An Examination of Ex-Dividend Day Stock Price Movements: The Case of Nontaxable Master Limited Partnership Distributions

Abstract

This study examines the unit (stock) price and volume behavior of master limited partnerships (MLP) around the ex-dividend day. Since the dividends of MLPs are not taxable to the unitholder, tax based hypotheses predict no abnormal unit movements around the ex-day. Significant positive excess returns and volume are found before the ex-dividend day, and significant negative excess returns are found on the ex-dividend day. The findings which are not significantly impacted by the Tax Reform Act of 1986 suggest ex-day stock movements are not solely a function of investor marginal tax rates or corporate trading behavior. ELTON AND GRUBER'S (1970) findings that in 1966-67 stock prices fell on average by less than the amount of the dividend on the ex-dividend date and that the ratio of the price decrease to the dividend was correlated with the dividend yield have led to the development of a tax clientele hypothesis relating to investor behavior. One puzzling result from their study was the finding that the price decreases for the highest yielding securities were significantly greater than the dividends which in their analysis implied an investor clientele with negative tax rates. While Michaely (1989) using 1986-87 data was unable to find support for the tax clientele hypothesis across different yield groups, he also documented the large price drop for the highest yielding securities. Michaely (1989) suggested that his results may demonstrate a preference of corporations for dividend over capital gains because of favorable tax treatment corporations receive on dividend income (corporate trader hypothesis). Shefrin and Statman (1984), however, suggest that preferences for dividends over capital gains may exist for nontax reasons such as self-control or a desire to segregate gains and losses. The purpose of this paper is to examine the ex-dividend day stock price behavior of master limited partnership (MLP) units during the 1985-88 period. Dividends from these high yielding securities are not taxable. Therefore, support for either the tax clientele hypothesis or the corporate trader hypothesis would be found only if the average ex-day price change on MLPs equalled the dividend. This result would also be consistent with Barclay's (1987) finding that before the enactment of an income tax in 1913 even high