Journal of Public Economics 49 (1992) 261-285.

North-Holland

A direct examination of the dividend

clientele hypothesis
John Karl Scholz*
Department of Economics and LaFollette Institute of Public Affairs, University of Wisconsin-
Madison, 1180 Observatory Drive, Madison, WI 53706, USA

Received March 1990, final version received October 1991

This paper describes and estimates an empirical model that directly tests the dividend clientele
hypothesis using data on individual portfolios from the 1983 Survey of Consumer Finances. The
results provide evidence that investors are sensitive to tax rates when choosing portfolio
dividend yields, and thus support a number of indirect tests that use security price data to
investigate the clientele hypothesis. However, the approach taken in this paper avoids the
difficulty, inherent in the indirect studies, of distinguishing between tax-driven and arbitrage-
driven changes in ex-day security prices.

1. Introduction

For most individuals, the U.S. Federal tax system taxes dividends more
heavily than capital gains. While the 1986 tax reform equalized the tax rates
on ordinary income and realized capital gains, capital gains in general
remain tax preferred because they are taxed when realized rather than when
accrued and because the basis of bequeathed assets is increased to market
value at the time they are passed on, effectively eliminating capital gains
taxes at death. Because dividends are relatively tax disadvantaged, one might
expect firms that have a high dividend-payout ratio to attract investors who
have relatively low marginal tax rates. Similarly, high marginal rate investors
might be expected to purchase the securities of low-dividend-yield firms, all
else being equal. This expectation, that firms attract investor clienteles based
on the dividend-payout ratio of the firm, is called the dividend clientele
hypothesis.
The hypothesis was first suggested by Miller and Modigliani (1961) as a

Correspondence to: J.K. Scholz, Department of Economics and LaFollette Institute of Public
Affairs, University of Wisconsin-Madison, 1180 Observatory Drive, Madison, WI 53706, USA.
*I wish to thank my dissertation committee, John Shoven (chair), Doug Bemheim and
Michael Boskin, for their comments and support. Particularly helpful suggestions were also
provided by Bill Gale, Mike Knetter, Paul Evans, James Poterba, Glenn Hubbard, Jonathan
Skinner, two anonymous referees, and seminar participants at Ohio State, Wisconsin, UCLA
and the Utah finance department. I am indebted to Arthur Kennickell for providing a cleaned
copy of the 1983 Survey of Consumer Finances and providing extensive documentation.

0047-2727/92/$05.00 0 1992-Elsevier Science Publishers B.V. All rights reserved

262 J.K. Scholz, The dividend clientele hypothesis

way of maintaining their dividend irrelevancy proposition when differential

personal taxation of dividends and capital gains is incorporated in their
model. In the Miller-Modigliani framework, the existence of clienteles is
important in determining the likely impact of dividend payouts on security
returns. The existence of clienteles may also be important to corporate
financial managers as the tax characteristics of the firm’s investors may
influence the firm’s optimal financial decisions [Hamada and Scholes (1985)].
Furthermore, to the extent that taxes influence the portfolio decisions of
individual investors, managers may be reluctant to alter established dividend
payouts. Deviations from a smooth pattern of dividends may cause investors
to incur transactions costs as they reshuffle their portfolios to achieve their
desired clientele.
While it may appear that the clientele hypothesis says little more than
investors will maximize their after-tax return, there are a number of
complications to this proposition. Because of these complications, most
papers examining the hypothesis have been empirical. The majority of studies
are indirect tests, which try to infer the tax characteristics of a firm’s
marginal investor by movements in ex-day security prices. These studies are
difficult to interpret, however, because arbitrage activity and tax effects have
similar implications for the behavior of ex-day prices. Previous direct tests
examine the relationship between tax rates and dividend receipts in investors’
portfolios. Unfortunately, the previous direct studies have important data
limitations.
In this paper, after describing the previous theoretical and empirical
literature, I develop an empirical model of individual investor dividend
clienteles that focuses on taxes, transactions costs, and risk. The 1983 Survey
of Consumer Finances (SCF) is used to construct the variables and estimate
the model.’ Econometric complications arise both from the censored nature
of the dependent variable, portfolio yields, and from the endogeneity of the
primary independent variable, tax rates. The principal result of the paper is
that in a variety of different empirical specifications tax rates appear to affect
the dividend yields of investors’ portfolios, even after proxy variables are
included to control for transactions costs and risk.

2. Previous literature
2.1. Theoretical considerations

Two papers have presented theoretical models of dividend clienteles. Miller

‘The 1983 Survey of Consumer Finances (SCF) is a U.S. micro-data set that contains specific
information on both equity holdings and dividend recepts, which makes it particularly useful for
this study. It also contains a wide variety of other financial, demographic, and attitudinal
questions. The SCF was developed by the Board of Governors of the Federal Reserve System
and is described in Avery and Elliehausen (1988).
 J.K. Scholz, The dividend clientele hypothesis 263

(1977) describes an equilibrium model of capital structure in the presence of

taxes where ‘high dividend paying stocks will be preferred by tax exempt
organizations and low income investors; those stocks yielding more of their
return in the form of capital gains will gravitate to the taxpayers in the
upper brackets’ (p. 30). Auerbach (1983) extending the work of Auerbach
and King (1983), develops a formal model of dividend clienteles using a
capital asset pricing model framework. Auerbach’s derivation shows the
conditions, such as uncorrelated equity returns across firms, that are
necessary to make an unambiguous prediction that clienteles will exist.*
The theoretical plausibility of dividend clienteles is also affected by
different explanations of why firms pay dividends.3 If dividends help
alleviate agency problems [Jensen and Meckling (1976); Easterbrook (1984);
or Jensen (1986)] or signal future profitability [Bhattacharya (1979) or
Bernheim (1991)], high marginal tax rate investors may still prefer the
securities of high dividend-paying firms, contrary to the predictions of the
clientele hypothesis. Similarly, some people may value dividends, despite their
tax disadvantaged status, due to the behavioral reasons explored in Shefrin
and Statman (1984). Miller and Scholes (1978) describe how investors can
exploit provisions of the tax code to avoid paying dividend taxes.
These considerations alter the clear theoretical predictions of the Miller
equilibrium and Auerbach’s model, yet the clientele hypothesis remains a
fixture of academic discussions of dividends and taxes. Scholes and Wolfson
(1992), for example, write, ‘. . . if investors have different marginal tax rates,
and we assume that it is expensive to sell short, we would expect higher
dividend-yielding securities to attract lower marginal-tax-rate shareholders
than would lower dividend-yielding securities’ (p. 362). Because of the
theoretical ambiguity surrounding the hypothesis and its empirical nature,
most papers in this literature have been empirical.

