NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Dividends, Share Repurchases, and Tax Incentives

Firms with large individual ownership boosted the dividend portion of their total payouts, beginning a few months after enactment of the tax cuts.

In Dividends, Share Repurchases, and Tax Clienteles: Evidence from the 2003 Reductions in Shareholder Taxes (NBER Working Paper No. 16129), co-authors Jennifer Blouin, Jana Raedy, and Douglas Shackelford analyze how firms' investor composition and shareholder distributions changed after a 2003 reduction in the dividend and capital gains tax rates for individuals. The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) reduced the maximum tax rate on dividends from 39 percent to 15 percent for individuals. It also lowered the maximum individual tax rate on capital gains, which applies to repurchases of shares, from 20 percent to 15 percent. These changes may have altered the tax-efficient mix of dividends and capital gains, at least for some individual investors, and prompted them to re-balance their portfolios.

The researchers find that the net effect of these changes was to make firms that distributed profits mostly through dividends more attractive for individual investors than those that distributed profits mostly through share repurchases. They conclude that corporate directors and officers, but not other individual investors, rebalanced their portfolios to maximize after-tax returns in light of the new tax rules enacted in 2003 and that their firms adjusted their distribution policy -- specifically, increasing dividends in lieu of share repurchases -- in a manner consistent with the altered tax incentives for individual investors.

Analyzing data from 1,923 firms before and after the introduction of JGTRRA, the researchers find that 145 companies initiated dividends after JGTRRA, while only 30 firms omitted dividends. More than 200 firms began repurchasing shares after enactment of JGTRRA, while 370 companies stopped repurchasing shares. Twenty-six firms both initiated dividends and ceased repurchasing shares after passage of JGTRRA, while three firms omitted dividends and began repurchasing shares. Among 702 firms that repurchased shares both before and after JGTRRA, 90 of them initiated dividends while 10 omitted dividends. And, among the 408 firms that paid dividends both before and after JGTRRA, 46 began repurchasing shares after its passage, but 58 stopped buying back shares.

Firms with large individual ownership boosted the dividend portion of their total payouts, beginning a few months after enactment of the tax cuts. Firms were particularly responsive to the changed tax incentives if their directors and officers held large equity positions, but also if there were other individuals and mutual funds with particularly large holdings.

-- Frank Byrt

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