Dividend Taxes, Investor Horizon, and Idiosyncratic Volatility

ABSTRACT We examine whether dividend tax induced lock-in reduces idiosyncratic volatility. The 2012 Dividend Tax Reform in China tied individual investors' dividend tax to the length of their shareholding period, with short-term individual investors entering into higher tax brackets. We find that high dividend firms experience a reduction in idiosyncratic volatility, relative to low dividend firms, after the reform. The effect is more pronounced when high dividend firms have more retail investors and exhibit greater uncertainty. High dividend firms also experience a reduction in stock price crashes. Finally, with reduced trading by individual investors who are likely less informed, earnings announcements of high dividend firms trigger less trading volume during the event window post-reform, but enable more complete price reactions. We conclude that dividend tax induced lock-in, through discouraging short-term individual investors' trading, stabilizes the market and improves share price informativeness. JEL Classifications: G12; G14; G35; F38.