A Tax-Based Test of the Dividend Signaling Hypothesis

We propose and implement a new test of the dividend signaling hypothesis. Dividend signaling models generally imply that an increase in dividend taxation should increase the share price response per dollar of dividends (or "bang-for-the-buck"). Many other dividend-preference theories have the opposite implication. An analysis of recent variations in tax policy reveals a strong positive relation between dividend tax rates and the bang-for-the-buck. Additional evidence on the relation between the bang-for-the-buck and other variables that are related to the marginal cost of paying dividends provides further support for dividend signaling.