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Keywords:

  • Capital gain;
  • Dividends;
  • Double taxation;
  • Stock repurchase
  • G32;
  • G35;
  • H25

Abstract

  1. Top of page
  2. Abstract
  3. 1. Introduction
  4. 2. Elimination of Double Taxation of Dividends and the Tax System in Taiwan
  5. 3. Related Work and Hypotheses Development
  6. 4. Data Source and Variable Definition
  7. 5. Effect of Elimination of Double Taxation of Dividends on Dividend Policy
  8. 6. Conclusion
  9. References

Taiwan eliminated double taxation of dividends in 1999, and allowed firms to repurchase stocks from July 2000. Taiwanese firms tend to pay dividends as opposed to repurchasing stock, even with zero tax on capital gains, and firms pay larger dividends after the elimination of double taxation of dividends. The relation between dividends and director ownership has been reinforced by the elimination of double taxation of dividends. The relation between dividends and the elimination of double taxation of dividends has also been reinforced by director ownership as stockholders receive more tax credits from dividends following the elimination of double taxation of dividends and directors act to protect stockholders’ interests.


1. Introduction

  1. Top of page
  2. Abstract
  3. 1. Introduction
  4. 2. Elimination of Double Taxation of Dividends and the Tax System in Taiwan
  5. 3. Related Work and Hypotheses Development
  6. 4. Data Source and Variable Definition
  7. 5. Effect of Elimination of Double Taxation of Dividends on Dividend Policy
  8. 6. Conclusion
  9. References

According to Alli et al. (1993), Allen and Michaely (2003), and Bernhardt et al. (2005) the deviation between dividend tax and capital gain tax reinforces the dividend puzzle, because in numerous countries dividends are taxed more than capital gains. To reduce stockholders’ tax burden, firms should repurchase stock rather than pay dividends.

A common issue in US corporations is the double taxation of dividends. Dividends are paid after deducting corporate taxes from incomes. Dividends received by stockholders are then taxed again as components of their taxable incomes. Before 1998, stockholders in Taiwan suffered from the double taxation of dividends, just like stockholders in the USA. However, on 26 December 1997, Taiwanese legislators revised the tax law to resolve the issue of double taxation of corporate dividends. Elimination of double taxation of dividends (EDTD) became effective on 1 January 1998. After EDTD, corporate and personal income taxes were integrated and stockholders only had to pay taxes on earnings from invested firms at the personal level but not at the corporate level. We use a unique set of Taiwanese data on double taxation of dividends to examine corporate dividend policy before and after EDTD.

Capital gains taxes on securities in Taiwan have been suspended since 1976. Investors in Taiwan should prefer stock repurchase to dividends because capital gains are not taxed at all. Double taxation of dividends along with zero tax on capital gains would encourage firms to repurchase stocks instead of paying dividends. However, stock repurchase in Taiwan was not permitted until 19 July 2000. From 19 July 2000, firms in Taiwan were allowed to buy back their stocks, with no more than 2% of their registered number of shares permitted for each repurchase and the accumulated repurchased stocks limited to 10% of shares outstanding.

Miller and Modigliani (1961) note that given a perfect and complete capital market, stock repurchases and dividends are perfect substitutes. Grullon and Michaely (2002) examine the relationship between dividends and stock repurchases. They argue that corporations are substituting stock repurchases for dividends. Firm managers decide whether to pay dividends based simply on the feelings of their stockholders regarding such payments. Under the tax system of double taxation on dividends (before 1998), if stock repurchase had been allowed, firms should have preferred stock repurchase to dividends because of the zero tax on capital gains. Taiwan eliminated double taxation on dividend after 1998 and allowed firms to repurchase stocks from July 2000. Whether EDTD resulted in stockholders preferring dividends to capital gains depends on the difference between corporate and personal tax rates. EDTD makes it possible to examine the impact of the integration of corporate and personal tax on corporate dividend payouts using a unique set of Taiwanese data.

Jensen (1986), Moh’d et al. (1998), and Gomes (2000) demonstrate that dividends are paid to protect outsiders. The board of directors is responsible for monitoring management and protecting the interests of outside stockholders. High director ownership makes board monitoring more efficient and encourages managers to pay more dividends, favoring outsiders. Furthermore, if managers increase the payout ratio with increasing director ownership, firm propensity to pay dividends according to director ownership will be reinforced by the tax credits levied on dividends following EDTD. We also examine how director ownership influences dividend policy with and without double taxation of dividends.

We find that firms tended to pay dividends as opposed to repurchasing stock following EDTD in response to stockholder demand. More importantly, we find that firms with higher available tax credits levied on dividends pay larger dividends when director ownership is higher. Furthermore, available tax credits reinforce the effect of director ownership on dividend payments, whereas director ownership reinforces the effect of available tax credits on dividend payments.

The present paper contributes to the published literature in two ways. First, we examine the effect of the elimination of double taxation on dividend policy. Second, we consider directors’ role in implementing dividend policy in light of the EDTD.

The remainder of this paper is organized as follows. Section 2 discusses the mechanisms used to eliminate double taxation of dividends and the personal tax system in Taiwan. Section 3 reviews the related published work and develops some hypotheses. Section 4 describes the data sources used. The effect of EDTD on corporate dividend policy is discussed in Section 5. Finally, Section 6 presents conclusions.

2. Elimination of Double Taxation of Dividends and the Tax System in Taiwan

  1. Top of page
  2. Abstract
  3. 1. Introduction
  4. 2. Elimination of Double Taxation of Dividends and the Tax System in Taiwan
  5. 3. Related Work and Hypotheses Development
  6. 4. Data Source and Variable Definition
  7. 5. Effect of Elimination of Double Taxation of Dividends on Dividend Policy
  8. 6. Conclusion
  9. References

Double taxation of dividends describes the situation where stockholders pay personal income tax on dividends received, although the paid dividends were already taxed at the corporate tax rate prior to distribution. Integration of corporate and personal tax eliminates corporate income tax by taxing corporate earnings at the stockholder level. Basically, the mechanisms for eliminating double taxation of dividends include the dividend deduction method, the stockholder credit method, or some combination of the two (Litzenberger and Van Horne, 1978).

The dividend deduction method treats dividends as a tax deductible item exactly like loan interest. Firms benefit from tax savings when they pay dividends, and stockholders pay taxes on dividends received. However, according to the stockholder credit method, firms do not receive a tax savings on paid dividends, with stockholders receiving a credit instead. Suppose a firm receives earnings before tax of $100, where the corporate tax rate is 25% and the dividend payout ratio is 50%. In this case, the available tax credit amount of the firm is $25, the net income of the firm is $75, and the firm distributes dividends of $37.5 among stockholders. The stockholders receive taxable income of $50, with an associated $12.5 tax credit. However, if the firm pays no dividends, the stockholders receive no taxable income or tax credits from the firm. Tax credits can be earned only when dividends are paid. The stockholders pay taxes on the received taxable income depending on their personal income tax rates. In Taiwan, the stockholder credit method is used to eliminate double taxation of dividends.

