Whose Taxes Matter? Institutions' Monitoring Role in Dividend Decisions around Tax Rate Changes

Abstract

We study whether institutions’ monitoring role affects the relation between shareholder-level taxes and dividends. Prior work finds that firms pay “tax-motivated special dividends” in, or “shift” planned dividends to, the period prior to tax rate increases to reduce taxable shareholders’ taxes, especially when insider ownership is high. We find that firms’ decisions to engage in these behaviors vary with institutions’ monitoring role, despite the monitoring role sometimes conflicting with institutions’ tax incentives. For example, tax-insensitive monitoring institutions encourage tax-motivated special dividends, although these institutions receive no direct tax benefits, when the benefits accrue broadly to other non-insider tax-sensitive investors. Further, we find that ownership by tax-insensitive monitoring institutions attenuates the positive relation between insider ownership and tax-motivated special dividends. This suggests that insiders’ taxes matter in tax-motivated special dividend decisions, but only when monitoring is weak. We find little evidence that monitors constrain insiders’ ability to shift dividends, consistent with lower costs to a small shift in dividend timing relative to a tax-motivated special dividend. Our study highlights the importance of considering heterogeneous tax and non-tax shareholder attributes when academics and policymakers evaluate how taxes affect dividends. We also document a previously unidentified role of institutional monitoring in the relation between shareholder-level taxes and firms’ dividend decisions.

Keywords: Dividend Payout Policy, Institutional Ownership, Monitoring, Tax-Sensitivity, Shareholder-Level Taxes, JGTRRA

JEL Classification: G35, H24