Investor-Level Taxes and Corporate Dividend Policy: Evidence from a Quasi-Natural Experiment

Abstract

We combine a change to the treatment of franking credits in the hand of domestic shareholders,
namely the introduction of fully refundable franking credits, and a novel methodological approach
to provide robust evidence on the causal effect of investor-level taxes on corporate dividend policy.
Consistent with investors having a greater preference for the distribution of dividends, we find that
the introduction of fully refundable franking credit increases both the likelihood that firms pay
dividends and the level of the dividend payments they make. Subsequent analysis reveals that
effective tax rate and firm size explain cross-sectional variation in dividend policy responses to
the tax reform, with large firms and firms with high effective tax rates more likely to pay dividends
and to pay larger dividends than their peers.

Keywords: Corporate dividend policy; Dividend imputation system; Franking credit refundability; Australian tax law reform

JEL Classification: G35; H24; H25