Shifts in Ownership Composition and Changes in the Implied Cost of Equity Capital for Dividend and Non-Dividend Stocks Following JGTRRA03

ABSTRACT: Prior studies of the Jobs and Growth Tax Relief Reconciliation Act of 2003, which cut individual tax rates on both dividends and capital gains, unexpectedly find that non-dividend firms were more favorably affected by this legislation than dividend firms. We address this apparent inconsistency by extending prior research to account for significant shifts in institutional holdings for non-dividend stocks relative to dividend stocks following the tax change. These clientele shifts were especially concentrated among high-risk firms and provide a plausible explanation for the results reported in prior literature. Specifically, we find that significant increases in institutional ownership for high-risk firms led to larger reductions in the implied cost of equity capital compared to other firms that were more heavily favored by individuals following the reduction in shareholder tax rates.