The Effect of Dividends Tax and Tax Integration on Stock Ownership and Expected Returns:Evidence from Shareholder-Level Data

Cheng-Few Lee, PhD Distinguished Professor of Finance

Rutgers University, USA Nan-Ting Kuo, PhD

National Central University, TaiwanTsingZai C. Wu, PhD, CPA

Professor of Accountancy, School of ManagementNational Cheng Kung University, Taiwan

Revised on October 24, 20111

Figure 1. Flow Chart (from The Evolution of Capital Asset Pricing Models by Chen, Chen, Lee, and Shih, 2011)

The Original CAPM Sharpe (1964), Lintner (1965),and Mossin (1966)

The Static CAPM(single-period)

Behavioral FinanceKahneman and Tversky (1979, Econometrica)Tversky and Kahneman (1992, Journal of Risk and Uncertainty)Levy (Forthcoming, European Financial Management)

Intertemporal CAPM－Merton ModelMerton (1973, Econometrica)

Intertemporal CAPM－ Consumption-based ModelsBreeden (1979, Journal of Financial Economics)Campbell (1993, American Economic Review)Campbell and Cochrane (1999, Journal of Political Economy)Jagannathan and Wang (1996, Journal of Finance)Lettau and Ludvigson (2001a, Journal of Finance)Lettau and Ludvigson (2001b, Journal of Political Economy)Lewellen and Nagel (2006, Journal of Financial Economics)Balvers and Huang (2009, Journal of Financial and Quantitative Analysis)

Supply-Side Effect ModelsBlack (1976, American Economic Review)Grinols (1984, Journal of Finance)Lee, Tsai, and Lee (2009, Quarterly Review of Economics and Finance)

Equilibrium Models with Heterogeneity Beliefs and InvestorsConstantinides (1982, Journal of Business)Constantinides and Duffie (1996, Journal of Political Economy)Brav, Constantinides, and Geczy (2002, Journal of Political Economy)Basak (2005, Journal of Banking and Finance)Levy, Levy, and Benita (2006, Journal of Business)

Dividend and Taxation Effect ModelsMiller and Modigliani(1961,Journal of Business)Brennan (1970, National Tax Journal)Black and Scholes (1974,Journal of Financial Economics)Sasson and Kolodny(1976, The Review of Economics and Statistics)Miller and Scholes (1978,Journal of Financial Economics)Litzenberger and Ramaswamy (1979, Journal of Financial Economics)Morgan (1982,The Journal of Finance)Litzenberger and Ramaswamy (1982,The Journal of Finance)Hagiwara and Herce (1997, The American Economic Review)

Equilibrium Models with Heterogeneity Investment HorizonLee (1976, The Review of Economics and Statistics)Levhari and Levy (1977, The Review of Economics and Statistics)Lee, Wu, and Wei (1990, Journal of Financial and Quantitative Analysis)

Existence of EquilibriumHart (1974, Journal of Economic Theory)Nielsen (1989, Review of Economic Studies)

Skewness Effect ModelsBorch (1969, Review of Economics Studies)Feldstein (1969, Review of Economics Studies)Jean (1971, Journal of Financial and Quantitative Analysis)Tsiang (1972, American Economic Review)Ingersoll (1975, Journal of Financial and Quantitative Analysis)Schweser (1978, Journal of Financial and Quantitative Analysis)

Intertemporal CAPM－ Production-based ModelsBalvers, Cosimano, and McDonald (1990, Journal of Finance)Cochrane (1991, Journal of Finance) (1996, Journal of Political Economy)Balvers and Huang (2007, Journal of Financial Economics)

Liquidity-based ModelsPastor and Stambaugh (2003, Journal of Political Economy)Acharya and Pedersen (2005, Journal of Financial Economics)Yoel(2009,working paper)

The Dynamic CAPM(multi-period)

International CAPMStulz (1981a, Journal of Finance)Stulz (1981b, Journal of Financial Economics)Stulz (1982, Journal of International Economics)Stulz (1984, Journal of International Business Studies)

