New Evidence that Taxes Affect the Valuation of Dividends

This paper uses British data to examine the effects of dividend taxes on investors relative valuation of dividends and capital gains. British data offer great potential to illuminate the dividends and taxes question, since there have been two radical changes and several minor reforms in British dividend tax policy during the last twentyfive years. Studying the relationship between dividends and stock price movements during different tax regimes offers an ideal controlled experiment for assessing the effects of taxes on investors valuation of dividends. Using daily data on a small sample of firms, and monthly data on a much broader sample, we find clear evidence that taxes change equilibrium relationships between dividend yields and market returns. These findings suggest that taxes are important determinants of security market equilibrium, and deepen the pizzle of why firms pay dividends.