Dividend Taxes and Implied Cost of Equity Capital

Abstract

We estimate firm-level implied cost of equity capital based on recent advances in accounting and finance research and examine the effect of dividend taxes on the cost of equity capital. We investigate whether dividend taxes affect firms' cost of capital by testing the relation between the implied cost of equity capital and a measure of the tax-penalized portion of dividend yield, which we define as the product of dividend yield and the dividend tax penalty. The results generally support the dividend tax capitalization hypothesis. We find a positive relation between the implied cost of equity capital and the tax-penalized portion of dividend yield that is decreasing in aggregate institutional ownership, our proxy for tax-advantaged investors. The evidence in this study adds to the understanding of the effect of investor-level taxes on equity value. Copyright 2005 The Institute of Professional Accounting, University of Chicago.

The Implied Equity Risk Premium - An Evaluation of Empirical Methods

“…The strong explanatory power of the dividend yield in RIM2 confirms the findings of Dhaliwal et al (2005). The rather poor performance of the standard regression tests for expected returns raises the question what variables determine the implied risk premium calculated from the RIM approach.…”

“…For a detailed study on taxation and implied cost of capital, see Dhaliwal et al (2005) 9 Although analysts usually forecast earnings beyond year 1, we had not any access to this data. Claus and Thomas (2001) use the same approach to generate missing data in their study.…”

The Effect of Shareholder Taxes on Corporate Payout Choice

“…The variable t d is the maximum tax rate for individual shareholders on dividend income and t cg is the maximum tax rate for individual shareholders on recognition of capital gains. This is the same formula used to calculate the dividend tax penalty in Dhaliwal, Krull, Li and Moser (2004 institutional owners classified as mutual funds or investment advisors (brokers) and its probability of repurchasing stock as the dividend tax penalty increases.…”

Capital Tax Reform and the Real Economy: The Effects of the 2003 Dividend Tax Cut

“…See Poterba and Summers (1985), Ayers, Cloyd, and Robinson (2002), and Auerbach and Hassett (2007) for evidence of e¤ects on …rm value. 49 In fact, the new view implies that reducing the dividend tax rate to a minimum conceivable rate could actually reduce investment because dividend tax rates could then only rise (Korinek and Stiglitz 2009). other …rms (Auerbach and Hassett 2002;Dhaliwal, Krull, Li, and Moser 2005), especially startups that may be particularly reliant on external equity …nancing. This paper's main analysis sample contains many start-ups, but most …rms are not young: the median …rm age studied here is 22 years, and only one of the one hundred most valuable publicly traded companies in the United States was founded since 2003.…”