Principles of Corporate Finance_ 12th Edition

The most obvious and serious market imperfection has been the different tax treatment of divi-

dends and capital gains. U.S. tax rates on dividends have in the past been much higher than on

capital gains. By 2014, the tax rate on both dividends and capital gains was 23.8%, although the

effective tax rate on capital gains was lower because payment can be deferred until shares are sold.

Thus taxes have favored repurchases.

Taxes alone cannot explain payout policy, however. For example, corporations paid out massive

sums in cash dividends even in the 1960s, 1970s, and early 1980s, when the top income-tax rate on

dividends was 70% or more.

Of course some investors—widows and orphans, for example—may depend on regular cash

dividends. But the supply of dividends should expand to satisfy this clientele, and if the supply of

dividends already meets demand, then no single firm can increase its market value simply by pay-

ing dividends. (A dividend announcement may be good news for investors, but that news would

come out sooner or later through other channels.)

It is difficult to be dogmatic about payout. But remember, if investment and capital-structure

decisions are held constant, then arguments about payout policy are largely about shuffling money

from one pocket to another. Unless large tax consequences accompany these shuffles, it’s unlikely

that firm value is much affected by the choice between dividends and repurchases. The short-run

choice is tactical. Longer-run payout strategy depends on the life cycle of the firm from youth and

growth to profitable maturity.

Investors seem interested in payout mostly because of the information they read into payout

decisions. Investors also push mature firms to pay out cash. Committing to a regular cash dividend

is a particularly effective signal of financial discipline.

For comprehensive reviews of the literature on payout policy, see:

F. Allen and R. Michaely, “Payout Policy,” in G. Constantinides, M. Harris, and R. Stulz, (eds.), Hand-

book of the Economics of Finance: Corporate Finance (Amsterdam: North-Holland, 2003).

H. DeAngelo, L. DeAngelo, and D. Skinner, “Corporate Payout Policy,” Foundations and Trends in

Finance 3 (2008), pp. 95–287.

J. Farre-Mensa, R. Michaely, and M. Schmalz, “Payout Policy,” in A. Lo and R. Merton (eds.), Annual

Review of Financial Economics 6 (December 2014), pp. 75–134.

For a survey of managers’ attitudes to the payout decision, see:

A. Kalay and M. Lemmon, “Payout Policy,” in B. E. Eckbo (ed.), Handbook of Empirical Corporate

Finance (Amsterdam: Elsevier/North-Holland, 2007), Chapter 10.

A. Brav, J. R. Graham, C. R. Harvey, and R. Michaely, “Payout Policy in the 21st Century,” Journal of

Financial Economics 77 (September 2005), pp. 483–527.

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FURTHER

READING

Select problems are available in McGraw-Hill’s Connect.

Please see the preface for more information.

BASIC

1. Dividend payments In 2014, Entergy paid a regular quarterly dividend of $.83 per share.
   a. Match each of the following dates.
   (A1) Friday, July 25 (B1) Record date
   (A2) Monday, August 11 (B2) Payment date
   (A3) Tuesday, August 12 (B3) Ex-dividend date
   (A4) Thursday, August 14 (B4) Last with-dividend date
   (A5) Tuesday, September 2 (B5) Declaration date

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PROBLEM

SETS

430 Part Five Payout Policy and Capital Structure

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