THE IMPACT OF A LARGE DIVIDEND TAX CHANGE ON EX-DIVIDEND DAY SHARE PRICE BEHAVIOR: A NATURAL EXPERIMENT FROM SOUTH AFRICA Phillip de Jager & Michelle Chinhema University of Cape Town

Introduction 1 April 2012: STC changed to DT Average SA investor better off Did share prices reflect this fact?

Introduction JSE is 16th largest 381 companies +- 20% dual listed British American Tobacco; SABMiller; BHP Billiton; Richemont; Anglo American

Limited other market factors

Literature review Elton & Gruber (1970): 𝑃 𝑐𝑢𝑚 −( 𝑃 𝑐𝑢𝑚 − 𝑃 0 ) 𝑡 𝑐𝑔 = 𝑃 𝑒𝑥 −( 𝑃 𝑒𝑥 − 𝑃 0 ) 𝑡 𝑐𝑔 +d(1- 𝑡 𝑑 ) PDR= 𝑃 𝑐𝑢𝑚 − 𝑃 𝑒𝑥 𝑑 = (1− 𝑡 𝑑 ) (1− 𝑡 𝑐𝑔 ) P0 came off both sides of the equation. Thus struggled with equation‘s explanation. Audience not all convinced of the mechanism of arbitrage. Relates somewhat back to not fully believing that STC was shareholder tax.

Literature review Tax clientele effect exists: Or not: Elton, Gruber & Blake (2005) – confirmed in more than 12 countries Or not: Kalay (1982) – transaction costs limit arbitrage Frank & Jagannatham (1998) – Hong Kong, microstructure effect Bali & Hite (1998) – discreteness in prices rather than taxes Recent work: Elton, Gruber & Blake (2005) – closed-end dividends Whitworth & Rao (2010) – very long US time series Assumes marginal shareholder = individual tax payers Assumes binary outcome Assumes marginal shareholder = individual & corporate tax payers No control for other factors

Contribution “There are fewer better opportunities to test theories about taxes than the natural experiment created by changes in a country’s tax laws” Excellent “control for other possible factors” Tax paying shareholders grouped into 4 categories Linked with literature on “institutional investors” Not forcing a binary outcome Research question: What does the 2012 dividend tax change in SA tell us about the tax clientele theory?

Tax collection statistics Dividend tax in SA STC=10% and DWT=15% Tax collection statistics Tax year Company income tax STC DWT 2009/10 134 883m 15 468m - 2010/11 132 902m 17 178m 2011/12 151 627m 21 965m 2012/13 159 259m 9 814m 9 925m 2013/14 177 460m 911m 16 398m Audience not convinced that STC was a dividend tax that influenced investor decisions. Can be argued that STC reduced amount payable as dividend and thus those that prefer capital gains would have not preferred dividends. Also, definitive change into new dividends dispensation where shareholders can now choose. From system where decision was to pay CGT or not to one where you choose. Why did SARS change the dividend tax system in 2012? Why STC receipt after 2012 for ½ year?

Change expected PDR = (1− 𝑡 𝑑 ) (1− 𝑡 𝑐𝑔 ) Needed to explain more where PDR comes from. Put formula here for PDR.

Research approach Calculate PDR for all companies two years before 1 April 2012 and 2 years after Control for market movement on ex day Comparison of means/medians Fixed effect regression with control variables: Size Std deviation co/market Dividend size Dividend yield Explain more such as all dividends less exclusions. Unbalanced panel. winsorization.

Comparison of means Pre change Post change Change % Mean - PDR 0.72* 0.87* 22.4% Mean – PDR noadj. 0.67*** 0.89*** 33.3% Median - PDR 0.86*** 0.96*** 11.6% Median – PDR noadj. 0.87*** 0.98*** 12.6% Sample size 509 517 Intuition for low PDR cannot be based on information effect. Rather liquidity effect. Add mean and median for unadjusted PDR

Regression results 𝑃𝐷𝑅 𝑖𝑡 = 𝛼 0 + 𝛼 1 𝑝𝑒𝑟𝑖𝑜𝑑+ 𝛼 2−5 𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑠 𝑖𝑡 + 𝜇 𝑖 + 𝜀 𝑖𝑡 Variable Coefficient Standard error Constant 10.16159 5.17026** Period dummy 0.37092 0.13744*** Control: size -0.50761 0.24159** Control: sd ratio -0.16845 0.09458* Control: div 0.65224 0.21247*** Control: dyield -10.31826 4.70797** R-squared = 30.42% Implied growth = 3.65% Suggestions for size effect: Remember smaller PDR means preference for dividends Institutions rebalancing portfolios with dividends; thus prefer dividends. Ties up with institutional herding and not signalling stock holdings to the competition. Institutional investors prefer large liquid stocks. “…then a change in firm size may be more appealing because of additional liquidity, but less appealing because increased agency problems reduce expected cash flows”. In the absence of institutions the individual shareholders become the marginal shareholders and lower PDR results. Institutions prefer “to invest in large, liquid stock that have low past returns”. High return companies all else equal will tend to grow fastest and thus not preferred by institutions. In the absence of institutions the individual shareholders become the marginal shareholders and lower PDR results. What explains the negative relationship between increases in changes in size (beyond time invariant portion) and PDR?

Robustness checks No market adjustment – 4.29% and better fit Differences model: ∆𝑃𝐷𝑅 𝑖𝑡 = 𝑃𝐷𝑅 𝑖𝑡−1 + 𝛼 0 + 𝛼 1 𝑝𝑒𝑟𝑖𝑜𝑑+ 𝛼 2−5 𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑠 𝑖𝑡 + 𝜇 𝑖 + 𝜀 𝑖𝑡 2.02% growth implied (2.20% without market adjustment) Remember that dividends and buybacks go hand in hand. Have to exclude buybacks as limitation.

Conclusions Direction of change consistent with tax explanation Size of change consistent with tax explanation Other explanations also valid and seemingly related to size effect So what? Trading opportunity for foreigner individuals Argument that natural experiments are rare and thus SA experience valuable: Sideways market (low noise) Large tax effect that impacts different shareholders differently Fixed effects eliminate other omitted variables Comments for future study: What about looking at PDRs when CGT came into market?