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Tax-Induced Trading of Equity Securities: Evidence from the ADR Market
Abstract
We examine ex-dividend date trading of American Depositary Receipts (ADRs) using a sample of 1,043 dividends over the period 1988 to 1995. ADR dividends are often subject to foreign withholding taxes, creating incentives for certain investors to avoid the distribution. ADRs exhibit negative abnormal ex-dividend day returns, and their prices behave consistently with their related withholding taxes. Abnormal trading volume for taxable issues exceeds 130 percent and 300 percent of normal volume on the cum- and ex-dates, respectively. Abnormal volume is an increasing function of foreign withholding tax rates and decreasing function of transactions costs. This abnormal ex-date trading activity is consistent with tax-motivated trading. Copyright (c) 2003 by the American Finance Association.
... While some foreign investors can recover these taxes in the form of tax credits, other investors cannot recoup them since they are unable to utilize the tax credits. 2 Callaghan and Barry (2003) document that taxexempt U.S. institutions sell ADRs before the exdate to avoid these withholding taxes. We compare the exdividend behavior of ADRs and underlying stocks in the much simpler setting of Hong Kong ADRs to obtain a clearer assessment of the factors influencing ex day behavior of ADRs. ...
... They find that exchange rate risk cannot account for the higher returns. They conclude that differences in dividend payment policies and the delay in dividend payment discourage dividend capture in ADRs. They do not identify the tax characteristics associated with the ADR dividend payments. Callaghan and Barry (2003) examine trading volume around 1043 ADR exdividend events during the period 19881995. They argue that taxexempt institutions have incentives to sell ADRs before the exdate in order to avoid withholding taxes on dividends, since they cannot reclaim these taxes. They segment their sample into taxable and nontaxable events based on the ...
... The sizeable, positive exday ADR returns suggest that traders can profit from dividend capture trading. We examine whether insufficient liquidity prevents traders from arbitraging away these returns. Callaghan and Barry (2003) document that trading volume increases around ADR exdays. Although ADRs associated with foreign withholding taxes on dividends experience greater increases in trading volume, they find higher trading volume even for ADRs of stocks with taxfree dividends in the home market.Table 4 We also examine the impact of liquidity on exday retur ...
Previous research documents that Hong Kong stocks have a full ex-dividend price adjustment consistent with dividends and capital gains being tax free. We examine ex-dividend price behavior of Hong Kong ADRs to assess the impact of differing tax environments in US and Hong Kong. These ADRs typically go ex-dividend before their underlying stock. They experience significant abnormal returns of 1.16% on their ex-day; the average ex-day price drop is only 30% of the dividend. However, ADR prices drop when the underlying stock goes ex-dividend subsequently. The cumulative ADR price drop is equal to the dividend. Thus, the ADR ex-dividend adjustment resembles that of the underlying stock, consistent with home country tax laws governing ADR price behavior. Neither liquidity nor transaction costs can explain the anomalous delayed ex-dividend adjustment of ADRs.
... We investigate this question by examining ex-dividend price movements and trading volume for American Depositary Receipts (ADRs) and their underlying Australian stocks. This examination follows the increased attention being given to ADR's in the exdividend literature (Callaghan and Barry 2003;Gorman et al. 2004). ...
... 2 This would alleviate the time and costs associated with obtaining an offset to their US tax liability for overseas withholding taxes. The work of Callaghan and Barry (2003) suggests that this benefit is significant. ...
... Given the work of Callaghan and Barry (2003), we expect dividend avoidance in the ADR market. In the presence of dividend avoidance trading, ADR cumprices are likely to be depressed by selling pressure, which reverses on the exdate. ...
Australian residents are tax-advantaged, relative to American investors, in their access to imputation tax credits on Australian stocks. This paper provides evidence consistent with a difference in dividend valuations between Australian stocks and their American Depositary Receipts (ADRs). The ex-dividend drop-off ratio is lower for ADRs relative to their underlying Australian stocks and this difference is most pronounced for stocks that have imputation tax credits and high dividend yields. Consistent with dividend capture trading in the Australian market, the difference in drop-off ratios is driven by both temporarily higher Australian cum-prices and temporarily lower Australian ex-prices. Abnormal trading volume about the ex-day is present in both markets and in the Australian market the abnormal volume is greater for dividends with imputation tax credits. Dividend-related trading leads to price differences across the markets on the ex-dividend day. Price differences are also observed when the stock and the ADR trade with different dividend entitlements due to different ex-dividend dates. Copyright (c) 2008 The Authors. Journal compilation (c) International Review of Finance Ltd. 2008.
... To U.S. shareholders, tax treatment of the dividend income for ADRs is generally the same as for U.S. domestic securities. While U.S. shareholders must still pay foreign withholding taxes, they are entitled to a dollar-for-dollar foreign tax credit for taxes withheld by foreign jurisdictions (see Callaghan and Barry 2003). ...
... Second, Dahlquist and Robertson (2001) and Callaghan and Barry (2003) show that foreign withholding tax creates incentives for certain investors to avoid ADR dividends. We therefore control for the effect of ADR dividend taxation on a firm's dividend decision in (2.1) and (2.2). 25 In addition, DeAngelo, DeAngelo, and Stulz (2006) show that the earned ⁄ contributed capital mix is a superior measure of firm maturity relative to cash balances. ...
