Accrued capital gains and ex-dividend day pricing

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Purpose – The purpose of this paper is to show how recent capital gains affect ex-dividend stock pricing. Traditional models assume that investors are motivated to sell a stock before its ex-date to avoid paying higher taxes on dividends. However, if a stock has appreciated significantly, stockholders have an offsetting incentive to delay the realization of capital gains by continuing to hold the stock in spite of the higher dividend tax rate. Design/methodology/approach – This paper develops a model showing that ex-dividend price drops should be greater in the presence of larger accrued capital gains. The model was tested by regressing ex-day pricing measures on the relative size of the recently accrued gain, along with other control variables. Findings – Empirical tests confirm that accrued gains reduce the magnitude of the ex-day effect, increasing the price drop ratio (ΔP/D) and reducing ex-day returns. Also documented was that ex-day price drops are larger for stocks that have recently experienced positive gains, that the observed effect of recent price performance is stronger for higher-yield stocks, and that share turnover is usually lower for stocks with greater gains. Research limitations/implications – This paper's findings suggest that the results of existing empirical investigations of ex-day pricing should be interpreted with some caution, and that future studies should control for gains that occur prior to the ex-date. Originality/value – While the tax clientele explanation of ex-day pricing has been investigated extensively, this is the first study to show how accrued gains and losses impact ex-dividend price changes.

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