DIVIDEND POLICY AND CAPITAL STRUCTURE UNDER THE IMPUTATION TAX SYSTEM: SOME CLARIFYING COMMENTS

This paper analyses the effects of the imputation and capital gains taxes on the dividend and financing decisions of Australian companies. We develop a framework, consistent with Miller's [1977] approach, in which interactions between dividend and financing decisions can be explored. The significance of these interactions depends on both corporate dividend policy and on the relationship between personal and corporate income tax rates. We conclude that under imputation, dividend decisions are more important relative to capital structure decisions, than under the classical tax system.     

Dividend taxation and corporate investment: a comparative study between the classical system and imputation system of dividend taxation in the United States and Australia

In recent times a number of countries have initiated some important tax reforms to eliminate the distortions of double taxation. In this context, Australia adopted a dividend imputation system in 1987, while the US employed the 1986 Tax Reform Act (TRA). The analysis in this paper examines the effects on the level of corporate capital investment, on proxies for corporate tax rates, financial leverage, liquidity, capital intensity and firm size after controlling for the tax reforms. The empirical results provide evidence that: (1) dividend imputation as introduced in Australia is an effective way to reduce the distortions caused by the traditional system of taxation. (2) Compared with the TRA, dividend imputation has been better able to positively stimulate corporate capital investment. (3) TRA effect on corporate investment is more pronounced in the US for firms having a net operating loss. (4) Individual tax rates play a role in corporate investment decisions in both the US and Australia.

Shareholder taxation and aggregate dividend payout: Evidence from the tax reform act of 1986

The effect of shareholder taxation on corporate dividend policy is a major controversy in financial economics. The Tax Reform Act of 1986 eliminated the statutory tax disadvantage of dividends versus long-term capital gains for individual shareholders. Using aggregate time series data I find evidence that corporate dividend payout has become more generous in the period after tax reform.     

Taxes and dividend clientele: Evidence from trading and ownership structure

Although dividend clientele have been studied over several decades, their existence remains controversial. We study the interaction of dividends and taxes by exploiting a unique dataset from Taiwan, where the capital gains tax is zero. We find strong evidence of a clientele effect. Agents subject to high rates of taxation on dividends tend to hold stocks with lower dividends and sell (buy) stocks that raise (lower) dividends. Agents in lower tax brackets behave in the opposite manner. After legalization of repurchases in 2000, firms with higher concentrations of more heavily taxed shareholders were more apt to begin repurchase programs.     

World dividends and tax shocks

For a sample of 28,895 firms across 30 countries and 29 years, there is a negative relation between dividend tax rates and dividend payout. Firms increase dividend payout in response to both absolute and relative (to capital gains tax rates) decreases in dividend tax rates. This negative relation is robust to both increases and decreases and both shocks and continuous variation in dividend tax rates and affects both dividend payer status and dividend payout level. However, dividend payers do not increase dividend payout levels following decreases in dividend tax rates. The negative relation between dividend tax rates and dividend payout is stronger in countries and firms with better governance and suggests a dividend taxation elasticity of −0.45.     

Dividend taxation and the ownership structure of private firms

This paper examines the effect of dividend taxation on the ownership structure of private firms. I exploit a German dividend tax increase that only affects corporate shareholders owning a minority stake. Using data on private German firms and their shareholders, I find that corporate shareholders reduce their minority stakes in firms after the dividend tax reform. This result is in line with the notion that, because minority shareholders do not have sufficient decision-making power to influence the payout policy, they can only react to a dividend tax increase by selling their shares. This effect is larger when the affected minority shareholders face high dividend tax costs. However, I find a smaller effect when the benefits of the minority stakes are highly relevant for the firm and the affected shareholders, suggesting that non-tax factors mute the response to dividend taxes. In addition, I find that the largest shareholder of the firm buys the minority stake, resulting in greater ownership concentration. These findings extend the prior literature that finds no effect of dividend taxes on the ownership structure of private firms.     

The Cost of Equity Capital at the Corporate and Investor Levels Allowing a Rational Expectations Model with Personal Taxations

This paper argues that the conventional definition of the cost of equity at the corporate level is likely to be fundamentally flawed under conditions of personal taxation. A 'dimensionally consistent' definition is developed utilising the pioneering contributions of Auerbach and Elton and Gruber. Consequent benefits are straight-forward expressions for the cost of equity capital at the corporate level (for both retained earnings and new equity) as well as at the investor level (post personal tax) in terms of both the dividend discount and CAPM-type models, which are applicable to classical and imputation tax systems. A fundamental framework is thereby provided which succeeds in illuminating investor pesonal tax liabilities as they might be expected to impact on a firm's investment and related dividend policies.     

