Determination of marginal stockholder tax rates and its use in testing the clientele effect

Abstract

Purpose of Study: Marginal Stockholder Tax Rates play an important role in many facets of modern financial theory. This paper was intended to extend an earlier study by Edwin J. Elton and Martin J. Gruber by redefining their test statistic in accordance with modern capital market theory. By observing the ex-dividend behavior of common stocks, it is theoretically possible to infer marginal stockholder tax rates. Identification of such rates would allow an examination of the relationships between those rates and a firm's dividend policy as measured by its dividend yield and payout ratio. A significant relationship-between these variables would lend support to Miller and Modigliani's Clientele Effect (each firm is assumed to have a body of stockholders who find its dividend policy optimum).

Findings and Conclusions: The study found that marginal stockholder tax rates could be inferred using the newly defined test statistic. Although results concerning a firm's dividend yield and marginal stockholder tax rates were less than definitive, a plausible explanation for the outcome is offered. A significant relationship was found between payout ratios and implied tax rates, however, using the redefined statistic. On the basis of the tests conducted in this study, it appears the adjusted {redefined) statistic is a better measure for determining marginal stockholder tax rates than the statistic used by Elton and Gruber.