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Tax Policy and the Dividend Puzzle

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Author Info
B. Douglas Berhheim

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Abstract

This article offers a new explanation of the dividend puzzle, based upon a model in which firms signal profitability by distributing cash to shareholders. I assume that dividends and repurchases are identical, except that dividends are taxed more heavily. Nevertheless, I demonstrate that under certain plausible conditions, corporations will pay dividends. Indeed, some firms will actually pay dividends and then retrieve a portion of these payments by issuing new equity (perhaps through a dividend reinvestment plan), despite the fact that this appears to create gratuitous tax liabilities. In addition to providing an explanation for the dividend puzzle, I derive a number of strong results concerning corporate payout decisions and government tax policy. Some of these results are surprising. For example, the relationship between repurchases and firm quality is hump-shaped. Moreover, despite the fact that a higher dividend tax rate depresses dividend payments, it does not affect either government revenue or welfare.

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File URL: http://links.jstor.org/sici?sici=0741-6261%28199124%2922%3A4%3C455%3ATPATDP%3E2.0.CO%3B2-R&origin=repec
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Publisher Info
Article provided by The RAND Corporation in its journal RAND Journal of Economics.

Volume (Year): 22 (1991)
Issue (Month): 4 (Winter)
Pages: 455-476
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Handle: RePEc:rje:randje:v:22:y:1991:i:winter:p:455-476

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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.:
  1. James M. Poterba & Lawrence H. Summers, 1985. "The Economic Effects of Dividend Taxation," NBER Working Papers 1353, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Bagwell, Laurie Simon & Shoven, John B, 1989. "Cash Distributions to Shareholders," Journal of Economic Perspectives, American Economic Association, vol. 3(3), pages 129-40, Summer. [Downloadable!] (restricted)
  3. Constantinides, George M & Scholes, Myron S, 1980. " Optimal Liquidation of Assets in the Presence of Personal Taxes: Implications for Asset Pricing," Journal of Finance, American Finance Association, vol. 35(2), pages 439-49, May. [Downloadable!] (restricted)
  4. John, Kose & Williams, Joseph, 1985. " Dividends, Dilution, and Taxes: A Signalling Equilibrium," Journal of Finance, American Finance Association, vol. 40(4), pages 1053-70, September. [Downloadable!] (restricted)
  5. Ambarish, Ramasastry & John, Kose & Williams, Joseph, 1987. " Efficient Signalling with Dividends and Investments," Journal of Finance, American Finance Association, vol. 42(2), pages 321-43, June. [Downloadable!] (restricted)
  6. Sudipto Bhattacharya, 1979. "Imperfect Information, Dividend Policy, and "The Bird in the Hand" Fallacy," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 259-270, Spring. [Downloadable!] (restricted)
  7. Milgrom, Paul & Roberts, John, 1986. "Price and Advertising Signals of Product Quality," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 796-821, August. [Downloadable!] (restricted)
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  8. Asquith, Paul & Mullins, David Jr., 1986. "Equity issues and offering dilution," Journal of Financial Economics, Elsevier, vol. 15(1-2), pages 61-89. [Downloadable!] (restricted)
  9. Poterba, James M. & Summers, Lawrence H., 1983. "Dividend taxes, corporate investment, and `Q'," Journal of Public Economics, Elsevier, vol. 22(2), pages 135-167, November. [Downloadable!] (restricted)
    Other versions:
Full references

Cited by:
(explanations, 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.)