2

Figure 2. The Dynamic CAPM

Intertemporal CAPM－Merton ModelMerton (1973, Econometrica)

Intertemporal CAPM－ Consumption-based Models

Breeden (1979, Journal of Financial Economics)Campbell (1993, American Economic Review)Campbell and Cochrane (1999, Journal of Political Economy)Jagannathan and Wang (1996, Journal of Finance)Lettau and Ludvigson (2001a, Journal of Finance)Lettau and Ludvigson (2001b, Journal of Political Economy)Lewellen and Nagel (2006, Journal of Financial Economics)

Balvers and Huang (2009, Journal of Financial and Quantitative Analysis)

Supply-Side Effect Models

Black (1976, American Economic Review)Grinols (1984, Journal of Finance)Lee, Tsai, and Lee (2009, Quarterly Review of Economics and Finance)

Intertemporal CAPM－ Production-based Models

Balvers, Cosimano, and McDonald (1990, Journal of Finance)Cochrane (1991, Journal of Finance) (1996, Journal of Political Economy)Balvers and Huang (2007, Journal of Financial Economics)

The Dynamic CAPM(multi-period)

International CAPMStulz (1981a, Journal of Finance)

Stulz (1981b, Journal of Financial Economics)

Stulz (1982, Journal of International Economics)

Stulz (1984, Journal of International Business Studies)

3

Figure 3. The Static CAPM

The Static CAPM

(single-period)

Equilibrium Models with Heterogeneity Beliefs and InvestorsConstantinides (1982, Journal of Business)

Constantinides and Duffie (1996, Journal of Political Economy)

Brav, Constantinides, and Geczy (2002, Journal of Political Economy)

Basak (2005, Journal of Banking and Finance)

Levy, Levy, and Benita (2006, Journal of Business)

Dividend and Taxation Effect ModelsMiller and Modigliani(1961,Journal of Business)

Brennan (1970, National Tax Journal)

Black and Scholes (1974,Journal of Financial Economics)

Sasson and Kolodny(1976, The Review of Economics and Statistics)

Miller and Scholes (1978,Journal of Financial Economics)

Litzenberger and Ramaswamy (1979, Journal of Financial Economics)

Morgan (1982,The Journal of Finance)

Litzenberger and Ramaswamy (1982,The Journal of Finance)

Hagiwara and Herce (1997, The American Economic Review)

Equilibrium Models with Heterogeneity Investment HorizonLee (1976, The Review of Economics and Statistics)

Levhari and Levy (1977, The Review of Economics and Statistics)

Lee, Wu, and Wei (1990, Journal of Financial and Quantitative Analysis)

Skewness Effect ModelsBorch (1969, Review of Economics Studies)

Feldstein (1969, Review of Economics Studies)

Jean (1971, Journal of Financial and Quantitative Analysis)

Tsiang (1972, American Economic Review)

Ingersoll (1975, Journal of Financial and Quantitative Analysis)

Schweser (1978, Journal of Financial and Quantitative Analysis)

Liquidity-based ModelsPastor and Stambaugh (2003, Journal of Political Economy)

Acharya and Pedersen (2005, Journal of Financial Economics)

Yoel(2009,working paper)

4

Abstract• The purpose of this paper is to explore the effects of investor-level

dividend taxes on the relation between dividend policy and firm valuation. The unique Taiwanese stock ownership data allows us to construct a measure of investors’ tax statuses that varies at firm level and considers the tax characteristics heterogeneity among shareholders. By examining price reactions to the enactment of the integrated tax system that integrates corporate taxes with individual investors’ dividend taxes, we find that a firm’s dividend yield is positively related to share price reactions, and this relation is affected by the tax statuses of individual shareholders, especially those whose effective tax rates are within the lowest and highest tax brackets. Our findings hold for either the cash dividend or the taxable stock dividend cases. We repeat our tests by controlling for the potential effects of investors’ risk tolerances, and our conclusions remain unchanged. Our results support the traditional view of dividend taxes capitalization and that tax statuses of investors affect the relation between firm’s dividend policy and equity value. 5

The Purpose of This Study

to explore

(1) whether dividend taxes paid by investors is irrelevant to firm value as argued by Miller and Scholes (1978).