Taiwan has adopted the dividend imputation system, providing stockholders with a tax credit that is used to offset personal tax on dividend income. Corporations in Taiwan pay corporate tax on profits, including income from operations, income from securities investments, undistributed income,1 and income from any other taxable sources, to acquire available tax credits for their stockholders. Corporations distribute available tax credits to their stockholders by paying dividends. When firms pay dividends to distribute profits, their stockholders earn the available tax credits. However, stockholders earn no tax credits if no corporate profits are distributed, even though there are available tax credits. Firms in Taiwan pay dividends only once a year.

Taiwan has a progressive personal income tax system. Taiwan has the following income tax brackets (as of 2007): 6% on the first TWD$370 000 taxable income; 13% on the next TWD$620 000 taxable income; 21% on the next TWD990 000 taxable income; 30% on the next TWD1 740 000 taxable income; and 40% of taxable income over TWD 3 720 001. The corporate tax rate in Taiwan is 25%. Following EDTD, investors receive tax credits from paid dividends. Consequently, investors with personal income tax rates lower than 25% get tax refunds from the received dividends, whereas investors with personal tax rates higher than 25% pay extra tax for the difference between their personal tax rates and corporate tax rates on the received dividends.

In Taiwan, only individual stockholders can receive dividends as taxable income along with tax credits on the dividends. The institutional stockholders receive dividends as non-taxable income without any tax credits on the dividends. Chen and Kao (2005) show that domestic individual investors are the majority stockholders of listed firms in Taiwan. That is, most of the stockholders of Taiwanese firms are minority individuals and are very likely to receive tax credits on dividends.

3. Related Work and Hypotheses Development

  1. Top of page
  2. Abstract
  3. 1. Introduction
  4. 2. Elimination of Double Taxation of Dividends and the Tax System in Taiwan
  5. 3. Related Work and Hypotheses Development
  6. 4. Data Source and Variable Definition
  7. 5. Effect of Elimination of Double Taxation of Dividends on Dividend Policy
  8. 6. Conclusion
  9. References

3.1. Related Literature

Lie and Lie (1999) demonstrate that tax issues clearly influence dividend policy. Imposing personal income tax on dividends should reduce dividend payments. Lie and Lie (1999), however, also show that firms are more likely to pay dividends as opposed to repurchasing stock as the tax rates on dividends are relatively low. Moser (2007) considers the lower tax rate on capital gains than on dividends as a dividend tax penalty and argues that firms are more likely to initiate dividends or to increase dividends when the dividend tax penalty declines. Pattenden and Twite (2008) find that dividend payments decrease with the introduction of a dividend imputation tax credit system. Chetty and Saez (2005) demonstrate that US firms tended to raise dividends in response to the US Tax Act 2003.2 However, Brav et al. (2008) argue that the dividend tax reduction owing to the US Tax Act has only a temporary and second-order impact on corporate dividend policy.

Obviously, the imputation tax credits are valuable because they can be used to offset personal tax obligation. Wood (1997) and Cannavan et al. (2004) estimate the value of imputation tax credits in Australia and show that the implied value of tax credits declines when the tax law prevents the trading of imputation tax credits. Pattenden and Twite (2008) also find that dividend initiation, dividend payout, and dividend reinvestment increase with the introduction of an imputation tax credit system. Twite (2001) documents that the introduction of a dividend imputation credit system reduces the cost of holding equity, leading to a decrease in debt financing and an increase in external equity financing.

Dividend clientele hypothesis argues that investors with higher marginal income tax rates prefer capital gains while those with lower marginal income tax rates prefer dividends. Bajaj and Vijh (1990)Scholz (1992), and Graham and Kumar (2006), support the theory of dividend clienteles. Following EDTD, stockholders whose personal tax rate is below the corporate tax rate obtain tax refunds on received dividends. Stockholders whose personal tax rate exceeds the corporate tax rate pay the difference between the personal tax rate and the corporate tax rate. Consequently, stockholders prefer dividends to repurchasing stock even though capital gains are not taxed at all once their personal tax rates are below the corporate tax rates. In addition, whatever the amount of stockholders’ personal taxes, they have a stronger preference for receiving dividends following EDTD compared to before EDTD. To meet stockholder demand, the propensity of firm managers to pay dividends should be increased following EDTD.

Walker and Petty (1978) and Dwyer and Lynn (1989) indicate that private firms are less likely to pay dividends than publicly listed firms. Outside stockholders prefer corporate managers to disgorge cash to mitigate agency problems. Hermalin and Weisbach (1998) argue that directors play a role in monitoring managers. Chetty and Saez (2005) show that the principal–agent issues play an important role in corporate payout policy. In the present paper, we further examine how director ownership influences the effect of EDTD on corporate dividend policy.

3.2. Hypotheses

Taiwan eliminated double taxation of dividends after 1998 and allowed firms to repurchase stocks after July 2000. Before EDTD, individual investors had to pay additional personal tax on dividends taxed at the corporate level. Following EDTD, the corporate tax paid became a tax credit for stockholders. Therefore, stockholders face a reduced tax burden or are even eligible for a tax refund when tax credits are provided on dividends, depending on the difference between the corporate and personal tax rates. Consequently, stockholders encourage corporate managers to pay dividends because, by doing so, they receive tax credits. Our first hypothesisis:

Hypothesis 1.  Firm propensity to pay dividends and the amount of paid dividends are higher after EDTD than before EDTD.

Corporate governance disciplines directors to monitor firm managers to protect the interests of outside stockholders. As directors increase their level of ownership, their monitoring power increases to force managers to oblige stockholders. The relation between director ownership and dividend payments should be positive. Hypothesis 1 argues that investors have a higher preference for dividends after EDTD than before because of the available tax credits levied on dividends. Tax credits on dividends after EDTD provide directors with a greater incentive to ask managers to disgorge cash to benefit the stockholders. Before EDTD, stockholder benefit from dividends was smaller than that after EDTD. To protect stockholder interests, directors should put more effort into asking managers to pay dividends after EDTD than before EDTD because stockholders’ benefit from dividends is higher. Therefore, director ownership reinforces the influence of EDTD on dividend payouts. Similarly, the relation between director ownership and dividend payouts is positive in that directors would urge managers to pay dividends to favor stockholders. Since EDTD, stockholders benefit more from dividend payments because of the tax credits. Therefore, EDTD should reinforce the relationship between director ownership and dividends to raise the wealth of the stockholders. Thus, our Hypotheses 2a, 2b, and 2c are:

Hypothesis 2a.  Firm propensity to pay dividends and the amount of paid dividends increase with director ownership.

Hypothesis 2b.  The relation between dividends and EDTD is reinforced by director ownership.

Hypothesis 2c.  The relation between dividends and director ownership is reinforced by EDTD.

