1

Investor Protection, Taxation, and Dividends

Mohammed Alzahrania and Meziane Lasferb,* a King Fahd University of Petroleum & Minerals, Dhahran 31261, Saudi Arabia

b Cass Business School, 106 Bunhill Row, London EC1Y 8TZ

Abstract

We find that governance and taxation affect dividends across countries. Unlike previous

studies, firms in strong investor protection countries pay lower dividends than in weak

investor protection countries when the classical tax system is implemented, but they buy

more shares to maximise their shareholders’ after-tax returns. However, in weak

protection countries, dividends are less responsive to taxes. Our results suggest that when

investors are protected, they weigh the tax cost of dividends against the benefit of

mitigating the agency cost, but when they are not, they accept whatever dividends they

can extract, even when this entails high tax costs.

JEL Classification: G18, G35, H24 Keywords: Shareholder rights, Dividend policy, Dividend taxation, Agency costs

Corresponding author: Tel +44 207 040 8634, Fax: +44 207 040 8881, email m.a.lasfer@city.ac.uk. Alzahrani: Tel: +966 3 860 1626, Fax: +966 3 860 2585, Email: mfaraj@kfupm.edu.sa. We would like to thank Lubomir Litov, Huai Zhang, Laura Moreau, Ashraf Eid, and Jungwon Suh for useful suggestions. We also benefited from comments offered by seminar participants at Western Finance Association meetings, European Financial Management Association meetings, Asian Finance Association meetings, Financial Management Association meetings, Cass Business School, King Fahd University, and Universite Paris Dauphine. This work started when Alzahrani visited Cass Business School. He thanks Cass for the hospitality and support and acknowledges the summer research grant from the British Council and the support from King Fahd University of Petroleum & Minerals.

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Investor Protection, Taxation, and Dividends

Previous cross-country studies identified the level of investor protection as the primary

determinant of dividend payments. In good investor protection countries, shareholders are

able to use their power to make managers disgorge cash. However, in countries with poor

investor protection, undistributed excess cash is easily appropriated by controlling

shareholders for their own private benefits (see La Porta et al., hereafter LLSV, (2000a)

for a review), and thus, investors welcome as much dividends as possible (LLSV

(2000b)), and they assign higher value to those dividends (Pinkowitz, et al. (2006) and

Kalcheva and Lins (2007)). These arguments are based on LLSV (2000b) who develop

two distinct models of dividends: The outcome model where dividends emanate from a

legal protection for minority shareholders and the substitute model where dividends are a

mechanism of market self-regulation that can substitute for weak shareholder protection.

Their empirical results support the outcome model, suggesting that, unlike weak investor

protection countries, better shareholder protection forces managers to payout more

dividends, and thus prevents them from gaining private benefit from excess cash flows.

Subsequent studies confirm these findings under different specifications.1

Do these results hold in the presence of taxes? Pinkowitz et al (2006) argue that

the introduction of taxation complicates the LLSV arguments, as when dividends are tax

disadvantaged, their value for minority shareholders is reduced, and shareholders in

countries with poor investor protection will gain from dividends only in the absence of

taxes, or when the gains from preventing expropriation of minority shareholders more

than offset the tax disadvantage of dividends. Despite their theoretical importance, the

empirical evidence provided to-date on the impact of taxes on dividends at country and

1 See, for example, Faccio, Lang and Young (2001), Mitton (2004), Brockman and Unlu

(2009), and Shao, Kwok, and Guedhami (2009).

3

firm level is mixed.2 In this paper, we expand these arguments by asking the following

questions: Do companies in strong investor protection countries pay dividends when their

tax cost is high, or do they substitute them for share repurchases to maximize their

shareholders’ after tax return? Conversely, in weak investor protection countries, do

investors prefer to receive dividends, even if they incur high tax cost, to mitigate the

appropriation of private benefits by controlling shareholders, or do taxes affect dividends?

We use a sample that spans 24 OECD countries and 8 years to answer these

questions. We split our sample into strong and weak governance system countries,

following Djankov et al (2008), and into two main tax groupings, using a unique database.

