Ex‐Dividend Profitability and Institutional Trading Skill

• Date: 01 February 2017
• Author: TYLER R. HENRY,JENNIFER L. KOSKI
• DOI: http://doi.org/10.1111/jofi.12472
• Published date: 01 February 2017

THE JOURNAL OF FINANCE •VOL. LXXII, NO. 1 •FEBRUARY 2017

Ex-Dividend Profitability and Institutional

Trading Skill

TYLER R. HENRY and JENNIFER L. KOSKI∗

ABSTRACT

We use institutional trading data to examine whether skilled institutions exploit posi-

tive abnormal ex-dividend returns. Results show that institutions concentrate trading

around certain ex-dates, and earn higher profits around these events. Dividend cap-

ture trades represent 6% of all institutional buy trades but contribute 15% of overall

abnormal returns. Institutional dividend capture trading is persistent. Institutional

ex-day profitability is also strongly cross-sectionally related to trade execution skill.

The relation between execution skill and profits disappears around placebo non-ex-

days. Results suggest that skilled institutions target certain opportunities rather

than benefiting uniformly over time. Furthermore, only skilled institutions can profit

from dividend capture.

PRIOR LITERATURE SHOWS THAT TRADERS who are able to execute trades at favor-

able prices may earn abnormal profits (see, e.g., Perold (1988), Anand et al.

(2012)). In this paper, we examine whether institutions that exhibit this type

of skill (“trade execution skill”) benefit from lower execution costs uniformly

over time, or whether they target specific opportunities to exploit this skill. We

identify a relatively unique opportunity for institutions with execution skill to

realize abnormal profits: dividend capture.

Ex-day prices decline on average by an amount less than the dividend,

generating positive pre-tax ex-day returns (e.g., Elton and Gruber (1970),

Graham, Michaely, and Roberts (2003), Zhang, Farrell, and Brown (2008)). In

this study, we use Abel Noser Solutions institutional trading data from 1999

to 2007 to examine whether skilled institutional investors are able to profit

from abnormal ex-day returns, a strategy known as dividend capture. The

database is unique in that it includes transaction-level purchases and sales

with associated trading costs for two specific types of institutional traders.

∗TylerR. Henry is at Miami University. Jennifer L. Koski is at the University of Washington. The

authors thank Kenneth Singleton (the Editor), an Associate Editor, and two anonymous referees.

They also thank Vladimir Atanasov, Sinan Gokkaya, Jarrad Harford, Chris Hrdlicka, Gang Hu,

Paul Koch, Jeff Pontiff, Andy Puckett, Ed Rice, Gautam Vora,and seminar participants at the 2014

FMA meetings, the 2013 FMA European Conference, Ohio University, the University of Toledo,

and the University of Washington for helpful comments. Henry acknowledges financial support

from the Frank H. Jellinek Jr., Endowed Assistant Professor Chair in Finance. Koski thanks the

John B. and Delores L. Fery Fellowship for financial support. The authors have no conflicts of

interest, as identified in the Journal of Finance’s disclosure policy.

DOI: 10.1111/jofi.12472

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462 The Journal of Finance R

Based on these data, we study three closely related research questions. First,

do institutions target ex-dividend events in ways predicted by the theory?

Second, do institutional traders earn abnormal profits from ex-day pricing?

And third, is ex-day profitability cross-sectionally related to measures of

institutional trade execution skill?

Dividend capture presents a unique setting to examine the role of execution

skill because traders are not picking stocks in the traditional sense. Ex-days are

known in advance, and stocks are generally selected for dividend capture due

to factors such as dividend yield, risk, or transaction costs rather than because

they are undervalued. Ex-days for regular quarterly dividends are relatively

predictable, recurring events. Although ex-day returns are small relative to

transaction costs, they are large relative to abnormal returns on non-ex-days,

and therefore present an opportunity for skilled, low-cost investors. Because

ex-day returns are small, trade execution skill may be a particularly important

determinant of cross-sectional variation in institutional dividend capture prof-

itability. Furthermore, dividend capture trading represents a potential source

of the abnormal profits realized by skilled institutional investors.

