Dividend Taxes and Share Prices: Evidence from Real Estate Investment Trusts

Financial economists have debated the impact of dividend taxes on firm valuation for decades, but existing empirical evidence is mixed. In this study, we avoid certain complications inherent in previous empirical work by exploiting institutional characteristics of Real Estate Investment Trusts (REITs). For REITs, dividend policy is largely non-discretionary, share repurchases are not tax advantaged relative to dividends, and the market value of a firm's assets is relatively transparent to investors. In addition, REITs are exempt from corporate taxes, so their tax deductions flow directly to shareholders as reductions in dividend taxes. Within this environment, we regress the market value of a REIT's equity on the market value of its assets and its tax basis in assets, which creates tax deductions that lower future dividend taxes. We find that tax basis has a positive effect on firm value, which suggests that investors capitalize future dividend taxes into share prices.