Why do stock prices drop by less than the value of the dividend? Evidence from a country with a flat tax rate on capital gains and dividends.

Abstract

We examine the effect of taxes, trading activity and different market microstructures on the ex-dividend day stock price behaviour. Based on previous literature, we build our hypotheses and test them on 1380 ex-dividend day observations in order to pinpoint the explanations behind the empirical findings on the Stockholm Stock Exchange over the period 2007 to 2016. We find price-drop ratios of 72% and 56% in the close-to-close sample and close-to-open sample, respectively. This finding opposes the theoretically implied price-drop ratio of one given the prevailing tax regime in Sweden. The trading activity increases around the ex-dividend day and is the greatest in high-yield stocks. We also find that the price-drop ratio is positively related to dividend yield, indicating that stock prices are set more efficiently in high-yield stocks on the ex-dividend day. Our findings are generally consistent with the short-term trading explanations from previous literature. Transactions costs seem to be the factor limiting the stock prices to drop by the value of the dividend. It is also possible that ex-dividend day stock prices are affected by factors that has not been discovered by financial literature.