Relationship between franking credits and the market risk premium

Gray, Stephen and Hall, Jason (2006) Relationship between franking credits and the market risk premium. Accounting and Finance, 46 3: 405-428. doi:10.1111/j.1467-629X.2006.00175.x

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Author Gray, Stephen
Hall, Jason
Title Relationship between franking credits and the market risk premium
Journal name Accounting and Finance   Check publisher's open access policy
ISSN 0810-5391
Publication date 2006
Sub-type Discussion - responses, round table/panel discussions, Q&A, reply
DOI 10.1111/j.1467-629X.2006.00175.x
Open Access Status File (Author Post-print)
Volume 46
Issue 3
Start page 405
End page 428
Total pages 24
Editor R. Faff
Place of publication Oxford, England
Publisher Blackwell
Collection year 2006
Language eng
Subject C1
720106 Taxation
350000 Commerce, Management, Tourism and Services
350300 Banking, Finance and Investment
350301 Finance
Abstract In a dividend imputation tax system, equity investors have three potential sources of return: dividends, capital gains and franking (tax) credits. However, the standard procedures for estimating the market risk premium (MRP) for use in the capital asset pricing model, ignore the value of franking credits. Officer (1994) notes that if franking credits do affect the corporate cost of capital, their value must be added to the standard estimates of MRP. In the present paper, we explicitly derive the relationship between the value of franking credits (gamma) and the MRP. We show that the standard parameter estimates that have been adopted in practice (especially by Australian regulators) violate this deterministic mathematical relationship. We also show how information on dividend yields and effective tax rates bounds the values that can be reasonably used for gamma and the MRP. We make recommendations for how estimates of the MRP should be adjusted to reflect the value of franking credits in an internally consistent manner.
Keyword Franking credits
Dividend imputation
Market risk premium
Cost of capital
Q-Index Code C1
Q-Index Status Provisional Code
Institutional Status UQ

Document type: Journal Article
Sub-type: Discussion - responses, round table/panel discussions, Q&A, reply
Collections: Excellence in Research Australia (ERA) - Collection
2007 Higher Education Research Data Collection
UQ Business School Publications
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Citation counts: TR Web of Science Citation Count  Cited 11 times in Thomson Reuters Web of Science Article | Citations
Scopus Citation Count Cited 11 times in Scopus Article | Citations
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Created: Wed, 15 Aug 2007, 06:43:27 EST