Dividends and Taxes: Some Empirical Evidence

TLDR

The study revisits tests of whether higher dividend yields earn higher risk‑adjusted returns to offset heavier dividend taxes compared to capital gains, focusing on the shortcomings of short‑run yield measures that infer tax differentials from non‑dividend‑paying shares. Short‑run yield measures are shown to be inappropriate, with any observed yield effects arising from biases—particularly dividend‑announcement effects—rather than the long‑term tax differential.

Abstract

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.