Following EDTD, individual investors can obtain tax credits on dividends only when firms pay dividends. In order to earn tax credits on dividend following EDTD, investors urge firms to pay dividends. To maximize stockholder wealth, firms do tend to pay dividends following EDTD. The higher the available taxable credits, the higher the benefit the stockholders can earn from dividends paid. Stockholders earn nothing if the firms have no available tax credits. Similar to Hypotheses 2b and 2c, director ownership reinforces the relation between dividend payouts and available tax credits. In addition, the positive relation between dividends and director ownership is reinforced by the available tax credits. Therefore, our Hypotheses 3a, 3b, and 3c are:

Hypothesis 3a.  Firm propensity to pay dividends and the amount of paid dividends increase with available tax credits on dividends.

Hypothesis 3b.  The relation between dividends and available tax credits on dividends is reinforced by director ownership.

Hypothesis 3c.  The relation between dividends and director ownership is reinforced by available tax credits on dividends.

4. Data Source and Variable Definition

  1. Top of page
  2. Abstract
  3. 1. Introduction
  4. 2. Elimination of Double Taxation of Dividends and the Tax System in Taiwan
  5. 3. Related Work and Hypotheses Development
  6. 4. Data Source and Variable Definition
  7. 5. Effect of Elimination of Double Taxation of Dividends on Dividend Policy
  8. 6. Conclusion
  9. References

4.1. Data Source

Our data comprise all the listed firms in Taiwan from 1990 to 2006. The sample period runs from 1990 because the number of listed firms prior to 1990 was very small, and there was a consequent lack of transaction data on the Taiwan stock market. However, from 1990, the number of listed firms increased and the Taiwan stock market began to boom. Since the 1990s, numerous firms have listed on the market each year and transactions and turnover have increased considerably. All study variables, including dividends, net income, book assets, book equity, market equity, debt, operating income, cash, cash equivalent, stock returns, stock prices, and director ownership are obtained from the Taiwan Economic Journal (TEJ) database. Tax credit data are available from after 1998 (the effective year of EDTD). Stock repurchase data are available from 2000, and are also obtained from TEJ.

4.2. Variable Measurement

The variables of corporate payout and tax credits associated with EDTD are detailed below.

4.2.1. Payout variables (PAYER, PAYRATIO, DIVYIELD, BUYRATIO, BUYMV, and DIVBYREP)

This study uses three variables to measure dividend payout. PAYERit is a dummy variable with a value of 1 if firm i pays dividends in year t, and 0 otherwise. PAYRATIOit is the dividend payout ratio of firm i in year t. The dividend payout ratio is the proportion of a firm’s net income paid out as dividends. Meanwhile, dividend yield (DIVYIELDit) is the ratio of dividend per share to the stock price:

  • image(1)
  • image(2)
  • image(3)

Stock repurchase was not allowed in Taiwan until 2000. We use the ratio of stock repurchase amount to net income as a measure for stock repurchase. BUYRATIOit is the repurchase ratio of firm i in year t:

  • image(4)

Furthermore, BUYMVit is the ratio of the dollar amount of repurchase to the market value of the equity of firm i in year t, used to measure the proportion of outstanding stocks repurchased:

  • image(5)

After 2000 (the year stock repurchase was allowed), if repurchases were made instead of dividends, the percentage of outstanding shares that could be repurchased is measured by DIVBYREPit:

  • image(6)

A. Director ownership (DIRECTOR):

DIRECTORit represents director ownership of firm i at the end of year t.3

  • image(7)

B. Period dummy of EDTD (PERIOD): PERIODt = 1 if year t is after EDTD; PERIODt = 0 otherwise.

C. Available tax credit on dividends following EDTD (TAXCRD1 and TAXCRD2):

We use two measures of available tax credits on dividends following EDTD. Available tax credits are the paid corporate tax on profits. Firms acquire available dividend tax credits by paying taxes and distribute available tax credits to stockholders by paying dividends. The first measure is the available tax credit amount divided by the market value of equity at the end of the year (TAXCRD1), while the other is the ratio of the available tax credit amount to the retained earnings at the end of the year (TAXCRD2).

D. Control variables (BETA, Q, OI, CASH, StdOI, and LogMV):

Following Rozeff (1982), Fama and French (2001), and Lie (2005), we employ firm risk, investment opportunity, profitability, cash level, prior income volatility, and firm size as control variables for dividend policy. We use systematic risk to measure firm risk. BETAit denotes the systematic risk of firm i in year t measured by the market model with the daily returns in year t.

Pseudo Q (Q) measures the investment opportunity of a firm.4 Firms with good investment opportunity are expected to experience high Q and tend to retain earnings instead of paying dividends:

  • image(8)

Firm profitability (OI) is measured by operating income to lagged assets.5OIit denotes the profitability of firm i in year t. Profitability represents firm capacity to pay dividends. Paying dividends in the absence of profitability hurts creditors and should be forbidden to prevent a firm becoming unable to raise funds from creditors. Therefore, profitability is the basis on which dividend payout depends.

Cash level (CASH) is measured as the cash and cash equivalents scaled by total assets. CASHit is the cash level of firm i at the end of year t. Stockholders of firms with higher cash balances are likely to require firms to pay out higher levels of dividends.

Prior income volatility (StdOI) is the standard deviation of the ratio of operating income to total assets measured from 4 years prior to the event year t hrough the event year. Firms with higher past volatility of operating income are less likely to make dividend distributions and are more likely to have smaller dividends per share.

The logarithm of market capitalization (LogMV) proxies for firm size. Dividend payers are generally much larger than non-payers.

4.3. Descriptive Statistics

Tables 1 and 2 list the descriptive statistics of the study variables. In Table 1, Panel A lists the statistics of the firm-year observations of the entire period, while Panels B and C list the statistics of the firm-year observations before and after EDTD, respectively. In Table 2, Panels B and C list the statistics of payers and non-payers, respectively.

