Can firm‐specific dividend drop‐off ratios be used to infer shareholder marginal tax rates?

In a seminal study, Elton and Gruber (1970) argue that ex-dividend day pricing can be used to infer the marginal tax rates of shareholders. If this view is correct, managers of individual firms would be provided with information of relevance to major financing and distribution decisions. We examine ex-dividend day pricing for individual firms and ask whether their CFOs could use the history of a firm’s ex-dividend price-drop to dividend ratios to infer reasonable estimates of their shareholders’ marginal tax rates. We use TAQ data for 1,124 US firms that have at least 30 ex-dividend days during a sample period from August 1993 to October 2012. Our results show that ex-dividend day pricing is so noisy as to prohibit sensible estimates of shareholders’ marginal tax rates. In addition, the results indicate that drop-off ratios generally lie within transaction cost boundaries, consistent with a limits to arbitrage transactions’ cost explanation provided by Kalay (1982).