While theory suggests that dividends can be an important signal for firm performance, prior studies have been unable to provide strong evidence of dividend signaling among publicly listed U.S. companies. One potential explanation for this inconsistency between theory and empirical evidence is that the cross-sectional variation in information asymmetry across U.S. firms is insufficient to provide adequate test power. In this study, we revisit the link between dividend signaling and firms’ information environment by examining the dividend behavior of foreign firms that cross-list on the U.S. stock market in the form of American Depository Receipts (ADRs). Our evidence suggests that ADR firms with poorer information environments have stronger incentives to adopt dividend increases as a signaling device. We also find that such firms experience an increase in one-year-ahead earnings and a decline in systematic risk following a dividend increase. Additional analysis shows that ADR firms have fewer other information channels compared to similar U.S. firms. Overall, we provide evidence consistent with the importance of dividend signaling, especially for firms with poorer information environments.
... Our research differs from previous studies on several aspects. For example, Callaghan and Barry (2003) examined ex-dividend date trading of ADRs and found that abnormal ex-dividend date trading is consistent with tax-motivated trading. Bin et al. (2003) found that ADR portfolios were sensitive to movements in both U.S. stock market and the underlying foreign equity market. ...
... The weight is Journal of Money, Investment and Banking - Issue 3 (2008) beta (β j ). The idiosyncratic risk is defined as the standard deviation of the errors, σ (ε jt ) 7 . For empirical implementation, the following relation was used: ...
Determinants of ADR's idiosyncratic risk are examined from the perspective of undiversified investors. Since ADRs enjoy a unique status, vis-à-vis US companies, we study whether determinants of their risk, derived from a two-stage regression model, are different from the one for U.S. firms. For the time period from 1999 through mid 2005, we found that, with the exception of the smallest US stocks in the sample, ADR's idiosyncratic risks are analogous to the ones observed for US firms. Also, ADR's sensitivity to fundamental variables that represent their inner financial structure is similar to US firms.
... Under the Multi-Jurisdictional Disclosure System, Canadian firms have modified SEC reporting requirements that lower the costs of direct listing (see Frost and Kinney 1996). Prior research has documented that U.S. investors own a substantial portion of ADRs and direct listings, suggesting that the marginal investor might be a U.S. taxable individual (Callaghan and Barry 2003; Bradshaw et al. 2004; Ammer et al. 2006). In the U.S., depositary receipts, direct listings and directly-owned foreign securities are taxed similarly. ...
... Hence, tax-specific barriers to arbitrage did not change around the event, which is a nice feature of our setting. 5 With respect to capital gains, ADRs and directly owned foreign securities held by U.S. taxable individuals are taxed at the U.S. individual capital gains tax rates, identically to U.S. equity investments (see Callaghan and Barry (2003) for an in depth discussion of ADR taxation). From a risk perspective, an ADR represents the same cash flows as its underlying homecountry stock. ...
We examine how shareholder-level taxes affect the contemporaneous pricing of foreign firms' U.S. cross-listed and underlying home-country securities surrounding the 1997 reduction in U.S. capital gains tax rates. Consistent with tax capitalization, we find that the performance of cross-listed shares is negatively related to dividend yield, suggesting an abnormal price increase for shares with greater anticipated taxable capital gains. Due to barriers to cross-border arbitrage, underlying home-country securities, on average, do not react during the event, creating a temporary tax-induced pricing spread. When costs of arbitrage are low, the pricing disparity quickly dissipates and home-country shares closely mirror the pricing of their cross-listed counterparts. In further tests, we are unable to document lock-in behavior, which predicates a decrease in prices attributable to a surge in volume for shares with greater accrued taxable capital gains. Overall, our findings suggest that an exogenous shock to the U.S. tax regime reverberates in international asset prices, thereby affecting foreign firms' costs of capital.
... 3 Many other studies share a similar tax-based interpretation. See for example Booth and Johnston (1984), Eades, Hess and Kim (1984), Poterba and Summers (1984), Barclay (1987), Poterba (1986), Hietala (1990), Lasfer (1995), Bell and Jenkinson (2002), Callaghan and Barry (2003) and Zhang, Farrell and Brown (2008). behaviour of taxable closed-end funds are consistent with effective tax rates. ...
In a seminal study, Elton and Gruber (1970) argue that ex-dividend day pricing can be used to infer marginal tax rates of shareholders. We examine ex-dividend day pricing for individual firms and ask whether their CFOs could use the history of a firm's ex-dividend price-drop ratios to infer reasonable estimates of shareholders’ marginal tax rates. We use TAQ data for 1,124 US firms that have at least 30 ex-dividend days during the period August 1993 to October 2012. Our results show that ex-dividend day pricing is so noisy as to prohibit sensible estimates of shareholders’ marginal tax rates.
... RF increases the variability of tracking errors either through greater funding illiquidity reinforcing asset illiquidity or by time-varying securities lending activities by the ETF fund manager adding additional noise to the replication error. DIV is expected to be positively related to TESD due to the differential treatment of dividends (a similar relationship as to what is found by Callaghan and Barry [2003] in the American depository receipt [ADR] market). AGE is expected to be negatively related to TESD, since fund managers are expected to optimize the tracking process ...
Exchange traded funds (ETFs) provide a means for investors to access assets indirectly that may be accessible at a high cost otherwise. I show that liquidity segmentation can explain the tendency for ETFs to trade at a premium to net asset value (NAV) as well as the life-cycle pattern in premiums. ETFs with larger NAV tracking error standard deviations (TESDs) tend to trade at higher premiums and the liquidity benefits offered by foreign ETFs and fixed income ETFs are revealed to be the most valuable to investors. Further tests validate that TESD has the desirable properties of a liquidity segmentation measure.
... In general, as long as the foreign tax rate does not exceed the investor's marginal tax rate, the credit will directly offset the US tax liability, resulting in a single level of taxation equivalent to the investor's US marginal tax rate. Capital gains, when realized, are taxable only in the US (Callaghan and Barry, 2003). Currently, foreign (US) investors who trade in Indian domestic stocks do not pay taxes on dividends. ...
