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Direct Evidence of Dividend Tax Clienteles

Magnus Dahlquist, Goran Robertsson, Kristian Rydqvist

PII: S0927-5398(14)00046-2DOI: doi: 10.1016/j.jempfin.2014.05.003Reference: EMPFIN 733

To appear in: Journal of Empirical Finance

Received date: 3 April 2013Revised date: 18 February 2014Accepted date: 9 May 2014

Please cite this article as: Dahlquist, Magnus, Robertsson, Goran, Rydqvist, Kristian,Direct Evidence of Dividend Tax Clienteles, Journal of Empirical Finance (2014), doi:10.1016/j.jempfin.2014.05.003

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Direct Evidence of Dividend Tax Clienteles

Magnus Dahlquist Goran Robertsson Kristian Rydqvist∗

May 2014

Abstract

The paper is the first to evaluate the dividend tax clientele hypothesis using a data set

of all domestic stock portfolios in the market. We find that investment funds that face

a higher effective tax rate on dividend income than on capital gains tilt their portfolios

away from dividend-paying stocks. These investors consequently earn a dividend yield

that is about 35 basis points lower than that of investors who are tax neutral between

dividends and capital gains (pension funds, unit-linked insurance, life insurance). Con-

sistent with tax rules and charter provisions, we also find that private corporations

prefer growth stocks, that foundations exhibit strong dividend preferences, and that

partnerships rarely hold stocks portfolios.

Keywords: After-tax CAPM, dividend tax, capital gains tax, stock ownership, insti-

tutional investors, private corporations, foundations, partnerships.

JEL Classification Numbers: G11, G35.

∗We are grateful for institutional information from Ingrid Eriksson, Kerstin Nilsson, Viveca Scherman Johansson,

and Per Swanstrom of the Swedish Tax Agency, Kristina Melzen and Marie Rosvall of Svenska Forsakringsforeningen,

Lina Sjostrom, Krister Swaretz, and Stig Westman of Swedbank, Vigg Troedsson of Swedish Securities Dealers

Association, Jan Bjuvberg, Hakan Thorsell, and Filip Wijkstrom of Stockholm School of Economics, Svante Johansson

of Carnegie Investment Bank, Johnny Larsson of Statistics Sweden, Roger Pettersson of RPA Forsakringsmakleri,

Sune Rydqvist of Configura, Ingmarie Severien of Handelsbanken’s research foundations, and Bo Winnerfeldt of

the Nordic Central Securities Depository. We also appreciate the comments we have received from an anonymous

referee, Michael Brennan, William Goetzmann, Yaniv Grinstein, Michael Lemmon, Greg Nagel, Jeffrey Pontiff,

and by seminar participants at the Adam Smith Asset Pricing workshop at London Business School, Advances in

Portfolio Decision Making at the University of Notre Dame, Annual Conference of the Caesarea Center at IDC 2007,

Binghamton University, Duke University, Financial Intermediation Research Society meeting in Anchorage 2008,

Frontiers of Finance meeting in Curacao 2007, Helsinki School of Economics, New University of Lisbon, Norwegian

School of Economics, Norwegian School of Management, Ohio State University, Rensselaer Polytechnic Institute,

Royal Institute of Technology, SIFR - Institute for Financial Research, Swedish Ministry of Finance, University

of Maastricht, and University of Oxford. Financial support from the Bank of Sweden Tercentenary Foundation,

and Johan och Jakob Soderbergs stiftelse is gratefully acknowledged. Dahlquist: Stockholm School of Economics,

and CEPR; e-mail magnus.dahlquist@sifr.org. Robertsson: Sveriges Riksbank; e-mail goran.robertsson@riksbank.se.

Rydqvist: Binghamton University and CEPR, School of Management, Binghamton, NY 13902, USA; tel: 607 777

2673; e-mail: rydqvist@binghamton.edu.

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1 Introduction

When corporations pay dividends, investors must pay income tax on those dividends. Investors also

pay income tax on capital gains when they sell their shares, but they can choose when to realize

capital gains and losses. Miller and Modigliani (1961) conjecture that investors can reduce the

overall tax bill by sorting themselves into clienteles in which low-tax investors collect dividends and

high-tax investors realize capital gains. Understanding and quantifying the effects of tax clienteles

has implications for the pricing of financial securities, for corporations issuing securities, and for

governments collecting taxes.

In this paper, we provide evidence of dividend tax clienteles in the Swedish stock market. We

are the first to study the tax clientele hypothesis using a data set of all domestic stock portfolios

in the market. The data are obtained from the Swedish official securities register and consist

of the universe of Swedish investors’ holdings of listed Swedish stocks. As the data set consists

of the stock portfolios of both retail and institutional investors, it allows us to make market-wide

conclusions. Aspects of the Swedish tax code offer an advantage to researchers studying the dividend

tax clientele hypothesis. Tax rates are proportional (flat rates), and the variation across investors

is due to different parts of the tax code applying to different investor types. This proportional tax

structure eliminates many of the difficulties in estimating marginal tax rates in a progressive tax

system with multiple income brackets.

We identify four domestic tax clienteles in the Swedish stock market. The first consists of tax-

neutral investors, who are indifferent between dividend income and capital gains. The second are

businesses and individuals who prefer capital gains over dividends because tax liability on capital

gains can be deferred until the gains are realized. The third tax clientele comprises investment funds

for which dividends are taxed at source, while capital gains accrue tax-free within the fund until the

fund owner sells his shares in the investment fund. Investment funds have a stronger tax preference

for capital gains over dividends than do businesses and individuals because the fund manager can

re-balance the stock portfolio without triggering capital gains tax liability. The fourth tax clientele

consists of partnerships. Dividend income and capital gains are taxed as ordinary income for the

partners, and the effective tax rate on ordinary income is much higher than that on dividend income

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and capital gains. Partnerships are the most averse to holding dividend-paying stocks because the

value of deferring capital gains tax is particularly high under the high taxation of ordinary income.

In this tax environment we find that tax-neutral investors, investment funds, and partnerships

behave according to the predictions of the dividend tax clientele hypothesis. Tax-neutral investors

earn a portfolio dividend yield that is 35 basis points higher than that of investment funds. Also

consistent with the tax clientele hypothesis, partnership portfolios are almost non-existent. Less

than one percent of all registered partnerships in Sweden hold stock portfolios, and their average

dividend yield is much lower than other portfolio yields. However, the portfolio behavior of busi-

nesses and individuals is difficult to reconcile with the predictions of the dividend tax clientele

hypothesis. In some econometric specifications, the stock portfolios of businesses and individuals

sort nicely between tax-neutral investors and investment funds, while in other specifications, busi-

nesses and individuals appear to have a stronger preference for either dividends or capital gains.

We argue that the portfolios of directly held stocks are a poor reflection of the total wealth of

businesses and individuals, and that income from stock portfolios and its taxation is unimportant

relative to other income. Therefore, without an appropriate set of control variables, it is more

difficult to evaluate the dividend tax clientele hypothesis based on the stock portfolios of businesses

and individuals.

