Do Investors Ignore Dividend Taxation? A Reexamination of the Citizens Utilities Case

Citizens Utilities Company (CU), Stamford, CT, has two classes of common stock, one paying cash dividends and one paying stock dividends. Unless CU shareholders ignore dividend taxation, the price of the cash dividend shares should increase relative to the stock dividend shares after the 1986 tax change. Contrary to this hypothesis, we find that the relative valuation of these two classes of shares was not permanently affected by the tax change. We do observe a pricing change around the time of the tax reform, but the effect is only temporary—the relative valuation before the tax change (1982–1984) and after (1987–1989) is almost equal. Two possible explanations for the observed valuation of the two stocks are clientele effects and differences in liquidity. We find that neither of these explanations can account for the relative pricing of the shares.