The positive relationship between dividend yield and risk-adjusted return, which is called the dividend yield effect, is well documented in the US market. Yet, the drivers of the yield effect are unclear. Some argue this evidence is consistent with the prediction that the investor-level tax burden is capitalized in stock prices, also known as the tax capitalization hypothesis. Still others contend that nontax omitted factors drive the yield effect. The purpose of this paper is to contribute to the debate by exploring if the yield effect occurs in Hong Kong market where no taxes exist on either dividend income or capital gain.
The authors use two main approaches to detect the dividend yield effect. The first approach groups stocks into portfolios based on dividend yields and tests for the presence of a yield effect at the portfolio level. The second approach employs the Fama-MacBeth methodology at the firm level and tests if a yield effect is existent after controlling for firm characteristics known to explain stock returns.
The paper documents a robust dividend yield effect in the Hong Kong market and suggests that nontax reasons help to explain the yield effect.
Tax capitalization is a long-standing question in financial economics and the research evidence is mixed. The findings do not completely rule out the tax capitalization hypothesis. The main contribution is to illustrate the difficulty of conducting a powerful test of this hypothesis in practice and to urge caution in interpreting the dividend yield effect as evidence in support of this hypothesis.
JEL Classification — G12, H20
The authors thank the guest co-editor, H. Kent Baker, anonymous referees, Elena Asparouhova, Hank Bessembinder, Uri Loewenstein, Eleanor Xu, and participants at the University of Utah’s PhD student seminar and the 2013 Financial Management Association annual meeting for helpful comments and suggestions. The authors also thank Andrew Ang, Robert Hodrick, Yuhang Xing, and Xiaoyan Zhang for kindly sharing the Hong Kong Fama-French factors that the authors used in an earlier version of the paper.
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