Taxable Cash Dividends: A Useful Way of Burning Money

Ken L. Bechmann, Johannes Raaballe

Publikation: Working paperForskning

Resumé

Firms pay out cash using both dividends and share repurchases. In many aspects these twomeans are similar, but one important difference is that dividends are generally taxed more heavily than share repurchases. Nevertheless firms persist in paying out large amounts in dividends. This paper provides an explanation for this dividend puzzle by developing a class of signaling models violating the `single-crossing' property in which information about the quality of the firm is asymmetric between the management and the shareholders. In these models a high-quality firm can always signal its quality by using share repurchases only. However, in certain cases share repurchases become costlier on the margin for a high-quality firm than for a low-quality imitator. In such cases, the high-quality firm signals most cost efficiently by means of a combination of share repurchases and taxable cash dividends financed by the issuance of new shares. Taxable cash dividends financed by the issuance of new shares then can be considered a positive kind of money burning whose role is to signal a firm's high quality. The implications of the models are consistent with several important empirical facts about dividends and share repurchases. Thus, this paper's main contribution is to examine a range of new signaling models that provides a role for taxable cash dividends and share repurchases and to derive their empirical implications.Key words: Dividends, Share Repurchases, Signaling, Single-Crossing Property, Money BurningJEL Classification: G35, D82
Firms pay out cash using both dividends and share repurchases. In many aspects these twomeans are similar, but one important difference is that dividends are generally taxed more heavily than share repurchases. Nevertheless firms persist in paying out large amounts in dividends. This paper provides an explanation for this dividend puzzle by developing a class of signaling models violating the `single-crossing' property in which information about the quality of the firm is asymmetric between the management and the shareholders. In these models a high-quality firm can always signal its quality by using share repurchases only. However, in certain cases share repurchases become costlier on the margin for a high-quality firm than for a low-quality imitator. In such cases, the high-quality firm signals most cost efficiently by means of a combination of share repurchases and taxable cash dividends financed by the issuance of new shares. Taxable cash dividends financed by the issuance of new shares then can be considered a positive kind of money burning whose role is to signal a firm's high quality. The implications of the models are consistent with several important empirical facts about dividends and share repurchases. Thus, this paper's main contribution is to examine a range of new signaling models that provides a role for taxable cash dividends and share repurchases and to derive their empirical implications.Key words: Dividends, Share Repurchases, Signaling, Single-Crossing Property, Money BurningJEL Classification: G35, D82
SprogEngelsk
Udgivelses stedFrederiksberg
UdgiverCopenhagen Business School [wp]
Antal sider36
ISBN (Trykt)8790705955
StatusUdgivet - 2005
NavnWorking Papers /Department of Finance. Copenhagen Business School
NummerWP 2005-4
ISSN0903-0352

Emneord

  • Finansiering
  • REPO-forretninger
  • Dividende
  • Dividendepolitik
  • Money Burning
  • Single-Crossing Property
  • Share Repurchases

Citer dette

Bechmann, K. L., & Raaballe, J. (2005). Taxable Cash Dividends: A Useful Way of Burning Money. Frederiksberg: Copenhagen Business School [wp]. Working Papers /Department of Finance. Copenhagen Business School, Nr. WP 2005-4
Bechmann, Ken L. ; Raaballe, Johannes. / Taxable Cash Dividends : A Useful Way of Burning Money. Frederiksberg : Copenhagen Business School [wp], 2005. (Working Papers /Department of Finance. Copenhagen Business School; Nr. WP 2005-4).
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Bechmann, KL & Raaballe, J 2005 'Taxable Cash Dividends: A Useful Way of Burning Money' Copenhagen Business School [wp], Frederiksberg.

Taxable Cash Dividends : A Useful Way of Burning Money. / Bechmann, Ken L.; Raaballe, Johannes.

Frederiksberg : Copenhagen Business School [wp], 2005.

Publikation: Working paperForskning

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N2 - Firms pay out cash using both dividends and share repurchases. In many aspects these two means are similar, but one important difference is that dividends are generally taxed more heavily than share repurchases. Nevertheless firms persist in paying out large amounts in dividends. This paper provides an explanation for this dividend puzzle by developing a class of signaling models violating the "single-crossing" property in which information about the quality of the firm is asymmetric between the management and the shareholders. In these models a high-quality firm can always signal its quality by using share repurchases only. However, in certain cases share repurchases become costlier on the margin for a high-quality firm than for a low-quality imitator. In such cases, the high-quality firm signals most cost efficiently by means of a combination of share repurchases and taxable cash dividends financed by the issuance of new shares. Taxable cash dividends financed by the issuance of new shares then can be considered a positive kind of money burning whose role is to signal a firm’s high quality. The implications of the models are consistent with several important empirical facts about dividends and share repurchases. Thus, this paper’s main contribution is to examine a range of new signaling models that provides a role for taxable cash dividends and share repurchases and to derive their empirical implications.

AB - Firms pay out cash using both dividends and share repurchases. In many aspects these two means are similar, but one important difference is that dividends are generally taxed more heavily than share repurchases. Nevertheless firms persist in paying out large amounts in dividends. This paper provides an explanation for this dividend puzzle by developing a class of signaling models violating the "single-crossing" property in which information about the quality of the firm is asymmetric between the management and the shareholders. In these models a high-quality firm can always signal its quality by using share repurchases only. However, in certain cases share repurchases become costlier on the margin for a high-quality firm than for a low-quality imitator. In such cases, the high-quality firm signals most cost efficiently by means of a combination of share repurchases and taxable cash dividends financed by the issuance of new shares. Taxable cash dividends financed by the issuance of new shares then can be considered a positive kind of money burning whose role is to signal a firm’s high quality. The implications of the models are consistent with several important empirical facts about dividends and share repurchases. Thus, this paper’s main contribution is to examine a range of new signaling models that provides a role for taxable cash dividends and share repurchases and to derive their empirical implications.

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Bechmann KL, Raaballe J. Taxable Cash Dividends: A Useful Way of Burning Money. Frederiksberg: Copenhagen Business School [wp]. 2005.