In addition to these general results, we find that there is a large number of private corporations

that hold stock portfolios. These portfolios are heavily concentrated in growth stocks that do

not pay dividends. Special tax rules for private corporations, where the owner is also an employee,

encourage private firms to invest excess liquidity in growth stocks instead of paying dividends to the

owners. In fact, some closely held corporations are better characterized as private investment funds

than as non-financial businesses.1 Furthermore, we find that foundations earn higher dividend yields

on their stock portfolios than most other investors in the Swedish stock market. Their portfolio

behavior is consistent with the common view that foundations are constrained by charter provisions

to make distributions from income and not from principal.2 Finally, there is no Prudent Man Rule

1Karhunen and Keloharju (2001) report that private corporations are major stockholders in Finland, where private

corporations are subject to similar tax rules.2See, e.g., Brealey and Myers (2003), pp.447-448.

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in Sweden that would restrict institutional investors to overweight in dividend-paying stocks. In our

data set, there are institutional investors that overweight in dividend-paying stocks (life insurance,

pension funds, unit-linked insurance) as well as underweight (mutual funds).

Our objective is to empirically investigate the relation between tax preferences and dividend

yield in the Swedish stock market. We do not study how corporations adjust payout policy to meet

the demand from dividend tax clienteles. This potential role of payout policy is proposed by Miller

and Modigliani (1961) and empirically investigated by numerous papers.3

The rest of the paper is organized as follows. Section 2 reviews the empirical literature on the

tax-clientele hypothesis. Section 3 provides the reader with the institutional background and the

methodology that is used to identify the dividend tax clienteles in Sweden. Section 4 presents our

main empirical results. We begin with an examination of the aggregate stock portfolios of the four

tax clienteles and then report the results of multivariate regression analysis. Section 5 concludes

the paper.

2 Literature Review

The formal analysis of tax clienteles begins with Brennan (1970), who extends the Capital Asset

Pricing Model to include investor-level taxes (the after-tax CAPM).4 When investors face higher

effective tax rates on dividends than on capital gains, the model predicts a positive relation between

the before-tax rate of return of a stock and its dividend yield. A second prediction of the after-tax

CAPM is that investors hold a combination of the market portfolio, a portfolio that derives from tax

specialization, and the riskless asset. Investors with a relative tax preference for dividends invest

more in high dividend paying stocks, while investors with a relative tax preference for capital gains

prefer low-yield stocks. Since the after-tax CAPM also implies a negative relation between stock

price and dividend yield, investors with a tax preference for dividends hold portfolios with a higher

dividend yield than other investors do.

Early attempts to evaluate the after-tax CAPM, including Black and Scholes (1974), Litzen-

3E.g., Julio and Ikenberry (2004), Chetty and Saez (2005), Brav, Graham, Harvey, and Michaely (2008)).4See also subsequent articles by Litzenberger and Ramaswamy (1979), Auerbach and King (1983), and Allen,

Bernardo, and Welch (2000).

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berger and Ramaswamy (1982), and Miller and Scholes (1982), consider the implications of the

model for the cross-section of returns. Some authors find a positive relation between stock returns

and dividend yields, but they disagree on whether this is due to taxes, information, or time-varying

risk premia.5 Others report event-study evidence. Elton and Gruber (1970) find that average stock

returns on the ex-dividend day are positive and decreasing with the dividend yield. They interpret

this as indirect evidence of dividend tax clienteles, but the subsequent literature, notably Kalay

(1982), challenges this interpretation.

The empirical literature has also investigated the portfolio implications of the after-tax CAPM.

Pettit (1977) and Lewellen, Stanley, Lease, and Schlarbaum (1978) study a data set of stock

portfolios of 900 individuals from a retail brokerage house, and relate portfolio dividend yields to

proxies for marginal tax rates. The statistical relation is weak, and Pettit (1977) concludes that

tax rates have an important influence on portfolio decisions only at the margin. Scholz (1992) looks

at self-reported data from 4,000 individuals in the Survey of Consumer Finances (SCF) and finds

evidence consistent with dividend tax clienteles. Contrary to the previous two studies, he reports

that marginal tax rates have a strong economic effect on portfolio dividend yield. More recently,

Graham and Kumar (2006) combine security-specific information from a brokerage house and self-

reported survey data from 30,000 individuals. They find that older, low-income individuals invest

more in high-yield stocks. Since income is a proxy variable for marginal tax rates, their result

may indicate the presence of a tax clientele effect. There is also recent international evidence

from Taiwan, where high-net-worth individuals tilt their stock portfolios away from dividends

while corporations and tax-exempt institutions pick up the dividend-paying stocks. Lee, Liu, Roll,

and Subrahmanyam (2005) argue that these portfolio effects are driven by differences in dividend

taxation. A limitation of their study is that the Taiwanese ownership statistics have been aggregated

without differences of taxation in mind. Finally, studying the portfolio behavior of institutional

investors in the United States, Michaely, Thaler, and Womack (1995) find that institutions re-

balance their stock portfolios around dividend initiations and omissions.6 Del Guercio (1996) and

5See the survey by Allen and Michaely (2003). See also Amihud and Mendelson (1986) for a similar approach to

studying liquidity clienteles in the stock market.6See also subsequent work by Dhaliwal, Erickson, and Trezevant (1999), and Hotchkiss and Lawrence (2007).

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Grinstein and Michaely (2005) find that institutions overweight their portfolios with dividend-

paying stocks. These results are more difficult to attribute to tax effects because the tax status of

U.S. institutional investors cannot be accurately determined.7

Each of the three approaches to estimating tax-clientele effects in stock markets is subject

to its own limitations. The indirect evidence (cross-section return studies and ex-dividend day

studies, respectively) cannot distinguish between tax effects and alternative explanations. The

papers with direct portfolio evidence either have accurate tax information from small subsets of

shareholders (e.g., Pettit (1977) and Graham and Kumar (2006)), or they have market-wide data,

but incomplete tax information (e.g., Lee, Liu, Roll, and Subrahmanyam (2005) and Grinstein and

Michaely (2005)). Our study offers the advantage over previous studies by having access to detailed

tax information from almost two thirds of the stock market.

We end the literature review by mentioning a few papers on payout policy and personal taxation

in Sweden. Daunfelt (2007) and Daunfelt, Selander, and Wikstrom (2009) study the ex-dividend

day behavior of Swedish stocks around the tax reform of 1990, and Green and Rydqvist (1999)

investigate the ex-day behavior of Swedish lottery bonds. The gist of the tax reform of 1990 is

to separate ordinary income from investment income, and to tax investment income at a low,

proportional rate. As a result, the marginal tax rate on dividends decreases precipitously from

65%–85% before the tax reform to 30% after. If personal income tax matters to the formation of

investment portfolios, one would expect to see price responses around the tax reform. Lottery bond

prices change in accordance with the changes in taxation, while the tax reform has no impact on

price formation in the stock market. Holmen, Knopf, and Peterson (2008) investigate the role of

large shareholders in determining corporate payout policy. They conclude that corporate insiders

with sufficient voting power determine payout policy to reduce their personal tax burden. In sum,

the Swedish studies on the impact of personal income tax on dividends provide mixed evidence of

dividend tax clienteles.