The first is the dividend tax system at corporate level. Some countries, such as the US,

follow a classical tax system that treats corporate income differently from personal

income in terms of statutory tax rate and deduction rules, and in which, the same unit of

earning paid as dividend is taxed first at firm level and then at the personal level; a

disadvantage known as “double taxation”. Others have a partial integration or imputation

system between corporate and personal income taxes, which mitigates part of the tax

disadvantage of dividends, or a full imputation system, where dividends are, like debt

interest, fully tax deductible. The second tax measure is the tax differential between

dividends and capital gains (TD) at shareholder level, defined as the ratio of after-tax

dividends relative to capital gains. This comparison of the tax effect across countries with

different tax rates and investor protection helps us reduce the impact of varied marginal

tax rates among investors.

2 See, for example, Pinkowitz et al (2006), and LLSV (2000) for cross-country evidence

and surveys of Allen and Michaely (2003), DeAngelo, DeAngelo and Skinner (2008) and

Graham (2008) for predominantly firm level studies. We review some evidence in the

next section.

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In strong investor protection countries, when dividend tax is low, we expect

minority shareholders to use their stronger rights to obtain higher dividend payouts, but

when dividend tax is high, they will demand their firms to substitute dividends for share

repurchases. In weak investor protection countries, the agency theory, under the outcome

model in LLSV (2000b), predicts that managers will refrain from paying dividends to

consume private benefits. In this situation, investors will be willing to receive dividends

as the benefits of reducing the cost of expropriation of minority shareholders outweigh the

tax cost of dividends. Moreover, as investors in weak protection countries have less power

to force managers to pay out cash, there is no reason to believe that they have power to

choose the method of payment. Therefore, under the outcome model, we expect investors

in weak protection countries to welcome any kind of payout even in its less tax-efficient

form, implying weak or no tax effect on payouts. Alternatively, as argued by LLSV

(2000b) under their substitute hypothesis, managers need to pay dividends to establish

reputation, particularly for future capital raising decisions. In this case, they can use the

dividend tax system as a tool to convince minority shareholders that they need to retain

cash. Therefore, we expect the tax cost on dividends to affect the propensity of these firms

to hoard cash, and dividend taxation will have negative impact on dividend payout.

Our aggregate results indicate that cash dividends are significantly higher in strong

governance countries, consistent with the outcome hypothesis and in line with previous

evidence (e.g., LLSV (2000b); Brockman and Unlu (2009)). However, we find that the

distribution of payouts across tax systems is not homogeneous. First, we show that in

classical tax system, firms in strong investor protection countries pay significantly lower

dividends than their counterparts in weak investor protection countries. Further analysis

reveals that companies in strong investor protection countries that operate the classical tax

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system buyback significantly more shares than other firms, and as the tax cost of

dividends decreases, they pay higher dividends but buyback fewer shares. These results

suggest that in strong protection countries, investors settle for less dividends and more

repurchases when the tax cost of dividend outweigh the benefit of reducing the agency

cost, and indicate that managers maximize their shareholders’ after tax return by

substituting cash dividends for repurchases. In contrast, in weak protection countries, we

find lower dividends and repurchases and less impact of taxation on dividends, suggesting

that firms in weak governance countries pay out less cash with no consideration of the tax

disadvantage attached to the payout, and investors do not mind the tax disadvantage as

long as they can extract cash from managers.

We account for the firm and country fundamentals in our regressions.3 We find

that, in strong, not weak, investor protection countries, cash dividends are substantially

higher in the partial and full imputation tax systems, compared to the classical tax system.

The tax discrimination variable is significantly positive for cash dividends, and negative

for repurchases, and the two payout methods are substitutes. These results suggest that

companies maximize their shareholders’ after-tax return by choosing a tax efficient

distribution method.

We support these results by analyzing the impact of a set of interaction variables.

We first create a dummy equal to one for firms residing in countries that apply the

imputation system and have strong investor protection. This variable is positively

(negatively) associated with cash dividends (share repurchases), suggesting that firms in

3 Previous studies report that firms across investor protection countries are not

homogenous. For example, firms in weak investor protection countries are likely to be

more risky (e.g., Ellul, Guntay and Lel (2009)), thus, they may hold cash to weather

potential shocks.