Dividend payouts and catering to demands: Evidence from a dividend tax reform

Utilizing the 2012 dividend tax reform in China, this paper examines how firms make dividend payout decisions that cater to the controlling shareholders' demand, especially when controlling shareholders and outside minority shareholders have different dividend preferences. We find that firms increase dividend payouts when controlling shareholders demand higher dividends after the dividend tax reform. In particular, firms pay higher dividends when facing increased demand from controlling shareholders than when the demand is from minority investors. In addition, we find that firms that increase dividend payments due to the controlling shareholders' demand subsequently have more debt financing and poorer firm performance, suggesting that catering to the demands from controlling shareholders is subject to the Type II agency problem.     

The effects of ownership structure on dividend policy: Evidence from seasoned equity offerings (SEOs)

This paper examines the effects of ownership structure on dividend policy, specifically the role of controlling shareholders in shaping dividend policy in a sample of firms that pay dividends and issue new equity simultaneously. The results show that managers in weakly governed firms are more likely to initiate customized dividends to meet outside large shareholders' needs while simultaneously using costly external capital to finance new investment projects. This paper contributes to the existing literature on agency problems by explaining why firms engage in this suboptimal dividend policy: it allows large shareholders to extract private benefits.     

Inside shareholders’ effective tax rates and dividends

Using information collected from the Swedish tax authorities, we calculate insiders’ actual effective tax rates on dividends. With this unique dataset, we find a significant negative cross-sectional relationship between insiders’ effective tax rates and dividend payout. This result is consistent with a tax-induced clientele effect for dividends. We also look at the impact of large block trades on dividends. We find that when insiders with zero effective taxes sell blocks, subsequent dividend payments are significantly more likely to decrease. This provides evidence that large shareholders are adjusting dividends for their individual tax situations.     

Dividend valuation,trading and transactions costs: the 1997 partial abolition of dividend tax credit repayments

Although UK resident tax-exempt shareholders lost the right to repayment of tax credits on dividends paid by UK resident companies in July 1997, they could continue to receive tax credit repayments in respect of dividends received from Irish resident companies until December 1998. In July 1997 the rate of tax credit on Irish companies' dividends was 21%, and this was reduced to 11% in December 1997. We obtain insights into the incentives and behaviour of UK tax-exempt investors in response to these changes in the relative ‘tax attractiveness’ of investments in Irish resident companies. We find that only at its highest rate, 21%, was the level of dividend tax credit on Irish companies' dividends sufficient to induce changes in UK tax-exempt shareholders' investment strategies; and that the propensity for dividend capture by tax-exempt investors is heightened when the dividend tax credit yield is of the order of 0.8 or more and dividend yield is of the order of 2.6% or more.     

Do Tax Law Changes Influence Ex-Dividend Stock Price Behavior? Evidence from 1926 to 2005

We test the Elton and Gruber model of ex-dividend stock pricing over a period spanning all US tax law changes since 1926. Our results indicate that price drop ratios (ΔP/D) and ex-day returns are related to dividend and capital gains tax rates in the theorized manner. Consistent with tax clienteles, we also find that ex-day price movements of higher dividend yield stocks are driven more by corporate tax rates, while lower yield stocks are more influenced by personal rates. Finally, we demonstrate that the positive relationship between ΔP/D and the dividend yield becomes stronger as the tax differential | t_d− t_cg | widens.     

Taxes and dividends: The UK evidence

This paper provides empirical evidence on the simultaneous effects of both corporation and personal income taxes on dividend payment adjustments and on the behaviour of share prices on the ex-dividend dates. The results show that companies set their dividend policies to minimise their tax liability and to maximise the after-tax return of their shareholders. In particular, firms that are unable to deduct the advanced corporation tax from their tax liability are found to pay low dividends. In addition, consistent with the tax hypothesis, we find that the differential taxation of dividends and capital gains results in a decrease in ex-day share prices by significantly less than the amount of the dividend. There is no evidence of a tax-induced dividend clientele.     

The Impact of Personal Taxes on the Firm's Weighted Average Cost of Capital and Investment Behaviour: A Simplified Approach Using the Dempsey Discounted Dividends Model

The discounted dividends model advanced by Dempsey (1996) is extended to provide a weighted average cost of capital (WACC) assessment of investment opportunities with irregular cash flows. Thereafter, the framework is extended to an assessment of the implications of government tax policy for the firm's investment behaviour. The developed framework is consistent with the empirical evidence of Poterba and Summers (1985) which — over the period of UK tax history 1950–1983 encompassing four major tax on equity reforms — observes how the related dividend and investment politics of UK firms appear to be influenced by the level of dividend taxes.     

