12.5 Other factors
raising an equal amount by share issue on the other hand, as equivalent. This will
not be true in practice. Issuing new shares tends to involve the business in fairly
large legal and administrative costs (see Chapter 8). It seems likely that this is an
important factor in making decisions on dividend payment levels.
l Taxes, corporate and personal, do not exist. Certainly this is untrue, and it is often a
significant feature. From the business’s point of view, its corporation tax liability is
not dependent on the level of dividends.
From the shareholders’ perspective, the main question is whether it is more tax
efficientto receive dividends or to make capital gains. The answer tends to depend
on who the shareholders are and on their individual level of income and capital
gains for the year concerned. For some shareholders (such as tax-exempt institu-
tions, for example, a pension fund), neither dividend nor capital gains will attract
tax. For others, tax becomes significant. To the extent that it is possible to generalise,
it is probably true to say that for individuals with high levels of dividends and
capital gains, further dividends tend to be taxed at the same rate as capital gains.
l A feature of the UK investment scene is the increasing tendency for equities to be
owned by investing institutions. Many of these, for example pension funds and life
assurance funds, are exempt from taxes both on income and on capital gains.
l The situation is complicated still further by the fact that the business’s corporation
tax liability will, to a large extent, depend on what it does with any funds that it
retains. Some investments in real assets are more tax efficient than others; for ex-
ample, an investment in a factory attracts tax relief whereas an investment in an
office block does not.
l MM’s ‘no tax’ assumption is perhaps not too significant provided that businesses
show some consistency in their dividend policy. We shall shortly return to this point.The deficiencies of the individual assumptions do not seem sufficiently profound to
destroy the MM case. Clearly, the existence of significant dealing and share issue costs
must weaken it, but there seems no reason why MM’s analysis should not reasonably
represent the true position – not, at least, as far as their analysis goes.12.5 Other factors
There are some other factors that might bear on the position and explain why dir-
ectors seem to regard the dividend decision as an important one, despite the MM
assertion that it is not.Informational content of dividends
Some hold the view that the level of dividends, and perhaps more particularly
changes in the level of dividends, convey new public information about the business.
For example, an increased level of dividend might be (and seems often to be inter-
preted as) a signal that the directors view the future of the business with confidence.
(This contrasts strikingly with the conclusion that might be reached by following
MM’s analysis. Paying any dividend, let alone one that showed an increase over the
previous year, might well indicate that the directors cannot find sufficient investment
opportunities to use all the finance available to them, so they are returning some to