Tax-induced trading of equity securities: Evidence from the ADR market

We examine ex-dividend date trading of American Depositary Receipts (ADRs) using a sample of 1,043 dividends over the period 1988 to 1995. ADR dividends are often subject to foreign withholding taxes, creating incentives for certain investors to avoid the distribution. ADRs exhibit negative abnormal ex-dividend day returns, and their prices behave consistently with their related withholding taxes. Abnormal trading volume for taxable issues exceeds 130 percent and 300 percent of normal volume on the cum- and ex-dates, respectively. Abnormal volume is an increasing function of foreign withholding tax rates and decreasing function of transactions costs. This abnormal ex-date trading activity is consistent with tax-motivated trading.