2.2. Empirical evidence

Indirect empirical tests of the clientele hypothesis attempt to infer the tax
characteristics of a firm’s marginal investor by movements in ex-day security
prices. Elton and Gruber (1970) Litzenberger and Ramaswamy (1980), and
Auerbach (1983) find nearly dollar for dollar security price changes for firms

‘Sandmo (1986) provides a nice discussion of how correlated asset returns, different functional
form assumptions, and different institutional features of the tax code, such as imperfect loss
offsets and different tax bases, will alter and often make indeterminate simple predictions about
the effects of taxes on risk-taking. These considerations would also complicate theoretical models
of dividend clienteles.
3Auerbach’s derivation is consistent with either the old-view or new-view of dividend taxes,
which in his framework is a question of whether equilibrium 4. the value by which a dollar of
retentions increases the value of the firm, is equal to or less than one. See Auerbach (1983),
particularly pages I 11, 112, and 116, for a more detailed discussion of this point.
264 J.K. Scholz, The dividend clientele hypothesis

with higher dividend payouts, while firms with lower payouts have ex-day
prices that fall by less than dollar for dollar of dividend payout. This is
interpreted as evidence supporting the clientele hypothesis.4
If there are fixed costs or a nonconvex transactions technology associated
with arbitrage, however, there could be a positive correlation between ex-day
security price changes and the size of a firm’s dividend payout even in the
absence of dividend clienteles. Kalay (1982, 1984) and Lakonishok and
Vermaelen (1986) show that if ex-day prices fall by less than dollar for dollar
of dividend payout, there would be profit-making opportunities for any
investor purchasing a security immediately before the ex-day and selling
after, as long as the tax rate on dividends exceeds the tax rate on capital
gains.5 With arbitrage, ex-day security returns will be driven close to one
for high-yield securities, since potential arbitrage profits increase with the size
of the firm’s dividend payout. Lower yield securities could have ex-day
returns that deviate more from the zero-arbitrage profit equilibrium if there
are costs associated with arbitrage. Lakonishok and Vermaelen (1986) and
Karpoff and Walkling (1988), in fact, find disproportionately more short-term
trading activity around the ex-day of securities with larger dividend payouts
and securities that are more actively traded. This suggests that arbitrage may
influence the pattern of ex-day security price changes, which means these
changes may reveal little about dividend clienteles.
Four papers look directly at investor portfolio data to see whether
dividend yields vary inversely with tax rates.6 Blume, Crockett and Friend
(1974) present cross-tabulations that show declining portfolio yields as
adjusted gross income (AGI) increases. While these results are suggestive,
they do not control for other factors that might influence investors’ desired
portfolio yields. Furthermore, the level of aggregation (tabulations of yield by
nine AGI classes) obscures the relationship between tax rates, which are not
perfectly correlated with AGI, and portfolio yield.
Two studies make use of a unique data set developed from a survey of
brokerage firm customers in the mid-1970s. The survey includes a listing of
the securities that compose each investor’s portfolio and a number of
demographic and income-related questions. These data allow the analyst to
control for the risk characteristics of the portfolio in a manner that is

4Elton and Gruber (1970) show that in the absence of arbitrage, the ex-day price change of a
security equals (P, - PJ/D = (1 - tr)/( 1 - t,), where P, is the asset price before the ex-day, Pa is
the price after, td and t, are the dividend and capital gains tax rates on the firm’s marginal
investor, and D is the dividend.
‘Given the ex-day price change in footnote 4, potential arbitrage profits equal UP=
(1 - z)D [(td - t,)/( 1- rJ]i where r isthe arbitrager’s tax rate on ordinary income.
‘A fifth study, King and Leape (1984), examines a variety of issues having to do with portfolio
composition, among-them is the role taxes play in portfolio choice. The; find ‘. contrary to
much of the recent literature, taxes do not play a decisive role in explaining the differences in
portfolio composition across households’ (p. 26). However, they do not analyze the effects of
taxes on the dividend yield of an investor’s portfolio.
 J.K. Scholz, The dividend clientele hypothesis 265

impossible using other individual-level data. Pettit (1977) presents evidence

that is supportive of the clientele hypothesis. Using the same data, Lewellen,
Stanley, Lease and Schlarbaum (1978) find very little supporting evidence. It
is difficult to determine what accounts for this difference in findings. The
methodology of the two studies differs, Pettit uses regression techniques
while Lewellen et al. use multivariate discriminant analysis to differentiate
the holders of securities grouped into ten different yield classes. The
shortcoming of the data used in both studies is their lack of tax-related
information. Individuals are asked to indicate their income by checking-off
from a list of income ranges. The tax computation is based on this reported
income so all people in a relatively broad income class are assumed to have
identical marginal tax rates.
The final direct study, Chaplinsky and Seyhun (1987), uses the Internal
Revenue Service’s Individual Income Tax Model to investigate a number of
issues, including the clientele hypothesis. While these data have outstanding
tax-related information, they do not have asset information that allows the
authors to develop a measure of portfolio yield. Instead, Chaplinsky and
Seyhun use dividends divided by the sum of dividends and realized long-term
capital gains as their dependent variable. However, capital gains realizations
have been shown by many authors [for example, Feldstein, Slemrod and
Yitzhaki (1980) and Lindsey (1987)] to be sensitive to tax characteristics and
hence, the cross-sectional variation they ascribe to clientele behavior may
instead be due to capital gains realization behavior. In addition, Chaplinsky
and Seyhun do not attempt to control for differences in risk preferences
among taxpayers.

3. The empirical model

The literature on portfolio choice suggests that three broad factors -

transactions costs, taxes, and portfolio risk - may potentially influence the
dividend yield of a household’s portfolio. In the next two sections I motivate
and describe the calculations of the variables used in the empirical model.
Several variables are used to proxy for the importance of transactions costs,
including wealth, age, family size, and portfolio size. Since the focus of the
clientele hypothesis is on the relationship between tax rates and dividend
yields, particular care is taken to construct the relevant marginal tax rate
variables. Finally, a set of variables including self-reported investor attitudes
toward risk, the number of companies that the investor holds stock in, and
the value of like insurance as a percentage of wealth are used to proxy for
investor risk preferences.
The Miller-Modigliani theorem implies that in the absence of market
imperfections (such as taxes and transactions costs), an investor will not care
whether a firm pays dividends or retains earnings. The change in share value
266 J.K. Scholz, The dividend clientele hypothesis

