This paper analyzes the effects of dividend taxation on corporate behavior using the large tax cut on individual dividend income enacted in 2003. Using data spanning 1980 to 2004-Q2, we document a sharp and widespread surge in dividend payments following the tax cut, along several dimensions. First, an unprecedented number of firms initiated regular dividend payments after the reform. As a result, the number of publicly traded firms paying dividends, after having declined continuously for more than two decades, began to increase precisely in 2003. Second, many firms that were already paying dividends prior to the reform raised regular dividend payments significantly. Third, special dividends also rose. All of these effects are robust to introducing controls for profits and other firm characteristics. Additional evidence for specific groups of firms suggests that the tax cut induced increases in total payout rather than substitution between dividends and repurchases. The tax response was confined to firms with lower levels of forecasted growth, consistent with an improvement in capital allocation efficiency. The response to the tax cut was strongest in firms with strong principals whose tax incentives changed (presence of large taxable institutional owners or independent directors with large share holdings), and in firms where agents had stronger incentives to respond (large executive ownership and low levels of executive stock-options outstanding). These findings show that principal-agent issues play a central role in corporate responses to taxation.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
10841.
Length: Date of creation: Oct 2004 Date of revision: Handle: RePEc:nbr:nberwo:10841
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Find related papers by JEL classification: H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents G3 - Financial Economics - - Corporate Finance and Governance
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Malcolm Baker & Jeffrey Wurgler, 2004.
"A Catering Theory of Dividends,"
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[Downloadable!] (restricted)
Other versions:
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
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Bernhardt, Dan & Robertson, Fiona J., 1993.
"Testing Dividend Signalling Models,"
Working Papers
828, California Institute of Technology, Division of the Humanities and Social Sciences.
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