I examine several possible explanations for why Infosys' Deposirtary Receipts (DRs) trade at significant premiums to the equivalent underlying domestic shares. I find that a limited supply of DRs and a downwoard-sloping demand curve, significant transaction costs associated with investing directly in the domestic market, and trend-chasing by smaller and potentially uninformed investors partly explain the DR premiums. I also examine the wealth effects of non-capital raising secondary depositary receipt offerings by Infosys Technologies and find significant wealth transfers from existing DR holders to selling domestic shareholders who are comprised significantly of Infosys' founders.
... Their findings are consistent with the hypothesis that taxes determine the value of dividends relative to capital gains. Further evidence of the tax affect is reported by Callaghan and Barry (2003) who examined ex-dividend date trading of American Depositary Receipts using a sample of 1,043 dividends over the period 1988 to 1995. They report evidence that is consistent with tax-motivated trading. ...
We examine the ex-dividend day behaviour in a unique setting where (1) there are neither taxes on dividends nor on capital gains, (2) stock prices have been decimalized, (3) dividends are distributed annually, and (4) we have data that enable us to examine bid-ask bounce effects. In this economy, any price decline that is smaller than the dividends can not be attributed to taxes and price discreteness. Like previous studies, we find that the stock price drops by less than the amount of dividends and there is a significant positive ex-day return. By examining abnormal returns and abnormal volumes around the ex-dividend day, we find no evidence of short-term trading. We are able to account for our results using market microstructure models. When the impact of market microstructure is taken into account, the ex-dividend drop is not significantly different to the value of the dividend paid.
... Previous studies investigated the tick-size effect in environments where there are taxes on dividends and capital gains making it hard to differentiate whether the incomplete price adjustment is due to taxes or tick-size. The absence of taxes in Oman allows us to test the tick-size reduction effect in the absence of confounding tax effects present in other markets. 2 For a description of how complex the US tax system, see Callaghan and Barry (2003). Third, if tick size is sizable in relation to the bid-ask spread, the minimum tick size introduces a friction which could potentially inhibit a full ex-day price adjustment. ...
This paper examines the effect of the reduction in tick size on ex-dividend day stock price behavior taking advantage of a unique data where there are no taxes on dividends and capital gains and the tick size is fixed for all traded securities. These data allow us to differentiate among competing ex-dividend day hypothesis in the absence of confounding tax effects present in other markets. We find that ex-day premiums increase and abnormal returns decrease as the tick size become smaller, which is in line with the market microstructure hypothesis. On the other hand, we do not find any significant increase in abnormal volume with the reduction in tick size. This finding is inconsistent with the pattern that should occur if transaction cost is the dominant factor causing the ex-day phenomenon.
... Other studies in alternative settings also report results that are broadly consistent with tax motivated trading around ex-days. A few examples are Callaghan and Barry (2003) in the case of American Depository Receipts; Elton, Gruber, and Blake (2005) in the case of taxable and tax free closed-end funds; and Chay, Choi, and Pontiff (2006) in the case of capital gains distributions. However, the tax explanation has not been without challenge, and consensus on its validity has been elusive. ...
REIT dividends can be divided into three components based on how they are taxed to the recipient shareholders: ordinary income, long-term capital gains, and return of capital. This variation in tax characteristics enables us to examine the cross-sectional pricing of dividends on the ex-days. Since the ordinary income component of dividends is tax penalized, it should lead to positive ex-day returns while the other two components should have limited effects. We provide evidence consistent with this argument. In particular, abnormal returns and trading volume around REIT ex-days appear to be driven by the component taxed as ordinary income, but not the other components. Our results support a tax-based explanation for the ex-day pricing of dividends and investor trading behavior.
... We also thank the participants at the 17th Asian FA/FMA Conference for their valuable comments. 1 For a description of how complex the US tax system is, see Callaghan and Barry (2003). Other interpretations include price discreteness, transaction costs, and bid– ask bounce. ...
We examine the ex-dividend day behaviour in a unique setting where (1) there are neither taxes on dividends nor on capital gains, (2) stock prices have been decimalized, (3) dividends are distributed annually, and (4) we have data that enable us to examine bid-ask bounce effects. In this economy, any price decline that is smaller than the dividends can not be attributed to taxes and price discreteness. Like previous studies, we find that the stock price drops by less than the amount of dividends and there is a significant positive ex-day return. By examining abnormal volumes around the ex-dividend day, we find no evidence of short-term trading. We are able to account for our results using market microstructure models. When the impact of market microstructure is taken into account, the ex-dividend drop is not significantly different to the value of the dividend paid.
... Even with the rising importance of FPI, the taxation of foreign portfolio income has been largely ignored until recently (Graetz and Grinberg (2003)). The literature on cross-border taxation and equity markets examines topics such as dividend tax arbitrage (McDonald (2001)), tax effects on ex-day behavior of ADR securities (Callaghan and Barry (2003)), the effects of dividend taxation on FPI (Amiram and Frank (2010)), the effect on worldwide portfolio allocation surrounding the Jobs and Growth Tax Relief Reconciliation Act (Desai and Dharmapala (2011)), and effects of changes in the corporate taxation of foreign earnings on dividend payout and share repurchases (Dharmapala, Foley, and Forbes (2011)). While these papers advance our understanding of the effects of taxation in international portfolio investment, none of these papers examines the effects of tax evasion. ...
