Stock Repurchase as a Tax-Saving Distribution

Journal of Financial Research, Vol. 4, No. 1, pp. 69-79, Spring 1981

11 Pages Posted: 14 Feb 2008 Last revised: 8 Oct 2013

See all articles by Dan Palmon

Dan Palmon

Rutgers, The State University of New Jersey - Accounting & Information Systems

Uzi Yaari

Rutgers University; School of Business-Camden

Abstract

The personal tax impact on share prices of a permanent distribution via stock repurchase was first modeled by Bierman and West (JF 1966, #4) who argued that the tax impact is minimized under permanent ownership by the same shareholders. Elton and Gruber (JF 1968, #1) faulted the original model for lack of time consistency and argued that market forces would lead to an annual turnover of ownership. One-year ownership would be the dominate behavior since tax saving is at a maximum in the first year. This study develops a time-consistent theoretical model which demonstrates that Bierman and West's intuition was correct: Indefinite holding by the original shareholders would minimize the impact of capital gains tax thereby maximizing the current share price both in absolute terms and relative to a pure distribution by cash dividends. In contrast, an annual turnover of owners would decrease the tax saving and its impact to a minimum as measured by the ratio of the two tax rates, erasing the tax shield of stock repurchase. The corrected valuation model under an indefinite holding period reveals that the annual tax shield and post-tax distribution constitute decreasing non-geometric series.

Keywords: stock repurchase, stock buyback, tax-saving distribution

JEL Classification: G35, G38, H21, H24, H32

Suggested Citation

Palmon, Dan and Yaari, Uzi, Stock Repurchase as a Tax-Saving Distribution. Journal of Financial Research, Vol. 4, No. 1, pp. 69-79, Spring 1981, Available at SSRN: https://ssrn.com/abstract=1093165

Dan Palmon

Rutgers, The State University of New Jersey - Accounting & Information Systems ( email )

96 New England Avenue, #18
Summit, NJ 07901-1825
United States
201-648-5472 (Phone)
201-648-1283 (Fax)

Uzi Yaari (Contact Author)

Rutgers University ( email )

School of Business
Camden, NJ 08102
United States
610-664-2086 (Phone)

HOME PAGE: http://camden-sbc.rutgers.edu/FacultyStaff/Directory/yaari.htm

School of Business-Camden ( email )

Rutgers University
227 Penn Street
Camden, NJ 08102
United States
610-664-2086 (Phone)
610-664-2198 (Fax)

HOME PAGE: http://camden-sbc.rutgers.edu/FacultyStaff/Directory/yaari.htm

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