and transaction costs (log of market capitalization) in regressions (2), (3), and (4). Consistent with the theory, we find a significant negative relation between risk and a significant positive relation between market capitalization and the PDR in all but one specification (Pre-Act) where risk is insignificant. (17) In the pre-Act period, the dividend yield effect is very strong, which may dominate the effect of risk. Because stocks with large firm size tend to have lower transaction costs, the positive relation between the PDR and market capitalization indicates a negative association between transaction costs and the PDR. The 2003 Act significantly increases the average PDR even after controlling for dividend yield, risk, and market capitalization, as reflected in the significant positive coefficient on a post-Act dummy variable in regression (3). In column 4, we interact the dividend yield with our post-Act dummy variable to further determine whether dividend clienteles weaken after the reduction in dividend taxes for individuals. The coefficient on the interaction term (-18.121) is negative and significant, suggesting that the dividend clienteles weaken significantly after the 2003 Act.

[FIGURE 1 OMITTED]

We similarly analyze the relation between dividend yield and ex-dividend day excess returns with results reported in Panel B of Table 4. Regression (1) shows that the dividend yield effect is significant in the pre-Act period and is insignificant in the post-Act period. Regression (2) shows that market capitalization has a significant effect on excess returns in both pre- and post-Act periods, indicating that transaction costs have a significant positive effect on ex-dividend day excess returns. Risk, however, is insignificant in all model specifications, consistent with the finding of Michaely and Villa (1995). They argue that this result is consistent with the notion that only beta risk is priced, as excess returns are already beta adjusted.

We also test the structural change in ex-dividend day excess returns before and after the 2003 Act. The average excess return declines after the tax cut, as reflected in the significant negative coefficient on a post-Act dummy variable in regression (3). This result lends further support to our first hypothesis that the relative taxation of dividends and capital gains does affect the ex-dividend day excess return behavior of stocks. We further add the interaction term of the dividend yield with the post-Act dummy variable into regression (4). The excess return is positively related to the dividend yield, but the relation weakens in the post-Act period, as indicated by the statistically significant negative coefficient of the interaction term: -12.825 percent. The results in Table 4 Panels A and B provide support for our second hypothesis that predicts a weakening of the dividend clienteles.