We empirically investigate one form of illegal investor-level tax evasion and its effect on foreign portfolio investment. In particular, we examine a form of round-tripping tax evasion in which U.S. individuals hide funds in entities located in offshore tax havens and then invest those funds in U.S. securities markets. Employing Becker’s (1968) economic theory of crime, we identify the tax evasion component in foreign portfolio investment data by examining how foreign portfolio investment varies with changes in the incentives to evade and the risks of detection. To our knowledge, this is the first empirical evidence of investor-level tax evasion affecting cross-border investment in equity and debt markets.
... Three elements of tax law combine to create the tax that mutual funds' retirement accounts pay on cross-border dividends. First, major economies generally tax dividends headed over the border (see, e.g., Callaghan and Barry, 2003). The tax rate can depend on bilateral treaties; the usual rate, and the rate for the U.S./Canada border, is 15%. ...
We consider how fund managers respond to the conflicting preferences of their investors. We focus on the conflict between the taxable and retirement accounts of international funds, which face different tradeoffs between dividends and capital gains. In principle, managers could resolve this conflict through dividend arbitrage, but a proprietary database of dividend-arbitrage transactions shows that in practice they cannot. Thus, managers must resolve it through their investment policies. We find robust evidence that managers with more retirement money favor the preferences of retirement investors and further evidence for this view in the difference between U.S. and Canadian funds’ portfolio weights.
... Under the first test, corporations resident in a US possession (such as Puerto Rico) automatically qualify, as do corporations resident in certain former US territories that are treated as possessions for tax purposes. Under the second test, dividends from 6 Three exceptions to this are the analyses of trading strategies in Christoffersen et al. (2005) and Callaghan and Barry (2003) and the study of the role of withholding taxes in Chan, Covrig and Ng (2005). This paper is most closely related to the analysis by Bond, Devereux and Klemm (2007a, b) of the effects of the 1997 UK tax reform that abolished the preferential treatment of UK pension funds with regard to refundable dividend imputation credits for corporate taxes paid by UK firms. ...
This paper investigates how dividend taxes influence portfolio choices, using the response to the distinctive treatment of a subset of foreign dividends in the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) of 2003. An open-economy after-tax capital asset pricing model is used to derive the hypothesis that JGTRRA should lead to a portfolio reallocation by US investors towards equities in tax-favored countries. A difference-in-difference analysis that compares US equity holdings in affected and unaffected countries finds a substantial portfolio reallocation towards the former. This effect cannot be explained by several potential alternative hypotheses, including differential changes to the preferences of American investors, differential changes in investment opportunities, differential time trends in investment, changed tax evasion behavior, or changes in stock prices associated (or contemporaneous) with JGTRRA.
... Three elements of tax law combine to create the tax that mutual funds' retirement accounts pay on cross-border dividends. First, major economies generally tax dividends headed over the border (see, e.g., Callaghan and Barry, 2003). The tax rate can depend on bilateral treaties; the usual rate, and the rate for the U.S./Canada border, is 15%. ...
We consider how fund managers respond to the conflicting preferences of their investors. We focus on the conflict between the taxable and retirement accounts of international funds, which face different tradeoffs between dividends and capital gains. In principle, managers could resolve this conflict through dividend arbitrage, but a proprietary database of dividend-arbitrage transactions shows that in practice they cannot. Thus, managers must resolve it through their investment policies, and we find robust evidence that managers with more retirement money favor the preferences of retirement investors. We find additional evidence in the difference between U.S. and Canadian funds' portfolio weights.
Nous étudions comment les gestionnaires de fonds réagissent aux préférences contradictoires de leurs investisseurs. Notre étude se concentre principalement sur les conflits entre les comptes taxés et les comptes de retraite des fonds internationaux qui font l'objet de compromis différents entre les gains en dividendes et les gains de capital. En théorie, les gestionnaires peuvent résoudre ces conflits par des opérations d'arbitrage sur les dividendes, mais une base de données privée d'opérations d'arbitrage fait apparaître qu'en pratique ils ne peuvent pas. Les gestionnaires doivent alors résoudre ces conflits à travers leurs politiques d'investissement, et nous trouvons des résultats significatifs montrant que ceux dont le capital est issu majoritairement des retraites favorisent les investisseurs de fonds de pension. Nous trouvons également des différences entre les poids des portefeuilles de fonds américains et canadiens.
... Many economies withhold a portion of dividends paid to foreign accounts (see Callaghan and Barry, 2003, for a country listing and a discussion). This tax can depend on the country of the recipient; the tax applied to payments between Canada and the U.S. is 15%. ...
The political economy of trade policy has largely neglected popular election. When legislatures determine protection, politicians supply tariffs that are demanded by their constituents. A model of this political market is specified and tested with data related to the McKinley Tariff of 1890. An index of the extent to which tariff protection accrued to individual congressional districts is applied, along with demand and supply variables, to three questions: Did representatives supply tariffs to their districts as the model predicts? Did they vote in accordance with the district tariff interest in the roll-call vote on the McKinley Tariff? Did electors reward representatives for the district tariff protection in a manner consistent with a political market model? Empirical estimations based on the model provide answers that are generally affirmative and appear to be inconsistent with the traditional view that the Republic defeat in 1890 was a result of the McKinley Tariff. Copyright 1991 by MIT Press.
I study how arbitrage affects liquidity by analyzing several billion trades in the American Depositary Receipt (ADR) market from 2001 to 2016. Price deviations persist, on average, for 12 minutes, and mainly arise because of price pressure. Impulse response functions estimated at 1-minute intervals indicate that a positive shock to arbitrage—simultaneous trades of the ADR and the home-market share in the opposite direction—decreases deviations and bid-ask spreads. I confirm these findings by exploiting institutional details that create exogenous variation in the impediments to arbitrage across days. Overall, these results suggest that arbitrage decreases price pressure and provides liquidity.