Table 1.   Descriptive statistics (before and after EDTD) The descriptive statistics of dividend payer (PAYER), payout ratio (PAYRATIO), dividend yield (DIVYIELD), available tax credits (TAXCRD1 and TAXCRD2), director ownership (DIRECTOR), beta risk (BETA), profitability (OI), investment opportunity (Q), cash position (CASH), prior income volatility (StdOI), and repurchase ratio (BUYRATIO) are measured by firm-year observations from 1990 to 2006. The entire sample is further split into subsamples of observations before and after elimination of double taxation of dividends (EDTD). Tax credits are only available following EDTD. aPAYER is a dummy variable with PAYER = 1 if a firm pays dividends; PAYER = 0 otherwise. bPAYRATIO is the dividend payout ratio. cDIVYIELD is the dividend yield. dDIRECTOR is the director ownership at the end of the year. eBETA is the beta risk measured by the market model of daily returns. fOI is the profitability measured by the operating income to lagged total assets. gQ is the pseudo Q measured by (Total assets − book equity + market equity)/total assets. hCASH is the cash position measured by the cash and cash equivalent scaled by total assets. iStdOI is the operating income volatility during the prior 4 years. jBUYRATIO is the repurchase ratio measured by dollar amount of stock repurchase to net income. kBUYMV is the proportion of outstanding shares repurchased. lDIVBYREP is the percentage of outstanding shares that could be repurchased if repurchases were made instead of dividends. mTAXCRD1 is the available tax credit amount divided by market value of equity at the end of the year. nTAXCRD2 is the available tax credit amount divided by retained earnings at the end of the year.
VariableNMeanStandard deviationMinimumMedianMaximum
Panel A: Entire sample period
PAYERa82200.4820.4920.0000.0001.000
PAYRATIOb822023.797%29.266%0.000%0.000%99.920%
DIVYIELDc82201.928%2.689%0.000%0.000%39.994%
DIRECTORd822028.252%17.454%0.000%24.540%100.000%
BETAe82200.7740.544−8.0130.7959.131
OIf82206.090%11.133%−97.523%6.331%93.272%
Qg82201.5150.9470.2181.24820.401
CASHh82207.571%8.600%0.008%4.524%71.094%
StdOIi82206.044%4.760%0.003%4.890%51.736%
BUYRATIOj54182.810%14.213%−94.176%0.000%97.979%
BUYMVk54180.227%0.322%0.000%0.000%1.991%
DIVBYREPl54183.991%5.332%0.000%1.852%59.760%
Panel B: Before EDTD
PAYER16680.2750.4470.0000.0001.000
PAYRATIO166812.364%23.784%0.000%0.000%99.684%
DIVYIELD16680.577%1.121%0.000%0.000%9.145%
DIRECTOR166829.059%17.198%0.000%25.480%100.000%
BETA16680.8400.346−2.0220.8801.766
OI16686.797%9.184%−95.258%6.613%89.945%
Q16682.0560.8910.8911.85515.208
CASH16688.127%9.192%0.014%4.404%66.520%
StdOI16685.961%3.696%0.655%4.992%32.019%
Panel C: After EDTD
PAYER65520.5350.4980.0001.0001.000
PAYRATIO655226.485%29.783%0.000%15.861%99.920%
DIVYIELD65522.242%2.845%0.000%1.160%39.994%
TAXCRDm65521.284%2.279%−1.515%0.569%47.778%
TAXCRD2n655214.573%13.271%−24.420%12.180%51.530%
DIRECTOR655228.091%17.500%0.000%24.350%100.000%
BETA65520.7560.585−8.0130.7709.131
OI65525.733%11.983%−97.523%6.122%93.272%
Q65521.3900.9150.2181.12620.401
CASH65527.429%8.438%0.008%4.550%71.094%
StdOI65526.066%4.999%0.003%4.828%51.736%
BUYRATIO54182.810%14.213%−94.176%0.000%97.979%
BUYMV54180.227%0.322%0.000%0.000%1.991%
DIVBYREP54183.991%5.332%0.000%1.852%59.760%
Table 2.   Descriptive statistics (payers and non-payers) The descriptive statistics of dividend payer (PAYER), payout ratio (PAYRATIO), dividend yield (DIVYIELD), available tax credits (TAXCRD1 and TAXCRD2), director ownership (DIRECTOR), beta risk (BETA), profitability (OI), investment opportunity (Q), cash position (CASH), prior income volatility (StdOI), and repurchase ratio (BUYRATIO) are measured by firm-year observations from 1990 to 2006. The entire sample is further split into subsamples of observations of payers and non-payers. aPAYER is a dummy variable with PAYER = 1 if a firm pays dividends; PAYER = 0 otherwise. bPAYRATIO is the dividend payout ratio. cDIVYIELD is the dividend yield. dTAXCRD1 is the available tax credit amount divided by market value of equity at the end of the year. eTAXCRD2 is the available tax credit amount divided by retained earnings at the end of the year. fDIRECTOR is the director ownership at the end of the year. gBETA is the beta risk measured by the market model of daily returns. hOI is the profitability measured by the operating income to lagged total assets. iQ is the pseudo Q measured by (Total assets − book equity + market equity)/total assets. jCASH is the cash position measured by the cash and cash equivalent scaled by total assets. kStdOI is the operating income volatility during the prior 4 years. lBUYRATIO is the repurchase ratio measured by dollar amount of stock repurchase to net income. mBUYMV is the proportion of outstanding shares repurchased. nDIVBYREP is the percentage of outstanding shares that could be repurchased if repurchases were made instead of dividends.
VariableNMeanStandard deviationMinimumMedianMaximum
Panel A: Entire sample period
PAYERa82200.4820.4920.0000.0001.000
PAYRATIOb822023.797%29.266%0.000%0.000%99.920%
DIVYIELDc82201.928%2.689%0.000%0.000%39.994%
TAXCRD1d82201.284%2.279%−1.515%0.569%47.778%
TAXCRD2e822014.573%13.271%−24.420%12.180%51.530%
DIRECTORf822028.252%17.454%0.000%24.540%100.000%
BETAg82200.7740.544−8.0130.7959.131
OIh82206.090%11.133%−97.523%6.331%93.272%
Qi82201.5150.9470.2181.24820.401
CASHj82207.571%8.600%0.008%4.524%71.094%
StdOIk82206.044%4.760%0.003%4.890%51.736%
BUYRATIOl54182.810%14.213%−94.176%0.000%97.979%
BUYMVm54180.227%0.322%0.000%0.000%1.991%
DIVBYREPn54183.991%5.332%0.000%1.852%59.760%
Panel B: Payers
PAYRATIO396748.528%23.376%0.866%46.294%99.920%
DIVYIELD39673.804%2.669%0.041%3.226%39.994%
TAXCRD139671.255%1.732%−0.804%0.694%33.532%
TAXCRD2396717.805%12.222%−24.420%16.610%48.150%
DIRECTOR396729.373%15.386%0%26.240%100%
BETA39670.7440.528−5.7640.7569.131
OI396711.074%7.291%−15.995%9.462%64.409%
Q39671.6040.9440.4541.35211.951
CASH39678.884%9.441%0.023%5.658%71.094%
StdOI39674.710%3.396%0.003%4.021%51.736%
BUYRATIO31335.122%14.955%−29.729%0.000%97.979%
BUYMV31330.301%0.310%0.000%0.000%1.991%
DIVBYREP31337.021%5.346%0.045%5.856%59.760%
Panel C: Non-payers
TAXCRD142531.317%2.823%−1.515%0.406%47.778%
TAXCRD2425310.757%13.396%−5.950%2.270%51.530%
DIRECTOR425325.986%15.193%0%22.84%100%
BETA42530.7690.551−8.0130.8006.950
OI42533.006%11.852%−97.523%4.028%93.272%
Q42531.4260.9400.2801.14120.401
CASH42536.346%7.531%0.008%3.516%66.520%
StdOI42537.269%5.454%0.151%5.789%51.736%
BUYRATIO2285−0.361%12.452%−94.176%0.000%93.803%
BUYMV22850.125%0.278%0.000%0.000%1.620%

