Dividend taxes and security prices: the reaction of dividend-paying stocks to the jobs and growth tax relief reconciliation act of 2003

We analyze cumulative abnormal returns (CARs) around key events leading up to the passage of JGTRRA to determine whether a reduction in the individual tax rate on dividend income affects stock prices, and if so, whether that effect differs for different groups of firms. In general, we find that dividend yield is positive and significantly related to CARs around both the December and January announcements that legislation might be enacted to reduce or eliminate the dividend tax. Consistent with this observation, when Congress subsequently passed the final Senate vote to reduce but not eliminate dividend taxes, we observe positive and statistically significant returns for high-yield dividend firms, but not for other firms. Additionally, we analyze the role of institutional ownership in the relation between firm yield and price reaction. The incentive to buy dividend-paying stocks should not be influenced by the degree to which a firm's stock is held by institutional investors but rather by the firm's dividend yield. Our results suggest that this distinction is important - institutional ownership appears to be significant for tax changes that induce seller-initiated market reactions, but not for changes that increase buyer-initiated reactions.