This paper is the first to highlight that the stock-ADR arbitrage pair trading found by (Alsayed and McGroarty, 2012) is directly influenced by the market microstructure of ADRs. In (Alsayed and McGroarty, 2012) they are the first to demonstrate that arbitrage opportunities exist between stocks and their ADRs, through convergence pairs trading. Given that such arbitrage opportunities exist, we pose the question as to why such pair trades occur, rather than be eliminated by the law of one price? Using high frequency data over a 3 year sample period, with over 3.7 million 1-minute observations, we investigate stock-ADR arbitrage pair trading.
In this paper, we find pair trading returns exhibit substantial asymmetry in returns: pair trades involving ADR shorts (compared to stock shorts) have significantly less probability of loss, substantially higher returns but higher convergence risk. The asymmetric results are consistent with the market microstructure of ADR trading, specifically the sourcing of ADRs. Whilst long and short stocks can be easily sourced from the relevant markets, long and short ADR sourcing is less viable due to the market microstructure, but also, ADR’s microstructure directly impacts the stock’s price. We test our microstructure hypothesis further for robustness, with respect to specific investor types (such as retail traders), as well as during different market conditions (before, during and after the commencement of the global financial crisis), and find our results are consistent with our ADR microstructure hypothesis. This is also supported by CFD (contracts for difference) and ADR pairs trading results. Our results also confirm the results of (Alsayed and McGroarty, 2012) by conducting trades over a substantially longer and more varied trading period. Our results have implications for ADR markets, as well as market microstructures upon financial innovations such as exchange traded funds.<br/
This chapter discusses, including mathematical descriptions, trading strategies based on tax arbitrage, including municipal bond tax arbitrage, which amounts to borrowing money and buying tax-exempt municipal bonds, which is attractive to companies in jurisdictions where tax rules allow them to buy tax-exempt municipal bonds and deduct interest expenses from their taxable income, cross-border tax arbitrage exploiting the difference in the tax treatment of the foreign and domestic stockholders in countries with “dividend imputation” corporate tax systems, which effectively penalizes foreign investors holding stock through ex-dividend creating an incentive for such investors to sell stock cum-dividend and buy it back ex-dividend, or utilize other strategies using American put options, or stock loans or swap agreements involving domestic investors.
This study examines the effects of legal and investor protection mechanisms on the efficiency of R&D. This study makes two contributions to the literature. First, when a company lists shares in a common law country or one with higher investor protection (i.e., a company has better country-level corporate governance), the R&D investments of companies create more value. Second, companies that issue ADRs generate higher value from their R&D investments than those that do not issue ADRs. For some companies without ADR issues, their R&D investments decrease the market value of the company. The issuance of ADR strengthens the level of supervision, reducing the agency problem and inducing a higher value of their R&D investment. To the best of our knowledge, no previous studies have examined this phenomenon.
This work is the first tax-induced empirical research that examines how investor tax homogeneity simultaneously affects ex-dividend day trading returns and volumes. Previous studies employ U.S. stocks that are investor tax heterogeneous to test tax-induced behaviors. However, regulatory tax heterogeneity induces diverse trading strategies for various investors who are subject to differential tax obligations. The heterogeneity of the investors makes it difficult for previous studies to summarize how tax affects the investors behaviors. Therefore, the innovation of this work in terms of data selection is to focus on American Depository Receipts (ADRs) which are investor tax homogeneous in order to examine whether tax on dividends will induce investors transactions during ex-dividend days. Furthermore, this study is the first in utilizing three-stage least squares (3SLS) and genetic algorithms to simulate the impact of institutional holding, tax rate, dividend yield, transaction cost, and risk factors on the ADR excess trading. The model-base management system we have constructed employs institutional ownership of ADR as an indicator for investor tax homogeneity to prove how investor tax homogeneity induces consistent trading strategy around ex-dividend day. Our analysis results provide convincing insights not only on investors rational tax-induced strategy, but also on implications for legislating tax policies in financial instruments.
Purpose
– Cross-listed firms may face unique incentives for establishing dividend policies in comparison to US firms. This study aims to test the implications of the lifecycle and signaling theories of dividend policy in the context of non-US firms cross-listed on US stock exchanges via American depository receipts (ADRs).
Design/methodology/approach
– ADRs are classified according to the firms' dividend paying histories as regular payers, non-payers, former payers, new payers and switchers. Multinomial logit regressions measure the likelihood of dividend payers to pay dividends, as well as the possibility of a dividend amount increase, decrease, or no change, based upon previously identified determinants of dividend payments and a measure of economic conditions in the home country.
Findings
– The results indicate that firm size, growth opportunities, and the mix of earned and contributed capital partially explain observed dividend policies for ADR firms. Multinomial logit regressions reveal profitability and home-country macro-economic conditions significantly affect ADR firms' decisions to change their dividend policies.
Originality/value
– The findings suggest macro-economic conditions affect dividend payment changes among ADR firms. The results also imply that the lifecycle and catering theories may help explain dividend changes among ADR firms.
An alternative approach to valuing dividends is developed and applied to American Depositary Receipts (ADRs) on Australian stocks. The values of ADR dividends are estimated from the period when, due to different ex-dividend dates, the ADRs and their underlying stocks trade with differential dividend entitlements. Australian ADR dividends are valued at less than their face value and the dividends on the underlying stocks are valued at more than their face value. This suggests that ADR dividends are priced by a clientele of US investors placing little value on the imputation tax credits attached to the dividends and that a clientele of Australian resident investors, who obtain value from imputation tax credits, price the dividends on the underlying stock.
