The Ex-Day Behavior of Preferred and Common Stocks

Abstract

This paper examines the effects of investor level taxes on ex-dividend day behavior. Using fifteen years of historical data, we perform a quasi-experiment using the 2017 Tax Cuts and Jobs Act (TCJA), which reduced corporate investors' tax rate on capital gains relative to dividends. We exploit variation in the portion of shares held by institutional investors to identify securities for which corporate investors set prices, and we leverage a market adjusted model to describe ex-day price drops. Using a cross-sectional methodology, we find that ex-day behavior among common stocks did not change around the TCJA but price drops decreased for preferred stocks held by corporate investors. We implement a matched-pairs design to show that this observation among preferred stocks is attributable to tax effects. These findings suggest that while short-term arbitrageurs are capturing dividends for common stocks, tax clienteles affect ex-day pricing for preferred stocks. We vet these conclusions by back testing a dividend capture strategy and looking at ex-day behavior outside of the TCJA. While we document support for the aforementioned results, we find evidence for tax clienteles among illiquid common stocks and show that arbitrageurs are capturing ex-day returns for the most liquid preferred stocks.