The Effect of Financial Constraint on Shareholder Taxes and Firm Investments

Abstract

We demonstrate that firms' investment and job creation are influenced by shareholder taxes on capital gains and dividend. More importantly, the relation between shareholder taxes and firms' investment and job creation varies with financial constraint that firms face. Less financially constrained firms show larger increases in capital investment than more financially constrained firms in association with shareholder tax cut. For job creation, while non-financially constrained firms show increases in firms' number of employees when shareholder tax rates are cut, severely financially constrained firms exhibit decreases in firms' number of employees. Using the Taxpayer Relief Act of 1997 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 as our events of study, we find evidence supporting our predictions. Further, we show that the effect of shareholder tax change on firms' capital investment also varies with firms' dividend yield.

JEL Classification: G32, G35, H24, E22, E24