We begin by documenting significant abnormal institutional volume during

the ex-dividend period. Consistent with our assertion that these institutions

should execute dividend trading strategies, abnormal institutional volume is

almost double overall abnormal volume as measured using CRSP data. Results

show that trading volume for the institutions in our sample varies positively

with dividend yield and negatively with idiosyncratic risk, as expected based

on the ex-dividend literature.

Although average abnormal ex-day returns are positive, they become nega-

tive once we account for transactions costs. However, average ex-day returns

may not accurately measure dividend capture profitability. First, ex-day re-

turns do not consider whether an institution has a long or a short position over

the ex-day. Furthermore, institutions may focus their trades on certain ex-day

events, and profitable dividend capture strategies may include trades that are

executed over a window surrounding the ex-dividend day.

We control for these factors to test whether institutions earn positive prof-

its after transaction costs from dividend capture trading. To estimate prof-

itability, we compare total cash outflows and inflows around the ex-dividend

day using actual transaction prices after all commissions and related trading

costs. When we calculate profitability averaged across institutions (or more

specifically, across client-manager pairs), institutional profits to long positions

are significantly positive even after incorporating all trading costs.1We sho w

that institutions concentrate their trading around certain ex-days, and ex-day

events with higher institutional buying intensity are associated with higher

profits. Furthermore, institutional dividend capture buying intensity is per-

sistent: active buyers one quarter continue to buy for at least the next several

1For this calculation, each observation is the collection of trades executed by a particular money

management firm on behalf of a particular client during an individual ex-dividend event window.

See Section III for more details.

Ex-Dividend Profitability and Institutional Trading Skill 463

quarters, and earn significantly higher profits two quarters later. Persistence is

much weaker for selling intensity,implying that selling during the ex-day event

window is more likely the result of general liquidity trading rather than (short)

dividend capture. There is also less persistence in targeted stocks: institutions

appear to select stocks for dividend capture each quarter and incorporate prior

ex-day returns into their decision.

Are ex-days distinctive, or are dividend capture profits similar to profits

earned by institutions during other periods? To address this question, we esti-

mate abnormal returns for all buy trades in our sample, and compare abnormal

returns from dividend capture buy trades to buy trades executed during other

periods. Results show that abnormal returns after commissions from dividend

buys are significantly positive (0.44%), but postcommission abnormal returns

to other buy trades are significantly lower (0.23%) and insignificantly different

from zero.2Furthermore, although buy trades immediately before the ex-day

represent less than 6% of all buy trades in the sample we analyze, they consti-

tute 15% of the overall abnormal returns realized by the average institution in

our sample. Dollar profits from dividend capture trades by Abel Noser institu-

tions total almost $4 billion. Dividend capture therefore contributes materially

to the overall abnormal returns realized by these institutions.

Cross-sectionally, institutional dividend capture profitability is strongly re-

lated to more general (nondividend) measures of institutional trade execution

skill (Anand et al. (2012)). Institutions that demonstrate prior trading skill are

better able to implement profitable dividend capture strategies. The difference

in profitability between institutions in the low-skill decile and those in the

high-skill decile is approximately 40 bps. Importantly, we see no evidence of

a relation between execution skill and profits when we repeat our experiment

on a placebo non-ex-day. The relation between execution skill and returns is

stronger for dividend capture trades than for other, nondividend trades. Our

evidence suggests that trade execution skill may be as important in explaining

dividend capture as some of the firm-specific characteristics (such as yield and

risk) examined previously in the ex-day literature. Dividend capture traders

also earn higher profits when they provide liquidity,and they do not specifically

target undervalued stocks.

Our overall conclusion is that institutions profit from dividend capture when

skilled institutions target certain ex-day events and execute trades at prices

that are favorable relative to the market. We add to the ex-dividend litera-

ture by documenting that institutions do indeed practice profitable dividend

capture, and abnormal dividend capture buying intensity is strongly related

to transaction costs and prior ex-day returns. We also extend the ex-dividend

literature by showing that only certain institutions—those with trade execu-

tion skill—are able to profit from short-term dividend capture trading. Finally,

we contribute to the literature on skill-related trading profits by showing that

2These figures are based on abnormal returns using the method of Puckett and Yan (2011)in

their interim trading performance calculation. We compare abnormal returns for buy trades made

immediately before the ex-day with all other buy trades (see Section III.B).