Table 1 indicates that 48.2% of the observations pay dividends, and that the average dividend payout ratio is 23.797%, with a dividend yield of 1.928%. The number of dividend payers, the payout ratio, and the dividend yield are smaller before EDTD than after. Before EDTD, only 27.5% of the observations pay dividends, compared to 53.5% paying dividends after. The payout ratios before and after EDTD are 12.364% and 26.485%, respectively. Before EDTD, the average dividend yield is 0.577%, compared to 2.242% afterwards. These findings imply that firms pay more and larger dividends after EDTD. Table 1 also shows that the average repurchase ratio (BUYRATIO) is 2.810% and that the average proportion of outstanding shares repurchased (BUYMV) is 0.227%, indicating that stock repurchase is much smaller than dividend payments.6 After stock repurchase was allowed in 2000, if repurchases were made instead of dividends, on average, 3.991% of outstanding shares could be bought. Following EDTD, the average ratio of available tax credit amount to equity market value (TAXCRD1) is 1.284%, while the ratio of available tax credit amount to retained earnings (TAXCRD2) is 14.573%. Because some firms benefit from corporate tax treaties with a negative tax rate, there are some negative tax credits for investors.7 The minimum TAXCRD1 and TAXCRD2 are −1.515% and −24.420%, respectively. Before EDTD, firms exhibit better investment opportunity (higher Q) and higher profitability (higher OI). Director ownership (DIRECTOR) appears similar before and after EDTD (29.059 versus 28.091%).8

Table 2 shows that dividend payers have smaller TAXCRD1 than non-payers (1.255% for payers and 1.317% for non-payers). However, the average TAXCRD2 is much higher for payers than for non-payers (17.805% versus 10.757%). Director ownership is higher for payers than non-payers (DIRECTOR = 29.373% for payers and DIRECTOR = 25.986% for non-payers). Table 2 also shows that payers have higher profitability than non-payers (OI = 11.074% versus OI = 3.006%), higher investment opportunity (Q = 1.604 versus Q = 1.426), higher cash level (CASH = 8.884% versus CASH = 6.344%), and lower prior income volatility (StdOI = 4.710% versus StdOI = 7.269%).

Generally, the univariate analyses in Table 2 indicate that firms with higher profitability, cash position, director ownership, and/or available tax credits are more likely to pay dividends, whereas firms with higher prior income volatility are less likely to pay dividends.

5. Effect of Elimination of Double Taxation of Dividends on Dividend Policy

  1. Top of page
  2. Abstract
  3. 1. Introduction
  4. 2. Elimination of Double Taxation of Dividends and the Tax System in Taiwan
  5. 3. Related Work and Hypotheses Development
  6. 4. Data Source and Variable Definition
  7. 5. Effect of Elimination of Double Taxation of Dividends on Dividend Policy
  8. 6. Conclusion
  9. References

5.1. Are Dividends and Stock Repurchase Substitutes?

Grullon and Michaely (2002) argue that dividends and stock repurchase are substitutes. Moser (2007) finds that firms are more likely to pay dividends when the dividend tax penalty relative to capital gains is lower. However, the data used in Grullon and Michaely (2002) and Moser (2007) was collected during the system of double taxation of dividends. This paper, instead, examines the role of stock repurchase under EDTD.

Figure 1 illustrates the percentage of firms paying dividends and repurchasing stocks after year 2000 (the year t hat stock repurchase was initially allowed). Figure 1 indicates that after 2000 increasing numbers of firms have paid dividends and fewer firms have repurchased stocks. Figure 2 shows the dollar amount of dividends and the dollar amount of stock repurchase after year 2000. Figure 2 indicates that the dollar amount of dividends is increasing while the dollar amount of stock repurchases is stable over time.

image

Figure 1.  Percentage of firms paying dividends and percentage of firms repurchasing stocks after stock repurchase is allowed in year 2000.

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image

Figure 2.  The total dividend amount and total repurchase amount after stock repurchase is allowed in year 2000.

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Table 3 provides the descriptive statistics of the characteristics of payers versus non-payers and repurchasers versus non-repurchasers after year 2000. Panel A of Table 3 shows that there are fewer stock repurchasers than non-repurchasers for those paying dividends (520 versus 2613). For stock repurchasers, there are more payers than non-payers (520 versus 281). Panel B of Table 3 shows that payers have higher stock repurchase ratio than non-payers (5.122% versus −0.361%). Panel C of Table 3 also shows that stock repurchasers have higher dividend payout ratios than non-repurchasers (29.560% versus 25.905%). These findings imply that dividend payment and stock repurchase are not substitutes following EDTD. After EDTD, dividend payments dominate stock repurchasing.

Table 3.   Descriptive statistics after stock repurchase is allowed The mean statistics of payout ratio (PAYRATIO), available tax credits (TAXCRD1 and TAXCRD2), director ownership (DIRECTOR), beta risk (BETA), profitability (OI), investment opportunity (Q), cash position (CASH), prior income volatility (StdOI) and stock repurchase ratio (BUYRATIO) are measured by firm-year observations from 2000 to 2006. The entire sample is further split into payers, non-payers, repurchasers and non-repurchasers. Stock repurchase in Taiwan was not allowed until year 2000. aPAYER is a dummy variable with PAYER = 1 if a firm pays dividends; PAYER = 0 otherwise. bTAXCRD1 is the available tax credit amount divided by market value of equity at the end of the year. cTAXCRD2 is the available tax credit amount divided by retained earnings at the end of the year. dDIRECTOR is the director ownership at the end of the year. eBETA is the beta risk measured by the market model of daily returns. fOI is the profitability measured by the operating income to lagged total assets. gQ is the pseudo Q measured by (Total assets − book equity + market equity)/total assets. hCASH is the cash position measured by the cash and cash equivalent scaled by total assets. iStdOI is the operating income volatility during the prior 4 years. jBUYRATIO is the repurchase ratio measured by dollar amount of stock repurchase to net income. kBUYMV is the proportion of outstanding shares repurchased. lDIVBYREP is the percentage of outstanding shares that could be repurchased if repurchases were made instead of dividends.
Panel A: Payers, non-payers, repurchasers and non-repurchasers
 Non-payer and non-repurchaserNon-payer and repurchaserPayer and non-repurchaserPayer and repurchaser
PAYRATIOa  46.974%50.653%
TAXCRD1b1.593%1.189%1.285%1.279%
TAXCRD2c9.306%10.985%17.772%16.689%
DIRECTORd23.498%20.606%28.754%23.709%
BETAe0.7330.8640.7190.811
OIf−2.953%−1.782%10.768%7.945%
Qg1.0370.9731.5181.191
CASHh5.683%7.029%8.883%9.119%
StdOIi7.982%7.567%4.598%4.827%
BUYRATIOj −2.939% 30.864%
BUYMVk 0.094% 0.928%
DIVBYREPl  7.127%5.964%
N20042812613520
Panel B: Payers and non-payers
 Non-payerPayert-value for the difference
PAYRATIO 47.640% 
TAXCRD11.527%1.284%3.46***
TAXCRD29.590%17.570%−20.04***
DIRECTOR23.02927.816%−12.94***
BETA0.7540.7361.09
OI−2.763%10.243%−48.74***
Q1.0271.457−22.84***
CASH5.901%8.889%−13.21***
StdOI7.914%4.642%24.73***
BUYRATIO−0.361%5.122%−14.29***
BUYMV0.125%0.301%−9.271**
N22853133 
Panel C: Repurchasers and non-repurchasers
 Non-repurchaserRepurchasert-value for the difference
PAYRATIO25.905%29.566%−3.46***
TAXCRD11.419%1.244%2.48**
TAXCRD214.777%14.818%−0.08
DIRECTOR26.473%22.487%8.13***
BETA0.7250.832−6.96***
OI4.8124.113%1.77*
Q1.3091.10511.49***
CASH7.468%8.296%−2.73***
StdOI6.082%5.913%0.94
DIVBYREP4.031%3.564%1.95*
N4617801 

