Who Wants to Trade Around Ex-Dividend Days?

Abstract

We examine order flows around ex-dividend dates on the Taiwan Stock Exchange. By using Taiwan's data, we can examine the heterogeneity of investors' behavior around ex-dividend dates to test different hypotheses. We find that for both taxable and nontaxable samples, small investors sell before the ex date and buy from the ex date, suggesting that small investors prefer low-priced stocks. We find weaker evidence that tax-disadvantaged foreign and large domestic investors avoid participating in taxable dividends. We find strong evidence that taxneutral institutions play the role ofshort-term arbitrageurs around ex-dividend dates. In this article, we examine order flows around ex-dividend dates (ex date) on the Taiwan Stock Exchange. Not only does Taiwan's tax code allow us to separate the tax hypothesis from other explanations, but Taiwan's data also permits us to examine the heterogeneity of investors' behavior around ex dates. Taiwanese companies pay both stock and cash dividends. There are two types of stock dividends, and they differ for both accounting and tax purposes. For accounting, the source of stock dividends can come from capital surplus or retained earnings. If the source is capital surplus, then the stock dividend is nontaxable. If the source is retained earnings, then the stock dividend will be taxable, just like cash dividends. However, since the accounting method has no real effect, the tax consequence is the only difference between the two types of stock dividends. Therefore, Taiwan's data allow us to separate the tax hypothesis from the nuisance hypothesis and the price effect hypothesis. If we examine a sample of stock dividends with capital surplus as the dividend source, then tax has no role to play. If we contrast the nontaxable sample with the taxable sample, then any differences should be due to taxes. Taiwan's data allow us to examine the heterogeneity of investors' behavior around ex dates. Utilizing intraday order data, we can categorize investors into four groups: foreign, institutional, and large and small individual investors. Different investor groups have drastically different patterns of order submission under the nuisance, the price effect, and the tax hypotheses, even though these hypotheses have similar implications on returns. Each of the three hypotheses identifies a reason why a certain group of investors would prefer the ex-dividend stock to the cum-dividend stock. The nuisance hypothesis considers the transaction cost associated with odd-lot trading, the price effect hypothesis considers the price drop on the ex date, and the tax hypothesis emphasizes the income tax liability of the dividend. Previous research tests some of these implications using trading volume data (Koski and Scruggs,