An Empirical Study Of China's Stock Market Goes Ex-dividend Day Stock Price Behavior

In a perfect Walrasian market with no taxes or transations' costs, share prices on the ex-dividend day would fall by exactly the value of the dividend that is paid on each share. However, it is well documented that stock prices do not fall by full amount, on average. Following Elton and Gruber(1970),we use Chinese data to examine the effect of dividend taxes on investors' relative valuation of dividends and capital gains. The tax effect on ex-dividend day behavior of common stock predicts that ex-dividend day price ratio can be used to estimate marginal tax rates in China. The tax clientele effect of MM holds that each firm is assumed to have a body of stockholders who find its dividend policy optimum. Investors who hold stocks with high dividend yields should be in low tax brackets relative to stockholders who hold stocks with low dividend yield.Studying the relationship between dividends and stock price movements during 1995 to 2000,we find the average of the ex-dividend day price ratio is less than one. While the spearman's rho correlation coefficient between the dividend yield and ex-dividend price ratio is positive, but not statistically significant at 5% level. So the ex-dividend day price ratios do not provide much evidence in support of dividend tax clienteles. The results of this paper suggest that tax rate doesn't play an important role in investor's portfolio decision and the ex-dividend day price ratio can't be used to measure the market's marginal tax rate.Tax effect hypothesis and the tax clientele hypothesis are based on the assumption that the marginal stockholders are primarily long-term investors, but short-term traders dominate China's stock markets. Since tax exemption for capital gain is not a major consideration in Chinese investor's decision, we suggest levying, tax on capital gain at appropriate time. The new tax system should be devised to fit for Chinese market. It will restrict the unduly speculation in China's capital market and accelerate orderly development of it.