7See Desai and Jin (2011) for an attempt to classify U.S. institutions that manage taxed and tax-deferred accounts.

Sialm and Starks (2012) use survey data to estimate the portion of tax-deferred assets of mutual fund portfolios.

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3 Institutional Background & Data

3.1 Sample Firms and Payouts

We study firms listed on the Stockholm Stock Exchange. Financial data are taken from Thomson

Financial. Descriptive statistics on the sample firms and their payouts are displayed in Table 1. The

left column reports averages over the 2001–2005 period, and the other columns descriptive statistics

for each year. Stock market capitalization is about SEK 2000 billion (corresponding to USD 300

Table 1: Firms and Payouts in the Swedish Stock Market

Average 2001 2002 2003 2004 2005

A. Values (SEK billion)

Stock market capitalization 2,290 2,650 1,909 1,760 2,331 2,802

Value of dividend-paying firms 2,033 2,465 1,674 1,511 1,851 2,663(% of total) (88.2) (93.0) (87.7) (85.8) (79.4) (95.0)

Value of repurchasing firms 578 702 483 327 753 625(% of total) (25.2) (26.5) (25.3) (18.6) (32.3) (22.3)

Dividend yield (%) 2.7 2.0 2.0 3.4 3.1 3.2

Repurchase yield (%) 0.6 0.7 0.4 0.5 0.9 0.6

B. Frequencies

Number of listed firms 273 288 280 276 265 254

Number of dividend-paying firms 145 159 141 138 141 146(% of total) (53.1) (55.2) (50.4) (50.0) (53.2) (57.5)

Number of share-repurchasing firms 31 40 38 36 25 15(% of total) (11.3) (14.0) (13.4) (13.2) (9.6) (6.0)

The table presents summary statistics on the firms in the sample over the period 2001–2005. The numbers in the

left column are averaged across the years. Market values are reported in SEK billion and are calculated at the end

of June each year. The dividend yield includes all dividends in a year divided by the market value at the beginning

of the year. The repurchase yield is defined as the value of all repurchased shares in a year divided by the market

value at the beginning of the year. The yields are reported in percent.

billion).8 The market value of dividend-paying firms is 88% of the total stock market capitalization,

while share-repurchasing firms constitute 25% of total stock market capitalization. Dividends are

paid annually after the approval of the shareholder meeting. The average dividend yield is 2.7%

and the average share-repurchase yield 0.6%. These yields vary with stock market capitalization.

Furthermore, the average number of listed firms is 273, 53% of these firms pay dividends, and 11%

8The SEK-USD exchange rate varied between 6.5 and 10.5 during the sample period.

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repurchase shares. Combining the percentages from the two panels, we conclude that dividends

and share repurchases are concentrated in the largest firms, a phenomenon that is also a feature of

the U.S. stock market (see Fama and French (2001) and DeAngelo, DeAngelo, and Skinner (2004)).

3.2 Tax Clienteles

We identify four tax clienteles that can be sorted from relative high to relative low tax preference

for dividends over capital gains.9 We take a long-term perspective on stock portfolio holdings and

assume that investors have taxable income. Hence, we ignore the complications that arise when

investors can generate offsetting capital losses.10

A. Tax-neutral investors. As the name indicates, tax-neutral investors are indifferent between

dividend income and capital gains. Relative to all other domestic investors, tax-neutral investors

have the strongest tax preference for dividends over capital gains. There are three types of tax-

neutral investors in Sweden. First, government entities and charitable organizations are exempt

from dividend income and capital gains tax. Second, income tax on pension accounts is deferred to

retirement. Since the effective tax rate is independent of the source of retirement income, the retiree

is indifferent between earning his pension through dividends or capital gains. Tax-deferred accounts

are managed by pension funds, life insurance companies, mutual funds (unit-linked insurance), and

households with individual retirement accounts. Third and finally, banks and brokerage houses

calculate their taxable income according to the mark-to-market principle, so dividend income and

capital gains (realized or not) are treated the same way.

B. Businesses and individuals. Dividend income and capital gains are taxed at the 28% rate

for businesses and at 30% for individuals.11 In what follows, we ignore this small difference in

statutory rates. We also ignore the possibility that businesses have a richer array of tax shelters than

9Swedish tax rules relating to income from stocks since 1991 can be found in three legislative acts: Inkomst-

skattelagen (SFS 1999:1229), Lagen om avkastningsskatt pa pensionsmedel (SFS 1990:661), and Kupongskattelagen

(SFS 1970:624).10Extensive analysis of the value of tax-loss options can be found in Constantinides (1983), Constantinides (1984),

Dammon, Dunn, and Spatt (1989), and Dammon and Spatt (1996).11Subsequently, after the sample period from 2001–2005, Sweden lowered its corporate tax rate to 26.3% in 2009

and further down to 22% in 2013.

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individuals. Taxes on dividends are collected at source, while investors themselves are responsible

for paying capital gains tax. Businesses and individuals prefer capital gains over dividends because

capital gains tax can be postponed to the time of realization. Stock clubs, sole proprietorships,

and estates are taxed as individuals.12 Businesses and non-profit organizations, except charities,

must pay business income tax on dividend income and capital gains. One exception referred to

as the participation exemption rule is made for dividend payments between a holding company

and its operating unit. Inter-corporate dividends are exempt from business income tax, when the

ownership stake exceeds 25% before 2003 or 10% thereafter.13 Participation exemption also extends

to the sale of shares in the operating unit.

Special tax rules apply to income from a private corporation, where the owner is also an em-

ployee. The purpose of these rules is to tax labor income the same way regardless of whether it is

earned directly as wages or channeled through a partnership or a corporation. The top marginal

tax rate on dividends from a private corporation is 69%.14 The taxation of capital gains from

selling shares in the private firm is more favorable. Capital gains exceeding approximately SEK

8 million are taxed at the lower 30% rate.15 Capital gains below SEK 8 million are taxed as half

capital gains at the 30% rate and half ordinary income. The personal portion of the capital gains

tax can be postponed to the time of realization.

C. Investment funds. This class comprises closed-end funds and open-end mutual funds. Div-

idends earned by an investment fund pass through to fund owners and get taxed at the 30% rate

(individuals). Capital gains accrue tax-free inside the investment fund, but fund owners must pay

capital gains tax when they sell their shares in the fund. These tax rules imply an unambiguous

ordering of tax-neutral investors (A) and investment funds (C) because the latter organization of

12All tax obligations of a deceased individual, also capital gains tax liability, pass through to the estate.13Morck (2005) reports similar tax rules in most developed countries except in the United States where intercor-

porate dividends are taxed for the explicit reason of discouraging the formation of business groups.14The rules are complex and change frequently. A small dividend can be paid tax free. An additional amount,

which depends on paid-in-capital and total wages paid to employees other than the owner, is subject to a 30% tax.

