Jeff Whitworth

Professional Programs in Business (Finance)

Ex-Dividend Stock Price Behavior:

Evidence from a Century of Tax Law Changes

My research focuses on understanding the behavior of a company’s stock price around ex-dividend dates. When a corporation decides to pay a dividend to its stockholders, there is a certain “cutoff” date by which a person must own the stock in order to receive this dividend. The ex-dividend date is one day too late – in other words, it is the first day where the right to the next dividend no longer trades with the stock. Logic suggests that the stock price should (on average) drop by the dividend amount on that date, but it is well-documented that the actual price drop tends to be smaller.

Why does this occur? The oldest and best-known theory was proposed in 1970 by Elton and Gruber. They effectively argued that since dividends usually have been taxed more heavily than stock price increases (capital gains), no rational person would continue holding the stock through an ex-dividend date unless the price drop were indeed less than the dividend. Since 1970, Elton and Gruber’s idea has been tested in a number of ways, and surprisingly there is no strong consensus supporting or refuting their theory.

My research uses a large sample of events where stocks have gone “ex-dividend” over the last century and compares actual stock price drops with what the Elton- Gruber model would predict, given the respective tax rates t_d and t_cg for dividends and capital gains in effect at the time of each event. I find evidence in support of Elton and Gruber’s theory. In other words, the ex-dividend stock price drop is actually smaller (relative to the dividend amount) when there is a greater difference between t_d and t_cg.