|Investors who receive stock dividends will find their tax burden increases as of the day of ex-right, because stock dividends are recognized as a taxable income in Taiwan. Elton and Gruber ( 1970 ) model neglects the risk of one-day holding period, and hence tends to misjudge the tax effect. Chen ( 1989 ) and Chow and Wang ( 1990 ) who apply the Elton and Gruber model to stock dividends suffer yet another drawback, that is, stock dividends can not be measured as if they were cash dividends.
This research introduces a one day holding strategy which not only takes into ac-count the effect of one day risk, but also avoid the difficulty of measuring stock divi-dends. The results show that even if investors are in the highest tax bracket, buying on the day before ex-right and selling on the ex-right day, both at the closing price, will earn excess return, net of round trip transaction costs, security transaction tax and the incremental income tax. We thus conclude the existence of after-tax excess return on the ex-right day.
The magnitude of excess return is positively related to the stock dvidend rate, and is negatively related to the ratio of ex-right price to rights-on price, which support the so-called bargain hunting hypothesis proposed by Lee ( 1991 ).