New Evidence on the Behavior of Canadian Stock Prices in the Days Surrounding the Ex-Dividend Day
Athanassakos, George, Fowler, David, Quarterly Journal of Business and Economics
Ever since Elton and Gruber (1970) used the ratio of the ex-dividend day price change to the dividend per share to infer the typical investor's marginal tax rate and advanced the dividend (tax) clientele hypothesis there has been considerable debate about the interpretation of their results.(1) Miller and Scholes (1982) and Kalay (1982) have challenged Elton and Gruber's dividend clientele hypothesis. They argue that the Elton and Gruber analysis ignores the short-term trades by members of the exchange and by tax-exempt investors whose activities tend to eliminate abnormal returns around the ex-dividend day. The findings of Lakonishok and Vermaelen (1986) support Kalay's short-term trading hypothesis in that trading volume increases around the ex-dividend day, particularly in the period following the introduction of negotiable commissions in 1975. Karpoff and Walkling (1988) provide further support for the short-term trading hypothesis. Their study of stock returns on the ex-dividend day shows that short-term traders are the marginal investors in high yield stocks on the NYSE, particularly since the advent of negotiated commissions. Short-term trading, however, is not evident in low yield stocks at any time.
Foster and Oldfield (1986), on the other hand, find that transactions costs are large enough to limit the ability of short-term traders to effect particular price adjustments. Heath and Jarrow (1988) demonstrate that the ex-dividend day stock price may differ arbitrarily from the dividend for each individual stock; therefore, short-term traders cannot generate riskless arbitrage profits. As a result, ex-dividend stock returns must include a risk premium. Their argument does not rely on transactions costs, but on risk considerations.
Lakonishok and Vermaelen (1983) and Booth and Johnston (1984) have performed similar studies using Canadian data. Lakonishok and Vermaelen examine the ex-dividend day behavior of Canadian stock prices around the introduction of a tax reform in 1972 and conclude that the Elton and Gruber tax clientele
hypothesis is invalid. Booth and Johnston, on the other hand, investigate the ex-dividend day behavior using the Elton and Gruber methodology over four distinct tax regimes between 1970 and 1980. They find that the marginal tax rate implied by the ratio of the ex-dividend day price change to the dividend is greater than the maximum marginal tax rate payable. The only firm conclusion they are able to reach is that the ex-dividend day price changes for stocks interlisted on Canadian and U.S. exchanges are determined by U.S. rather than by Canadian investors.
Green (1980) extends the Elton and Gruber analysis by introducing costs of delaying or accelerating a transaction. His work sets the theoretical foundation for the development of the model of delay and acceleration of trade in response to different tax rates. Grundy (1985) extends and tests Green's model by examining the extent to which investors accelerate or delay trades in response to the payment of the dividend. He argues that a tax-induced incentive to either delay or accelerate trades would result in specific patterns of abnormal returns around the ex-dividend day. He shows that when capital gains are taxed on realization rather than accrual, the stock price behavior is affected not only on the ex-dividend day, but also during a few days around it. His empirical results lead him to conclude that the evidence is consistent with the predictions of the model of delay and acceleration of trade and the existence of dividend clienteles.
This study tests the clienteles and short-term traders hypotheses employing a modified version of the model of delay and acceleration of trade to Canadian data over different tax and transactions cost regimes from 1970 to 1984. There were significant differences between the structure of tax rates and transactions costs in Canada and in the U.S. over the period studied. …