This paper extends the research on investor herds to American Depository Receipts (ADRs). Using daily price data on 305 ADRs traded in U.S. exchanges issued by corporations from 19 countries, we examine herding behavior in the market for ADRs within country and sector-based portfolios. There is significant evidence of herding behavior in the market for ADRs from Chile only regardless of alternative model specifications. On the other hand, we find a significant effect of the Asian crisis and the recent credit market crisis on herding behavior in ADR issues from Korea and the U.K., respectively, suggesting a link between market crisis periods and herding behavior. Furthermore, we find no significant effects of currency rates (except Korea) or the performance of the market of origin on herding behavior among ADR issues. In the case of sector-based ADR portfolios, evidence of herding behavior exists in Basic Industries, Capital Goods, Food & Tobacco, and Textile & Trade, but only during periods of large market downturns.
Off-market share buybacks in Australia are often structured with the buyback price comprising a large dividend component (which may carry imputation tax credits) and a small capital component. This unique structure has the consequence that institutions on low tax rates stand to benefit most from selling shares back to the company. In this paper, we explore evidence of abnormal trading activities around key dates in the conduct of off-market buybacks and investigate the drivers of these activities. We find evidence of abnormal trading activities around the initial announcement and the final announcement dates of the buyback. The significant differences in abnormal volumes between the buybacks with and without imputation tax credits highlight the importance of tax motivations in explaining abnormal trading activities in the shares of companies conducting off-market buybacks.
While theory suggests that dividends can be an important signal for firm performance, prior studies have been unable to provide strong evidence of dividend signaling among publicly listed U.S. companies. One potential explanation for this inconsistency between theory and empirical evidence is that the cross-sectional variation in information asymmetry across U.S. firms is insufficient to provide adequate test power. In this study, we revisit the link between dividend signaling and firms’ information environment by examining the dividend behavior of foreign firms that cross-list on the U.S. stock market in the form of American Depository Receipts (ADRs). Our evidence suggests that ADR firms with poorer information environments have stronger incentives to adopt dividend increases as a signaling device. We also find that such firms experience an increase in one-year-ahead earnings and a decline in systematic risk following a dividend increase. Additional analysis shows that ADR firms have fewer other information channels compared to similar U.S. firms. Overall, we provide evidence consistent with the importance of dividend signaling, especially for firms with poorer information environments.
This paper investigates how taxes influence portfolio choices by exploring the response to the distinctive treatment of foreign dividends in the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA). JGTRRA lowered the dividend tax rate to 15% for American equities and extended this tax relief only to foreign corporations from a subset of countries. This paper uses a difference-in-difference analysis that compares US equity holdings in affected and unaffected countries. The international investment responses to JGTRRA were substantial and imply an elasticity of asset holdings with respect to taxes of -1.6. This effect cannot be explained by several potential alternative hypotheses, including differential changes to the preferences of American investors, differential changes in investment opportunities, differential time trends in investment or changed tax evasion behavior.
The distributions of Real Estate Investment Trusts (REITs) are comprised of components that differ in how they are taxed to the recipient shareholders. This variation in tax characteristics enables us to study the effect of shareholder taxes on stock prices around ex-dividend days while avoiding the non-tax confounds and inter-temporal tests that have hampered the interpretation of previous studies. Using a dataset that includes the component makeup of individual REIT distributions, we provide evidence that abnormal returns and trading volume around ex-dividend days are driven by the component of the distributions that is most tax-penalized. Our results support a tax-based explanation for ex-dividend day pricing and investor trading behavior.
Capital gains tax can impose a potentially large cost on investors selling stocks. This cost can sometimes be an order of magnitude larger than conventional transaction costs. This paper addresses the question of whether capital gains tax serves as an impediment to selling and if so, to what degree this delayed selling by investors subsequently affects stock prices. Using a database of large U.S. institutions' stock holdings with data on institutions' client profiles, two main results are obtained. First, selling decisions by institutions serving tax-sensitive clients are shown to be sensitive to their cumulative capital gains, a pattern not observed for institutions with predominantly tax-exempt clients. In particular, both the likelihood and magnitude of selling by institutions that serve tax-sensitive clients are negatively related to cumulative capital gains. Second, tax-related underselling appears to significantly impact stock prices during large earnings announcements. Specifically, following a large quarterly earnings surprise, tax-sensitive investors sell less aggressively a stock that has large capital gains; thus for a stock held primarily by tax-sensitive investors, the corresponding price reaction is less negative (or more positive) if it has accumulated large capital gains. Further analysis shows that the price reaction pattern is more severe when arbitrage is more costly.
We study ex-dividend returns in Mexico, where an imputation system entitles individual investors to a net dividend tax credit. Based on taxation, we expect ex-day abnormal returns to be negative or at most zero in Mexico. However, they are significantly positive. Because ex-day returns are positive even for stocks restricted to Mexican nationals, they are not attributable to foreign stockholders’ tax considerations. None of the market microstructure-based hypothesis in the literature can explain these positive ex-day returns. Ex-day returns in Mexico are a puzzle.
This study examines the ex-dividend day trading behavior of all investors in the Finnish stock market. Consistent with dynamic dividend clientele theories, investors with a preference for dividend income buy shares cum-dividend and sell ex-dividend; the reverse is true for investors with the opposite preference. Investors also engage in overnight arbitrage, earning on average a 2% overnight return on their invested capital. Trades at the investor-level reveal that idiosyncratic risk is an important determinant in the choice of stock for short-term ex-day trading. Furthermore, transaction costs and dividend yield jointly determine whether the volume of short-term trading activity is nonzero.
