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Dividend taxes and stock volatility

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  • Erin E. Syron Ferris

    (Federal Reserve Board)

Abstract

How do dividend taxes affect stock volatility? If a risk-averse executive faces price risk through his incentive contract, changes in stock volatility due to dividend taxes may increase agency costs and therefore decrease overall welfare. In this paper, I use a decrease in dividend taxes as a natural experiment to identify their effect on the firm’s idiosyncratic stock return volatility. Stock volatility decreased after the tax cut for firms at which executives have larger sensitivity to stock price in their incentive compensation package relative to firms at which executives have a smaller sensitivity. Therefore, with risk-averse executives and risk-neutral shareholders, dividend taxes may exacerbate agency costs. The increase in agency costs will decrease shareholder welfare, which can be partially offset by the use of options in the employment contract.

Suggested Citation

  • Erin E. Syron Ferris, 2018. "Dividend taxes and stock volatility," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 25(2), pages 377-403, April.
    • Handle: RePEc:kap:itaxpf:v:25:y:2018:i:2:d:10.1007_s10797-017-9455-2
    DOI: 10.1007/s10797-017-9455-2
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    More about this item

    Keywords

    Dividend taxes; Stock volatility; Executive compensation;
    All these keywords.

    JEL classification:

    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • G3 - Financial Economics - - Corporate Finance and Governance

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