Payout Taxes and the Allocation of Investment
Executive Summary — The corporate payout that shareholders periodically receive--dividends or repurchases of shares--is subject to taxation in many countries. Such taxes make it cheaper to finance investment out of retained earnings than from equity issues. Using tax data from 25 countries over a 19-year period, this paper discusses whether these taxes have a direct effect on investor behavior, and to what extent. Research was conducted by Bo Becker of Harvard Business School, Marcus Jacob of the European Business School, and Martin Jacob of the Otto Beisheim School of Management. Key concepts include:
- Capital expenditures are higher in firms with easy access to inside equity.
- High taxes tend to lock capital into companies that generate internal cash flows, ahead of companies that need to raise outside equity. Tax rates do affect investment decisions.
- Firms with low ownership by corporate insiders are less affected by tax changes than firms with high insider ownership. This may reflect the fact that insiders with high stakes have incentives aligned with other shareholders.
When corporate payout is taxed, internal equity (retained earnings) is cheaper than external equity (share issues). High taxes will favor firms that can finance internally. If there are no perfect substitutes for equity finance, payout taxes may thus change the investment behavior of firms. Using an international panel with many changes in payout taxes, we show that this prediction holds well. Payout taxes have a large impact on the dynamics of corporate investment and growth. Investment is "locked in" in profitable firms when payout is heavily taxed. Thus, apart from any aggregate effects, payout taxes change the allocation of capital.