5.2. Dividend Payout: A Time Trend or Consequence of Elimination of Double Taxation of Dividends?

Panels B and C of Table 1 list preliminary results indicating that firms tend to pay more dividends following EDTD. However, this increase might result from other trends unrelated to EDTD. Boards of directors monitor managers and encourage managers to favor stockholders. Furthermore, EDTD provides tax credits that enable stockholders to obtain tax refunds on corporate tax levied on paid dividends. If no dividends were paid, no tax credits levied on dividends would be received. Once director shareholding increases, directors have increased power to force managers to disgorge cash flow to protect the interests of external stockholders. Consequently, we expect that EDTD will reinforce the influence of director ownership on corporate dividend payouts and vice versa.

Table 4 is used to analyze the determinants of corporate dividend policy. Columns 1 and 2 of Table 4 use logistic regressions to investigate the possibility of firms paying dividends, with PAYER = 1 for firms paying dividends and PAYER = 0 otherwise. Columns 3 and 4 and Columns 5 and 6 of Table 4 illustrate Tobit regressions with dividend payout ratio and dividend yield as the dependent variables bounded at zero, respectively.9Table 1 shows that investment opportunity (Q) is lower after EDTD than before EDTD. Consequently, the increase in dividend payments after EDTD could be partly attributed to the reduction in investment opportunity. Table 4 indicates that beta risk, investment opportunity, and prior income volatility are negatively related to dividend payouts, whereas profitability, cash position, firm size, director ownership, and the period dummy of EDTD are positively related to dividend payouts. Essentially, riskier firms have a lower likelihood of paying dividends and also pay smaller dividends. After controlling for investment opportunity, profitability, cash level, prior income volatility, and firm size, the significantly positive period dummy of EDTD in Table 4 demonstrates that firms are more likely to pay dividends, and to pay larger dividends following EDTD, supporting Hypothesis 1. The significantly positive director ownership implies that dividend payments increase with director ownership, which supports Hypothesis 2a. The interaction between the period dummy of EDTD and director ownership is significantly positive in Columns 2, 4, and 6, with t-values = 2.15, 2.17 and 1.98, respectively. The significantly positive interaction of the period dummy of EDTD and director ownership confirms that EDTD reinforces the influence of director ownership on dividend payments, and vice versa. Hypotheses 2b and 2c are thus confirmed.

Table 4.   Determinants for dividend payout Payer or not, dividend payout ratio, and dividend yield are used as the dividend payout variables Elimination of double taxation of dividends (EDTD) became effective on 1 January 1998. We focus on the effects of director ownership and EDTD on dividend payout. Columns 1 and 2 are run by logistic regressions, while Columns 3–6 are run by Tobit regressions as the dependent variable bounded at 0. In parentheses are t-values adjusted with clustered standard errors to avoid spurious inflation in the panel dataset (see Petersen, 2009). ***, **, and * denote statistical significance at the 1%, 5%, and 10% level, respectively. aPAYER is a dummy variable with PAYER = 1 if a firm pays dividends; PAYER = 0 otherwise. bPAYRATIO is the dividend payout ratio. cDIVYIELD is the dividend yield. dDIRECTOR is the director ownership at the end of the year. ePERIOD is a dummy variable with PERIOD = 1 if after EDTD; PERIOD = 0 otherwise. fOI is the profitability measured by the operating income to lagged total assets. gBETA is the beta risk measured by the market model of daily returns. hQ is the pseudo Q measured by (Total assets − Book equity + market equity)/Total assets. iCASH is the cash position measured by the cash and cash equivalent scaled by total assets. jStdOI is the operating income volatility during the prior 4 years. kLogMV is the logarithm of market equity.
 PAYERaPAYRATIObDIVYIELDc
123456
Intercept−4.030*** (−6.92)−4.042*** (−6.03)−0.723*** (−5.35)−0.734*** (−4.73)−4.430*** (−4.71)−4.411*** (−4.10)
DIRECTORd1.710*** (4.37)1.750* (1.80)0.371*** (4.36)0.411* (1.93)3.042*** (5.30)2.974** (2.06)
PERIODe1.508*** (4.09)1.526*** (2.84)0.267*** (4.09)0.281** (2.50)2.4384*** (4.85)2.4145*** (2.98)
DIRECTOR × PERIOD 0.064** (2.15) 0.049** (2.17) 0.083** (1.98)
OIf28.295*** (7.31)28.297*** (7.31)4.302*** (11.81)4.303*** (11.84)43.951*** (15.58)43.948*** (15.56)
BETAg−0.165 (−1.32)−0.165 (−1.33)−0.066** (−2.12)−0.066** (−2.14)−0.618** (−2.34)−0.617** (−2.35)
Qh−1.121*** (−6.59)−1.121*** (−6.59)−0.214*** (−8.23)−0.214*** (−8.24)−2.589*** (−11.13)−2.589*** (−11.12)
CASHi25.439*** (4.258)22.552*** (5.214)3.489*** (8.246)3.601*** (8.254)36.541*** (10.235)35.413*** (9.587)
StdOIj−18.639*** (−2.74)−20.312*** (−2.58)−3.516*** (−2.697)−4.103*** (−3.214)−34.888*** (−2.84)−34.625*** (−2.69)
LogMVk0.294*** (6.02)0.293*** (6.04)0.062*** (5.76)0.062*** (5.75)0.395*** (5.44)0.395*** (5.44)
N822082208220822082208220
Pseudo R2 (%)38.9038.9325.3425.3630.0730.15

Table 4 supports the argument that corporate dividends increase following EDTD. However, if there was a pre-existing trend towards increased dividend payments, the period dummy for 1998 (the year of EDTD) would be significantly positive. To examine the trend of dividend payouts, Figure 3 lists the proportion of dividend payers, the dividend payout ratio, and the dividend yield for each year during 1990–2006.

image

Figure 3.  Patterns of dividend payment over 1990–2006.

