Ex-Dividend Day Stock Price Behavior: Evidence from the 2003 Tax Cut

Abstract

This paper analyzes the behavior of ex-day prices when one of the imperfections is naturally removed as a result of the 2003 U.S. tax legislation, and attempts to observe if the ex-day price drop is affected by taxes. This equality of tax rates provides for an ideal condition under which the interaction between the ex-day price behavior and taxes can be examined. Consistent with the tax-effect hypothesis, I find that the price change-to-dividend ratio increased significantly after the elimination of preferential tax treatment of capital gains. Moreover, this evidence also contrasts the short-term trading hypothesis, since the new law did not change the tax incentives of short-term traders. The significant change in the ratio shows that the market is not dominated by short-term traders instead the marginal stockholders are long-term individual investors.