Corporate Finance: Dividend Policy and Company Value CFAI p1 investor, why, capital, someone

hassan

Can someone please explain intuitively why if the investor’s marginal tax rate on dividends is higher than marginal tax rate on capital gains, the share price should drop by less than the amount of dividend when the share goes ex-DIV.
Thanks.

economicz

Just work it through the formula. (Pw - Px) is the adjusted price.
Pw - Px = D * (1 - Td) / (1 - Tcg)
Let say marginal rate is 50% and capital gains rate is 25%.
Pw - Px = D * 0.67
In this case, D must decrease by 0.67 to keep the equation balanced. It might be easier to imagine the last term, (1 - Td) / (1 - Tcg), as a whole. If it’s greater than 1, ex-div price will increase by more than the dividend. If it is equal to 1, ex-div price will decrease exactly by the amount of dividend. If it is less than 1, the ex-div price must decrease by more than the dividend.
It’s easier to understand if you plug numbers.