Dividend Tax Capitalization and Firm Valuation: Insights from Taiwan's Capital Markets

Abstract This study investigates the impact of comprehensive personal income taxes on capital markets using the market model estimated by seemingly unrelated regressions. Focusing on the repeal of Article 238 of the Companies Act in Taiwan in 2001, which allowed companies to choose whether to transfer capital reserves to retained earnings, we explore how this decision affected firm valuation. While theoretically, such a transfer does not alter firm value, it enhances a company’s ability to distribute cash dividends. We examine whether shareholders discount stock prices due to anticipated increases in comprehensive personal income tax associated with dividend payments. Our findings reveal negative abnormal returns following the repeal of Article 238, particularly pronounced for companies with larger amounts of transferable capital reserves. Moreover, investors assign lower valuations to capital reserves eligible for transfer into retained earnings. These results carry implications for understanding the impact of dividend taxes on stock prices and broader considerations regarding the effects of similar tax burdens on capital markets.