A note on transaction costs and the interpretation of dividend drop‐off ratios

In a recent edition of this Journal, Bartholdy and Brown (1999) presented an analysis of the ex‐dividend share price behaviour of shares listed on the New Zealand Stock Exchange. The authors conclude that their results are consistent with the tax clientele effect (driven by long‐term investors) and that there is little or no support for the short‐term trading hypothesis. Our purpose is to highlight the importance of transaction costs in analyses such as Bartholdy and Brown’s. We argue that their results have an alternative interpretation because their analysis excludes the impact of transaction costs. We extend their model to include transaction costs and show that their results are not necessarily inconsistent with the short‐term trading hypothesis. A critical point of our analysis is that, in the presence of transaction costs, the equilibrium drop‐off ratio for dividend strip traders will be less than one, and, in some cases, can be less than the equilibrium drop‐off ratio for long‐term investors.