The excess dividend is taxed as wage income at a marginal tax rate of 56.6%, but is not subject to social security

tax. Therefore, the marginal tax rate on dividends from a private corporation is 1− (1− 0.28)(1− 0.566) = 0.69. Aprivate firm cannot repurchase its own shares.

15Calculating the effective rate is complex as it depends on the value of deferral of capital gains tax. Corporate

tax at the 28% rate is paid when corporate income is earned, and capital gains tax at the 30% rate is paid when the

shares are sold.

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stock ownership triggers dividend taxation while the former does not. The preference ordering of

direct stock ownership by individuals (B) versus indirect stock ownership through an investment

fund (C) is weaker. Indirect stock ownership offers the tax advantage that the stock portfolio

can be re-balanced without triggering capital gains tax liability. However, if the turnover rate of

investment fund shares is equal to the turnover rate of the investment fund stock portfolio, then

the relative tax preferences of individuals and investment funds are equal.

D. Partnerships. Though a partnership can have both individual and institutional partners,

we simplify the presentation by assuming that the partners are individuals. Dividend income and

capital gains are transformed and taxed as ordinary income by the partners. Ordinary income

is subject to a progressive tax schedule with the tax rate in the highest income bracket being

67.2%.16 The transformation of dividend income and capital gains into ordinary income discourages

individuals from owning stock through a partnership because the top marginal tax rate on ordinary

income (67.2%) is much higher than the marginal tax rate on dividend income and capital gains

(30%). Partnerships dislike dividends relative to capital gains more than any other tax clientele in

the Swedish stock market because deferral of capital gains tax is particularly valuable at the high

statutory tax rates that apply to ordinary income.

3.3 Identification of Investor Tax Preferences

Ownership of Swedish listed stocks is registered by the Nordic Central Securities Depository

(NCSD), in which each investor or custodian bank must have an account. Regulations require

that a complete ownership record is made publicly available at the end of June and December

each year. Furthermore, the law requires Swedish banks to reveal the identities of the owners of

all shares held in custody. There is one important gap in the data: foreign banks do not have to

report the nominee identity and usually choose not to. We use the ownership record at the end of

June each year. The records contain the names of the shareholders and the number of shares held.

16The marginal tax rate on wage income in the top income bracket is 1 − (1/1.3246) (1 − 0.566) = 0.672, where32.46% is the social security tax rate and 56.6% is the sum of the local tax rate (average of 31.6%) and the central

tax rate (25%). In Sweden, unlike the United States and many other countries, there is no cap on the social security

tax. In 2004, the top income bracket begins at SEK 465,000 (approximately USD 60,000).

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For institutional investors, the name is followed by an organization identification number that we

use to construct institutional investor portfolios. The portfolios held by individuals are constructed

based on the NCSD account number.

We infer the tax status of an investor from the name, organization identification number, and a

legal code from Statistics Sweden. The legal code uniquely identifies the tax status of many insti-

tutional investors in our sample: entities in the public sector, banks, and religious associations (A);

estates, stock clubs, proprietorships, and corporations other than those mentioned elsewhere (B);

and partnerships (D). The legal code in combination with the investor’s name uniquely identifies

the tax status of life insurance, unit-linked insurance, pension funds, and brokerage houses (A);

property and casualty insurance (B); and closed-end funds (C). The ownership share uniquely iden-

tifies tax-exempt intercorporate holdings (A), and individuals (B) are singled out by the absence

of organization identification number.

The legal code identifies mutual funds as a separate category. Mutual funds manage both

taxed and tax-deferred accounts. For some mutual funds, the name reveals that the mutual fund

manages tax-deferred accounts (unit-linked insurance). For all other mutual funds, the tax status

is an average of tax neutral (A) and investment fund status (C). On the basis of aggregate statistics

and assumptions on the proportion of mutual fund assets invested in Swedish stocks, we estimate

that the tax-deferred proportion of mutual fund portfolios is less than 30%. The mix of taxed

and tax-deferred accounts means that any estimated difference in portfolio dividend yield between

tax-neutral investors and investment funds is conservative.

The legal code also identifies foundations and associations. Non-profit organizations are required

to file a tax return each year. The local tax agency decides whether the non-profit organization is

charitable and qualifies for tax-exempt dividend income and capital gains (A) or must pay business

income tax (B). In what follows, we refer to the stock portfolios held by foundations and associations

as Tax Clientele X because the tax status decisions are unavailable.17 Since we do not know the

identities of foreign investors, we also refer to them as Tax Clientele X.

17We have elaborated on name-based classifications. Non-profits with charitable-related names were classified as

tax-neutral (A) and non-profits with names related to a specific group of people as businesses (B). The name method

classified 88% of the associations and 29% of the foundations. The resulting dividend preferences did not differ

between non-profits classified as A, B, or unclassified, so we do not report the results of the name-based classification.

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4 Empirical Results

4.1 Univariate Analysis

Table 2 presents summary statistics on the aggregate portfolios of the four tax clienteles. We first

construct aggregate portfolios by summing up the values of the stock portfolios of the shareholders

of each tax clientele and year:

Vk =Ik∑

i=1

J∑

j=1

pjnij , k = A,B,C,D, (1)

where pj denotes the stock price of security j, and nij is the number of shares of security j held

by investor i. We divide the aggregate portfolios Vk by the stock market cap of the year, and then

compute the arithmetic average across the five years. The ownership shares are approximately 26%,

20%, 14%, and 0% of stock market capitalization, respectively. Foreign investors own 34% and

unclassified domestic investors the remaining 6%. The number of investors exceeds two million,

most of which are individuals. On the right, the portfolio weights invested in dividend-paying

stocks and the portfolio dividend yields are reported. The adjacent numbers to the right of each of

these two columns are deviations from the aggregate sample, 88.2% (portfolio weight) and 2.74%

(dividend yield). Three results emerge.

First, the ordering of stock portfolios follows closely, albeit not perfectly, the predictions of the

tax clientele hypothesis. The aggregate stock portfolio of tax-neutral investors (A) is tilted towards

dividend-paying stocks, and the dividend yield exceeds the market yield. All other stock portfolios

are tilted away from dividend-paying stocks, and the dividend yields on those portfolios are less

than the market dividend yield. The apparent flaw is the ordering of businesses and individuals (B)

versus investment funds (C), which depends on whether we look at portfolio weights or dividend

yields. Second, the differences are economically meaningful. For example, the excess weight of

the tax-neutral portfolio (A) over the investment fund portfolio (C) is 4.5 percentage points, and

the yield spread between these two portfolios is 35 basis points.18 Third, partnerships rarely hold

18To illustrate, consider tax-exempt Investor A (unit-linked insurance) and taxed Investor C (mutual fund), each

with a stock portfolio of SEK 500 million. Without sorting into tax clienteles, each investor would collect dividends

2.74% × 500 = 13.7 million and Investor C would pay income tax 30% × 13.7 = 4.11 million. After sorting into tax