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strong protection country pay higher cash dividends but buyback less shares as dividends

become more advantageous. We find similar results when we analyse the discrete

dividend and share repurchases decision. In particular, we show that the probability of

paying and increasing cash dividends is significantly higher in the partial and full

imputation systems, compared to the classical system, TD is positive and significant, and

while the investor protection variable is not significant, its interaction with the imputation

system is positive and significant, suggesting that it is not the governance per se that

makes firms pay or change their dividends, but the combination of taxation and

governance systems.

Overall, our results suggest that, unlike weak protection countries, the optimal

dividend in strong investor protection countries is, as predicted by John and Williams

(1985), larger when the tax disadvantage of dividends relative to capital gains is smaller.

However, unlike the predictions of the models of John and Williams (1985) and Allen,

Bernardo and Welch (2000), firms in strong investor protection countries repurchase

shares to avoid taxes as the signalling costs are lower. In contrast, in weak investor

protection countries, managers can get away with setting up dividend policies that are

independent of tax costs because investors’ rights are not well protected and also investors

are more concerned about extracting cash than about the tax consequences of such

extraction. Our results provide an additional perspective to the agency theory explanation

of dividends and show that the interrelation between agency costs and taxation explain

dividend payouts across firms and countries.

Our paper contributes to previous cross-country studies in three ways. First, unlike

pervious studies, we focus on the differences in tax systems following Graham’s (2006)

plea that it would be helpful if there were more research that exploits the rich variation in

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tax codes around the world. Second, we provide more support for the tax effect on

dividends and repurchases by showing that dividend tax system and TD affect both the

amount and propensity to pay and change dividends and repurchases. Previous studies

provide mixed evidence. For example, Pinkowitz et al. (2006) use dividend tax systems in

their regressions, but find weak evidence for the tax effect. LLSV (2000b) find

inconsistent evidence on the role of tax on dividends, as TD is only significant when

payout is measured as dividend to sales. Eije and Megginson (2008) find that TD is

positive and significant in determining the probability of paying dividend, but negative

and significant in determining the amount of dividends. Third, we show that taxation and

governance jointly explain the behaviour of dividends across countries. Contrary to the

general observation in the literature that firms in strong investor protection countries

payout more dividends vis-à-vis firms in weak protection countries, we show that the

validity of this observation depends on the extent of dividend tax disadvantage.

We note, however, that our results suffer from limitations inherent in cross-

country study. While we expand previous studies by providing a relatively deeper analysis

of the impact of a combination between the level of investor protection and taxation on

dividend payments, we recognise that the accounting numbers may not be comparable,

firms may be subject to tax and governance structures in other than their country of

registration, they may face different effective corporate and personal tax rates, and they

can have other internal and external corporate governance mechanisms to mitigate their

agency conflicts, including specific ownership structure, managerial shareholding, and

board structure, in addition to the magnitude of the country level investor protection.

We run a series of robustness tests to mitigate such effects, even though the

unavailability of more disaggregated data limited our ability to test for all the limitations.

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First we assess whether our results are driven by some countries in our sample. In our

country-classification, we have only US and Ireland as countries that are in the strong

investor protection and classical tax system.4 Since 98% of our sample firms are from the

US, our results indicate that dividends of US firms are different from the rest of the

OECD countries. However, we find similar qualitative results when we exclude the US

where dividends declined (Fama and French (2001)), and other countries with high

number of observations, such as Japan and UK. Second, we use alternative definitions of

our variables, and we control for time-variation in the relation between dividends and

firm-specific factors, as DeAngelo et al (2008) suggest that the impact of taxes on

dividend and repurchases can be gauged directly by observing the extent to which firms

alter their payout decisions in response to tax law changes. Finally, we control for

ownership structure as Mitton (2004) shows that the first-order determinant of the payout

policy is the firm-level shareholder protection in combination with the country-level

protection. We find relatively similar qualitative results, although the level of significance

of the investor protection variable is, in some cases, sensitive to the definition we use.

The rest of the paper is structured as follows. In Section 1, we review the literature,

present the tax framework, and set up our hypotheses. Section 2, describes the data and

the methodology. In Section 3, we present an analysis of the empirical results. In Section

4, we report some robustness checks. Conclusions are set out in Section 5.