  1. Roger H. Gordon & Young Lee, 1999. "Do Taxes Affect Corporate Debt Policy? Evidence from US Corporate Tax Return Data," NBER Working Papers 7433, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. Mihir A. Desai & C. Fritz Foley & James R. Hines Jr., 2002. "Dividend Policy inside the Firm," NBER Working Papers 8698, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Lombardo, Davide & Pagano, Marco, 1999. "Legal Determinants of the Return on Equity," CEPR Discussion Papers 2275, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  4. Trevor S. Harris & R. Glenn Hubbard & Deen Kemsley, 1999. "The Share Price Effects of Dividend Taxes and Tax Imputation Credits," NBER Working Papers 7445, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Roger Gordon & Martin Dietz, 2006. "Dividends and Taxes," NBER Working Papers 12292, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Thomas J. Prusa & Dobrin Kolev, 1999. "Dumping and Double Crossing: The (In)Effectiveness Of Cost-Based Trade Policy Under Incomplete Information," Departmental Working Papers 199901, Rutgers University, Department of Economics. [Downloadable!]
  7. B. Douglas Bernheim & Adam Wantz, 1992. "A Tax-Based Test of the Dividend Signaling Hypothesis," NBER Working Papers 4244, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  8. Renneboog, L.D.R. & Trojanowski, Grzegorz, 2005. "Patterns in payout policy and payout channel choice of UK firms in the 1990s," Discussion Paper 22, Tilburg University, Center for Economic Research. [Downloadable!]
    Other versions:
  9. Alan J. Auerbach, 2001. "Taxation and Corporate Financial Policy," NBER Working Papers 8203, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  10. B. Douglas Bernheim & Lee Redding, 1995. "Optimal Money Burning," Working Papers 96010, Stanford University, Department of Economics. [Downloadable!]
  11. Braggion, F. & Moore, L., 2008. "Dividend Policies in an Unregulated Market: The London Stock Exchange 1895-1905," Discussion Paper 2008-83, Tilburg University, Center for Economic Research. [Downloadable!]
  12. Bernhardt, Dan & Robertson, Fiona J., 1993. "Testing Dividend Signalling Models," Working Papers 828, California Institute of Technology, Division of the Humanities and Social Sciences. [Downloadable!]
    Other versions:
  13. Díez Esteban, José María & López de Foronda Pérez, Óscar, 2001. "Dividend Policy of European Banks," Documentos de Trabajo "Nuevas Tendencias en Dirección de Empresas". Working Papers "New Trends on Business Administration". 2001-03, Interuniversitary Doctorate Program "New Trends on Business Administration", Universities of Valladolid, Burgos and Salamanca (Spain). Programa de Doctorado Interuniversitario "Nuevas Tendencias en Di. [Downloadable!]
  14. Alan J. Auerbach & Kevin A. Hassett, 2000. "On the Marginal Source of Investment Funds," NBER Working Papers 7821, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  15. Roger Gordon & Laura Kalambokidis & Joel Slemrod, 2003. "A New Summary Measure of the Effective Tax Rate on Investment," NBER Working Papers 9535, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  16. Randall Morck, 2003. "Why Some Double Taxation Might Make Sense: The Special Case of Inter-corporate Dividends," NBER Working Papers 9651, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  17. Bernstein, J.I. & Nadiri, M.I., 1993. "Production, Financial Structure and Productivity Growth in U.S. Manufacturing," Working Papers 93-10, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
    Other versions:
  18. Jennifer L. Blouin & Jana Smith Raedy & Douglas A. Shackelford, 2007. "Did Firms Substitute Dividends for Share Repurchases after the 2003 Reductions in Shareholder Tax Rates?," NBER Working Papers 13601, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  19. Martin D. Dietz & Christian Keuschnigg, 2003. "Corporate Income Tax Reform in Switzerland," University of St. Gallen Department of Economics working paper series 2003 2003-07, Department of Economics, University of St. Gallen. [Downloadable!]
    Other versions:
  20. Bechman, Ken L. & Raaballe, Johannes, 2006. "Taxable Cash Dividends," Working Papers 2005-4, Copenhagen Business School, Department of Finance. [Downloadable!]
  21. Arturo, Ramirez Verdugo, 2004. "Dividend Signaling and Unions," MPRA Paper 2273, University Library of Munich, Germany, revised 04 Oct 2006. [Downloadable!]
  22. Hossain, Ferdaus & Jain, Ruchi, 2001. "Financial Structure, Production and Productivity Growth in U.S. Food Manufacturing Industry," 2001 Annual meeting, August 5-8, Chicago, IL 20756, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association). [Downloadable!]
  23. Dobrin R. Kolev & Thomas J. Prusa, 1999. "Dumping and Double Crossing: The (In)Effectiveness of Cost-Based Trade Policy Under Incomplete Information," NBER Working Papers 6986, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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