Tax reform and the identity of marginal traders around ex-dividend days ☆ Yun-lan Tseng a, ⁎, Shing-yang Hu b a National Pingtung Institute of Commerce, 51 Min Sheng E. Road, Pingtung 900, Taiwan, ROC b Department of Finance, National Taiwan University, No. 1, Sec. 4, Roosevelt Road, Taipei 106, Taiwan, ROC article info abstract Article history: Received 9 March 2012 Accepted 21 August 2013 Available online 5 September 2013 In 1998, Taiwan changed the computation of dividend income for domestic investors. This tax reform offers a natural experiment to explore the relation between taxes and investor behavior around ex-dividend days. We find that the 1998 tax reform reduces the ex-date return and changes the identity of marginal traders on the ex-dividend day. While large and small individual investors functioned as marginal traders before the reform, large individual investors and foreign investors play the role after the reform. We also find that all types of domestic investors engage in arbitrage around ex-dividend days prior to the tax reform, whereas following the tax reform, domestic investors and foreigners act as short-term arbitrageurs surrounding the ex-date. Overall, our findings strongly support the dynamic dividend clientele theories. © 2013 Elsevier B.V. All rights reserved. JEL classification: G12 G14 G15 Keywords: Ex-dividend day Tax reform Marginal trader Arbitrage Contents 1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182 2. Institutional aspects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183 2.1. Dividend tax system before the 1998 tax reform . . . . . . . . . . . . . . . . . . . . . 184 2.2. Dividend tax system after the 1998 tax reform . . . . . . . . . . . . . . . . . . . . . . 184 2.3. Taiwan Stock Exchange and market participants . . . . . . . . . . . . . . . . . . . . . . 185 3. Testable hypotheses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185 3.1. Tax-motivated trading hypothesis . . . . . . . . . . . . . . . . . . . . . . . . . . . . 186 3.2. Determinants of arbitrage trading around ex-dividend days . . . . . . . . . . . . . . . . 187 Pacific-Basin Finance Journal 25 (2013) 181–199 ☆ We are grateful to Jun-Koo Kang (the editor) and an anonymous reviewer. We also acknowledge the financial support from the National Science Council (NSC 96-2416-H-251-008). ⁎ Corresponding author. Tel.: +886 8 7238700 32648; fax: +886 8 7220549. E-mail addresses: tyunlan@npic.edu.tw (Y. Tseng), syhu@ntu.edu.tw (S. Hu) 0927-538X/$ – see front matter © 2013 Elsevier B.V. All rights reserved. http://dx.doi.org/10.1016/j.pacfin.2013.08.009 Contents lists available at ScienceDirect Pacific-Basin Finance Journal journal homepage: www.elsevier.com/locate/pacfin