Dividend Taxes and Investment Efficiency: Evidence from the 2003 U.S. Personal Taxation Reform
Journal of Accounting and Economics, Volume 75, No. 1, 101514, 2023
53 Pages Posted: 4 Jun 2020 Last revised: 6 Sep 2023
Date Written: May 5, 2022
Abstract
We examine the effect of a large dividend tax cut on corporate investment efficiency by exploiting the 2003 personal taxation reform in the U.S. as a quasi-natural experiment. Using a difference-in-differences approach based on the probability that a firm's marginal investor was an individual investor, we show that the 2003 dividend tax cut significantly improved the investment efficiency of U.S. listed firms. However, we find no evidence that the dividend tax cut increased the level of investment of U.S. listed firms. Further, we show that the tax cut increased investment efficiency by mitigating agency problems associated with the excessive free cash flows of overinvesting firms and by relaxing the financial constraints of underinvesting firms.
Keywords: Dividend Taxation, Investment Efficiency, Financial Constraints, Free Cash Flows
JEL Classification: G12, G14, G15, G31
Suggested Citation: Suggested Citation