Influence of dividend tax policy tied to investment horizon on stock price stability: Evidence from the 2015 dividend tax reform in China

• Published date: 01 September 2023
• Author: Nianzhi Guo,Ping‐Wen Sun,Huiqin Xiao
• Date: 01 September 2023
• DOI: http://doi.org/10.1111/irfi.12408

ORIGINAL ARTICLE

Influence of dividend tax policy tied

to investment horizon on stock price stability:

Evidence from the 2015 dividend tax reform

in China

Nianzhi Guo

1

| Ping-Wen Sun

1

| Huiqin Xiao

2

1

Newhuadu Business School, Minjiang

University, Fuzhou, China

2

School of Economics, Jinan University,

Guangzhou, China

Correspondence

Ping-Wen Sun, Newhuadu Business School,

Minjiang University, Fuzhou, China.

Email: sunpingwen@gmail.com

Funding information

Ministry of Education of the People's Republic

of China, Grant/Award Number:

19YJC790032; Minjiang University,

Grant/Award Number: MYS20011; National

Natural Science Foundation of China,

Grant/Award Number: 71801117; National

Office for Philosophy and Social Sciences,

Grant/Award Number: 18BJY241

Abstract

We examine how the dividend tax cut policy tied to the

investment horizon enforced on September 8, 2015, influ-

ences stock price stability in China's A-share market. As the

new dividend tax policy waives the tax on cash dividends

for investors holding a stock for more than a year, it encour-

ages long-term investment behavior. From 2013 to 2017,

we find that stock turnover, return volatility, and turnover

volatility decrease after the policy enforcement, especially

for stocks with high dividend yields. This result shows that

dividend tax reforms increase investors' stock investment

horizons and help stabilize the market. However, our find-

ings demonstrate that stock crash risk increases after policy

enforcement. Further analysis shows that earnings manage-

ment through real activities manipulation for stocks with a

higher dividend yield contributes to an increase in stock

crash risk. Therefore, one externality of the dividend tax cut

policy tied to the investment horizon is that top managers

of firms with a higher dividend yield may take advantage of

investors' passive longer-term investment behavior and

engage in more earnings management. This result suggests

that regulatory agencies should pay attention to top man-

agers' earnings management behavior after enacting policies

that encourage long-term investment.

Received: 27 November 2020 Revised: 24 November 2022 Accepted: 11 January 2023

DOI: 10.1111/irfi.12408

© 2023 International Review of Finance Ltd.

524 International Review of Finance. 2023;23:524–552.

wileyonlinelibrary.com/journal/irfi

KEYWORDS

crash risk, dividend tax, earnings management, share turnover,

stock return volatility

JEL CLASSIFICATION

G12, G14, G35, H20, M41

1|INTRODUCTION

On September 8, 2015, regulatory agencies, including the Ministry of Finance, State Taxation Bureau, and China's

Securities Regulatory Commission, announced a new dividend tax policy that waives not only the 5% dividend tax

for investors holding stock for more than a year, but also the immediate 5% dividend tax charge on cash dividends

that had been in force since the policy reform of November 16, 2012. The 2015 dividend tax reform aims to encour-

age long-term investment behavior; thus, we examine whether the new dividend tax cut policy tied to the invest-

ment horizon stabilizes stock prices. Specifically, we compare stock turnover, return volatility, turnover volatility, and

crash risk measures 2 years before (2013 and 2014) and after (2016 and 2017) the 2015 dividend tax reform.

1

Several studies have shown that dividend tax policies affect corporate behavior. Chetty and Saez (2005) find

that after the enactment of the U.S. Jobs and Growth Tax Relief Reconciliation Act of 2003, which lowered the divi-

dend tax rate, public companies increased their cash dividend payouts, especially those with large taxable share-

holders. Blouin et al. (2011) also document that public companies' directors and officers rebalanced their portfolios

to maximize their after-tax dividend income after the 2003 dividend tax reform. Similarly, Li, Liu, et al. (2017) study

the 2012 dividend tax reform in China, which lowers investors' dividend tax rates on the basis of their shareholding

period. They find that firms reacted to the 2012 dividend tax reform by paying more dividends if their investors

experienced a reduction in their dividend tax rates. Hanlon and Hoopes (2014) find that, immediately before

investor-level dividend taxes increase, firms increase their special dividends or regular dividend payouts. These stud-

ies demonstrate that public companies focus on how the dividend tax policy affects shareholders' tax liabilities when

forming their dividend payout policies.

In contrast to studies that examine how dividend tax policy affects corporate behavior, we explore how the

2015 dividend tax reform in China's A-shares market influences investors' behavior and the resulting stock price sta-

bility.

2

The 2015 dividend tax reform was enacted in September 2015 because the rapid stock market decline during

the summer of 2015. From June to August 2015, China's A-share market dropped by 50% from the highest point

reached on June 12, 2015. On September 8, 2015, to stabilize the stock market and encourage long-term investment

behavior, regulatory agencies further decreased the dividend tax rate from 5% to 0 on stocks held for more than a

year. Therefore, our study investigates whether the 2015 dividend tax reform stabilizes the market and provides reg-

ulatory agencies with an important reference for policy effectiveness. Furthermore, our empirical findings have impli-

cations for policies that encourage long-term investment behavior.

We proceed with the study as follows: First, we construct a sample to perform our analysis. Following Li, Liu,

et al. (2017), we exclude stocks in the financial industry and require our sample stocks to have all the variables used

for analysis in all 5 years from 2013 to 2017. We then use the years 2013 and 2014 before the 2015 dividend tax

reform and the years 2016 and 2017 after the 2015 dividend tax reform as our sample period for our main analysis.

3

Second, we examine how the 2015 dividend tax reform influences stock price stability. Our proxies for stock price

stability include stock turnover, return volatility, turnover volatility, and two crash risk measures. To investigate

whether dividend tax reform affects high-dividend-yield stocks more, we also include the interaction term between

dividend yield and the post 2015 dividend tax reform dummy in the regression analysis. Third, we investigate which

groups of the sample stocks drive the effect of the 2015 dividend tax reform on stock price stability. We separate

our sample stocks into dividend- and non-dividend-paying stocks in 2014, the year before the policy year 2015. We

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