Ticks and Tax: The Effects of Price Discreteness and Taxation on Ex-Dividend Day Returns

Abstract

We investigate changes in the relation between dividend yield and exdividend day stock returns across four regimes, defined by two reductions in share price discreteness and two changes in differential tax rates on dividend versus longterm capital gain income of individual investors. Our research design enables us to examine the effect of changing price discreteness (1/16 to decimals) in early 2001 while holding tax rates constant, as well as the effect of changing tax rates in May 2003, while holding price discreteness constant. Changes in the relation between dividend yield and ex-dividend day abnormal returns across these regimes suggest that differential taxation is primarily responsible for the relation between dividend yield and ex-dividend day returns, although we find weak evidence that price discreteness also affects this relation.