CORPORATE TAXES AND DIVIDEND CLIENTELES: THE CASE OF PUBLIC UTILITY PREFERRED STOCK

Recent research has documented the existence of abnormal returns on the day a stock trades ex-dividend. Much research is consistent with a tax hypothesis to explain this phenomena. Less explored is the effect of heterogenous income tax law on ex-dividend day returns. For example, U.S. corporations face a high domestic tax rate on capital gains and a low domestic rate on dividend income. Individuals, on the other hand, have higher tax rates on their dividend income. This dissertation searches for effects that corporate investment activity may have on ex-day returns by examining the effect of two corporate tax variables which affect corporate invcestors but not individual investors. Public utility preferred stock was selected for study because it has a special corporate tax attribute and since preferred stock isolates the effect of dividend taxation from capital gains taxation. The period 1948-1964 was selected because it covers a United States tax law change affecting the dividends received corporate stockholders.; One goal for this study is to characterize tax based corporate dividend clienteles and the effect of corporate investment activity on the ex-dividend price setting process. A second goal for this project is to contribute to the understanding of the effects of corporate tax rules on the ex-dividend returns.; This work extends earlier studies on ex-day returns by developing a previously unexplored data set. It confirms work done on other data documenting an abnormal ex-day return consistent with an income tax effect. The findings of this research are partially consistent with corporate investors being the marginal investor for public utility preferred stock. In spite of higher yields, ex-day returns increased after the imposition of a holding period for the corporate dividends received deduction. Such a holding period should reduce effective returns to corporate investors who act as marginal trader and bid away the abnormal return tax premium in the period. On the other hand, new money public utility preferred stock, which has lower effective corporate tax rates than the corporate tax rate on dividends from old money stock, are not associated with lower abnormal ex-day returns. This result is not consistent with tax motivated corporate investors being marginal ex-day traders for new money preferred stock. Risk is conjectured as a factor interacting with tax costs to impact clientele formation.