Tax Effect and Ex-Dividend Day Pricing Related to Distribution from Reduced Capital Reserves

Dividends based on retained earnings are taxed as dividend income when they are distributed to shareholders. However, dividends from reduced capital reserves are considered a return of capital and are not taxed under current Korean tax law. Therefore, firms can utilize distributions from reduced capital reserves as a means to increase firm value through tax effects favorable to shareholders. This study examines the status of dividends from reduced capital reserves in Korean listed companies and empirically analyzes whether dividends from reduced capital reserves affect firm value (stock prices). This study conducts empirical analyses on Korean listed companies that paid cash dividends from 2012 to 2021. After selecting a group of firms that paid dividends from reduced capital reserves and a comparison group with similar firm characteristics through propensity score matching, we examine whether there is a significant difference in the stock price decline on the ex-dividend day between the two groups using t-tests and multiple regression analysis. We find that differences in tax effects between dividends from reduced capital reserves and dividends based on retained earnings are reflected in stock prices on the ex-dividend day. This study contributes to the policy discussion surrounding tax law revisions related to dividends from reduced capital reserves by confirming that dividends from reduced capital reserves can be used as a means to increase firm value through favorable taxation to shareholders. It also contributes to prior research on stock price adjustments on the ex-dividend day and existing literature on tax effects reflected in the capital market (tax capitalization hypothesis). In addition, this study proposes a methodology to estimate the amount of dividends from reduced capital reserves by using financial statements and other relevant data sources, thereby contributing to collecting primary data for future empirical studies on firms’ dividend distributions from reduced capital reserves.