Investor tax heterogeneity and ex-dividend day trading volume: The effect of dividend yield and institutional ownership

Abstract

I demonstrate how the presence of institutional investors impacts the volume effect of dividend yield around ex-dividend days. Dividend yield proxies for the tax-disadvantaged portion of security return while the level of institutional ownership proxies for the degree of tax-induced investor heterogeneity. Cross-sectional tests support the tax-motivated trading hypotheses: (1) Ex-day excess trading volume increases in dividend yield and this positive relation is a concave quadratic function of the level of institutional ownership. (2) The volume effect of dividend yield peaks when the level of institutional ownership is at 32.18%--lower than 50%, implying that institutional investors may be more risk tolerant than individual investors. (3) Across tax regimes, some support is also found for the ex-day tax-motivated trading hypotheses. These results, combined with studies supporting dividend tax capitalization, suggest that tax matters in valuation and it impacts both stock price and investor trading patterns around ex-dividend days.