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Table 2: Aggregate Portfolios of the Tax Clienteles

Market Market Number of Weight in Dividendvalue share investors dividends yield

A. Tax-neutral 604.7 26.5 1,400 92.8 +4.6 3.01 +0.27

B. Businesses and individuals 451.2 19.7 2,078,301 85.4 –2.8 2.67 –0.07

C. Investment funds 321.8 14.1 302 88.2 0.0 2.66 –0.08

D. Partnerships 1.0 0.0 936 48.4 –39.8 1.64 –1.10

A–D 1,378.8 60.3 2,080,938 89.3 +1.1 2.81 +0.07

X. Unclassified domestic 136.1 6.0 25,583 93.2 +5.0 3.48 +0.74

X. Foreign investors 775.6 33.7 123,468 85.4 –2.8 2.50 –0.24

Market 2,290.5 100.0 2,229,990 88.2 0.0 2.74 0.00

The table presents statistics, averaged over 2001–2005, for the aggregate portfolios of the tax clienteles in the

sample. Market values are reported in SEK billion. Market shares, portfolio weights in dividend-paying stocks,

and dividend yields are reported in percent. The adjacent columns measure the deviation from the market, 88.2%

(portfolio weight) and 2.74% (dividend yield), respectively.

stock portfolios, and the portfolio weight in dividend-paying stocks and the dividend yield of the

few partnership portfolios fall substantially below those of all other investors. The number of

partnerships in our sample is only 936, representing less than 1% of the approximately 130,000

registered partnerships in Sweden, and the aggregate portfolio of the partnerships accounts for

only 0.04% of total stock market capitalization. The near complete absence of stock portfolios held

by partnerships and their demonstrated strong dividend aversion is consistent with tax preferences.

The tax rule that transforms dividend income and capital gains (30%) into ordinary income (67%)

makes indirect stock ownership through a partnership unattractive. The individual partners fare

much better from holding the desired stock portfolio on their own.

Pairwise comparisons. Table 3 presents summary statistics on major investor categories. The

breakdown of the data into subgroups allows us to directly compare the dividend preferences of

organizations that are similar except for tax treatment. First, we compare the stock portfolios

clienteles, Investor A collects tax-exempt dividends 3.01% × 500 = 15.5 million, and Investor C 2.66% × 500 = 13.3million subject to income tax 30%× 13.3 = 3.99 million. The income tax bill decreases by 4.11− 3.99 = 0.12 million

per year at the expense of suboptimal risk sharing.

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Table 3: Aggregate Portfolios of Major Investor Categories

Market Number of Weight in Dividendshare investors dividends yield

A. Tax-neutral

Public sector 9.2 150 93.3 +5.1 2.42 –0.32

Life insurance 7.2 19 91.5 +3.3 2.96 +0.22

Controlling shares 5.1 81 94.3 +6.1 4.12 +1.38

Banks and brokers 2.0 115 95.2 +7.0 3.43 +0.69

Pension funds 1.9 765 90.8 +2.6 3.08 +0.34

Unit-linked insurance 1.1 63 90.0 +1.8 2.79 +0.05

Religious associations 0.1 206 88.1 –0.1 2.85 +0.11

B. Businesses and individuals

Individuals and stock clubs 14.6 2,049,541 86.0 –2.2 2.64 –0.10

Private corporations 2.7 28,511 81.0 –7.2 2.56 –0.18

Public corporations 1.3 128 81.7 –6.5 2.71 –0.03

Non-life insurance 1.3 121 91.0 +2.8 3.09 +0.35

C. Investment funds

Mutual funds 9.5 285 88.0 –0.2 2.67 –0.07

Closed-end funds 4.6 17 88.3 +0.1 2.63 –0.11

D. Partnerships 0.0 936 48.4 –39.8 1.64 –1.10

X. Unclassified domestic

Foundations 4.5 3,137 95.0 +6.8 3.66 +0.92

Associations 0.9 1,793 88.8 –0.6 3.00 +0.26

Other 0.6 20,652 86.1 –2.1 2.88 +0.14

The table presents statistics, averaged over 2001–2005, on major investor categories in the sample. Market shares,

portfolio weights, and dividend yields are reported in percent. The adjacent columns measure the deviation from

the market, 88.2% (portfolio weight) and 2.74% (dividend yield), respectively. The tax clienteles are described in

Section 3. “Other” refers to institutional investors that we are unable to classify.

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labeled as controlling shares (A) with the stock portfolios of public corporations (B). Consistent

with tax preferences, above average dividends are paid, when one firm owns a controlling share

in another firm. The portfolio weights are 94.3% versus 81.7% and the corresponding dividend

yields are 4.12% and 2.71%. The excess payout may be the result of the controlling shareholder

influencing the firm’s payout policy rather than the controlling shareholder’s choice to invest in

a stock that pays a large dividend. For example, Barclay, Holderness, and Sheehan (2009) and

Holmen, Knopf, and Peterson (2008) study whether the tax preferences of controlling shareholders

influence payout policy of the firm they control. We cannot tell the direction of causality from our

data. Next, we compare the stock portfolios of unit-linked insurance (A) with mutual funds (C). The

portfolio weights are 90% and 88% and the dividend yields 2.79% and 2.67%, respectively. These

differences in revealed dividend preferences are not striking, and may reflect that mutual funds

carry a blend of tax-deferred (A) and taxed accounts (C). Finally, we look at the stock portfolios

of life insurance (A) versus property and casualty insurance (B). The portfolios weights, 91.5%

and 91.0%, and the dividend yields, 2.96% and 3.09%, are about the same despite the prospective

difference in taxation. One possible explanation is that regulations provide property and casualty

insurance companies with ominous tax shelters that make them behave like tax-neutral investors.

Private corporations. In Panel B of Table 3, we have used intercorporate ownership data

from the Market Manager database to classify a corporation as a public firm if it or its parent is

registered in the securities depository, or as a private firm otherwise. Private corporations are the

second largest subcategory with more than 28,000 stock portfolios. The abundance of corporate

stock portfolios is interesting because corporate income is subject to triple taxation: the public

corporation that generates taxable corporate income, the private firm that earns dividend income

and capital gains on the stock, and the owner of the private corporation when he earns dividend

income and capital gains from his privately owned firm. Corporations may hold a liquid stock

portfolio for future investments in operating assets. However, many corporate stock portfolios

captured in our data set may serve as supplemental retirement accounts for the company owners.

A portfolio of non-dividend paying stocks does not trigger any investor-level taxes before the owner

sells the private firm. Saving for retirement through a stock portfolio held by the firm has the

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advantage that the portfolio can be liquidated at any time and used for purposes other than

retirement. This benefit must be evaluated against the advantage of a private pension plan that is

protected by the limited liability of the corporation.