generated by the firm retaining earnings would be valued exactly the same as
a prospective dividend payment. If the firm retained earnings and the
investor preferred cash, the investor would simply sell a sufficient number of
shares to generate the preferred level of dividends.
Taxes and transactions costs alter this irrelevance proposition.’ Divi-
dends have the advantage of being regular and immediately liquid. To
convert shares of stock into liquid assets, an investor has to at least take
time and pay brokerage fees. For smaller sales these fees can be a significant
percentage of the total sale as they often contain a fixed component. The
disadvantage of dividends is that taxpayers who have dividend receipts that
exceed the dividend exclusion face a higher marginal tax rate on dividends
than on capital gains.8 Thus, when investors decide whether to invest in
high- or low-yield securities, they must trade off the tax advantage of capital
gains against the transactions costs incurred when they convert shares of
stock into capital gains.
The importance of transactions costs is likely to be affected by at least two
factors: the size of the transactions costs relative to wealth and the number of
transactions made. Wealth and in one specification portfolio size are
included in the empirical model. My expectation is that transactions costs
will be more important for less wealthy taxpayers. Thus, investors with less
wealth are expected to hold higher-yield securities.
Since transactions costs are incurred whenever capital gains are realized, I
expect investors who prefer regular income streams to hold higher-yield
securities. I use age and family size to proxy for these effects. Life-cycle
theory suggests that the elderly dissave. Thus, all other things being equal, I
expect the coefficient on age to be positively associated with portfolio yield.
Similarly, I expect larger families (and less wealthy families) to have a greater
demand for disposable income and consequently hold higher-yield portfolios.
The tax advantage of capital gains is directly related to the difference in
the marginal tax rate applied to dividends and the imputed marginal tax rate
on accrued capital gains. Therefore, I include this differential tax rate
variable in the empirical model of an investor’s desired portfolio yield. The
implication of the clientele hypothesis is that taxpayers with high marginal
tax rates on dividends relative to capital gains will purchase lower yield
securities. Given its central nature, care must be taken when constructing the
tax differential variable. I describe this variable in more detail in the
following section.
There is a presumption in the literature that securities from lower-risk

‘Leape (1987) provides a clear theoretical discussion of the importance of transactions costs in
asset market equilibrium. Transactions costs are sufftcient to ensure that each investor will not
simply hold the market portfolio.
‘In 1982 the U.S. tax system excluded the first $100 of dividend income from taxable income
for single taxpayers and $200 for joint filers.
 J.K. Scholz, The dividend clientele hypothesis 261

firms, such as public utilities, tend to have higher dividend payouts than
securities from riskier, growth-oriented firms [Pettit (1977)]. Auerbach (1983)
finds little empirical evidence that investor clienteles form on the basis of
portfolio risk. Nevertheless, if risk preferences vary systematically with tax
rates and payouts vary with risk, I want to avoid confusing the effect risk
preferences have on portfolio yields with the tax-driven story that is the
essence of the clientele hypothesis. To do this I use a variety of proxy
variables for investors’ risk preferences.g
The first proxy is an additional question asked on the survey. The
question reads: ‘Which of the following statements comes closest to the
amount of financial risk you are willing to take when you make invest-
ments?’ The possible responses are: (1) take substantial financial risks
expecting to earn substantial returns: (2) take above-average risks expecting
to earn above-average returns: (3) take average financial risk expecting to
earn average returns; and (4) not willing to take any financial risk.” The
second proxy variable is the number of companies in which the investor
holds stock. Respondents who hold mutual funds are coded as holding the
maximum permissible number of companies, ten.” Investors who are willing
to take substantial financial risks and hold portfolios with the equity of
relatively few firms are assumed to be more risk-loving and thus are expected
to have lower-yield portfolios. The third proxy variable measures the face
value of term- and whole-life insurance as a percentage of wealth. Respon-
dents who have an affinity for risk were expected to hold smaller amounts of
life insurance relative to wealth, controlling for the level of wealth.”

4. Data and the construction of variables

To calculate a measure of the relative tax treatment of dividends and

capital gains I constructed a tax simulation routine, described in the

‘Ideally I would include the individual’s portfolio beta to measure portfolio risk. However,
constructing the portfolio beta requires data on the specific securities held by each investor,
information that is not available in the SCF. The variables that are used are at best indirect
measures of beta, but are the best risk proxies available in the data.
“It is clear that the same response may correspond to different amounts of financial risk for
different investors, which makes it very difficult to interpret the resulting coeflicient estimates.
Manski (1990) discusses the usefulness and limitations of intentions questions.
“A threshold of thirty was also used with no effect on the results.
‘2Campbell (1980) and Karni and Zilcha (1985, 1986) develop theoretical models where,
ceteris paribus, more risk-averse decision-makers buy more life insurance. In some specifications
I have also used two additional proxies for investors’ preferences for risk. The first is a dummy
variable that is used to indicate risky occupations, such as fire fighters, policemen, lumber-jacks,
and pilots. The expectation is that risk-lovers will be more likely to have riskier occupations.
The second proxy is the percentage of the total equity portfolio held in mutual funds. The
presumption is that on balance, portfolios composed of mutual funds are less risky than those
composed of common stock and stock in the firm the respondent works for.
268 J.K. Scholz, The dividend clientele hypothesis

appendix, based on SCF financial and demographic information.13 The

simulation was constructed because taxpayers with identical marginal tax
rates on ordinary income may have different marginal tax rates on dividends,
due to the dividend exclusion. The marginal rate paid on dividends is
calculated as the difference in taxes before credits and taxes before credits
after adding $1 to dividend receipts. It varies from 0 to 50 percent.
The imputed marginal tax rate on accrued capital gains is more difficult to
calculate.i4 The appropriate measure depends on interest rates, inflation
rates, and the average holding period for capital assets. Protopapadakis
(1983) considers these factors and calculates average effective tax rates for the
period 1960-1978. These estimates vary from 3.4 to 6.8 percent. The range
for the final sample period, 1978, is 4.8-6.6 percent. With the decline in
inflation from 1978 to 1983, I make a somewhat lower estimate for the 1983
imputed tax rate. The calculation is made by taking the difference between
taxes before credits and taxes before credits after adding $0.25 of realized
capital gains to taxable income.” The tax variable (MTRD) is then equal to
the marginal rate on dividends less the imputed marginal rate on accrued
capital gains. MTRD varies from -5 to 45 percent.16
Below a certain threshold of equity holdings, the chosen portfolio yield
will be invariant to tax characteristics. Moody’s Handbook of Common Stocks
indicates that the highest-yield securities have yields in the 12-13 percent
range. Thus, a single taxpayer with equity holdings of under $800 will prefer
high-yield securities to low-yield securities, regardless of her tax characteris-
tics, as no portfolio will have a yield sufficiently high to make dividends
taxable. When equity holdings are large enough to make the marginal tax
rate on dividends exceed the marginal tax rate on capital gains, investors will
prefer low-yield securities. This implies that in the empirical work those with
tax-disadvantaged dividends are expected to have portfolio yields that are