(2) whether the firm’s dividend policy affects the relationship between dividend taxes and firm value.

(3) whether the investor-level taxes influence the relationship between dividend policy and firm value.

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Contributions of Our Study• We use the unique individual-level shareholder data of

Taiwanese tax integration in 1997 to construct the weighted average tax statuses of investors. These unique data set and methodology used by this paper have avoided problems faced by Guenther and Sansing (2010). In other words, they use institutional shareholdings as a proxy for individual shareholder data. Therefore, their empirical results rely upon a hypothetical marginal investor.

• The environment of institutional tax structure in Taiwan makes our results be not infected by factors unrelated to dividend taxes. Several features of the integrated tax system also allow us to identify whether our results support the traditional or new view of dividend taxes capitalization.

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Contributions of Our Study• Our empirical results are less subject to influences

of non-tax factors than those of prior studies. Our research uses public available ownership data to verify the identities of shareholders, and thus better reflects the effects of investors’ tax statuses.

• We develop a model to clarify the implication of the marginal investor and reconcile the conflict between the existence of the marginal investor and the after-tax CAPM. Therefore, the contribution of this paper is to resolve the debate in the relevance of the marginal investor.

• Since both cash dividends and stock dividend are taxable in Taiwan, our empirical results show that both cash and stock dividends are relevant to firm value. These results show an unique natural of the relationship between dividends and firm value.

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Contributions of Our StudyOur empirical results can be summarized as follows:

(1)A firm’s dividend yield is positively related to share price reactions.

(2) Share price reactions are primarily determined by individual shareholders instead of institutional investors.

(3) Tax statuses of individual shareholders affect the relationship between price reactions and dividend yields. Particularly, we find that price reactions are primarily determined by individual shareholders whose effective tax rates are within the lowest or highest tax brackets, (0%-6%) or (30%-40%), respectively. In sum, our study provides evidence to support the traditional view of dividend taxes capitalization instead of irrelevance view or new view.

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The Institutional Background in Taiwan

• The integrated tax system in Taiwan provides a natural experiment to identity the most influential investors of the price reactions, which are most likely individual shareholders, since they are the primary beneficiaries under the new tax system.

• We investigate the stock price reactions to the enactment of the integrated tax system, and whether dividend policy and the tax status of individual shareholders influence the stock price reactions.

• The unique data provided by Taiwan Economic Journal (TEJ) database allows us to investigate not only the identity of the most influential investors, but also their effective income tax rates.

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Equity Prices and Investor Taxes

• The dividend tax capitalization studies produced at least three schools of thought:

(1) The irrelevance view : the tax-exempt investor is the marginal investor, so taxes are irrelevant to firm values.

(2) The traditional view : dividend taxes are relevant to firm values, and a firm's dividend policy affects the relation between shareholder tax rates and stock price.

(3) The new view : dividend taxes are relevant to firm values, while a firm's dividend policy does not affect the relation between shareholder tax rates and stock price.

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• If a tax law change is expected to be temporary, both the new view and the traditional view suggest that the firm's dividend policy has an influence on the relation between dividend taxes and share prices.

• On the contrary, if a tax law change is permanent, only the traditional view predicts that the firm’s dividend policy is relevant.

• Since the integrated tax system is expected to be permanent in nature, if we find that the dividend policy is relevant, then we can conclude that our results support the traditional view.

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Four Empirical Methodologies have been used to Examine the Effect of Dividend Taxes on Firm Value

(1) Ohlson’s (1995) model: Research based on a price-level model developed by Ohlson (1995) usually faces misspecification problems, since estimated coefficients are sensitive to variable definitions, scalars, non-linearity, and influences of omitted variables.

