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The Dividend Substitution Hypothesis: Australian Evidence

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  • Christine Brown
  • John Handley
  • James O'Day

Abstract

type="main"> In a perfect capital market firms are indifferent to either dividends or repurchases as payout mechanisms, suggesting that the two payout methods should be perfect substitutes. Empirical research at the single country level, as well as cross country studies, provide evidence that dividends and repurchases act as substitutes (the dividend substitution hypothesis), and that the tax treatment of dividends versus capital gains affects this relation. Australia, which operates under a full dividend imputation system, has two types of repurchases: on- and off-market. On-market repurchases are taxed as capital gains while off-market repurchases comprise a large dividend component carrying valuable tax credits. Australia thus provides a natural setting to investigate how the tax treatment of proceeds affects the dividend substitution hypothesis. Dividend substitution is found to exist for on-market repurchases but not for off-market repurchases, thus providing further support for the idea that the tax treatment of proceeds affects the substitutability of repurchases and dividends.

Suggested Citation

  • Christine Brown & John Handley & James O'Day, 2015. "The Dividend Substitution Hypothesis: Australian Evidence," Abacus, Accounting Foundation, University of Sydney, vol. 51(1), pages 37-62, March.
    • Handle: RePEc:bla:abacus:v:51:y:2015:i:1:p:37-62
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    File URL: http://hdl.handle.net/10.1111/abac.12041
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    3. Robert W Faff & Stephen Gray & Kelvin Jui Keng Tan, 2016. "A contemporary view of corporate finance theory, empirical evidence and practice," Australian Journal of Management, Australian School of Business, vol. 41(4), pages 662-686, November.
    4. Jeffrey J. Coulton & Caitlin Ruddock, 2011. "Corporate payout policy in Australia and a test of the life‐cycle theory," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 51(2), pages 381-407, June.
    5. Anh Le & Xiangkang Yin & Jing Zhao, 2022. "The Capitalization Effect of Imputation Credits on Expected Stock Returns," Abacus, Accounting Foundation, University of Sydney, vol. 58(3), pages 523-566, September.
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    7. Damien Cannavan & Stephen Gray & Jason Hall, 2023. "Sampling error and the joint estimation of imputation credit value and cash dividend value," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 63(S1), pages 1029-1068, April.
    8. Michael Dempsey & Abeyratna Gunasekarage & Thanh Tan Truong, 2019. "The association between dividend payout and firm growth: Australian evidence," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 59(4), pages 2345-2376, December.
    9. Ota, Koji & Lau, David, 2021. "Share repurchases on the Tokyo Stock Exchange Trading Network," Journal of the Japanese and International Economies, Elsevier, vol. 61(C).
    10. Chintrakarn, Pandej & Jiraporn, Pornsit & Treepongkaruna, Sirimon & Mook Lee, Sang, 2022. "The effect of board independence on dividend payouts: A quasi-natural experiment," The North American Journal of Economics and Finance, Elsevier, vol. 63(C).

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