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Why Do Companies Pay Dividends?

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  • Feldstein, Martin
  • Green, Jerry

Abstract

This paper presents a simple model of market equilibrium to explain why firms that maximize the value of their shares pay dividends even though the funds could instead be retained and subsequently distributed to shareholders in a way that would allow them to be taxed more favorably as capital gains. The two principal ingredients of our explanation are: (1) the conflicting preferences of shareholders in different tax brackets and (2) the shareholders' desire for portfolio diversification, we show that companies will pay a positive fraction of earnings in dividends. We also provide some comparative static analysis of dividend behavior with respect to tax parameters and to the conditions determining the riskiness of the securities.

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File URL: http://dash.harvard.edu/bitstream/handle/1/3204679/green_companiesdividend.pdf
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Bibliographic Info

Paper provided by Harvard University Department of Economics in its series Scholarly Articles with number 3204679.

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Date of creation: 1983
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Publication status: Published in American Economic Review
Handle: RePEc:hrv:faseco:3204679

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  1. Auerbach, Alan J, 1979. "Wealth Maximization and the Cost of Capital," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 93(3), pages 433-46, August.
  2. Feldstein, Martin S & Slemrod, Joel, 1980. "Personal Taxation, Portfolio Choice, and the Effect of the Corporation Income Tax," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 88(5), pages 854-66, October.
  3. Feldstein, Martin & Sheshinski, Eytan & Green, Jerry, 1979. "Corporate Financial Policy and Taxation in a Growing Economy," Scholarly Articles, Harvard University Department of Economics 3203643, Harvard University Department of Economics.
  4. Sudipto Bhattacharya, 1979. "Imperfect Information, Dividend Policy, and "The Bird in the Hand" Fallacy," Bell Journal of Economics, The RAND Corporation, The RAND Corporation, vol. 10(1), pages 259-270, Spring.
  5. Feldstein, Martin S, 1970. "Corporate Taxation and Dividend Behaviour," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 37(1), pages 57-72, January.
  6. David F. Bradford, 1979. "The Incidence and Allocation Effects of a Tax on Corporate Distributions," NBER Working Papers, National Bureau of Economic Research, Inc 0349, National Bureau of Economic Research, Inc.
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