Individual investors’ dividend taxes and corporate innovation: evidence from China

In the context of China’s implementation of an innovation-driven development strategy and improvement of tax systems reform, we use the 2012 dividend tax reform, a unique quasi-experiment associating individual investors’ dividend tax with the length of the shareholding period, to examine empirically the impact of individual investors’ dividend taxes on corporate innovation. We find that firms facing a reduction in their individual investors’ dividend tax rates are more likely to reduce their innovation inputs and outputs. Our further findings are that: (1) reducing the internal cash flows triggered by increasing a cash dividend payout to cater to investors’ tax preferences is an important channel through which investors’ dividend taxes hinder corporate innovation; (2) if firms do not adjust the dividend payout policy when faced with the exogenous variation in individual investors’ dividend tax rates, they will suffer a fall in short-term market value. Overall, our study contributes to the literature on determinants of corporate innovation, and economic consequences of individual investors’ dividend taxes.