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 CAPM, 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 this 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. The Relationship Between Franking Credits and the Market Risk Premium ABSTRACTIn 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 CAPM, 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 this 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.3

This study further examines the phenomenon of conservative auditor behaviour by considering the level of voluntary disclosure of Year 2000 remediation information in company annual reports. Previous studies have provided evidence of conservative auditor behaviour by examining the link between Big 6 auditor choice and accruals (Francis and Krishnan 1999;Becker et al. , 1998;Defond and Subramanyam 1998). Protecting their reputation capital increases Big 6 auditor incentives to act conservatively to avoid litigation risk. We propose and find that Big 6 auditor clients disclose more Year 2000 remediation information than non-Big 6 auditor clients.

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Hybrid securities are becoming an increasingly important component of the capital structure of Australian firms. While displaying characteristics of both debt and equity, one principal equity attribute of hybrids is their ability to pay franked dividends. This enables resident domestic investors to claim corporate tax payments as a credit against personal tax obligations under Australia's dividend imputation tax system. This paper estimates a value for the 'franking credits' that attach to hybrid securities by examining stock price changes around ex-dividend dates. We add to the literature that examines the ex-day price changes of ordinary shares (OS) in that the hybrid securities we examine have high dividend yields and are relatively insensitive to market movements. Therefore the signal-to-noise ratio is much higher than for OS. Our analysis reveals that cum-dividend day prices on hybrid securities do not include any value for franking credits. This result is consistent with the notion that the price-setting investor in the Australian market is a foreign investor who places no value on franking credits. Copyright (c) 2010 The Authors. International Review of Finance (c) International Review of Finance Ltd. 2010.