‘jFor the sample of equity holders a self-reported marginal tax rate is 29.9 percent, while the
simulated marginal tax rate is 29.8 percent. Despite this equality, an upward bias in the tax
simulation routine should be noted. The bias occurs because the SCF is constructed on a
household, rather than taxpayer, basis. Therefore family income is aggregated so that the income
of each family member is included in the household’s adjusted gross income. This leads to the
household getting pushed into the highest applicable tax bracket.
%t 1982 the top U.S. Federal marginal tax rate on ordinary income was 50 percent. Sixty
percent of realized long-term capital gains (net of short-term capital losses) were statutorily
excluded from adjusted gross income, therefore the highest statutory marginal tax rate on
realized capital gains was 20 percent.
ISKing and Fullerton (1984) give a derivation that suggests the nominal tax rate on capital
gains should be approximately halved to account for the benefit of deferral. They then follow
several previous studies (cited on their p. 222) and further halve the capital gains rate to account
for step-up of basis at death and the selective realization of losses. I follow King and Fullerton
and the previous studies, thus generating a maximum marginal tax rate on accured capital gains
of 5 percent.
16There are six cases in the sample where 50 percent bracket taxpayers have short-term
capital losses. For these households MTRD is 50 percent.
 J.K. Scholz, The dividend clientele hypothesis 269

negatively related to MTRD. Investors with tax-advantaged dividends might

prefer high yields regardless of their tax circumstances, therefore I expect the
coefficient on MTRD to be insignificant for these investors. In most
specifications I interact the differential tax rate variable with dummy
variables to capture this hypothesized difference. In section 5 I also discuss
the complication that arises from the endogeneity of the differential tax rate
variable and the dummy variables, with the independent variable, portfolio
yield.
The wealth variable, described in the appendix, is a broad measure of
wealth that excludes only pension wealth, social security wealth, and human
capital. The dependent variable, yield, is calculated by dividing dividends
received by equity holdings. Equity holdings are the sum of stock held in the
company the respondent works for, stock held in stock clubs, and stock held
in other firms and mutual funds. Most other variables are transformed
directly from variables on the SCF.
The dividends-receipts variable for owners of subchapter S corporations
may have little to do with the payout ratios of the firms in which they hold
equity and thus may bias the yield variable.” In particular, the reported
dividend receipts for owners of subchapter S corporations may be abnor-
mally large. Unfortunately, the data only indicate whether an individual
owns a business, not whether the business is a subchapter S corporation. In
sensitivity analysis, I examine the robustness of the results to excluding all
business owners.’ 8

5. Econometric methodology
There is a large group of households in the SCF that have portfolio yields
of zero. In the primary empirical specification I assume that some of these
individuals may actually desire negative dividends, that is, investors may
want to make dividend payments to the firm. If the IRS allowed the payment
to be deductible from taxable income, it would only cost the investor $(l -t,,)
to pay this ‘anti-dividend’. Meanwhile, the firm could retain the $1 in a
specific account, which would increase the individual’s value in the firm
“Subchapter S corporations, which are also referred to as ‘tax-option’ corporations, have
elected by unanimous consent of its shareholders, under U.S. tax law (subchapter S), to not pay
any corporate income tax on the corporation’s income. Rather the shareholders pay individual
income tax on the corporation’s income, regardless of whether the income is distributed.
Undistributed taxable income of the S-corporation is distributed to the shareholders for tax
purposes at the end of the fiscal year.
‘*I also have some concern about trusts and managed accounts. It is possible that these
accounts distribute dividends that are reported as such. This would lead to the yield variable
being overstated as the equity portion of the managed account would not be included in the
denominator of the yield variable. While owners of trusts and managed accounts are included in
the primary sample, in the sensitivity analysis I also examine the robustness of the results to
excluding these households.
270 J.K. Scholz, The dividend clientele hypothesis

$(l -t,) and hence, allow the investor to arbitrage against the dividend and
capital gains tax differential. The investor would like to do this until she has
reached the point where the marginal value of the ‘anti-dividend’, including
all transactions costs and risk, is equal to the marginal value of the accrued
capital gain. i9 To ensure the censoring assumption is not driving the
empirical results, however, I also estimate the model treating the observed
zeros as true zeros, rather than the manifestation of a censored dependent
variable. This alternative specification is discussed in the following section.
I start by writing the empirical model as

Y=Xj?+crZ*+c, when RHS>O,

=o, otherwise, (1)

where

Y = portfolio yield,
X = independent variables,20
Z* = differential marginal tax rate (MTRD).

The clientele hypothesis suggests that an investor’s marginal tax rate will
affect the yield of the investor’s portfolio. However, the portfolio yield also
affects the investor’s marginal tax rate, hence the differential tax rate variable,
Z*, is endogenous. Recognizing this, I define a second equation where Z* is
regressed against variables that are exogenous to Y, including an
instrument.21 This generates the system

Y=X/I+aZ*+s, RHS>O,

= 0, otherwise Pa)

z*= wt+u, G’b)

“This transaction can almost be mimicked by an individual investor who sells short prior to
the ex-day. The dividend payment, which the short-seller pays to the lender of the security, is
deductible as a nonbusiness expense (itemized deduction) at ordinary income tax rates. The gain
or loss from completing the short-sale are treated as a capital gain, but generally as a short-term
gain, which is taxed the same as ordinary income. In addition, the transactions costs associated
with short-sales are quite severe and the IRS places restrictions on short-sales around the ex-
day. The hypothetical ‘anti-dividend’ differs from a new share issue in that the initial equity
purchase is not deductible from taxable income.
Z”As described previously, these include age of household head (broken into dummy variables
to account for nonlinearities), family size, wealth, attitudes towards risk (broken into dummy
variables), number of companies the investor holds stock in, and the value of insurance as a
percentage of wealth.
*‘The instrument I adopt is the differential tax rate assuming all investors have the same
portfolio yield, that is, I assume all fums follow a ‘neutral’ dividend policy.
 J.K. Scholz, The dividend clientele hypothesis 271

where W = the set of variables exogenous to Y, u N N(0, (r,“).

Ignoring for a moment the censoring of Y, the reduced-form equation for
Y can be written as

Y=X~+ccW~+e+au. (3)

Pettit (1977) estimates this reduced-form equation. He interprets the coeffi-

cient on the instrument in W as the structural parameter ~1,rather than the
product of the structural parameter and ti the coefficient of the instrument.
This can potentially bias both the resulting parameter estimates and the
reported standard errors.22
To derive the likelihood function I rewrite the system given in (2) as

Y=Xfl+ctWS+e,, RHS>O,

=o, otherwise (44

z*=W(+e2 PW
where
e,=au+& and e2=u.