4 Fan, Titman, and Twite (2011) classify also UK within the classical system in the post

2001 period. However, as we argue below, although the dividend tax system changed in

1997 for tax exempt investors and all other investors in 2000, dividend are still taxed at,

for example, 32.5% compared to tax on interest income of 40 for high tax payers. We

provide further details in the next and data sections.

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1. Review of the literature, Institutional Settings and Hypotheses Tested

1.1. Review of the literature

In theory, Miller and Modigliani (1961) show that, in the absence of various frictions,

firms could not create value from their payout policy over and above the value they

generate by their investment policy. In this paper we focus on two contrasting frictions:

agency conflicts and taxes.5 When dividends are subject to agency conflicts, firms will not

pay high dividend so that controlling investors extract private benefits from retained cash

flow. When dividends are taxed, companies are expected to defer them until the present

value of payout taxes are zero, or opt for share buybacks that are subject to capital gains

taxes if they are lower than the taxes on dividends (e.g., DeAngelo et al (2008), Auerbach

and Hassett (2003)). These arguments suggest that dividends will emanate from the trade-

off between mitigation of agency conflicts and taxation.

In terms of agency conflicts LLSV (2000b) develop two opposing hypotheses at

country level. The first is the outcome hypothesis where corporate governance quality is

expected to be positively related to dividend payouts because better-governed firms offer

stronger protection rights to their shareholders, and shareholders are expected to

pressurize managers to pay higher dividends rather than using the excess cash for their

own private benefits. The second is the substitution hypothesis which stipulates that

5 See Allen and Michaely (2003) for a review on the controversies on these two issues and

details on other frictions, including signalling, firm maturity, and behavioural motives,

which we control for in our analysis. In the public economics literature, the relationship

between dividend, taxes, and firms’ investments is also controversial. Under the “old

view” a cut in dividend taxes leads individuals to save and buy stocks, spurring business

investment, profits, and dividend distributions, but under the “new view” taxes do not

affect dividends because firms finance their marginal investments by retained earnings

rather than new share issues. See Auerbach (2002) Auerbach and Hassett (2003).

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dividends should be higher in weak governance system to mitigate the agency conflicts.

LLSV (2000b) provide evidence consistent with the outcome hypothesis. Other

subsequent studies also provide additional evidence on these effects. For example,

Pinkowitz et al. (2006) show that dividends are valued more in weak investor protection

countries. Brockman and Unlu (2009) study the relationship between creditor rights and

dividend policy. They find a positive relationship between country-level creditor rights

and dividend payout, consistent with the substitute model, as when creditor right is weak

at country-level, managers are more likely to restrict dividends in order to build a good

reputation and, hence, reduce costs of capital. However, Shao, Kwok, and Guedhami

(2009) find that the positive relationship between creditor rights and dividend payout is

significant only when shareholder rights are strong.6

In terms of the tax effect on dividends, the results of previous studies at firm level

are relatively mixed. While Desai and Jin (2011) show that taxable institutions are

significantly less likely to hold shares in firms with larger dividend payouts, Grinstein and

Michaely (2005) do not find meaningful tax-based preferences by institutional investors.

Chetty and Saez (2010) and Morck and Yeung (2005) introduced dividend tax cut as a

tool to reduce the agency problem of free cash flow because managers cannot use

dividend tax disadvantage as an excuse to retain excess cash when dividend tax is cut.

Other studies explore the impact of taxes on dividend in the context of a natural

experiment, such as the US 2003 dividend tax cut. For example, Chetty and Saez (2005)

and Brown, Liang and Weisbenner (2007) report significant effects of the US tax cut on

6 Hu and Kumar (2004), John and Knyazeva (2006), Nielsen (2006), Jo and Pan (2009),

and Officer (2007) also use agency theory to explain dividend behavior. Other studies

focus on the impact of corporate governance on various corporate outcomes such as cash

holding (e.g., Dittmar et al (2003)), and market liquidity (Chung, Elder, and Kim (2010)).