(2) The drop-off ratio, developed by Elton and Gruber (1970) is a good empirical setting, since trading around the ex-dividend day results neither from differences in information nor from those in preferences. However, it results from tax-induced differential valuation of cash flows. Such method is hampered by tick size restriction and short-term traders.

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Empirical Methodologies to Examine the Effect of Dividend Taxes

(3) Fama and French (1998) examine the relationship between long-run stock returns and dividend yield and conclude that it is difficult to separate the effect of non-tax factors (ex. signaling or reducing agency cost) from the effects of taxes. The relationship between long-run returns and dividend yields may be impossible to definitely attribute to the influence of taxes.

(4) Short-window event study method is used to test the valuation of investor taxes. This method is easier to control for influences of non-tax factors, since risks, agency costs, and information effects that affect the valuation of dividends are not expected to change significantly over a short window of time. 14

Short-Window Event Studies• An ideal event should (1) involve an economically

significant change in tax rates, (2) be permanent in nature, and (3) no other policy changes or events that might affect share prices operate concurrently.

• Our study bases on the event of the integrated tax system enacted in Taiwan on December 26 1997. This event satisfies all conditions mentioned above.

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(1) The new tax system is targeted, influencing only the dividend income valuation, and no other tax law changes simultaneously, so the price reactions we observed can all attribute to the effect of dividend taxes. The event of the Tax Reform Act of the U.S. in 1986 did not meet these conditions.

(2) The target beneficiaries of the integrated tax system are individuals. Since individuals account for a significant proportion of the stock market ownership, this event is economically significant and therefore is expected to be permanent in nature.

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The Tax Status of the Marginal Investor in

Dividend Taxes Capitalization

• Prior tax capitalization studies often assumed that the identity and tax status of the marginal investor determine the effects of taxes on firm valuation. (e.g. Elton and Gruber (1970) ; Kalay (1982); Miller (1977) ; Ohlson (1995) )

• To estimate the tax rates of shareholders, prior studies adopt following strategies: (1) drop-off ratios, (2) the Ohlson model, (3) the implicit tax concept, (4) the institutional shareholdings, and (5) CAPM.

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• Based on the concept of implicit taxes, studies usually compare returns on taxable assets with those on tax-exempt assets (assuming these assets differ in only tax treatments and identical in all other aspects such as risks), and the tax rate implicit in the difference in returns is equal to that of the marginal investor.

• Prior studies use the level of institutional ownership as a proxy for the tax status of the marginal investor. In U.S., institutional shareholders instead of individual shareholders are entitled to a dividend-received deduction and thus they face lower tax rates on dividend income than individual shareholders do.

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• This use of the instiutional shareholdings is problematic, since institutional investors invest in different ways than individuals for reasons that having nothing to do with taxes, and raw institutional ownership is a noisy proxy for the tax status of a firm’s investor base.

• Guenther and Sansing (2010) also suggest that shareholdings may relate to both the shareholder’s tax rate and risk tolerance.

• The uses of (1) drop-off ratios, (2) the Ohlson model, (3) the implicit tax concept, (4) the institutional shareholdings are all relying on the existence of a hypothetical marginal investor.

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• Based on the framework of the after-tax CAPM, Several asset pricing researches challenge the existence of the marginal investor. (e.g. Brennan (1970); Michaely and Vila (1995); Guenther and Sansing (2006 and 2010))

• These studies argue that the hypothesis of a single marginal investor is inconsistent the equilibrium after-tax CAPM derived by Brennan (1970). Brennan (1970) argues that All the investors are marginal in the sense that a change in the investment portfolio of any investor potentially affects the asset demand and prices.

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MODEL AND HYPOTHESES DEVELOPMENTS

• Without relying on the assumption of the marginal investor, the after-tax CAPM shows that tax rates of all investors within the market determine the effect of the dividend yield on firm valuation, and it provides a theoretical basis to guide the design of empirical studies.