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Figure 3 shows that the proportion of dividend payers, the dividend payout ratio, and the dividend yield decline before 1998 but subsequently increase. Furthermore, an annual variable (YEAR) is included in the regressions listed in Table 5 and the entire sample is split into subsamples comprising the periods before and after EDTD to see if dividend payout trends differ before and after EDTD. Table 5 shows that the annual variable is significantly negative before EDTD and significantly positive following EDTD, indicating that corporate dividends decline year by year before EDTD but increase year by year afterwards.

Table 5.   Trend of dividend payout before and after elimination of double taxation of dividends Payer or not, dividend payout ratio, and dividend yield are used as the dividend payout variables Elimination of double taxation of dividends (EDTD) became effective on 1 January 1998. We focus on the annual variable on dividend policy. Columns 1 and 2 are run by logistic regressions, while Columns 3–6 are run by Tobit regressions as the dependent variable bounded at 0. In the parentheses are t-values adjusted with clustered standard errors to avoid spurious inflation in the panel dataset (see Petersen, 2009). ***, **, and * denote statistical significance at the 1, 5, and 10% level, respectively. aPAYER is a dummy variable with PAYER = 1 if a firm pays dividend; PAYER = 0 otherwise. bPAYRATIO is the dividend payout ratio. cDIVYIELD is the dividend yield. dYEAR is the annual variable to measure the time trend of dividend policy. eDIRECTOR is the director ownership at the end of year. fOI is the profitability measured by the operating income to lagged total assets. gBETA is the beta risk measured by the market model of daily returns. hQ is the pseudo Q measured by (Total assets − Book equity + Market equity)/Total assets. iCASH is the cash position measured by the cash and cash equivalent scaled by total assets. jStdOI is the operating income volatility during the prior 4 years. kLogMV is the logarithm of market equity.
 PAYERaPAYRATIOjDIVYIELDk
BeforeAfterBeforeAfterBeforeAfter
123456
Intercept462.50*** (7.31)−651.60*** (−19.25)148.88*** (4.39)−96.57*** (−8.28)641.72*** (4.60)−853.28*** (−10.05)
YEARd−0.235*** (−7.42)0.324*** (19.16)−0.075*** (−12.48)0.048*** (24.04)−0.325*** (−12.11)0.424*** (25.67)
DIRECTORe1.610* (1.75)2.010*** (7.47)0.384* (1.77)0.392*** (4.86)2.154* (1.67)3.463*** (5.37)
OIf9.622*** (6.45)34.830*** (28.33)3.007*** (5.91)4.00*** (11.91)16.818*** (6.01)44.273*** (21.79)
BETAg−0.596** (−2.51)−0.236*** (−3.46)−0.169 (−1.57)−0.065** (−2.19)−0.721 (−1.37)−0.636** (−2.37)
Qh−0.554*** (−5.00)−1.243*** (−14.98)−0.154** (−2.45)−0.206*** (−9.38)−1.0281*** (−3.69)−2.7164*** (−12.71)
CASHi8.683*** (5.647)29.003*** (20.25)2.985*** (4.51)2.689*** (9.52)37.099*** (5.87)38.995*** (15.24)
StdOIj−8.140*** (−2.85)−20.145*** (−3.14)−2.228** (−2.45)−2.031** (−2.01)−30.125** (−2.01)−34.446** (−1.98)
LogMVk0.666*** (9.44)0.373*** (11.91)0.185*** (4.06)0.065*** (6.21)0.738*** (4.93)0.461*** (6.06)
N166865521668655216686552
Pseudo R2 (%)19.61%48.96%15.25%29.26%21.82%30.65%

Table 4 indicates that director ownership is positively related to dividend payouts. Table 5 further shows that even though director ownership is still positively related to dividend payouts before EDTD, director ownership is more significant following EDTD. The t-values of director ownership before EDTD (t-value = 1.75, 1.77, and 1.67 in Columns 1, 3, and 5, respectively) are smaller than those after EDTD (t-value = 7.47, 4.86, and 5.37 in Columns 2, 4, and 6, respectively). Table 5 further confirms Hypothesis 2c.

Notably, in Table 5, the pseudo R2 of the regression models before EDTD are smaller than those following EDTD. The pseudo R2 of the logistic regression models before and after EDTD are 19.61% in Column 1 and 48.96% in Column 2. The pseudo R2 of the Tobit regression models with dividend payout ratio and dividend yield as dependent variables before and after EDTD are 15.25% in Column 3 (21.82% in Column 5) and 29.26% in Column 4 (30.65% in Column 6), respectively. The pseudo R2 listed in Table 5 demonstrate that it is more difficult to explain the dividend payout policy before EDTD. The most recognized determinants of dividend payout only explain 19.61% of dividend payment decisions, 15.25% of dividend payout ratios, and 21.82% of dividend yields. However, after EDTD, the most recognized determinants can explain 48.96% of payment decisions, 29.26% of dividend payout ratios, and 30.65% of dividend yields.

Tables 4 and 5 demonstrate that the likelihood of paying dividends and dividend size both increased following EDTD. Moreover, the data indicates no pre-existing trend towards paying more dividends. Instead, dividend paying propensity, dividend payout ratio, and dividend yield were declining prior to EDTD and began increasing only following EDTD. Besides the trends of dividend paying propensity, dividend payout ratio, and dividend yield, we also find that dividend policy is more difficult to explain before than after EDTD.

5.3. Director Ownership and Tax Credits on Dividends Following the Elimination of Double Taxation of Dividends

Tables 4 and 5 demonstrate that following EDTD firms have become more likely to pay dividends and to pay larger dividends. EDTD increases dividend payments because investors can obtain tax credits levied on dividends to reduce their personal income tax. Therefore, the available tax credits from EDTD significantly influence manager decisions regarding dividend payments.

We further investigate how available tax credits influence corporate dividend policy, how director ownership influences the effect of available tax credits on dividend policy, and how available tax credits influence the effect of director ownership on dividend policy. Because tax credits are only available following EDTD, Table 6 only lists observations after EDTD. In Table 6, we use dividend payer dummy as the dependent variable.10

