The Cost of Misaligned Incentives: Evidence from the Funding Sources and Real Effects of Tax-Motivated Dividends

61 Pages Posted: 12 Mar 2020 Last revised: 15 Mar 2021

See all articles by Trent Krupa

Trent Krupa

University of Connecticut - Department of Accounting

Steven Utke

University of Connecticut - Department of Accounting

Date Written: March 15, 2021

Abstract

Prior research finds that firms pay special dividends before a dividend tax increase. We examine the funding sources and real effects of these tax-motivated special dividends, finding that firms incur costs – reducing investment and repurchases – to pay them. The funding sources, and related real effects, vary with shareholders’ tax incentives. When tax-insensitive institutional investors likely influence the dividend to benefit firms’ taxable shareholders other than insiders, firms reduce repurchases and capital expenditures. Conversely, when taxable insiders likely influence the dividend, and their tax incentives are misaligned with firms’ primarily tax-insensitive shareholder base, firms reduce R&D, consistent with misaligned payouts signaling managerial myopia which erodes shareholder value. Tests using both market responses to, and total factor productivity changes around, tax-motivated special dividends support these conclusions. These findings add to our understanding of tax-based agency issues influencing real corporate decisions and identify a previously unexplored cost of dividend tax increases.

Keywords: Investment, Agency Costs, Tax-Sensitivity, Dividend Payout Policy, Institutional Ownership, Shareholder-Level Taxes, JGTRRA, ATRA

JEL Classification: G35, H24, H32

Suggested Citation

Krupa, Trent and Utke, Steven, The Cost of Misaligned Incentives: Evidence from the Funding Sources and Real Effects of Tax-Motivated Dividends (March 15, 2021). University of Connecticut School of Business Research Paper No. 20-05, Available at SSRN: https://ssrn.com/abstract=3541067 or http://dx.doi.org/10.2139/ssrn.3541067

Trent Krupa (Contact Author)

University of Connecticut - Department of Accounting ( email )

School of Business
Storrs, CT 06269-2041
United States

Steven Utke

University of Connecticut - Department of Accounting ( email )

School of Business
Storrs, CT 06269-2041
United States

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