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Taxable Cash Dividends

Author

Listed:
  • Bechman, Ken L.

    (Department of Finance, Copenhagen Business School)

  • Raaballe, Johannes

    (Department of Finance, Copenhagen Business School)

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.

Suggested Citation

  • Bechman, Ken L. & Raaballe, Johannes, 2006. "Taxable Cash Dividends," Working Papers 2005-4, Copenhagen Business School, Department of Finance.
  • Handle: RePEc:hhs:cbsfin:2005_004
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    File URL: http://openarchive.cbs.dk/cbsweb/handle/10398/7156
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    References listed on IDEAS

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    More about this item

    Keywords

    Dividends; Share Repurchases; Signaling; Single-Crossing Property; Money Burning;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy

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