1 Department of Economics, Copenhagen Business School2 The Chinese University of Hong Kong
Evidence from the 2003 Dividend Tax Cut
The agency model of Chetty and Saez (2010) predicts that firms with stronger shareholder rights and a better market for corporate control are more responsive to a dividend tax cut in their dividend and investment policies. We test these predictions by exploiting the sudden and significant dividend tax cut following the Jobs and Growth Tax Relief Reconciliation Act of 2003 and the pre-tax cut variations in the firms’ governance indexes (the Corporate Governance Index constructed by Gompers, Ishii, and Metrick, 2003, and the Entrenchment Index constructed by Bebchuk, Cohen, and Ferrel, 2009). We find that firms with lower governance indexes raise dividends and reduce investment in response to the tax cut significantly more than firms with higher governance indexes. These differential reactions come from differences in corporate governance standards but not differences in ownership concentration ratios.