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Taxable Cash Dividends

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  • Bechman, Ken L.

    (Department of Finance, Copenhagen Business School)

  • Raaballe, Johannes

    (Department of Finance, Copenhagen Business School)

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    Abstract

    Firms pay out cash using both dividends and share repurchases. In many aspects these two means are similar, but one important difference is that dividends are generally taxed more heavily than share repurchases. Nevertheless firms persist in paying out large amounts in dividends. This paper provides an explanation for this dividend puzzle by developing a class of signaling models violating the “single-crossing property in which information about the quality of the firm is asymmetric between the management and the shareholders. In these models a high-quality firm can always signal its quality by using share repurchases only. However, in certain cases share repurchases become costlier on the margin for a high-quality firm than for a low-quality imitator. In such cases, the high-quality firm signals most cost efficiently by means of a combination of share repurchases and taxable cash dividends financed by the issuance of new shares. Taxable cash dividends financed by the issuance of new shares then can be considered a positive kind of money burning whose role is to signal a firm’s high quality. The implications of the models are consistent with several important empirical facts about dividends and share repurchases. Thus, this paper’s main contribution is to examine a range of new signaling models that provides a role for taxable cash dividends and share repurchases and to derive their empirical implications.

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    File URL: http://openarchive.cbs.dk/cbsweb/handle/10398/7156
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    Bibliographic Info

    Paper provided by Copenhagen Business School, Department of Finance in its series Working Papers with number 2005-4.

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    Length: 42 pages
    Date of creation: 28 Jun 2006
    Date of revision:
    Handle: RePEc:hhs:cbsfin:2005_004

    Contact details of provider:
    Postal: Department of Finance, Copenhagen Business School, Solbjerg Plads 3, A5, DK-2000 Frederiksberg, Denmark
    Phone: +45 3815 3815
    Email:
    Web page: http://www.cbs.dk/departments/finance/
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    Related research

    Keywords: Dividends; Share Repurchases; Signaling; Single-Crossing Property; Money Burning;

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    References

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    1. James M. Poterba, 1987. "Tax Policy and Corporate Saving," Working papers 470, Massachusetts Institute of Technology (MIT), Department of Economics.
    2. Franklin Allen & Antonio E. Bernardo & Ivo Welch, 2000. "A Theory of Dividends Based on Tax Clienteles," Journal of Finance, American Finance Association, vol. 55(6), pages 2499-2536, December.
    3. Miller, Merton H & Rock, Kevin, 1985. " Dividend Policy under Asymmetric Information," Journal of Finance, American Finance Association, vol. 40(4), pages 1031-51, September.
    4. Brav, Alon & Graham, John R. & Harvey, Campbell R. & Michaely, Roni, 2005. "Payout policy in the 21st century," Journal of Financial Economics, Elsevier, vol. 77(3), pages 483-527, September.
    5. Pugh, William & Jahera, John S, Jr, 1990. "Stock Repurchase and Excess Returns: An Empirical Examination," The Financial Review, Eastern Finance Association, vol. 25(1), pages 127-42, February.
    6. DeAngelo, Harry & DeAngelo, Linda & Skinner, Douglas J., 2004. "Are dividends disappearing? Dividend concentration and the consolidation of earnings," Journal of Financial Economics, Elsevier, vol. 72(3), pages 425-456, June.
    7. B. Douglas Bernheim, 1990. "Tax Policy and the Dividend Puzzle," NBER Working Papers 3434, National Bureau of Economic Research, Inc.
    8. B. Douglas Bernheim & Lee S. Redding, 2001. "Optimal Money Burning: Theory and Application to Corporate Dividends," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 10(4), pages 463-507, December.
    9. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-29, May.
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    11. Eugene F. Fama & Kenneth R. French, . "Disappearing Dividends: Changing Firm Characteristics or Lower Propensity to Pay?."," CRSP working papers 509, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    12. Siddiqi, Mazhar A, 1995. "An Indirect Test for Dividend Relevance," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 18(1), pages 89-101, Spring.
    13. Allen, Franklin & Michaely, Roni, 2003. "Payout policy," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 7, pages 337-429 Elsevier.
    14. James M. Poterba & Lawrence H. Summers, 1985. "The Economic Effects of Dividend Taxation," NBER Working Papers 1353, National Bureau of Economic Research, Inc.
    15. Olson, Gerard T & McCann, P Douglas, 1994. "The Linkages between Dividends and Earnings," The Financial Review, Eastern Finance Association, vol. 29(1), pages 1-22, February.
    16. Keith M. Howe & Steve Vogt & Jia He, 2003. "The Effect of Managerial Ownership on the Short- and Long-run Response to Cash Distributions," The Financial Review, Eastern Finance Association, vol. 38(2), pages 179-196, 05.
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