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Executive Financial Incentives and Payout Policy: Firm Responses to the 2003 Dividend Tax Cut


Jeffrey R. Brown


University of Illinois at Urbana-Champaign - Department of Finance; National Bureau of Economic Research (NBER); University of Illinois College of Law; University of Illinois at Urbana-Champaign - Institute of Government and Public Affairs (IGPA); University of Illinois at Urbana-Champaign - Department of Economics

Nellie Liang


Federal Reserve Board

Scott J. Weisbenner


University of Illinois at Urbana-Champaign - Department of Finance; National Bureau of Economic Research (NBER)

December 2004

AFA 2006 Boston Meetings Paper
FEDS Working Paper No. 2006-14

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.

Number of Pages in PDF File: 65

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

JEL Classification: G32, G35, H24

working papers series


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Date posted: December 15, 2004  

Suggested Citation

Brown, Jeffrey R. and Liang, Nellie and Weisbenner, Scott J., Executive Financial Incentives and Payout Policy: Firm Responses to the 2003 Dividend Tax Cut (December 2004). AFA 2006 Boston Meetings Paper; FEDS Working Paper No. 2006-14. Available at SSRN: http://ssrn.com/abstract=631182 or http://dx.doi.org/10.2139/ssrn.631182

Contact Information

Jeffrey R. Brown (Contact Author)
University of Illinois at Urbana-Champaign - Department of Finance ( email )
1206 South Sixth Street
Champaign, IL 61820
United States
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
University of Illinois College of Law ( email )
504 E. Pennsylvania Avenue
Champaign, IL 61820
United States
University of Illinois at Urbana-Champaign - Institute of Government and Public Affairs (IGPA) ( email )
Urbana, IL 61801
United States
University of Illinois at Urbana-Champaign - Department of Economics ( email )
410 David Kinley Hall
1407 W. Gregory
Urbana, IL 61801
United States
Nellie Liang
Federal Reserve Board ( email )
Capital Markets Section
20th & C. St., N.W.
Washington, DC 20551
United States
202-452-2918 (Phone)
202-452-3819 (Fax)
Scott J. Weisbenner
University of Illinois at Urbana-Champaign - Department of Finance ( email )
340 Wohlers Hall, MC-706
1206 S. Sixth Street
Champaign, IL 61820
United States
217-333-0872 (Phone)
217-244-9867 (Fax)
HOME PAGE: http://business.illinois.edu/weisbenn/
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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