Accounting data lend some support to the conjecture that the corporate stock portfolios serve as

supplemental retirement accounts. Using data from Market Manager, we compute the ratio of the

market value of the stock portfolio to the book value of total assets for financial and non-financial

firms. Most financial firms are securities trading companies, while the non-financial firms span

manufacturing, construction, trade, and service sectors. Many firms hold a significant part of their

assets in stock portfolios. In more than 3,000 non-financial firms (or 13% of the studied firms),

the ratio exceeds 50%. These firms are better characterized as private stock funds than operating

firms.19 This finding is robust across industries and firm size.

Foundations. Unrelated to taxation, foundations overweight their portfolios with dividend-paying

stocks by 6.8 percentage points above the market aggregate, and they earn an excess dividend yield

of 92 basis points (Panel X of Table 3). Charter provisions may explain the strong dividend prefer-

ence of foundations. Sometimes, foundations are restricted to making distributions from dividend

income only and not from capital gains or principal. The supervisory authority estimates that 30%

of the foundations can only distribute dividends, 20% can distribute dividends and realized capital

gains, and 50% have no restrictions and can therefore make payments from their principal. The

foundation charters that would allow us to study this hypothesis further are not available.

4.2 Multivariate Analysis

Theory implies that high-tax investors reduce their portfolio weights in dividend-paying stocks,

and vice versa. An immediate implication of such behavior is that the dividend yield of the stock

portfolio of a high-tax investor is less than the dividend yield of a low-tax investor. Based on

these arguments, we consider a regression model with the portfolio dividend yield as the dependent

variable as in Pettit (1977), Scholz (1992), and Graham and Kumar (2006). For each investor i in

year t, we compute the portfolio dividend yield Yit and estimate a pooled linear regression model

19The tax status of investment funds does not apply to private firms.

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of the dividend yield on dummy variables Dkit for each tax clientele and a set of control variables

Zi:

Yit = β0t + γBDBit + γCDC

it + γDDDit + β′Zi + εit. (2)

Coefficient β0t captures the dividend yield on the portfolios held by tax-neutral investors in year

t over and above what is predicted by the control variables Zi. The γk coefficients capture the

additional dividend yield for investors in tax clienteles k = B,C,D. The tax clientele hypothesis

predicts that:

0 > γB > γC > γD. (3)

In addition to tax preferences, the dividend yield of a stock portfolio likely depends on the

investor’s risk preferences. For example, the dividend yield of a stock portfolio held by an investor

who prefers value stocks may be high regardless of tax preferences. To control for investor risk

preferences, as in Graham and Kumar (2006), we compute portfolio betas in a three-factor regression

model and idiosyncratic risk as the standard deviation of the residuals from the same regression.

The betas capture exposures to the Swedish stock market, high-minus-low book-to-market ratios

(HML), and small-minus-big market capitalization (SMB). The calculations are based on the Dow

Jones Style Indexes for Sweden. We also collect data on firm size (market capitalization) and

liquidity (bid-ask spread and turnover) to control for other factors that may influence an investor’s

portfolio choice. However, including the value-weighted logged market value of the firms in the

portfolio, as well as their value-weighted turnover rate and bid-ask spread, does not change the

regression results in any significant way.

Many variables other than tax and risk preferences may influence the dividend yield of a stock

portfolio. For example, Graham and Kumar (2006) control for age, education, and access to retire-

ment accounts. We try to capture the multi-dimensional impact of such background variables with

one dummy variable for each tax clientele. A priori, we suspect that the effects of omitted variables

is more severe for businesses and individuals (B) and partnerships (D) than for institutional in-

vestors (A and C) because we think that institutional stock portfolios better represent total wealth

than the stock portfolios of small businesses and individuals. In particular, household portfolios are

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dominated by human capital (future labor income and pension contracts) and to a lesser extent,

by real estate. For most non-financial businesses, the operating assets ought to carry more weight

than holdings of publicly traded stocks.

4.2.1 Descriptive Statistics

Summary statistics on portfolio characteristics are reported in Table 4. The averages are equally

weighted over investors and years. The variation in average portfolio size across investor types

is noticeable. Life-insurance companies hold the largest and most diversified portfolios. Closed-

end funds are also large, but hold on average only 10 stocks, while pension funds hold smaller

and less diversified portfolios. In general, the lack of diversification in the Swedish market may

be compensated for by holding foreign stocks. The smallest and least diversified portfolios are

held by individuals, private corporations, and partnerships. The small number of directly owned

stocks in individuals’ portfolios is also a striking feature of U.S. data according to the Survey

of Consumer Finances (see Polkovnichenko, 2005). Calvet, Campbell, and Sodini (2007) show

that Swedish individuals diversify through the ownership of mutual funds. Hence, the portfolios of

directly owned stocks provide an incomplete picture of the aggregate stock portfolios of individuals.

Individuals dominate our sample with more than two million portfolios. Approximately one million

portfolios consist of only one stock and have a market value below SEK 15,000. More than 600,000

of these one-stock portfolios are invested in Ericsson, TeliaSonera, or Swedbank.

There is obvious variation in the portfolio strategies across investor types. Large portfolios

held by professional investors are tilted towards value stocks (positive or small negative HML

coefficients). Small portfolios held by businesses and individuals exhibit the opposite traits. In

particular, we observe a strong tendency among private corporations and partnerships to hold

growth stocks with very low HML betas. The frequency distributions of the HML betas, the

number of stocks, and the portfolio values indicate that the holdings of businesses, individuals, and

partnerships are dominated by single-stock portfolios. Only 2% of the portfolios held by businesses

and individuals are larger than SEK 1,000,000, while only 4% of the portfolios held by investment

funds are smaller that SEK 1,000,000.

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Table 4: Portfolio Characteristics of Major Investor Categories

Portfoliosize

Numberof stocks

Beta(market)

Beta(HML)

Beta(SMB)

Idiosync-ratic risk

A. Tax-neutral

Public sector 1,408.2 19.2 1.05 –0.14 0.10 10.6

Life insurance 8,546.5 48.2 1.05 –0.20 0.14 8.9

Controlling shares 1,508.9 1.2 0.82 –0.09 0.19 32.1

Banks and brokers 408.7 15.7 0.97 0.20 –0.16 13.4

Pension funds 56.8 7.7 1.14 –0.65 0.23 18.0

Unit-linked insurance 407.5 26.9 1.10 –0.31 0.13 9.9

Religious associations 6.8 6.9 1.07 –0.13 0.05 13.4

B. Businesses and individuals

Individuals and stock clubs 0.2 2.8 0.96 –0.44 0.14 21.5

Private corporations 2.1 3.7 1.15 –1.03 0.31 27.5

Public corporations 229.4 2.3 1.05 –0.53 0.31 20.7

Non-life insurance 239.4 15.0 1.04 –0.19 0.08 12.3

C. Investment funds

Mutual funds 762.8 24.3 1.08 –0.30 0.19 11.5

Closed-end funds 6,323.0 10.2 1.06 –0.08 0.23 20.0

D. Partnerships 1.1 2.4 1.13 –1.11 0.33 33.3

X. Unclassified domestic

Foundations 32.4 9.2 1.10 –0.28 0.15 13.1

Associations 11.4 7.1 1.08 –0.31 0.13 15.7

Other 0.6 3.9 1.08 –0.79 0.27 26.4

The table presents characteristics of portfolios for major investor categories in the sample. The characteristics

are averaged over 2001–2005 and over all investors in a subcategory. Portfolio size is reported in SEK billion.

