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Corporate investment, dividend decisions, differential taxation and the no-arbitrage condition

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  • Kavous Ardalan
  • Eliezer Prisman

Abstract

Masulis and Trueman (1988) investigated corporate investment and dividend decisions under differential personal taxation. They assumed investors in different tax brackets, a state-preference complete market (which includes pure securities for each state) with a ban on short-selling. They concluded that shareholders prefer non-zero dividend payment. In their model, the restrictions on short-sales were needed to bound tax arbitrage profits, among investors in different tax brackets, so that equilibrium could be reached. However, the joint assumptions of complete markets, and restrictions on short-selling, are inconsistent. By utilizing more recent results, from the tax arbitrage literature, we allow short-selling, and examine the role and implications of the no-arbitrage condition. We show that, with investors in different tax brackets, equilibrium is feasible. We conclude that a revised Masulis and Trueman type model does not explain a non-zero optimal dividend policy. Copyright Springer 1998

Suggested Citation

  • Kavous Ardalan & Eliezer Prisman, 1998. "Corporate investment, dividend decisions, differential taxation and the no-arbitrage condition," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 22(1), pages 49-58, March.
    • Handle: RePEc:spr:jecfin:v:22:y:1998:i:1:p:49-58
    DOI: 10.1007/BF02823232
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    References listed on IDEAS

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    1. Masulis, Ronald W. & Trueman, Brett, 1988. "Corporate Investment and Dividend Decisions under Differential Personal Taxation," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 23(4), pages 369-385, December.
    2. Ross, Stephen A, 1978. "A Simple Approach to the Valuation of Risky Streams," The Journal of Business, University of Chicago Press, vol. 51(3), pages 453-475, July.
    3. Dammon, Robert M & Green, Richard C, 1987. "Tax Arbitrage and the Existence of Equilibrium Prices for Financial Assets," Journal of Finance, American Finance Association, vol. 42(5), pages 1143-1166, December.
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