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the amount of dividends and the proportion of dividend payers. However, Blouin, Raedy,

and Shackelford (2004), examine dividend payments in the three months immediately

after this reform and show that virtually all the dividend payments increases was due

solely to 17 firms who paid special dividends. Brav, Graham, Harvey and Michaely

(2008) provide evidence that dividend initiations surged temporarily after the adoption of

this reform, but they also show that aggregate repurchases increased significantly, which

is inconsistent with the tax effect. Their survey suggests that the reform had only a

second-order influence on dividends. Other studies report that taxation does not explain

fully the recent “disappearing dividend” phenomenon in the US (Fama and French (2001),

Julio and Ikenberry (2004)). In addition to the difficulties of assessing the effect of taxes

on dividends as marginal tax rates differ among investors (Graham (2008)), these studies

are country-specific, focusing predominantly on the US market, where dividends are

double-taxed. Thus, the impact of taxation on dividends is difficult to detect and, between

investors, tax differences and tax clienteles may weaken the results of any tax effect.

These drawbacks can be mitigated in cross-country studies, but the results

provided to-date are also relatively mixed. Studies that focus on the disappearing

dividends at international level either ignore tax effects (Denis and Osobov (2008)) or

find that TD is positive and significant in determining the probability of paying dividend,

but negative and significant in determining the amount of dividends (Eije and Megginson

(2008)). Moreover, Pinkowitz et al (2006) split their sample of countries into four groups

based on dividend tax treatment and the corruption index. They find that the relationship

between market value and cash holding is independent of the tax effect, and dividends

contribute more to market value only in countries with poor investor protection where

dividends are tax disadvantaged. These results are not consistent with the tax hypothesis

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and suggest that dividends are likely to be more relevant to minority shareholders at the

margin because the dividend tax disadvantage subsidizes the consumption of private

benefits. We provide below details of cross-country institutional differences in taxes on

dividend to set up our tax framework and develop our hypotheses.

1.2. Institutional Setting

In a classical tax system, dividends, d, received by shareholders are taxed at personal

income taxes, m, resulting in a net after-tax income of d(1-m). In contrast, under the

imputation system, the same dividend carries a tax credit at a rate s. As a result,

shareholders are deemed to have received gross dividend, D, defined as d/(1 - s). As in the

classical tax system, they pay personal income tax at rate m, but on their gross dividend D,

i.e., mD, and at the same time, they receive a tax credit of sD, i.e., sd/(1 - s). Therefore,

their dividend tax is (m - s)D, i.e., d(m- s )/( 1 - s).

We use an example to illustrate these fundamental principles. Suppose that the

cash dividend, d, is $7.00, the personal income tax rate, m, is 40%, and the tax credit, s, is

30%. Investors in the classical tax system receive a net dividend of $7.00×(1-40%) =

$4.20 and pay income tax of $2.80. In contrast, in an imputation system, investors are

deemed to have received $7.00/(1-30%) = $10.00. Their income tax is $10.00×40% =

$4.00, but they can claim a tax credit of $10.00×30% = $3.00, resulting in an additional

income tax demand of $1.00 on the $7.00 dividend received. Their effective tax is 14.3%

((40%-30%)/(1-30%)) and their net after-tax dividend is $6.00 compared 40% and $4.20

in the classical system. Their excess net dividend is $1.80, representing 25.7% of the

$7.00 original payment.

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The treatment of other investors usually depends on particular applications of the

imputation system in different countries. Tax-exempt institutions can claim the full tax

credit and their after-tax dividend is $10.00. Investors taxed at the basic income tax rate

have no additional dividend tax to pay. Dividends received by corporate investors from

other domestic companies are not taxed again as a profit. The tax authorities do not refund

the associated tax credit but corporate investors can use it to frank their own dividend

payments or offset it against their previous tax liability. Overall, dividends under the

imputation system are taxed at a lower rate than the classical system.

In our paper, we expand these arguments and analyse the aggregate taxation of

dividends relative capital gains and corporation tax. We consider that the tax burden on

dividends depends on both the corporate and personal income tax systems, and that the

managers aim at minimising the overall tax liability when they decide on their dividends.

In a classical system, the total tax is the sum of the corporation tax, the effective capital

gains tax and the tax on dividend. Typically, the tax on dividend exceeds the capital gains

tax, creating an incentive to reduce dividends. In contrast, in an imputation system, the

total tax is the corporation tax plus the effective gains tax plus the reduced dividend tax. A

reduction in the tax on dividend that is large enough to make it lower than the effective

capital gains tax creates an incentive to increase dividend.

