Dividends, Short Selling Restrictions, Tax-Induced Investor Clienteles and Market Equilibrium ROBERT H. LITZENBERGER and KRISHNA RAMASWAMY* I. Introduction THEPURPOSE of this paper is to examine the effects of tax-induced investor clienteles on capital asset prices. In their seminal work on corporate dividend policy, Miller and Modigliani (1961) argued that in a world where dividend income is taxed at a higher rate than capital gains, and tax rates vary across investors, corporations would adjust their dividend policies until, in equilibrium, such policies coincided with the desires of shareholders. That is, tax-induced shareholder clienteles would form, with low (high) yielding stocks being held by investors in high (low) marginal tax brackets. Black and Scholes (1974) argue for a âsupply effectâ, such that in equilibrium, a marginal change in a corporationâs dividend distribution would leave its stock price unaffected. Brennan (1970) was the first to derive an After-Tax Capital Asset Pricing Model (CAPM) that accounted for the differential taxation of dividend and capital gains, and for a progressive tax scheme. The model was later extended by Litzenberger and Ramaswamy (1979) to account for restrictions on investorsâ borrowing. While in both models investorsâ tax brackets do influence their portfolio choices, it turns
The Journal of Finance – Wiley
Published: May 1, 1980
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