Tax Avoidance at Public Corporations Driven by Shareholder Taxes: Evidence from Changes in Dividend Tax Policy

ABSTRACT We exploit changes in a country's integration of corporate and shareholder taxes to identify the effect of investor-level taxes on costly corporate tax avoidance. Specifically, we rely on European countries eliminating imputation systems in different years in response to supranational judicial rulings. These eliminations, which are exogenous to the firm, remove managers' disincentive to engage in tax avoidance if they consider investor-level taxes. Using a difference-in-differences model with fixed effects, we find that the average firm affected by an elimination reduces its cash effective tax rate by 5.5 percent. Placebo tests support that this effect exists only for countries and years for which eliminations occur. Consistent with our cross-sectional predictions, we find that results are stronger for firms with lower growth opportunities, higher dividend payout, lower foreign income, and higher closely held ownership. Further analysis provides evidence consistent with shifting income to foreign countries as one method of tax avoidance. JEL Classifications: G38; G32; G15; H26.

Does Financial Constraint Affect the Relation between Shareholder Taxes and the Cost of Equity Capital?

ABSTRACT: We argue that reductions in shareholder taxes should lower the cost of equity capital more for financially constrained firms than for other companies. Consistent with this prediction, we find that, following the 1997 (TRA) and the 2003 (JGTRRA) cuts in U.S. individual shareholder taxes, financially constrained firms enjoyed larger reductions in their cost of equity capital than did other firms. The results are consistent with the incidence of the tax reductions falling mostly on firms with both pressing needs for capital and disproportionate ownership by individuals, the only shareholders who benefited from the legislations. The paper provides a partial explanation for the seemingly puzzling finding that, following the unprecedented 2003 reduction in dividend tax rates, non-dividend-paying firms outperformed dividend-paying firms. The results suggest that it was not dividend status that mattered, but financial constraint, a common attribute of non-dividend-paying companies. Data Availability: Data are available from public sources identified in the study.

Dividends, Share Repurchases, and Tax Clienteles: Evidence from the 2003 Reductions in Shareholder Taxes

ABSTRACT: This study jointly evaluates firm-level changes in investor composition and shareholder distributions following a 2003 reduction in the dividend and capital gains tax rates for individuals. We find that directors and officers, but not other individual investors, rebalanced their portfolios to maximize after-tax returns in light of the new tax rules. We also find that firms adjusted their distribution policy (specifically, dividends versus share repurchases) in a manner consistent with the altered tax incentives for individual investors. To our knowledge, this is the first study to employ simultaneous equations to estimate both shareholder and managerial responses to the 2003 rate reductions. We find that the generalized method of moments (GMM) estimates are substantially stronger than OLS estimates, consistent with our expectation that investor and manager responses are simultaneously determined. Failure to estimate systems of equations may account for some of the weak and conflicting results from prior studies of the 2003 rate reductions.

The Effect of Tax-Exempt Investors and Risk on Stock Ownership and Expected Returns

ABSTRACT: We investigate how shareholder taxes and risk preferences affect both a stock’s expected return, which reflects the capitalization of the dividend tax penalty into stock price, and the fraction of a firm’s stock held by tax-exempt investors. Our model demonstrates that the dividend tax capitalization effect reflects the weighted average tax rate of all investors, where the weighting depends on investors’ risk tolerances. This weighted average tax rate is not affected by the fraction of stock held by tax-exempt investors; however, tax-exempt investor ownership can be correlated with the weighted average tax rate if differences in tax-exempt investor ownership for different stocks reflect differences in investor risk tolerances for those stocks. Our empirical tests are consistent with the model’s predictions, and provide an equilibrium framework for interpreting prior empirical studies in accounting.

The Effect of Shareholder Taxes on Corporate Payout Choice

abstractThis study investigates whether the difference in individual shareholder tax rates between dividend income and capital gain (the dividend tax penalty) affects a firm's choice between distributing funds to shareholders through dividends or share repurchases. The results of this study suggest that, in periods in which the dividend tax penalty increases, firms are more likely to distribute funds to shareholders through share repurchases as opposed to dividends. The results also indicate that the relation between the dividend tax penalty and corporate payout choice is affected by the types of shareholders who own stock in the firm. As tax-disfavored institutional ownership increases and the dividend tax penalty increases, firms are more likely to repurchase shares as opposed to distributing dividends. In contrast, as tax-favored institutional ownership increases and the dividend tax penalty increases, firms are less likely to repurchase shares as opposed to distributing dividends. As senior managerial share ownership increases and the dividend tax penalty increases, firms are more likely to make distributions to shareholders in the form of share repurchases.