Assuming a corporation tax rate of τc, the dividend tax burden is, thus, the sum of

corporate tax paid by the company, τcd/(1 - τc), and the personal income tax paid by

shareholders, d(m - s)/(1 - s), as proportion of the pre-corporate-tax dividend, d/(l - τc), i.e.,

s1)m1)(1(1

1d

s1)sm(d

1d

c

c

c

c

−−τ−

−=

τ−

−−

+τ−

τ

(1)

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On the other hand, if earnings are retained and reinvested at the cost of capital,

they are expected to generate an after-tax capital gains of r(1 - z) where r is the firm's

after-tax earnings that are retained and z is the effective capital gains tax rate. The capital

gains tax burden is the sum of the corporate tax paid, τcr/(1 - τc), and the individual tax rz,

all divided by the pre corporate-tax capital gains, i.e.,

)z1)(1(1

1r

rz1

r

c

c

c

c

−τ−−=

τ−

+τ−τ

(2)

The overall tax burden on dividend and retained earnings borne by the firm and its

shareholders is the weighted average of the dividends and capital gains tax burdens as a

proportion of the firm's payout ratio and can be defined as:

[ ]

( )⎭⎬⎫

⎩⎨⎧

−+⎥⎦⎤

⎢⎣⎡ −−

−−

τ−−=

−τ−−⎟⎠⎞

⎜⎝⎛ −+⎥⎦

⎤⎢⎣⎡

−−τ−

−

)z1()z1(s1m1

Ed11

)z1)(1(1Ed1

s1)m1)(1(1

Ed

c

cc

(3)

where d/E is the firm's payout ratio and E are earnings.

Equation (3) implies that the overall tax burden on dividends and capital gains is a

function of the corporation tax, the dividend payout ratio and the differential taxation of

dividends and capital gains. Let

)1)(1()1(

zsmTD−−

−= (4)

represent this tax discrimination variable and rearranging, Equation (3) becomes:

[ ]⎭⎬⎫

⎩⎨⎧ +−τ−− 11TD

Ed)1(1 c (5)

While the taxation of capital gains (Equation 2) is relatively unaffected by the tax

systems, the taxation of dividends (Equation 1) and the overall tax burden (Equation 5)

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differ across the classical and the imputation systems. In the classical system, since s = 0,

shareholders are expected to be indifferent between dividends and capital gains when m =

z. In this case, the overall tax burden is invariant with respect to the payout ratio. However,

when m is higher than z, TD will be lower than one, and the overall tax burden on

dividends will rise as the payout ratio increases. In contrast, under the imputation system,

this tax on dividends will increase only if z < [(m - s)/(1 - s)], making the breakeven point

under which shareholders will prefer capital gains to dividends much lower. In practice,

TD varies with the income tax rate of individual investor. For example, tax-exempt

investors (m = z = 0), given a corporation tax rate of, say, 52% and a standard rate of

income tax of 30%, will have a tax discrimination factor of 1.43 and an overall tax burden

on dividends of 31.4% compared to 52% if earnings are retained. For individuals taxed at

m = s = 30% and at an effective capital gains tax of, say, 20%, TD is 1.25 and the

dividend tax is 52% but the capital gains tax burden rises to 61.6%. This implies that both

tax-exempt investors and basic income taxpayers are expected to favour dividends.

However, for investors taxed at a higher income tax rate, TD is less than one and their

dividend is taxed at a higher rate than retained earnings. They will prefer dividend only if

capital gains tax rate, z, is higher than the additional dividend tax, i.e., z > (m - s)/(1 - s).

The overall tax burden of dividends depends also on the link between corporate

and imputation tax rates. In the classic system, there is no effect. In the partial integration

system, 0 < s < τc, shareholders receive tax credit for part of the underlying corporate tax

paid on dividends, or only part of their dividend is taxed at the personal level with no

further tax credit. In the full integration system, s = τc, shareholders receive tax credit for

the full amount of the underlying corporate tax paid on dividends, or shareholders pay no

tax on dividends. In this case, dividends are, like interests, tax deductible. In the split rate

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system, dividends are taxed at different rate than retained earnings at the corporate level,

and, depending on the rate of deduction, s is between zero and the corporate tax rate, τc.

