Free Cash Flow, Shareholder Value, and the Undistributed Profits Tax of 1936 and 1937




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    • Christie is from Vanderbilt University, and Nanda is from the University of Southern California. The authors gratefully acknowledge the helpful comments of Cliff Ball, Mukesh Bajaj, Bhagwan Chowdhry, Harry DeAngelo, Bruno Gerard, David Hirshleifer, Roger Huang, John Matsusaka, Kelly McNamara, Paul Schultz, David Shimko, Hans Stoll, Anand Vijh, Vince Warther, Randy Westerfield, and seminar participants at the Hong Kong University of Science and Technology, University of Southern California, and Vanderbilt University. The article has also benefitted significantly from the comments of René Stulz (the editor) and two anonymous referees. Christie acknowledges the financial support of the Dean's Fund for Faculty Research at the Owen Graduate School of Management and the Financial Markets Research Center at Vanderbilt University. All remaining errors are ours.


In 1936, the Federal Government unexpectedly imposed a tax on undistributed corporate profits. Despite the direct costs of the tax, its announcement produced a positive revaluation of corporate equity, particularly among lower-payout firms. We interpret this as evidence of a divergence between managerial and shareholder preferences regarding dividend payout policies, consistent with the presence of agency costs. We also find that despite the incentives created by the tax, the actual growth in dividends during 1936 was lower among firms judged more likely to be subject to higher agency costs after controlling for liquidity, debt, and the growth in earnings.