Table 6.   The effects of director ownership and tax credits on dividend payout or not Payer or not is used as the dividend payout variable We focus on the effects of interaction of director ownership and available tax credits on dividends from EDTD on dividend payout or not. In the parentheses are t-values adjusted with clustered standard errors to avoid spurious inflation in panel dataset (see Petersen, 2009). ***, **, and * denote statistical significance at the 1, 5, and 10% level, respectively. aPAYER is a dummy variable with PAYER = 1 if a firm pays dividend; PAYER = 0 otherwise. bDIRECTOR is the director ownership at the end of year.cTAXCRD1 is the available tax credit amount divided by market value of equity at the end of the year. dTAXCRD2 is the available tax credit amount divided by retained earnings at the end of the year. eOI is the profitability measured by the operating income to lagged total assets. fBETA is the beta risk measured by the market model of daily returns. gQ is the pseudo Q measured by (Total assets − Book equity + Market equity)/Total assets. hCASH is the cash position measured by the cash and cash equivalent scaled by total assets. iStdOI is the operating income volatility during the prior 4 years. jLogMV is the logarithm of market equity.
Logistic regressions with PAYERa as the dependent variable
Intercept−2.698*** (−5.84)−2.649*** (−11.65)−2.557*** (−6.53)−2.552*** (−6.52)
DIRECTORb1.510*** (4.01)1.140*** (3.80)1.020*** (2.67)0.999*** (2.62)
TAXCRD1c9.634*** (3.09)2.482* (1.81)  
TAXCRD2d  2.740*** (6.23)0.027*** (4.15)
DIRECTOR × TAXCRD1 32.270** (2.31)  
DIRECTOR × TAXCRD2   0.130*** (2.85)
OIe34.443*** (7.85)34.337*** (29.23)30.617*** (6.35)30.619*** (6.35)
BETAf−0.177 (−1.28)−0.177*** (−2.82)−0.168 (−0.99)−0.168 (−0.99)
Qg−1.297*** (−6.34)−1.288*** (−14.43)−1.210*** (−5.46)−1.210*** (−5.46)
CASHh32.833*** (6.25)28.995*** (25.21)31.320*** (5.12)26.806*** (4.36)
StdOIi−28.415** (−1.99)−26.125** (−2.11)−27.945*** (−2.60)−27.941** (−1.99)
LogMVj0.296*** (6.46)0.300*** (10.17)0.285*** (6.42)0.285*** (6.42)
N6552655265526552
Pseudo R243.85%43.93%37.26%39.35%

In Table 6 it is revealed that that both director ownership and available tax credits are positively related to dividend payments. Additionally, the interactions of director ownership and both tax credit measures are significantly positive. Table 6 supports our argument that the sum stockholders can get back from corporate tax on dividends strongly influences the corporate decision to pay or to not pay dividends. The propensity to pay dividends increases with available tax credits on dividends. Therefore, Hypothesis 3a is supported. Director ownership strengthens dividend demand when available tax credits are high. The effect of available tax credits on dividend payout increases with director ownership, and the effect of director ownership on dividend policy increases with available tax credits levied on dividends. Consequently, Hypotheses 3b and 3c are also confirmed.

6. Conclusion

  1. Top of page
  2. Abstract
  3. 1. Introduction
  4. 2. Elimination of Double Taxation of Dividends and the Tax System in Taiwan
  5. 3. Related Work and Hypotheses Development
  6. 4. Data Source and Variable Definition
  7. 5. Effect of Elimination of Double Taxation of Dividends on Dividend Policy
  8. 6. Conclusion
  9. References

Dividend policy is important because it affects firm value and investor interests. One of the key issues facing corporations in the USA and in many other countries is the double taxation of dividends. Before 1998, investors in Taiwan were also subject to double taxation of dividends. However, double taxation of dividends was eliminated in Taiwan in 1998, creating an opportunity to examine how double taxation of dividends (or the integration of corporate and personal tax) affects corporate dividend policy. EDTD enables investors to receive tax credits levied on dividends. Investors with personal tax rates below corporate tax rates not only pay no tax on dividends but also receive tax refunds from dividends following EDTD.

Since EDTD stockholders have demanded that firm managers pay more dividends then they did before EDTD. Directors urge firm managers to meet stockholder demand, particularly when directors themselves are significant stockholders. We find that firm managers prefer dividends to stock repurchase and that firm managers have tended to pay more in dividends and larger dividends following EDTD. Tax cuts as a result of EDTD will have a long-lasting impact on dividend payout policy. We further demonstrate that director monitoring reinforces the influence of EDTD on dividend payments. More importantly, dividend payouts and the influence of EDTD on dividend policy increase with director ownership.

Footnotes
  • 1

    Corporations might not distribute all enterprise-level profits to their stockholders, creating the problem of “leakage” of tax credits. To take care of the leakage of tax credits, corporations in Taiwan will be taxed 10% on undistributed annual profits. If corporations do not distribute all the available tax credits by paying dividends, the undistributed tax credits will not be accumulated for future use.

  • 2

    One of the main provisions of the 2003 tax reform was to introduce favorable treatment for individual dividend income whereby dividends are taxed at a rate of 15% instead of the regular progressive individual income tax schedule with a maximum rate of 35%.

  • 3

    Ideally, we should use only independent director holding in our empirical design. However, such data are not available for Taiwan. From 2003, only initial public offering firms are required to appoint independent directors. Since 2007, it has been recommended but not required that the existing public firms appoint independent directors.

  • 4

    We also use the growth rate of total assets as another measure for investment opportunity and reach qualitatively similar results.

  • 5

    Our results are robust to the specifications of either assets or sales as the denominator.

  • 6

    The maximum proportion of outstanding shares repurchased is 1.99%, with the 99th percentile equal to 1.775% and the 95th percentile equal to 0.784%. The descriptive statistics of proportion of outstanding shares repurchased indicate that more than 99% of the stock repurchases do not reach the regulated stock repurchase limit, which the 2% of the registered shares. Consequently, the regulation that firms in Taiwan can buy back no more than the 2% of the registered shares is not a binding constraint for the optimal decision of stock repurchase.

  • 7

    In Taiwan, the Stature of the Encouragement of Investment provides firms with opportunities to earn investment tax credits from investing in fixed assets, R&D expenditures, and human resources. When the amount of earned investment tax credits is higher than the amount of corporate tax to be paid, the corporations are actually taxed at a negative tax rate, leading to a negative available tax credits on dividends.

  • 8

    Table 1 indicates that the sample size before EDTD is much smaller than that after EDTD. This is due to the fact that there are many newly listed firms following EDTD. However, if we delete the firms listed after EDTD keeping the sample firms after EDTD the same as those before EDTD, we still reach qualitatively similar results. That is, our findings are not driven by the newly listed firms.

  • 9

    In the pooling data regressions, t-values are adjusted with clustered standard errors to avoid spurious inflation in panel datasets (see Petersen, 2009).

  • 10

    The results of Tobit regressions with dividend payout ratio and dividend yield as the dependent variables (not reported in Table 6) are qualitatively similar to those in Table 6. Those results are available upon request from the authors.

References

  1. Top of page
  2. Abstract
  3. 1. Introduction
  4. 2. Elimination of Double Taxation of Dividends and the Tax System in Taiwan
  5. 3. Related Work and Hypotheses Development
  6. 4. Data Source and Variable Definition
  7. 5. Effect of Elimination of Double Taxation of Dividends on Dividend Policy
  8. 6. Conclusion
  9. References
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  • Alli, L. L., A. Q. Khan, and G. G. Ramirez, 1993, Determinants of corporate dividend policy: A factorial analysis, Financial Review 28, pp. 523547.
  • Bajaj, M., and A. Vijh, 1990, Dividend clienteles and the information content of dividend changes, Journal of Financial Economics 26, pp. 193219.
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