• However, several studies that report the relevance of the marginal investor is questionable. (e.g., Bell and Jenkinson 2002; Erickson and Maydew 1998; Ayers et al. 2002)

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• We further assume that in the short run, the enactment of the integrated tax system only changes the dividend tax burdens of investors without changing other parameters. These settings imply the equilibrium share price PH is determined by the firm’s dividend policy and investors’ tax statuses, as presented in equation (1).

Where

• If we set PH ( ) as the equilibrium price before (after) the enactment of the integrated tax system, by comparative static analysis the difference in equilibrium prices , which is the short-run price reaction to the new tax system, can be shown as equation (2):

where• Equations (2) implies that higher dividend amount DH will result in higher

price reactions, because a higher DH also leads to more tax savings for shareholders under the new tax system. 22

(1) ~ 2

LH

D)P(EP HLHHHH

1 ,

i i

(1 )

, anddi

i i

t

i i

r

1

The derivations of equation (1) are shown in the appendix, and the equilibrium price PL can be derived by repeating the same procedures as above.

Δ Δ Δ (2)H HTP D W D

TW

AHP

• Based to Bond et al. (2007), Desai and Dharmapala (2009), and Guenther and Sansing (2010), we derive a model to reconcile the conflict between the after-tax CAPM and findings of these studies.

• since foreign shareholders are not beneficiaries of the integrated tax system, the price reaction should not reflect their tax statuses. This can be shown by rearranging equation (2) as equation (3).

• WK, WF, and WI are the WAT for domestic, foreign, and individual shareholders, respectively.

• In equation (3), we recognize that the price reaction ΔP reflects only tax statuses of shareholders impacted by the new tax system, not tax statuses of all shareholders.

Δ Δ Δ Δ Δ Δ (3)

H HT K F I

H HK I

P W D W W W DW D W D

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• Equation (3) shows that it is not the case that the CAPM-based valuation model always reflects tax statues of all investors, even if all investors are marginal.

• Consequently, although all investors in the market jointly determine the equilibrium share price, only specific investors who are affected by the tax reform determine the price reaction.

• In other words, if those specific investors are viewed as the “marginal investor” (different from the traditional definition, as shown by our model), then studies that shows the existence of the marginal investor (e.g. Bell and Jenkinson 2002) can be reconciled with the framework of the after-tax CAPM.

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• In fact, prior studies that confirm the identity of the marginal investor usually involve with some specific exogenous events, such as a tax law change. Instead, studies that provide empirical evidence to support that all investor are marginal, such as Michaely and Vila (1995) and Guenther and Sansing (2010), are based on a general condition without relating to any specific exogenous events.

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• To derive equation (3), we assume that all parameters in the model keep unchanged in response to the integrated tax system, except for dividend tax rates of investors who benefit from the new tax law.

• Such assumption is most likely to hold in the short run, therefore our empirical model are based on the short-window event study.

• Research design based on long-window stock returns or price levels may be hampered by the confounding effects resulted from simultaneous movements in other non-tax parameters.

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• In conclusion, from equation (3) we know that the higher the dividend amount, the more tax savings the shareholder will get under the new tax system, so we expect that the higher the firm’s dividend payout, the more positive the share price reaction to the enactment of the integrated tax system.

• In addition, since the individual shareholders are the primary beneficiaries, they are most likely investors that determine the price reactions to the tax reform, and their tax statuses will influence the positive relation between firm’s dividend policy and the price reactions.

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Hypotheses

• Hypothesis 1: Ceteris paribus, the share price reaction to the enactment of the integrated tax system is positively related to a firm’s dividend yield.

• Hypothesis 2: Ceteris paribus, tax statuses of individual shareholders are most likely to affect the positive relation between the share price reaction and the dividend yield.

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RESEARCH METHODOLOGY • Based on Lee et al. (2006), we separate individual

ownership into five categories based on the five tax brackets of individual taxpayers.

