Corporate Dividend Policy and Tax Avoidance

38 Pages Posted: 2 Feb 2023

See all articles by Mark C. Anderson

Mark C. Anderson

University of Calgary - Haskayne School of Business

Muhammad Kabir

Asper School of Business, University of Manitoba

Harun Rashid

California State University, Dominguez Hills - College of Business Administration and Public Policy

Hussein A. Warsame

University of Calgary

Date Written: 2022

Abstract

This article investigates the relation between corporate dividend policy and tax avoidance. The payment of dividends facilitates the transfer of corporate resources, usually cash, from the company to its shareholders. An important aspect of dividend policy is that it is used to address agency problems between shareholders and managers associated with free cash flow. Given that a dividend payment policy is generally considered to be a fixed commitment, and managers may be penalized for cutting dividends, managers may adopt a tax-avoidance strategy to generate additional cash flow to meet this obligation and to fund operating and investment needs. Using data for US publicly listed corporations, we first document that a higher dividend payout ratio is associated with a lower cash-payment-based effective tax rate and a higher book-tax difference, indicating a higher level of tax avoidance. We then test whether tax avoidance increased with the initiation of dividends that occurred in response to the 2003 US dividend income tax cut, and find that it did. The results support our prediction that dividend policy affects tax planning. We employ a Heckman two-stage procedure to address other endogeneities. We also show that our baseline results are robust when an extensive set of tests is applied, including alternative measures of tax avoidance and dividend payout. In addition, we find that the relation between dividend payout and measures of tax avoidance is stronger for firms that experience a non-trivial increase in the dividend payout ratio and that have low institutional ownership, high leverage, and low operating cash flow. Overall, our findings provide persuasive evidence that dividend policy affects the distribution of surplus among shareholders, managers, and the tax authority.

Keywords: Agency, Corporate Distributions, Dividends, Effective Income Tax Rates, Tax Avoidance, Tax Benefits

Suggested Citation

Anderson, Mark C. and Kabir, Muhammad and Rashid, Harun and Warsame, Hussein A., Corporate Dividend Policy and Tax Avoidance ( 2022). Canadian Tax Journal/Revue fiscale canadienne, 2022, Vol. 70, No. 4, p. 747-784, Available at SSRN: https://ssrn.com/abstract=4343931

Mark C. Anderson (Contact Author)

University of Calgary - Haskayne School of Business ( email )

2500 University Drive, NW
Calgary, Alberta T2N 1N4
Canada
403-220-3926 (Phone)

Muhammad Kabir

Asper School of Business, University of Manitoba ( email )

Faculty of Management
Winnipeg, MB R3T 5V4
Canada

Harun Rashid

California State University, Dominguez Hills - College of Business Administration and Public Policy

Hussein A. Warsame

University of Calgary ( email )

2500 University Drive, NW
Calgary, Alberta T2N 1N4
Canada

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