The joint distribution of the error terms (e1,e2) is bivariate normal. The
likelihood function for the system given in (4) has two branches with the
following associated probabilities:

I. Y>O and Z*: P, =f2(el,e2,PeleJ;

(5)

II. YiOandZ*: P,=

**In Pettit’s paper the correlation between the instrument and the ‘true’ marginal tax rate
variable is very high, therefore ti takes a value very close to one. This correlation is much lower
in the SCF, where there is a great deal more variation in individual tax rates, because marginal
tax rates are calculated making use of much richer income and demographic data. Pettit also
found far fewer zero yield portfolios in his sample of equity holders. Without the censoring he
was able to use OLS regressions in his analysis.
272 J.K. Scholz, The dividend clientele hypothesis

where fi is the bivariate normal density, and @ and 4 are the univariate
normal distribution and density functions, respectively. The likelihood func-
tion is the product of these probabilities over the relevant subset of
observations. The standard deviations and correlations in eq. (5) are given by

ge*= flu, (6)

Earlier I argued that portfolio yields may differ depending on whether an

investor had tax disadvantaged or untaxed dividends. To examine this I
define the following dummy variables:

D = 1, ifZ*jO,
1
0, otherwise;

(7)

The empirical model can then be written

Y=Xfi+criD1Z*+cr2D2Z*+~, RHS>O,

=o, otherwise, (84

z*= wC$+u. W4

Eq. (8a) can be rewritten as

 J.K. Scholz, The dividend clientele hypothesis 273

Table 1
Calculated federal marginal income tax rates and holdings of dividends and equity, by
wealth percentile, 1983.”

Wealth Average MTRb Percentage of Percentage of

aercentile (percent) total dividends total equity
GlO 10.2 0.12 0.02
l&20 14.4 0.28 0.18
20-30 16.8 0.14 0.09
3G40 17.4 0.80 0.24
4&50 19.9 0.94 0.54
St%60 20.8 0.88 0.58
6Ck70 20.9 1.94 0.82
7tHo 25.2 2.22 1.73
8tL90 28.2 6.49 5.84
9G98 32.9 24.26 21.69
98-99 41.9 9.83 10.47
99-100 46.0 52.11 57.81
Total 20.9 100.00 100.00
“Data are from the 1983 Survey of Consumer Finances, weighted to represent the U.S.
population.
“Average Federal marginal income tax rates are calculated by the tax simulation
routine described in the appendix.

Y=Xj?+alW5+el, when Y>OandZ*sO,

Y=Xp+cr,W(+e:, when Y>O and Z*>O, (9)

=o, when Y SO,

where e, =c(ru +E and e: E CQU+E. The likelihood function for the system
given by (9) and (Sb) is a straightforward extension of that given in eq. (5).
There are now four branches to the likelihood function corresponding to the
probabilities of Y and Z* being greater than, or less than or equal to, zero.

6. Estimation results
6.1. Sample characteristics

The data in the 1983 Survey of Consumer Finances were collected from
interviews conducted with 4,144 households that when weighted, are rep-
resentative of the 84,748,382 households that were in the Continental United
States in 1983. Table 1, based on the full weighted sample, presents cross-
tabulations that illustrate the issue of dividend clienteles. Column 1 indicates
that Federal marginal income tax rate rise steadily through each percentile of
the wealth distribution. Columns 2 and 3 show the percentage of total
dividends and equity held by households in each wealth percentile. Stock
214 J.K. Scholz, The dividend clientele hypothesis

ownership is highly concentrated, 90 percent of equity is held by the top

population decile of the wealth distribution. It appears from these highly
aggregated numbers that the wealthiest, high marginal tax rate households in
the top 2 percent of the distribution receive relatively fewer dividends than
those in the rest of the wealth distribution. Of course, these tabulations do
not control for other nontax factors that might influence portfolio yield.
In the remaining empirical work, I exclude households who do not have
equity from the sample, since the focus of this paper is on the dividend yield
of equity portfolios. This reduces the sample to 1,079 cases, representing
17,268,430 households. There is also a potential timing problem with the
yield variable. The SCF reports the value of equity holdings at the time the
survey was taken. The dividend question asks for the total value of dividend
receipts in the preceding year. To the extent the value of equity at the time
the survey was taken deviates from the average value of equity from which
the dividends were drawn, the yield variable will be biased. Since there is no
information on the survey that suggests a direction for this potential bias, I
implicitly assume the overstated equity holdings are offset by investors with
understated holdings. In practice, SCF yields range from 0 to 25,000 percent.
Because extreme outliers dramatically affect the coefficient estimates, I
arbitrarily eliminate 26 records with yields greater than or equal to 50
percent in the primary specification. I then examine the sensitivity of the
results to moving the truncation point to 30 percent (which eliminates 47
records) and to 100 percent (which eliminates 14 records).
In table 2, cross-tabulations based on the sample of equity holders with
yields less than 50 percent are given. Here I compare the average marginal
tax rate on dividends with the average marginal rate on ordinary income. It
is clear that many households, even those with substantial amounts of
wealth, do not have dividend income that exceeds the $100 ($200 for couples)
dividend exclusion. Columns 3 and 4 contain the average dividend received
and average portfolio yield by wealth decile. These yields fluctuate through-
out the wealth distribution and give very little a priori support for the
existence of dividend clienteles. Weighted sample statistics, definitions, and
scaling factors for the variables used in the estimation are given in appendix
table A.l.

6.2. Estimation results

The results from the weighted maximum likelihood estimation are given in
table 3. The first column gives estimates where those with tax-disadvantaged
dividends are constrained to have the same tax differential coefficient as
those with tax-preferred dividends. The third column presents the same
specification except that dummy variables are used to allow these two groups
 J.K. Scholz, The dividend clientele hypothesis 215

Table 2
Marginal tax rates on dividends and ordinary income, dividend receipts and yields for
equity holders, by wealth percentile, 1983.”

Wealth Federal MTR’ MTR on dividendsd Avg. dividend

percentileb (percent) (percent) receipts Yield
t&10 20.4 2.2 66.2 3.53
lt320 24.1 7.1 465.4 8.67
20-30 21.8 4.1 50.3 5.45
3&40 23.8 2.3 39.6 2.61
4G50 23.9 4.8 280.4 4.33
5G-60 26.9 9.1 163.4 3.46
6&70 25.2 6.0 173.1 3.60
7&80 28.6 11.9 321.4 5.20
8&90 28.8 IS.1 693.7 4.73
9G98 35.4 23.5 2,724.9 4.39
98-99 43.8 37.9 8,212.2 5.29
999100 48.1 41.3 36,542,s 5.43
Total 29.8 14.8 2,406.9 4.53
“Data are from the 1983 Survey of Consumer Finances, weighted to represent the US.
population of equity holders.
‘Wealth percentiles are based on the entire population.
‘The Federal average marginal tax rate is calculated from the tax simulation routine
described in the appendix.
dMTR on dividends is the marginal tax rate on an additional dollar of dividend
income calculated from the tax simulation routine.