This paper provides new evidence regarding the magnitude and nature of noise trader risk. I examine returns for two pairs of “Siamese twin” stocks: Royal Dutch/Shell and Unilever NV/PLC. These unusual pairs of fundamentally identical stocks provide a unique opportunity to investigate two facets of noise trader risk: (1) the fraction of total return variation unrelated to fundamentals (i.e., noise), and (2) the short-run risk borne by arbitrageurs engaged in long-short pairs trading. I find that about 15% of weekly return variation is attributable to noise. Noise trader risk has both systematic and idiosyncratic components, and varies considerably over time. The conditional volatility of long-short portfolio returns ranged from 0.5% to over 2.75% per week during the 1989–2003 sample period. Noise trader risk was especially high around the failure of Long-Term Capital Management in 1998 and during the collapse of the technology bubble in 2000. I conclude that noise trader risk is a significant limit to arbitrage.
I study whether the capital gains tax is an impediment to selling by some investors and if so, to what degree associated delayed selling affects stock prices. I find that selling decisions by institutions serving tax-sensitive clients are sensitive to cumulative capital gains, a pattern not observed for institutions with predominantly tax-exempt clients. Moreover, tax-related underselling impacts stock prices during large earnings surprises for stocks held primarily by tax-sensitive investors. The corresponding price reactions are less negative (more positive) with higher cumulative capital gains. This price pressure pattern is more severe when arbitrage is more costly. Copyright 2006 by The American Finance Association.
German dividends typically carry a tax credit which makes the dividend worth 42.86% more to a taxable German shareholder than
to a tax-exempt or foreign shareholder. This results in a penalty for foreign investors who buy and hold German dividend-paying
stocks. I document that, as a result of the credit, the ex-day drop exceeds the dividend by more than one-half of the tax
credit, and show that futures and option prices embed more than one-half of the tax credit. The existence of the credit creates
opportunities for cross-border tax arbitrage—in which foreign holders of German stock transfer the dividend to German shareholders—and
implies that it is tax efficient for foreign investors to hold derivatives rather than investing directly in German stocks.
The empirical findings are consistent with costly tax arbitrage activity by German investors, who face tax risk due to antiarbitrage
rules. Since dividend tax credits exist in many other countries, the findings are potentially of broad interest.
We investigate the effect of asymmetric information on prices and liquidity by analyzing trades, quotes, spreads, and depths.
Information content should increase with trade size and the information asymmetry of the trading period. Results show that
price and liquidity effects are significantly associated with information content as measured by both trade size and timing
relative to information events. Results are stronger for purchases than sales. Quoted prices are better measures of information
effects than transaction prices, because they control for bid-ask bounce. Finally, trades that a priori contain no information
have no impact on prices and liquidity, despite their large size.
This survey of recent research in corporate finance discusses how business taxes, subsidies as well as a country's institutional development affect several important decision margins of heterogeneous firms. We argue that innovative firms, as a result of agency problems between insiders and outside investors, are most frequently finance constrained. We discuss how profit taxes reduce investment of constrained firms by their effect on cash-flow, and of unconstrained firms by their effect on the user cost of capital. Moreover, tax reform as well as tax financed R&D subsidies can enhance aggregate investment, innovation and efficiency by implicitly redistributing profits towards constrained firms where capital earns the highest return. We argue that the corporate legal form improves firms' access to external funds. We then explain the firms' choice between venture capital and bank financing and discuss how business taxation can affect venture capital financing on both the extensive and intensive margins. Finally, we review theory and evidence on how corporate finance may shape a country's comparative advantage in innovative industries as well as aggregate labor market performance when part of firms are finance constrained.
This paper investigates trading volume around ex-dividend days. For taxable distributions (cash dividends), it is found that trading volume increases significantly around the ex-dividend day. This increase is more pronounced for high yield, actively traded stocks and after brokerage commissions became negotiable. The results are consistent with the hypothesis that short-term traders have an impact on ex-day price behavior, at least for taxable distributions. For non-taxable distributions (stock splits and stock dividends) we find negative abnormal volume around ex-day.
This paper examines properties of daily stock returns and how the particular characteristics of these data affect event study methodologies. Daily data generally present few difficulties for event studies. Standard procedures are typically well-specified even when special daily data characteristics are ignored. However, recognition of autocorrelation in daily excess returns and changes in their variance conditional on an event can sometimes be advantageous. In addition, tests ignoring cross-sectional dependence can be well-specified and have higher power than tests which account for potential dependence.
Swedish lottery bonds offer a unique opportunity to study ex-day effects in an environment where cash distributions are tax-advantaged relative to capital gains. Thus, in the lottery bond market, we observe a reversal of the preference for capital gains that researchers have cited as an explanation for the ex-day behavior of U.S. equities. Further, in this market there are barriers to short-term arbitrage when prices do reflect the tax preferences of individual investors. We find the bonds are priced around the ex-day to reflect differential tax rates on income and capital gains consistent with the prevailing tax regimes. The bonds consistently experience negative returns over the coupon payment period, and in fact often sell at negative yields prior to the cash distribution, as one would expect given tax-motivated trading between high-tax investors, who buy prior to the distribution, and low-tax investors, who buy after the distribution.
A dividend tax penalty creates profitable trading opportunities for short-term traders with sufficiently low transaction costs. In stocks with ex-dividend day returns affected by short-term trading, ex-day returns are positively correlated with transaction costs. Data from 1964–1985 indicate that short-term traders are the marginal investors in high-yield stocks, primarily since the introduction of negotiated commissions on the NYSE. Short-term trading is not evident in low-yield stocks, nor does it appear prevalent before negotiated commissions.