• TEJ database provides (1) the proportion of shares held by individual shareholders and by foreign and domestic institutions (2) the number of shares held by all shareholders tabulated into different lot sizes. The tabulated ranges are less than 1 lot, 1-5 lots, 5-10, 10-15, 15-20, 20-30, 30-50, 50-100, 100-200, 200-400, 400-600, 600-800, 800-1,000 lots, and 1,000 lots and above

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• Lee et al. (2006) finds that the (effective tax rate range, average shareholdings in lots) pairs for different effective tax rate brackets are (0%-13%,35.6), (13-21%,66.7), (21%-30%,200.1), and (>30%,1136.7).

• Accordingly, we match the average shareholdings in lots to TEJ’s lot tabulated ranges, and thus we define the (effective tax rate range, individual shareholdings based on lots tabulated ranges) pairs for different tax brackets as (0%-6%, less than 10), (6-13%,10 to 50), (13%-21%, 50 to 100),(21%-30%, 100 to 1,000), and (30%-40%, 1,000 and above).

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• To test our hypotheses, we estimate following regression models:

• WATi= the measure of the weighted average income tax rate of all shareholders in firm i, which is equal to INSTDi*(1-25%)+INSTFi*(1-20%)+INAi*(1-6%)+INBi*(1-13%)+INCi*(1-21%)+INDi*(1-30%)+INEi*(1-40%);

0 1 2 3 4

it t i i i i i t

k ki it

CAR EVENT DIV DIV WAT DIV WAT EVENTX

(4)

0 1 2 3 4

5

it t i i i i i t

i i t k ki it

CAR EVENT DIV DIV WAT DIV WATIN EVENTDIV INSTDW EVENT X

(5)

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• Our stock ownership variables represent the weighted risk tolerance across all shareholders (which is in our theoretical model), and the separation of stock ownership into seven tax status categories allows us to estimate the weighted average tax statuses of specific firms (which is the WAT in our theoretical model).

• Therefore, our research design avoids problems faced by Guenther and Sansing (2010) by proxying for shareholders’ tax statuses with both ownership structure and tax rates.

• Moreover, our model includes a dummy variable indicating whether the observation falls within the event period. The dummy variable enables us to confirm the effect of changes in investor’s tax status (Δ represent changes in equation (3)).

i

i

1

32

• To test which individual tax brackets contribute most significantly to the effect of WATIN, we estimate following regression (6):

• In regression (6), we separate DIV·WATIN·EVENT into five variables DIV·INA·EVENT to DIV·INE·EVENT. This allows us to observe which groups of individual investors have the most significant influences. We include DIV·EVENT·INSTF to control for the potential influence of foreign shareholders.

0 1 2 3 4

5 6 7

8 9 10

it t i i t i i

i i t i i t i i t

i i t i i t i i

CAR EVENT DIV DIV EVENT DIV WATDIV INSTD EVENT DIV INSTF EVENT DIV INA EVENTDIV INB EVENT DIV INC EVENT DIV IND E

11

t

i i t k ki it

VENTDIV INE EVENT X

(6)

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Panel A: CAR of event week is higher than those of control periods => taxes affect firm values.

Panel B,C, and D: Fordividend paying firms, CAR of event week is also higher; but this is not the case of non-dividend paying firms =>dividend is relevant, and the traditional view is supported, since zero-dividend firms have no higher CAR.

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Empirical Results of Cash-Dividend Case• DIV·WAT·EVENT is

positive and significant, so the significance of DIV·EVEVT is not driven by non-tax factors.

• DIV*WATIN*EVENT is positive and significant, and this is consistent with our expectation that individuals are the most influential investors, and their tax statuses are relevant.

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Table 5Regression Estimates of Equations (4) and (5) for the Cash-Dividend-Only Case

Empirical Results of Stock-Dividend Case

• The results of stock-dividend is similar to those of the cash-dividend case.

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Table 6Regression Estimates of Equations (4) and (5) for the Taxable-Stock-Dividend-Only Case

Empirical Results of Cash-Dividend Case

• Table 7 shows the result of separating variable WAT into individual tax bracket variables.