to have different desired portfolio yields. Owing to the nonlinear relationship

between wealth and yield shown in table 2, the specification presented in
table 3 includes two nonlinear terms. Age is broken into four dummy
variables and a quadratic term for family size is included.23
The coefficients on the two older AGE dummies are positive and all have
increasing significance with age, indicating that the elderly may be avoiding
transactions costs by investing in higher-yield securities. Alternatively, to the
extent there is a relationship between risk and yield, older investors may
simply be more conservative and therefore be drawn to higher-yield securi-
ties. The relationship between family size and yield is convex. Yields fall as
family size increases up to roughly a 4-person family, then yields increase.
This may reflect different motivations for investing (i.e. the children’s
education) for smaller families while larger families may like more regular
income streams. Investors with portfolios composed of a larger number of
securities also have higher yields. Only one of the attitude toward risk

*‘The age dummies are for households where the head is under 30, between 30 and 50,
between 50 and 65, and over 65. The youngest households are the excluded category in table 3.
An alternative specification, discussed in the sensitivity analysis section, includes a quadratic
term for wealth, the size of equity portfolio, two additional risk proxies, a recoding of STKCO,
and dummy variables for single female and college graduate.
276 J.K. Scholz, The dividend clientele hypothesis

Table 3
Maximum likelihood estimates, dividend yield equation,” 1983.b

Dummy variable
specification
Variable Estimate t-stat. Estimate t-stat.
Constant 0.4143 (1.997) 0.5614 (2.736)
FAMSZ - 1.6433 (1.788) - 1.1979 (1.334)
WEALTH 0.1140 (0.444) 0.1618 (0.653)
DUMRS2 0.1179 (0.761) 0.1181 (0.788)
D UMRS3 -0.0657 (0.463) -0.0516 (0.375)
DUMRS4 - 0.2367 (i.542j -0.2389 (1.607)
STKCO 0.4595 (2.775) 0.4180 (2.601)
INSRA T 0.0300 iO.558j 0.0375 (0.706)
AGE (3&50) -0.0547 (0.449) -0.0031 (0.026)
AGE (5&65) 0.1236 (0.95 1) 0.1359 (1.079)
AGE (65 +) 0.3055 (2.318) 0.2257 (1.741)
FAMSZ (sq) 1.9218 (1.457) 1.3199 (1.026)
MTRD - 1.0431 (2.435)
MTRD (Pos) - 1.4918 (3.413)
MTRD (Neg) 9.7311 (2.980)
No. of observations 1,053 1,053
No. of positive observations 752 752
Log likelihood - 349 - 343
Rho 0.693 0.693
“These estimates are the maximum likelihood estimates for the parameters, a
and /J, of the system
Y=X/?+aZ*+~(col. 1) and Y =X/?+u,D,Z*+cr2D,Z*+~(col. 3)

= 0, =o,

z*= w<+u z*=ws+u.

Estimates for the jointly estimated r coefficients are not shown, but are available
on request.
bData are from the 1983 Survey of Consumer Finances, weighted to represent
the U.S. population of equity holders. The variables are defined and scaled as
described in table A.1 in the appendix.

dummies is even marginally significant and it is negative.24 The coefficient

on insurance as a fraction of wealth is insignificant as is the coeffkient on
wealth.
The coefficient of direct interest when examining the clientele hypothesis is
the MTRD coefficient. The implication of the hypothesis is that the dividend
yield of an investor’s portfolio will vary inversely with the differential tax
treatment of dividends and capital gains. This is indeed the case as the
coefficient on MTRD is negative and significant in column 1 of table 3.
Previously I suggested that investors’ desired portfolio yield may differ

24The omitted dummy is those who self-report that they will take substantial financial risk in
order to obtain substantial financial return when making investments.
 J.K. Scholz, The dividend clientele hypothesis 211

depending on whether or not an investor has dividend receipts that exceed

the dividend exclusion. To allow for this difference I interacted the differen-
tial tax rate variable with dummy variables. The estimate for those investors
who have tax-disadvantaged dividends, MTRD (pos), is significant and
negative in column 3 of table 3. This suggests that the larger the disparity on
marginal tax rates between dividends and accrued capital gains, the lower
will be the desired yield of the portfolio. This is the relationship suggested by
the clientele hypothesis.
The other tax differential coefficient, MTRD (neg), is the estimate for
investors who have dividends that are tax-preferred relative to capital gains,
that is, their dividend receipts do not exceed the dividend exclusion. The
significant and positive coefftcient in column 3 of table 3 suggests that the
more heavily capital gains are taxed, relative to dividends, the lower the
desired portfolio yield. This result was not expected. Recall, however, that the
lowest value of MTRD (neg), -0.05, corresponds to an investor with a 50
percent marginal tax rate on ordinary income. It is possible that investors
with high tax rates and small equity portfolios are positioning themselves so
that if their portfolios grow large enough to make dividends taxable, the
investor will already have a portfolio of low-yield securities. This explanation
suggests the marginal tax rate, rather than the differential rate on dividends
and capital gains, drives clientele behavior. Alternatively, investors may be
unaware of, or choose to ignore, the dividend exclusion when making
investment decisions.
While the tax rate coefficients are statistically significant and consistent
with the clientele hypothesis, the estimates alone do not provide much feel
for the importance of the effect. To facilitate a better interpretation, I
simulated the distribution of desired yields using the estimates presented in
table 3. The means of the resulting distribution using column 3 estimates,
which corresponds to an investor with a 29.8 percent marginal tax rate, is
0.99 percent. I then simulated the distribution of desired yields assuming, first
that there are no taxes, and second that the tax schedules have a single rate
of 50 percent. In these cases the desired dividend yields are 4.45 percent and
- 0.93 percent.25
A different and more conventional way of assessing the empirical signifi-
cance of the coefficient estimates is to use the empirical model to simulate
the implied elasticity of desired yields with respect to changes in marginal tax
rates. Doing so, with the coefficient estimates of column 3, implies that a 1
percent increase in marginal tax rates reduces desired dividend yields by

“A negative desired yield implies that the tax rate differential is sufftciently high so that on
average households would not only fail to receive dividends, but would prefer to make the
previously dicussed ‘anti-dividend’ in order to arbitrage against the dividend, capital gains tax
differential. Using column 1 estimates the corresponding figures are 2.50 percent with no taxes,
1.27 percent with the current system, and 0.74 percent with a flat tax of 50 percent.
278 J.K. Scholz, The dioidend clientele hypothesis

almost 3.5 percent. In this sense, within the context of this framework, taxes
have a noteworthy and empirically significant effect on the desired dividend
yield of a household’s portfolio. In addition, in every specification described
in the following subsection the marginal tax rate differential is statistically
significant.