The betas are the factor loadings in a three-factor regression model (market; high-minus-low book-to-market

ratio, HML, or value-minus-growth; small-minus-big market capitalization, SMB), and idiosyncratic risk is the

(annualized) standard deviation of the residuals from the same regression. The tax clienteles are described in

Section 3. “Other” refers to institutional investors that we are unable to classify.

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4.2.2 Regression Results

First, we establish a benchmark regression model with no control variables and the individual stock

portfolios excluded, then we add the control variables and, finally, we examine the impact of adding

the stock portfolios of more than two million individuals to the regression. There are three reasons

for studying the portfolio behavior of institutional investors separately. First, the directly held

stock portfolios of individuals appear to provide a decidedly incomplete picture of investors’ total

wealth. Many individuals with directly-held stocks also hold shares in mutual funds. Second, we do

not have important background variables such as age, income, vested pension plans, and residential

real estate that influence the investment behavior of individuals. Third, adding more than two

million stock portfolios to an equally weighted regression effectively means that the coefficients of

the control variables are determined by the characteristics of the individuals’ portfolios.

We estimate standard errors based on a pairwise bootstrap with 500 replications, accounting

for conditional heteroscedasticity and serial correlation.20 In the regressions with organizations

only, the standard errors are clustered at the investor level. When we add the stock portfolios

of individuals to the regression, we cannot control for serial correlation in standard ways because

there is no code that tracks the stock portfolios of individuals over time. We approach this issue

by bootstrapping the full sample 500 times, taking into account conditional heteroscedasticity, but

count each observation as only one fifth. This is a conservative way of dealing with the correlations

over time and is equivalent to computing the conditional heteroscedasticity-robust standard errors

without accounting for the correlation over the years, and inflating them by a factor of the square

root of five.

We begin with the regressions without individuals in Table 5. For brevity, we omit the coef-

ficients of annual year dummies. The coefficients of the tax clientele dummies are negative and

statistically different from zero at conventional levels. Hence, the dividend yield of the tax-neutral

stock portfolios exceeds the dividend yield of all other stock portfolios. Compared to the aggregate

stock portfolios examined in Table 2, the difference in dividend yield between A and B is larger

(regression coefficient 1.198 versus 0.34 difference in dividend yield), while the difference between

20Asymptotic standard errors from a GMM estimation, also accounting for conditional heteroscedasticity and serial

correlation, are very similar to the bootstrap standard errors and are therefore not reported in the tables.

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Table 5: Portfolio Dividend Yield and Relative Tax Preferences

Trimmed samples

Least squares Tobit analysis Many stocks Large size A versus C

B. Businesses –1.198 –1.670 –0.519 –0.798(0.047)∗ (0.018)∗ (0.037)∗ (0.047)∗

C. Investment funds –0.208 –0.109 –0.146 –0.450 –0.220(0.069)∗ (0.026)∗ (0.054)∗ (0.070)∗ (0.066)∗

D. Partnerships –0.259 –0.130 –0.238 –0.474(0.061)∗ (0.026)∗ (0.048)∗ (0.062)∗

Adjusted R2 3.4 3.0 10.0 4.3 4.2

N 152,308 152,308 38,434 65,512 8,196

N0 31.7 31.7 2.8 8.5 8.9

The table presents the results of pooled least square regressions of dividend yield on dummy variables equal to

one if an investor belongs to clientele B, C, or D, respectively, and zero otherwise. The portfolios of individuals

are excluded. The regressions include dummy variables for each year, but they are not reported in the table. The

trimmed samples only consider portfolios with five stocks or more, stock portfolios with a market value of SEK

250,000 or more, and tax clienteles A and C only (businesses and partnerships omitted). Standard errors based

on a pairwise bootstrap (500 replications) accounting for conditional heteroscedasticity and serial correlation are

reported in parentheses. The adjusted R-squares in the regressions are reported in %. For the tobit model, we

report the the squared correlation between predicted and observed dividend yields. N is the total number of

observations available; N0 is the number of observations with zero dividend yield expressed in % of total number

of observations. Asterisk ∗ denotes significance level 5% or better against the null hypothesis that the coefficient is

zero. For the tax dummy variables, we perform a one-sided test of whether the regression coefficients are negative.

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A and C/D is smaller (for C, the regression coefficient is 0.208 versus 0.35 difference in dividend

yield). As many as 31.7% of the stock portfolios have zero dividend yield. The non-linearity at

zero implies that the linear regression model can predict negative dividend yields.

We deal with this issue by estimating a Tobit model and by estimating the regression model

in trimmed samples. Specifically, we trim the sample by (i) eliminating the stock portfolios with

less than five stocks, (ii) deleting the stock portfolios with a value less than SEK 250,000, and (iii)

including only the stock portfolios of tax-neutral investors and investment funds. The cutoff points

at five stocks and SEK 250,000 portfolio value are arbitrary, but other cutoff points yield similar

results. After these exclusions, the number of observations falls dramatically; more importantly, so

does the share of portfolios with zero dividend yield. Glancing across the columns, all regression

coefficients remain statistically below zero, so the difference between tax-neutral investors and the

other tax clienteles is robust to the clustering of observations at zero dividend yield. The magnitudes

of the regression coefficients move around, but the internal ordering is preserved with businesses

showing the strongest aversion towards dividends.

Next, we add the control variables to the regression model in Table 6. The structure of the table

is the same with the base case results to the left followed by the Tobit model and the trimmed

samples to the right. Once we control for investors’ risk preferences, the coefficients of the tax

clientele dummies sort nicely according to the tax clientele hypothesis, i.e., the ambiguous ordering

of business portfolios is removed. The tax coefficients are statistically different from zero with the

exception of two instances, the Tobit model and the specification with five or more stocks, where the

regression coefficients of the business portfolios are positive. The estimated yield spread between

tax-neutral portfolios A and investment funds C ranges from 0.376 to 0.685. The magnitudes and

significance levels of the coefficients of the risk variables, as well as the regression R-squares, are

similar to those reported by Graham and Kumar (2006). We also estimate these regressions without

the HML and SMB betas with similar results (not reported).