It is well documented that stock prices on ex-dividend days drop by less than the value of the dividend, on average. This has commonly been attributed to the effect of tax clienteles. We examine data from the Hong Kong stock market, where neither dividends nor capital gains are taxed. As in the U.S., the average stock price drop is less than the value of the dividend; specifically, the average dividend for the period 1980–1993 is HK 0.06. We are able to account for this both theoretically and empirically through market microstructure arguments.
We examine execution costs for trades in NYSE issues completed on the NYSE, the NASD dealer market, and the regional stock exchanges during 1994. We find that effective bid-ask spreads are only slightly smaller at the NYSE. However, realized bid-ask spreads, which measure market-making revenue net of losses to betterinformed traders but gross of inventory or order-processing costs, are lower on the NYSE by a factor of two to three. This differential is attributable to the successful ‘cream skimming’ of uninformed trades by off-NYSE market makers. These findings reinforce existing concerns about whether orders are routed so as to receive the best possible execution.
In this paper we examine the ex-dividend day returns of several taxable and non-taxable distributions. The ex-dividend day returns for the taxable common stocks are consistent with the hypothesis that dividends are taxed more heavily than capital gains. However, the ex-dividend day returns of preferred stocks suggest that preferred dividends are taxed at a lower rate than capital gains; non-taxable stock dividends and splits are priced on ex-dividend days as if they are fully taxable; and non-taxable cash distributions are priced as if investors receive a tax rebate with them. We also find that each of these distributions exhibits abnormal return behavior for several days surrounding the ex-dividend day. We investigate several possible explanations for this anomaly, but none is capable of explaining the phenomenon.
This paper examines properties of daily stock returns and how the particular characteristics of these data can affect event study methodologies. We find no evidence that either nonnormality in the time-series of daily excess returns or bias in OLS estimates of Market Model parameters affect the specification or power of tests for abnormal performance. However, under plausible conditions, both autocorrelation in excess returns and changes in the variance of daily returns conditional on an event can affect the tests; simple procedures to deal with these issues are sometimes quite useful. We also show that taking into account dependence in the cross-section of the daily excess returns can be harmful, resulting in tests with relatively low power and which are no better specified than those which assume independence.
This paper reexamines some recent tests of whether holders of shares with higher dividend yields receive higher risk-adjusted rates of return to compensate for the heavier taxes on dividend payments than on long-term capital gains. Our particular concern is with tests using short-run measures of dividend yield--that is, measures that seek to deduce the differential tax burden on dividends over long-term capital gains from differences in rates of return on shares that do not pay a cash dividend during the return interval. We show that such measures are inappropriate for that purpose. Any yield-related effects associated with such measures must arise from sources other than the long-term tax differential. For the short-run measures considered here, the yield-related effects found in some tests are traced to biases, one of a fairly subtle kind, introduced by dividend announcement effects.
To investigate the effect of taxation on stock price and trading volume around the ex-dividend day, we use the Italian stock
market, where dividends on two classes of stock are taxed differently. We find that the weighted average of investors’ tax
rates is reflected in the ex-day prices and the variance of the relative tax rate across investors is reflected in the volume
of trades. We also show that higher transaction costs result in higher ex-dividend day excess returns and lower abnormal volume.
This finding is consistent with “profit elimination” activity by institutions and corporations.
Recent studies argue that the spread-adjusted Taylor rule (STR), which includes a response to the credit spread, replicates monetary policy in the United State. We show (1) STR is a theoretically optimal monetary policy under heterogeneous loan interest rate contracts in both discretionay and commitment monetary policies, (2) however, the optimal response to the credit spread is ambiguous given the financial market structure in theoretically derived STR, and (3) there, a commitment policy is effective in narrowing the credit spread when the central bank hits the zero lower bound constraint of the policy rate.
This study examines the ex-dividend day behavior of common stock prices before the enactment of the federal income tax. On ex-dividend days during the pre-tax period, stock prices fell, on average, by the full amount of the dividend. The data are consistent with the hypothesis that (i) investors in the pre-tax period value dividends and capital gains as perfect substitutes and (ii) the differential taxation of dividends and capital gains has since caused investors to discount the value of taxable cash dividends in relation to capital gains.
This study examines the unit (stock) price and volume behavior of master limited partnerships around the ex-dividend day. Since the dividends of master limited partnerships 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. Copyright 1991 by American Finance Association.
Capital gains taxes create incentives to trade. Our major finding is that turnover is higher for winners (stocks, the prices of which have increased) than for losers, which is not consistent with the tax prediction. However, the turnover in December and January is evidence of tax-motivated trading; there is a relatively high turnover for losers in December and for winners in January. We conclude that taxes influence turnover, but other motives for trading are more important. We were unable to find evidence that changing the length of the holding period required to qualify for long-term capital gains treatment affected turnover.
Past studies have documented an ex‐dividend day price drop which is less than the dividend per share and positively correlated with the corresponding dividend yield. In contrast to prior work, we show that, without additional information, the marginal tax rates cannot be inferred from this phenomenon which is, therefore, not necessarily the result of a tax induced clientele effect. Despite adjustments for potential biases in earlier work, however, the correlation between the ex‐dividend relative price drop and the dividend yield is still positive which is consistent with a tax effect and a tax induced clientele effect.
Staking a reclaim, Global Custodian, Fall 1994, 100 ^105. Shaw,Wayne, 1991, An examination of ex-dividend day stock price movements: The case of nontaxable master limited partnership distributions
- Reid
Reid, Fergus, 1994, Staking a reclaim, Global Custodian, Fall 1994, 100 ^105. Shaw,Wayne, 1991, An examination of ex-dividend day stock price movements: The case of nontaxable master limited partnership distributions, Journal of Finance 46, 755 ^771.
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Staking a reclaim Global Custodian Fall1994
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