6.3. Sensitivity of results

In table 4, tax rate coefficients and t-statistics are given for several
alternative samples and specifications. In all cases the tax rate coefficient for
those with tax-disadvantaged dividends, MTRD (pos), is negative and
significant. This is the result suggested by the clientele hypothesis. The
quantitative magnitude of the tax coefficients varies across specifications.
Adding outliers to the sample, for example, makes the coefficients larger.
Nevertheless, the qualitative results are not affected by varying the sample
truncation point, nor are they affected by estimating the model without the
sample weights. In the specification using a larger set of right-hand-side
variables, only the dummy variable for college graduate is significant at
standard levels among the new variables (it has a positive sign). The tax rate
coefficients remain statistically significant in this specification.
When the model does not account for a censored dependent variable, the
marginal tax rate differential plays no role in explaining observed yields for
households with tax-advantaged dividends. Earlier I suggested that if the
dividend exclusion results in dividends being tax-free for any given yield,
investors would prefer high-yield securities regardless of their tax circum-
stances. This intuition is consistent with the results of the no-censoring
mode1.26 For households with tax-disadvantaged dividends the tax differen-
tial variable is statistically significant and negatively correlated with yield.

6.4. Prediction of equity holdings

One might think that the existence of dividend clienteles would cause
problems for researchers who attempt to infer equity holdings by grossing-up
dividend receipts, as is commonly done with tax data where asset balances
are not available [for example, Feenberg and Skinner (1989)]. If clienteles
exist, dividing dividend receipts by average dividend yields should understate
the equity holdings of wealthy, high marginal tax rate investors and overstate
the holdings of poorer, low marginal tax rate investors.
Table 5 shows that this presumption, at least in the context of the SCF

26The censoring model implies that if given the chance to have a negative portfolio yield, a
high income, high marginal tax rate household with zero yield and a small equity portfolio
would prefer a large ‘anti-dividend’, since they would have the most to gain from exploiting the
dividend-capital gains tax rate margin should their dividends become taxable.
 J.K. Scholz, The dividend clientele hypothesis 279

Table 4
Sensitivity analysis for different specifications of the dividend yield equation,8 1983.”

Sample M TRD (pos) MTRD (neg) Log

Specification size (t stat.) (t stat.) likelihood
Table 3 1,053 - 1.492 9.731 -343
(3.4) (3.0)
Unweighted 1,053 -0.828 9.673 -409
table 3 (2.3) (2.8)
Truncate 1,032 - 0.976 11.261 -160
yield ~0.3 (3.0) (4.5)
Truncate 1,065 - 2.264 20.842 -628
yield c 1.0 (3.6) (4.2)
Exclude 898 - 1.562 8.239 -285
trust holders (3.2) (2.3)
Exclude 740 - 1.913 12.632 - 222
business owners (3.4) (3.0)
Larger set of 1,053 - 1.475 8.03 1 -331
RHS variables’ (3.2) (2.4)
Treat zeros as 1,053 -0.602 1.279 -289
‘true’ 2eroP (2.3) (0.6)
aThese are the maximum likelihood estimates for the parameters ~(r and CQ of the system

Y =X/J+a,D,Z*+a,D,Z*+&

=o,
z*=wt+u.
Tax disadvantaged dividends correspond to Q MTRD (pos).
‘Data are from the 1983 Survey of Consumer Finances. The variables are defined and scaled
as described in table A.1 in the appendix. Complete estimation results for each specification are
available from the author on request.
‘This specification allows the maximum number of companies in the investor’s portfolio to
equal 30, includes portfolio size, includes the fraction of equity portfolio held in mutual funds,
includes wealth squared, and adds dummy variables for college degree, no high school diploma,
single female, and risky occupations.
dThese are the maximum likelihood estimates for the parameters c(r and aI of the system
given below that does not treat Y as being censored:

Y=X/I+~,D,Z*+CZ,D,Z*+E,

z*= w(+u.

Tax disadvantaged dividends correspond to a2, MTRD (pos)

and this empirical model, is mistaken. The second and third columns
compare predicted yields from the no-censoring model with actual yields, by
wealth decile of the population of equity holders. In more than half the
deciles, a simple prediction of the average sample yield would be closer to
the actual yield than the prediction generated by the emprical model. Owing
to the endogeneity of tax rates, the empirical model jointly estimates Y and
Z*. The joint prediction of these two variables is better than what would be
280 J.K. Scholz, The dividend clientele hypothesis

Table 5
Prediction of yields by wealth percentile, using no-censoring
model, 1983.”

Wealth Predicted yield’ Actual yield

percentileb (percent) (percent)
&lo 3.23 4.93
lo-20 4.59 4.06
20-30 4.51 3.17
3&40 4.33 4.00
40-50 4.35 5.94
XL60 4.47 3.58
6&70 4.43 5.70
7@80 4.70 3.95
8G90 4.26 5.42
90-95 4.54 3.68
955100 4.80 5.41
Total 4.53 4.53
“Data are from the 1983 Survey of Consumer Finances,
weighted to represent the population of U.S. equity holders.
‘The wealth percentiles are based on the population of
equity holders. Each decile contains roughly 1.68 million
households.
‘Predicted yields are based on the no-censoring model.

obtained from a naive model; however, the results from table 5 provide no
evidence that large systematic errors arise from capitalizing dividend streams
with a measure of average dividend yield.

7. Concluding remarks

Using a sample of equity holders drawn from the 1983 Survey of

Consumer Finances, I have shown that dividend clienteles do appear to form
on the basis of investor tax characteristics. This result is consistent with a
number of studies that examine the behavior of ex-day security prices.
However, this result avoids a criticism of the ex-day studies, namely that
price changes are driven by short-term traders and thus reveal little about
the tax characteristics of a firm’s investors.
There may be several types of investors in a firm. These include managers
of other corporations, pension funds, and nonprofit institutions as well as
individual investors. While individual investors control the largest fraction of
total equity, the finding of a significant clientele effect in the ex-day studies
does not necessarily imply that individual investors form dividend clienteles,
even ignoring the arbitrage argument alluded to previously. Rather, the result
could be explained by the activities of other investors in the firm, particularly
professional portfolio managers. Individual investors presumably have less
information and fewer resources than professional managers, therefore indivi-
 J.K. Scholz, The dividend clientele hypothesis 281

duals may be the least likely group to be sensitive to taxation when making
portfolio decisions. Thus, finding evidence of a clientele effect among
individual investors strengthens the findings of a number of indirect studies,
while describing an interesting aspect of individual portfolio behavior.
The existence of clienteles may contribute to the well-documented reluc-
tance managers have for altering established dividend-payout ratios, as
investors appear to be sensitive to yield when making investment decisions.
The results, however, provide no support for the proposition that systematic
biases are incurred when dividend flows are capitalized with a measure of
average dividend yield to impute equity holdings.
While the clientele hypothesis first arose in the context of Miller and
Modigliani’s security pricing arguments, the finding that individual investors
form tax clienteles does not necessarily have implications for security pricing
due to the presence of ex-day arbitrage.

