The Limits to Dividend Arbitrage: Implications for Cross-Border Investment

The economic significance of the tax on cross-border dividends depends on the limits to dividend arbitrage. In the case of Canadian payments to the U.S. we observe these limits exactly because we see the actual pricing of the dividend-arbitrage transactions. These transactions recover only some withholding, so that Canadian and non-tax U.S. accounts perceive different expected returns from Canadian stocks, where the difference increases with dividend yield. The resulting difference in expected utility of wealth is small but the difference in efficient portfolio weights is potentially large and increasing in yield, and the actual difference between Canadian and U.S. holdings of Canadian stocks is large and increasing in yield. Governments may thus take advantage of robust financial markets to boost domestic governance of domestic firms at a low utility cost, though this may be more preferable for zero-dividend firms, whose governance moves abroad.