A Note on Transaction Costs and the Interpretation of Dividend Drop-off Ratios

In a recent edition of this Journal, Bartholdy and Brown (1999) presented ananalysis of the ex-dividend share price behaviour of shares listed on the NewZealand Stock Exchange. The authors conclude that their results are consistentwith the tax clientele effect (driven by long-term investors) and that there islittle or no support for the short-term trading hypothesis. Our purpose is tohighlight the importance of transaction costs in analyses such as Bartholdy andBrown's. We argue that their results have an alternative interpretation becausetheir analysis excludes the impact of transaction costs. We extend their modelto include transaction costs and show that their results are not necessarilyinconsistent with the short-term trading hypothesis. A critical point of ouranalysis is that, in the presence of transaction costs, the equilibrium drop-offratio for dividend strip traders will be less than one, and, in some cases, can beless than the equilibrium drop-off ratio for long-term investors.