Ex-dividend day pricing in the New Zealand equity market

Abstract

This study examines the pricing behaviour of shares in New Zealand around the cum-dividend - ex-dividend day period over five successive tax regimes covering a thirteen year period. It relies on the unique characteristics of the New Zealand tax and institutional environment to empirically detect the effect of taxes on equity prices in New Zealand. Using a data set of portfolios of shares with degrees of imputation ranging from zero to 100% it is aimed to determine (i) how dividend taxes are priced as reflected in the market's marginal valuation of dividends relative to capital gains (ii) the market's valuation of imputation tax credits and (iii) the identity of the marginal investor driving equity prices. This is facilitated by the introduction of a dividend imputation tax system whose benefits were initially restricted to New Zealand resident investors before being progressively extended to specific classes of non-resident investors. The theoretical underpinning of four complementary models used to identify these tax and valuation effects is described and benchmark parameter values against which empirical estimates are compared are derived. The research design permits both a within tax regime and a between tax regime comparative analysis. The evidence is consistent with the existence of a dividend tax effect, implying investors' require higher before tax rates of return where dividends are tax penalised relative to capital gains. The pricing of imputation credits is shown to vary over time in a manner that parallels the extension of their benefits to offshore investors. During tax regime 3, the period during which only New Zealand resident investors could access value from imputation credits, their market valuation was approximately zero. Following their extension to non-resident portfolio investors, one dollar of imputation credit was valued at around $1. This result was consistent across all four test metrics. These valuations were, in large measure, unchanged during the subsequent tax regime that extended the benefit of imputation credits to non-resident direct investors. Reservations were, however, necessary in interpreting point estimates in instances where standard errors were high. The statistical results, together with external corroborating evidence, gave credence to the conclusion that the marginal investor in the New Zealand equity market over the fiscal years 1990-2000 was most likely a non-resident portfolio investor.