New evidence of the impact of dividend taxation and on the identity ofthe marginal investor

This paper examines the impact of a major change in dividend taxation introduced in the UK in July1997. The reform was structured in such a way that the immediate impact fell almost entirely on thelargest investor class in the UK, namely pension funds. We analyse the behaviour of share pricesaround the ex-dividend day both before and after the reform to test clientele effects and the impact oftaxation on the valuation of companies. We find strong clientele effects in the UK, which are consistentwith the distortions introduced by the tax system (before the reform dividend income was taxadvantagedin the UK). We also find significant changes in the valuation of dividend income after thereform, in particular for high-yielding companies. These results provide strong support for thehypothesis that taxation affects the valuation of companies, and that pension funds were the effectivemarginal investors for high-yielding companies....