Direct evidence of dividend tax clienteles

The paper is the first to evaluate the dividend tax clientele hypothesis using a data set of all domestic stock portfolios in the market. We find that investment funds that face a higher effective tax rate on dividend income than on capital gains tilt their portfolios away from dividend-paying stocks. These investors consequently earn a dividend yield that is about 35 basis points lower than that of investors who are tax neutral between dividends and capital gains (pension funds, unit-linked insurance, life insurance). Consistent with tax rules and charter provisions, we also find that private corporations prefer growth stocks, that foundations exhibit strong dividend preferences, and that partnerships rarely hold stocks portfolios.     

Optimal dividend payments in the classical risk model when payments are subject to both transaction costs and taxes

In this paper, we study optimal dividend problem in the classical risk model. Transaction costs and taxes are required when dividends occur. The problem is formulated as a stochastic impulse control problem. By solving the corresponding quasi-variational inequality, we obtain the analytical solutions of the optimal return function and the optimal dividend strategy when claims are exponentially distributed. We also find a formula for the expected time between dividends. The results show that, as the dividend tax rate decreases, it is optimal for the shareholders to receive smaller but more frequent dividend payments.     

Anticipating Tax Changes: Evidence from the Finnish Corporate Income Tax Reform of 2005*

Using register‐based panel data covering all Finnish firms from 1999 to 2004, we examine how corporations anticipated the 2005 dividend tax increase via changes in their dividend and investment policies. The Finnish capital and corporate income tax reform of 2005 creates a useful opportunity to measure this behaviour, since it involves exogenous variation in the tax treatment of different types of firms. The estimation results reveal that those firms that anticipated a dividend tax hike increased their dividend payouts in a statistically significant way. This increase was not accompanied by a reduction in investment activities, but rather was associated with increased indebtedness in non‐listed firms. The results also suggest that the timing of dividend distributions probably offsets much of the potential for increased dividend tax revenue following the reform.     

Strategies and dividend imputation: the effect of foreign and domestic ownership on average effective tax rates

This study examines how dividend imputation affects the incentive of New Zealand firms to minimize tax. By effectively eliminating double taxation on company income, imputation reduces firms’ incentives to engage in costly tax minimization strategies. Before September 1993, resident and nonresident shareholders were treated differently under New Zealand’s imputation system. Because imputation credits cannot be passed to shareholders unless dividends are paid, we expect firms to pursue different tax paying strategies depending on their level of foreign ownership and their dividend payout ratios. After September 1993 when imputation credits were extended to nonresident portfolio shareholders, we expect that firms with high foreign ownership and high dividend payouts would have less incentive to minimize tax. Our results provide some support for these expectations.     

Changes to Income Trust Taxation in Canada: Investor Reaction and Dividend Clientele Theory

Abstract:  This paper explores the relationship between tax-induced dividend clientele theory and the recent changes to the taxation of income trusts in Canada. On October 31, 2006, the Canadian government announced the Tax Fairness Plan ( TFP ) calling for the elimination of the considerable tax advantage enjoyed by income trusts. Generally, distributions from income trusts are now taxed at rates comparable to those imposed on corporate dividends. We examine market reaction to the  TFP  to address three issues: first, whether the valuation effect of a dividend tax increase is consistent with the traditional or the new view of dividend taxation; secondly, whether the market reaction to tax increases has a differential impact on firm value that is related to the tax preferences of taxable, tax-exempt, and foreign investor tax clienteles; and thirdly, whether firms change their dividend policies in response to the preference of institutional investors (tax-based dividend policy effect) or whether institutional investors are sorting themselves across firms based on their dividend policies (investor sorting effect). Our results provide strong evidence as follows. First, the valuation effect in reaction to the  TFP  announcement is consistent with the traditional view of dividend taxation – i.e. that taxes on dividends reduce the net return to investors, increase the firm's cost of capital and lower the firm's ability to access capital markets, thereby discouraging investment and savings. Secondly, we saw that trusts with a larger percentage of their units held by tax-exempt, low-tax, and foreign investors had a higher decline in value when compared with trusts held mostly by ordinary taxable investors. These results support dividend tax clientele theory. Finally, we observed changes in institutional investor clienteles consistent with the investor sorting effect.