Appendix: The construction of the tax and wealth variables

The simulations used to construct the tax variables (table A.l) are done in
the following manner. Adjusted gross income (AGI) is, for the most part,
computed directly from survey responses. The items that are included
directly are wages and salaries; farm, professional and proprietors income;
interest income; rent, and royalty income; alimony and gifts; pensions,
annuity and disability income; and other income.
A variety of adjustments are then made to compute AGI. One hundred
dollars is excluded from dividend income ($200 for joint returns) in order to
calculate taxable dividends. Since there is no way to distinguish long- and
short-term capital gains, I assume all realized gains are long-term and all
realized losses are short-term. As specified in the U.S. tax law, 40 percent of
realized gains are included in AGI while capital losses were allowed to offset
ordinary income subject to a limit of $1,500 ($3,000 for joint returns). A two-
earner deduction reduced AGI by 10 percent of the wages and salaries of the
spouse with the lower earnings, subject to a ceiling of $3,000. Fifty percent of
unemployment benefits are included in AGI to the extent that AGI excluding
unemployment exceeded $12,000 ($18,000 for joint returns).27 IRA contribu-
tions, capped so as not to exceed the $2,000 limit ($2,250 or $4,000 for one-
or two-earner couples) are excluded from AGI as are contributions to Keogh
plans, capped at $15,000.
Filing status in the tax simulations is determined in the following manner.
Unmarried respondents with no dependents are assumed to file single
*‘If the sum of AGI and unemployment benefits is less than $12,000 ($18,000), unemployment
benefits are not taxed. If AGI is less than $12,000 ($18,000) and AGI plus employment benefits
exceed that level, then the percentage of that portion of unemployment that made AGI plus
unemployment exceed the threshold is included in AGI.
282 J.K. Scholz, The dividend clientele hypothesis

Table A.1
Weighted sample statistics for variables used in the estimation,
equity holders, 1983.

Variable Mean Standard deviation

YIELD 0.453 0.659
EQUITY 0.061524 0.6187
AGE 49.5 16.2
AGE2 0.408 0.492
AGE3 0.260 0.439
AGE4 0.212 0.409
FAMSZ 0.262 0.139
FAMSZSQ 0.088 0.095
WEALTH 0.0324456 0.1369
WEALTHSQ 0.0198 0.6210
DUMRS2 0.184 0.387
DUMRS3 0.489 0.500
DUMRS4 0.257 0.437
STKCO 0.260 0.281
COLLDP 0.386 0.487
NOHSDIP 0.090 0.286
SINGF 0.189 0.392
INSRA T 0.109 0.679
RISKOC 0.063 0.243
MUTEFUND 0.150 0.320
MTRD (Neg) - 0.026 0.012
MTRD (Pos) 0.311 0.110
MTRD 0.118 0.182
Based on 1,053 records representing 16,879,128 households.
YIELD = Portfolio yield measured as dividends received
divided by the value of equity holdings. Yield is
multiplied by 10.
EQUITY =Value of equity holdings including mutual funds,
stock held in the firm the respondent works for,
stock clubs, and all other equity. Equity is divided
by 1,000,ooO.
AGE =Age of the head of household. AGE2, AGE3, and
AGE4 are age dummies defined as in footnote 23.
FA MSZ =Family size divided by 10. FAMSZSQ is family size
squared, divided by 100.
WEALTH =Wealth of the family, defined in the appendix,
divided by lO,C00,000. WEALTHSQ is wealth
squared, divided by 1014.
DUMRS =These three variables are dummy variables which are
created out of the attitudinal question which asks
about the amount of financial risk the respondent is
willing to bear. DUMRS4 indicates an unwillingness
to take any financial risk while the omitted dummy,
DUMRSI indicates substantial risk in order to
receive substantial return.
STKCO =This is the number of companies in which stock is
held, divided by 10. The maximum number of
companies is limited to 10. Holders of mutual funds
are coded to 10. Sensitivity is performed with a
threshold of 30 (the mean increases to 3.2
companies).
 J.K. Scholz, The dividend clientele hypothesis 283

COLLDP =Dummy variable that takes the value of one if the

head of household has a college diploma.
NOHSDIP is a dummy variable that takes the value
of one if the head of household does not have a
high school diploma.
SINGF = Dummy variable that indicates whether the
responded is a single female.
INSRAT =Value of term and whole life insurance divided by
wealth.
RISKOC =Dummy variable that takes the value one if the head
of household is employed as a pilot, policeman,
detective, miner, fisherman, equipment operator,
heavy truck driver, or industrial equipment operator.
MUTEFUND=Fraction of total equity portfolio held in mutual
funds.
MTRD =Difference in the marginal tax rate paid on dividends
and the marginal tax rate paid on accrued capital
gains. (Neg) is the mean only for those with
marginal tax rates on capital gains that exceed
dividends, (Pos) is the mean for those who have tax
disadvantaged dividends relative to capital gains.

returns. Unmarried respondents with children living in the same household

are assumed to file head-of-household returns. All married respondents are
assumed to lile joint returns. Thus, I treat the 1 percent of returns filed by
married couples filing separate returns as joint returns.
I do not know whether a respondent itemized deductions. For lack of a
better indicator, I assume that only people who hold a home mortgage
itemize. This indicator is convenient as almost exactly the same number of
people hold mortages in the SCF (when the records are weighted appropria-
tely) as itemize in the Statistics of Income (SOI) (1984) volume.28 All
respondents who itemize deductions are assumed to have the average value
of total itemized deductions, adjusting for AGI and marital status as
reported in the SO1 volume.29
Taxable income is computed as being equal to AGI less exemptions and
itemized deductions that exceed the standard deduction of $2,300 ($3,400 for
joint returns). A $1,000 exemption is given for each family member as long as
children are under 18. An additional $1,000 is given for each family member
over 65. The tax-rate schedules are then applied to taxable income to
compute taxes before credits and marginal tax rates.
The wealth variable in the empirical work is composed of checking

‘sin fact, among itemizers 70 percent deduct home-mortgage interest.

%emized deductions include mortage interest, other interest paid, medical expenses, taxes
paid, charitable contributions, and other miscellaneous deductions.
284 J.K. Scholz, The dividend clientele hypothesis

accounts; IRA’s, Keoghs, and All-Saver certificates; short- and long-term

certificates of deposit; money-market funds; savings accounts; U.S. Savings
Bonds; Federal bonds; State, local and municipal bonds; corporate bonds;
mutual funds; stock at work; stock clubs; other public stock; the balance of
call accounts with brokers; trusts; non-borrowed cash value of life insurance;
the value of loans made to businesses; market value of businesses owned;
value of other investments, homes, property, notes on property and land
contracts owed to the respondent, and automobiles; and the discounted value
of real estate loans owed to the respondent.
The items that are subtracted from wealth are amounts the respondent
owes the business she owns, balance on loans taken from other investments,
discounted mortgage loans, discounted property debt, discounted debt on
loans for additions and repairs, discounted automobile loans, discounted real
estate debt, the amount owed on consumer debt with irregular payments, the
average balance carried on all credit cards, and the balance on general lines
of credit.

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