The Federal Reserve Board eagle logo links to home page
Finance and Economics Discussion Series
Finance and Economics Discussion Series logo links to FEDS home page Executive Financial Incentives and Payout Policy: Firm Responses to the 2003 Dividend Tax Cut
Jeffrey R. Brown, Nellie Liang, and Scott Weisbenner

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.

Keywords: Payout policy, Dividends, Share Repurchases, Executive Ownership,

Executive Compensation, Agency Costs

Full paper (251 KB PDF) | Full Paper (Screen Reader Version)

Home | FEDS | List of 2006 FEDS papers
To comment on this site, please fill out our feedback form.
Last update: April 18, 2006