Tuesday, June 1, 2004
William Bratton (Georgetown) has posted The New Dividend Puzzle on SSRN. Here is part of the abstract:
The dividend puzzle of economic theory asks why firms pay substantial dividends, given the classical tax rate preference for capital gains and deferral of capital gains taxation until realization. A new dividend puzzle arises at the level of practice in the wake of The Jobs and Growth Tax Relief Reconciliation Act of 2003 (the JGTRRA), which aligns tax rates on shareholder capital gains and dividend income at a maximum 15 percent even as it leaves in place the capital gains deferral. The new tax regime puts a difficult question to corporate boards: Whether, assuming payout, dividends hold out relative advantages over stock repurchases as the mode of payment….
The Article concludes that the shift to repurchases should not be read as a governance success story. Since repurchases held out tax benefits for most shareholders prior to the JGTRRA, there was no reason for outside monitors to ask hard questions about flexibility and adverse selection or to inquire further about the motivational effects of stock option valuation. With rate parity, the governance system needs to start the questioning process. The bargain repurchase possibility must be weighed against the adverse selection possibility, with the balance depending on the state of the market. Taxation remains a consideration: Repurchases and capital gains still hold out deferral value for long term, taxpaying shareholders. Finally, special dividends hold out advantages of transparency with the possible spillover of improved executive compensation policy. More generally, the JGTRRA poses a cost-benefit puzzle to be solved firm-by-firm, case-by-case. Unfortunately, the corporate governance system still rubber stamps management payout decisions, and so probably will fail to confront the questions. Governance reform is needed to assure that the payout decision is uncoupled from perverse incentives stemming from stock option compensation and reformulated in light of rate parity. It follows that payout should join management compensation in the emerging regime of governance by independent director committee.
2 responses to “Bratton on The Dividend Puzzle”
Mr Bush believes in too much of sunsets…..corporates have got to believe that DON’T THE SUN GO DOWN ON US…….The big question about the dividend tax rate cut is how will corporations respond? It appears likely that corporations will initiate or increase dividend payments in the hope of attracting capital, raising their stock price and, therefore, making it easier to attract equity capital. However, the six-year sunset provision may discourage corporations from moving quickly. Closely-held corporations, which traditionally extract funds in the form of compensation, rather than dividends, have new options. Compensation will still receive a corporate level deduction while dividends will not. However, compensation is taxed as high as 35 percent. Dividends, under the new law, will be taxed at 15 percent.
NITISH TEWARY
FINANCIAL ANALYST
Mr Bush believes in too much of sunsets…..corporates have got to believe that DON’T THE SUN GO DOWN ON US…….The big question about the dividend tax rate cut is how will corporations respond? It appears likely that corporations will initiate or increase dividend payments in the hope of attracting capital, raising their stock price and, therefore, making it easier to attract equity capital. However, the six-year sunset provision may discourage corporations from moving quickly. Closely-held corporations, which traditionally extract funds in the form of compensation, rather than dividends, have new options. Compensation will still receive a corporate level deduction while dividends will not. However, compensation is taxed as high as 35 percent. Dividends, under the new law, will be taxed at 15 percent.
NITISH TEWARY
FINANCIAL ANALYST