The Lock-In Effect and the Corporate Payout Puzzle
ISER DP No. 1070, 2019
47 Pages Posted: 27 Dec 2019
Date Written: December 2, 2019
Taxes on capital gains are deferred until realization, whereas dividend taxes are levied upon accrual. This often makes dividends tax-disadvantaged relative to share repurchases, which leads to the payout puzzle: why do firms pay dividends? This paper develops a model of corporate payout policy to demonstrate that tax deferment can also provide a partial solution to the payout puzzle: if shareholders demand repurchase premiums when selling equity back to a firm - as compensation for accelerated realizations - then dividend payments can become tax-efficient. This mechanism is appealing because it jointly explains a number of payout regularities without appealing to asymmetric information, incomplete contracting, repurchase constraints, and/or shareholder irrationality.
Keywords: Payout Policy, Capital Taxation, Portfolio Choice
JEL Classification: G35, H24, G50
Suggested Citation: Suggested Citation