• After considering the potential confounding effect of DIV*WAT, the coefficient of DIV*EVEVT keeps positive and significant.

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Table 7Estimates of Regression (6) for the Cash-Dividend-Only Case

Empirical Results of Stock-Dividend Case

• Table 8 shows the result of separating variable WAT into individual tax bracket variables for the stock-dividend case.

• Although less pronounced, the results are qualitatively the same with those of the cash-dividend case.

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Table 8Estimates of Regression (6) for the Taxable-Stock-Dividend-Only Case

• Overall, the results of tables 7 and 8 suggest that the most influential investors are individual shareholders, and the tax brackets of them are most likely falling within the highest and lowest tax brackets, which are (30 - 40%) and (0% - 6%), respectively.

• However, the inconsistency of significant marginal investor’s tax status between cash-dividend-only and stock-dividend-only samples may suggest that the determination of the marginal investor’s tax status is sensitive to the empirical model specification and inputs.

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• These less pronounced results in Table 8 may be because the integrated tax system results in more significant reduction in stock dividend taxes for large shareholders, who are usually subject to the highest tax rates.

• Unlike cash ones, stock dividends are taxable but produce no real incomes, so shareholders may have to change their personal investment portfolios toward higher cash positions to pay taxes.

• The liquidity pressure to tax payment impacts even more significantly to large shareholders due to their higher tax rates and due to that they receive much more stock dividends than do small shareholders. As a result, the integrated tax system mitigates the liquidity pressure for stock dividends received by large shareholders

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Sensitivity to the Measurement of WAT • The implicit assumption in the measurement of WAT is that

the effective tax rates of shareholders fall into the top rate of the tax brackets.

• We re-measure WAT by assuming that effective tax rates of shareholders fall into the middle rate of the tax brackets. That is, the new definition of WAT is equal to INSTDi*(1-12.5%)+INSTFi*(1-10%)+INAi*(1-3%)+INBi*(1-6.5%)+INCi*(1-10.5%)+INDi*(1-15%)+INEi*(1-20%).

• We repeat our tests by using the new WAT, and the results are similar to those in previous section.

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Sensitivity to the Partition Point of the

Individual Shareholding Variable • Given the limitation of the dataset, we presumably

assume that all institutional shareholders hold more than 1,000 lots. We redefine the partition point as 800, 600, and 400.

• The result is shown in Table 10 .Our conclusions essentially remain unchanged even we redefine the partition point.

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Sensitivity to the Exclusion of Firms Paying both Cash and Stock Dividends

• To rule out the potential confounding effects between cash and stock dividends, we separate our sample into cash-dividend-only and stock-dividend-only cases. However, this significantly reduces the sample size, and therefore may possibly affect the test power.

• We repeat our tests by including firms declaring both types of dividends in our sample, and our conclusions are unchanged even our sample include firms paying both cash and stock dividends.

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Sensitivity to the Potential Influence of the Effective Tax Rates of Invested Firms

• We extract from our sample those firms for which the effective tax rate is greater than the median or equal to zero, and re-estimate our empirical model.

• The results show that larger tax preferences lead shareholders of high-tech companies to expect that future effective tax rates of those companies will approach zero or even negative without respect to their current effective tax rates.

• Pooling the high-tech company in our sample will tend to bias regression coefficients of our experiment variables toward insignificant, and therefore our conclusions based on empirical results in previous section are conservative. 44

CONCLUSIONS • We find that there are significant market reactions during

the enactment week of the integrated tax system, this indicates that taxes are relevant to firm valuations.

• We found that (1) a firm’s dividend yield is positively related to share price reactions to the enactment of the integrated tax system, (2) the most influential investors that determine the price reactions are individual shareholders, and (3) their tax statuses affect the positive relationship between price reactions and dividend yields.

• These results support the traditional view of dividend tax capitalization, and support that shareholders’ tax statuses are relevant to firm valuations.

45