Keywords: Payout policy, Dividends, Share Repurchases, Executive Ownership,
Executive Compensation, Agency Costs
Abstract: Using the 2003 reduction in dividend tax rates to identify an exogenous change
in the after-tax value of dividends to shareholders, we test whether stock
holdings among company executives is an important determinant of payout policy.
We have three primary findings. First, we find that when top executives have
greater stock ownership, and thus an incentive to increase dividends for
personal liquidity reasons, there is a significantly greater likelihood of a
dividend increase following the 2003 dividend tax cut, whereas no such relation
existed in the prior decade when the dividend tax rate was much higher.
This finding is strongest for dividend initiations, and is robust to a rich set
of firm and shareholder characteristics. Second, we provide evidence that
approximately one-third of the firms that initiated dividends in 2003, a higher
share than in previous years, scaled back share repurchases by an amount
sufficient to reduce their total payouts. This offset potentially raised
the total tax burden on shareholders at these firms because share repurchases
are still tax-advantaged relative to dividends. Third, we find that while
dividend-paying firms with a larger fraction of individual shareholders had
greater stock price gains in response to the tax cut, the market appears to
have at least partially anticipated that executives with high stock ownership
might raise dividends at the expense of share repurchases and increase the
average tax burden for individuals, which is consistent with the presence of
agency conflicts within the firm.
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Last update: April 18, 2006