The Effect of Taxes on the Relative Valuation of Dividends and Capital Gains: Evidence from Dual-Class British Investment Trusts

Authors

  • JAMES S. ANG,

  • DAVID W. BLACKWELL,

  • WILLIAM L. MEGGINSON

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    • Ang is at Florida State University; Blackwell and Megginson are at the University of Georgia. We are grateful to Warren Bailey, Jim Brickley, Leroy Brooks, Larry Harris, John Neter, James Poterba, Annette Poulsen, Krishna Ramaswamy, John Shoven, Joe Sinkey, Mary Zimmer, workshop participants at The University of Alabama and Texas A&M University, and an anonymous reviewer for their helpful comments and recommendations. Mary Dehner provided valuable editorial assistance. We acknowledge the data collection assistance provided by Subodh Bhat, Drew Winters, and especially, Paul English. Earlier drafts of this paper were presented at the 1988 Western Finance Association and American Finance Association meetings.

ABSTRACT

We provide evidence that taxes affect equity valuation by studying British investment trusts having otherwise identical classes of cash- and stock-dividend-paying shares outstanding. We study 1969–1982, a period in which there were two dramatic changes in tax policy. We find that stock-dividend shares, which are convertible into cash-dividend shares, sell at premiums when the tax system favors capital gains and at discounts when the tax advantage of capital gains is reduced. After the 1975 elimination of the tax advantage to stock-dividend shares, we observe that investors convert virtually all stock-dividend shares into cash-dividend shares.

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