The Dividend Substitution Hypothesis: Australian Evidence

26 Pages Posted: 7 Mar 2015

See all articles by Christine A. Brown

Christine A. Brown

Department of Banking and Finance; Financial Research Network (FIRN)

John C. Handley

University of Melbourne - Department of Finance

Date Written: March 2015

Abstract

In a perfect capital market firms are indifferent to either dividends or repurchases as payout mechanisms, suggesting that the two payout methods should be perfect substitutes. Empirical research at the single country level, as well as cross country studies, provide evidence that dividends and repurchases act as substitutes (the dividend substitution hypothesis), and that the tax treatment of dividends versus capital gains affects this relation. Australia, which operates under a full dividend imputation system, has two types of repurchases: on‐ and off‐market. On‐market repurchases are taxed as capital gains while off‐market repurchases comprise a large dividend component carrying valuable tax credits. Australia thus provides a natural setting to investigate how the tax treatment of proceeds affects the dividend substitution hypothesis. Dividend substitution is found to exist for on‐market repurchases but not for off‐market repurchases, thus providing further support for the idea that the tax treatment of proceeds affects the substitutability of repurchases and dividends.

Keywords: Buyback, Dividend imputation, Equal access, Franking, Off‐market, On‐market, Payout, Repurchase

Suggested Citation

Brown, Christine A. and Handley, John C., The Dividend Substitution Hypothesis: Australian Evidence (March 2015). Abacus, Vol. 51, Issue 1, pp. 37-62, 2015, Available at SSRN: https://ssrn.com/abstract=2574469 or http://dx.doi.org/10.1111/abac.12041

Christine A. Brown (Contact Author)

Department of Banking and Finance ( email )

Building 11E
Clayton, Victoria 3800
Australia
+61 3 99031793 (Phone)
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Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: www.firn.org.au

John C. Handley

University of Melbourne - Department of Finance ( email )

Victoria
Parkville, Victoria 3010 3010
Australia
(61) 3 8344 7663 (Phone)
(61) 3 8344 6914 (Fax)

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