Finally, we examine the impact of including the two million stock portfolios of individuals in

Table 7. The stock portfolios of individuals strongly influence the regression coefficients. The tax

clientele coefficients in Specification (1) without control variables resemble the ordering and magni-

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Table 6: Portfolio Dividend Yield, Relative Tax Preferences, and Portfolio Characteristics

Trimmed samples

Least squares Tobit analysis Many stocks Large size A versus C

B. Businesses –0.204 0.020 0.024 –0.140(0.031)∗ (0.020) (0.026) (0.041)∗

C. Investment funds –0.472 –0.685 –0.376 –0.471 –0.506(0.047)∗ (0.028)∗ (0.040)∗ (0.052)∗ (0.050)∗

D. Partnerships –0.504 –0.781 –0.371 –0.513(0.039)∗ (0.031)∗ (0.031)∗ (0.045)∗

Beta (Market) –0.550 –0.398 –0.881 –0.600 –0.975(0.025)∗ (0.018)∗ (0.051)∗ (0.047)∗ (0.207)∗

Beta (HML) 1.161 1.417 1.528 1.299 1.433(0.010)∗ (0.012)∗ (0.022)∗ (0.027)∗ (0.057)∗

Beta (SMB) 0.287 0.511 0.571 0.374 0.562(0.026)∗ (0.017)∗ (0.052)∗ (0.064)∗ (0.149)∗

Idiosyncratic risk –0.026 –0.091 –0.048 –0.029 –0.024(0.001)∗ (0.001)∗ (0.001)∗ (0.002)∗ (0.003)∗

Adjusted R2 42.9 46.1 52.7 39.5 34.0

N 152,308 152,308 38,434 65,512 8,196

N0 31.7 31.7 2.8 8.5 8.9

The table presents the results of pooled least square regressions of dividend yield on portfolio characteristics over

2001–2005. B. Businesses, C. Investment funds, and D. Partnerships refer to dummy variables, equal to one if an

investor belongs to clientele B, C, or D, respectively, and zero otherwise. The portfolios of individuals are excluded.

The betas are the factor loadings in a market model regression or in a three-factor model regression (market;

high-minus-low book-to-market ratio, HML, or value-minus-growth; small-minus-big market capitalization, SMB).

Idiosyncratic risk is the (annualized) standard deviation of the residuals from the same regressions. The regressions

include dummy variables for each year, but they are not reported in the table. The trimmed samples only consider

portfolios with five stocks or more, stock portfolios with a market value of SEK 250,000 or more, and tax clienteles A

and C only (businesses and partnerships omitted). Standard errors based on a pairwise bootstrap (500 replications)

accounting for conditional heteroscedasticity and serial correlation are reported in parentheses. The adjusted R-

squares in the regressions are reported in %. For the tobit model, we report the the squared correlation between

predicted and observed dividend yields (pseudo R2). N is the total number of observations available; N0 is the

number of observations with zero dividend yield expressed in % of total number of observations. Asterisk ∗ denotes

significance level 5% or better against the null hypothesis that the coefficient is zero. For the tax dummy variables,

we perform a one-sided test of whether the regression coefficients are negative.

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Table 7: Portfolio Dividend Yield and Relative Tax Preferences, Including Individuals

(1) (2) (3)

B. Businesses and individuals –0.182 0.152 –0.769(0.052)∗ (0.042) (0.225)∗

C. Investment funds –0.177 –0.416 –0.383(0.076)∗ (0.059)∗ (0.063)∗

D. Partnerships –1.381 0.153 –0.095(0.087)∗ (0.072) (0.094)

Beta (Market) 0.455 –0.616(0.005)∗ (0.183)∗

Beta (HML) 1.379 1.292(0.003)∗ (0.054)∗

Beta (SMB) –0.059 0.450(0.005)∗ (0.164)∗

Idiosyncratic risk –0.030 –0.022(0.000)∗ (0.003)∗

B × Beta (Market) 1.072(0.182)∗

B × Beta (HML) 0.087(0.054)

B × Beta (SMB) –0.509(0.162)∗

B × Idiosyncratic –0.008(0.004)∗

Adjusted R2 2.2 51.7 51.7

N 10,406,430 10,406,430 10,406,430

N0 12.7 12.7 12.7

The table presents the results of pooled least square regressions of dividend yield on portfolio characteristics over

2001–2005, as in Equation (2). The portfolios of individuals are included. The variables are defined as in Table 5

with the addition of specific control variables for Clientele B. These variables are calculated as the Clientele B

dummy variable times the betas and the idiosyncratic risk, respectively. Standard errors based on a pairwise

bootstrap (500 replications) accounting for conditional heteroscedasticity and serial correlation are reported in

parentheses. The adjusted R-squares in the regressions are reported in %. N is the total number of observations

available; N0 is the number of observations with zero dividend yield expressed in % of total number of observations.

Asterisk ∗ denotes significance level 5% or better against the null hypothesis that the coefficient is zero. For the

tax dummy variables, we perform a one-sided test of whether the regression coefficients are negative.

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tudes of dividend yields on the aggregate stock portfolios in Table 2. As we add control variables in

Specification (2), the coefficients of businesses and individuals and partnerships turn significantly

positive, and when we interact the control variables with the tax clientele dummy for businesses

and individuals, all coefficients become statistically negative.21 As the coefficients are sensitive to

the specification, we conclude that the regression model cannot sort out the dividend preferences

of businesses and individuals (B) and partnerships (D). However, the regression coefficients of in-

vestment funds (C) are robust across specifications, so we feel confident that the difference between

tax-neutral investors and investment funds is a robust feature of our data. With the individuals in-

cluded, the estimated yield spread between tax-neutral portfolios A and investment funds C ranges

from 0.177 to 0.383.

5 Concluding Remarks

In this paper, we analyze a comprehensive data set of all domestic stock portfolios in the Swedish

market. Each stock portfolio is assigned with a letter code that identifies its owner’s relative tax

preference of dividends over capital gains, and we have investigated to what extent the letter code

is associated with the dividend yield on the stock portfolio. There are four domestic tax clienteles

in the Swedish stock market labeled A–D. We find that tax-neutral investors (A), investment

funds (C), and partnerships (D) behave in accordance with the predictions of the dividend tax

clientele hypothesis, while the evidence relating to businesses and individuals (B) is ambiguous and

depends on the sample and empirical specifications. The yield spread between tax-neutral portfolios

and investment funds in the order of 35 basis points is a robust and economically meaningful result

at the investor level. However, the implications for tax revenues and stock market valuation are

necessarily modest in Sweden where statutory tax rates relating to dividend income and capital

gains are fairly low and large investor groups do not pay tax on such income.

In addition to these general results, we find that foundations prefer dividend-paying stocks,

but we cannot tell whether these dividend preferences are related to favorable income taxation

or charter provisions that require foundations to make distributions from income and not from

21There are no interesting interaction effects between Tax Clientele C and the control variables (not reported).

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principal. The finding that private corporations holding stock portfolios is a curious phenomenon.

To the extent that corporate stock portfolios do not merely substitute for other corporate savings,

owners of private corporations suffer from consumption that is too low due to tax-induced lock-in

effects. The concentration of corporate stock portfolios in growth stocks suggests that the locked-

in capital is inefficiently diversified. Our interpretation of the data immediately implies that tax

cuts for private corporations would reduce the number of corporate stock portfolios and increase

corporate payouts. Further evaluations of these potential tax distortions may make for interesting

future research.

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• Tax-neutral investors and investment funds sort by tax preferences.

• Partnership portfolios are almost non-existent.

• Special tax rules for private corporations encourage private firms to purchase growth stocks.

• Foundations earn higher dividend yields than most other investors.

Highlights