1.3. Hypotheses Tested

Although the literature on the tax effect on dividends is mixed, recent studies indicate that

companies do consider taxation in their financial decision making (e.g., Riddick and

Whited (2009) and Foley et al (2007)). We expect taxation to affect dividends in two

ways. First, firms in the classic tax system countries will have a propensity to pay lower

or no dividends, but, to opt for share repurchases, which are both tax-favored and more

flexible than regular cash dividends, while in countries with more favourable dividend tax

environments (partial and full imputation systems), they will pay high dividends and will

be more likely to increase and initiate, rather than to omit or cut their dividends. Second,

firms with high (low) TD are expected to pay high (low) dividends. These impacts are,

however, more likely to apply in strong investor protection countries, where managers are

expected to maximise the wealth of their shareholders by adopting payouts that maximise

the after-tax returns of their shareholders. This discussion motivates our first hypothesis:

Hypothesis 1: Firms in strong investor protection countries maximize their

shareholders’ after tax returns by substituting cash dividends for share repurchases.

In weak investor protection counties, payouts are expected to be low and not a

function of the tax system because managers are less likely to maximise the wealth of

their shareholders and investors are more likely to welcome whatever cash they can get

regardless of its tax disadvantage. This is in line with LLSV (2000b) outcome model, as

controlling shareholders would like to hoard cash to pursue their interests at the expense

of minority investors. Thus, dividends taxation should not affect dividends payout in weak

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investor protection countries under the outcome model. Alternatively, under the substitute

model, managers choose to disgorge cash to their shareholders to build good reputations

so as to gain access to external financing or to maintain high stock prices. We consider

that taxation will allow them to achieve these opposite objectives. They could argue that

when dividends are taxed at a higher rate, they need to keep cash. Thus, under the

substitution model, dividends taxation will have a negative effect on dividend payouts in

weak protection countries. Previous studies do not provide support to the substitution

model. We therefore set our second hypothesis under the outcome model:

Hypothesis 2: Firms in weak investor protection countries do not pay attention to

dividends taxation when setting their payout policy.

2. Data and methodology

We first select all firms registered in 24 OECD countries from DataStream. We exclude

Korea for lack of data, Czech Republic, Slovak Republic, and Iceland for incomplete or

unreliable data. We also exclude from our sample Hungary, Germany in 2000, Norway in

2006-2007, and Poland in 2002 because they apply either a split rate system or other

dividend tax treatments, which are incomparable to other countries and may have unclear

effect on dividends. We follow LLSV (2000b) and exclude Greece because of the

mandatory dividend rule forced on Greek firms. In addition, we eliminate firms with

missing dividend or earning data and those with negative book equity, and financial and

utility firms as their dividend policy may exhibit different motivations. Our final sample

includes 9,806 firms from 2000 to 2007, resulting in 44,194 firm/year observations.

We follow Djankov, LaPorta, Lopez-De-Silanes, and Shleifer (2008) and use the

anti self-dealing index, Law, to capture corporate governance. The higher the index score,

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the higher the level of investor protection. Djankov et al. (2008) argue that the anti self-

dealing index measures investor protection better that pervious indices in LLSV (1998).

In our robustness checks, we simulate with alternative measures.

We focus on two measures of taxation on dividends. The first is the classification

of the countries in the sample into the three tax systems: (i) classical system where s = 0,

(ii) partial imputation system where 0 < s < τc, and (iii) the full imputation system where s

= τc. The second is the tax discrimination variable, TD, as defined in Equation (4). We

collect the relevant dividend tax data from the annual OECD tax database

(www.oecd.org/ctp/taxdatabase), and each country’s tax authorities’ official websites.

The classification into the three systems is relatively straightforward. We calculate TD for

each country and sample period, assuming effective statutory tax rates on distributions of

domestic source income7 to a resident individual shareholder, taking account of corporate

income tax, personal income tax and any type of integration or relief to reduce the effects

of double taxation. We start with the corporate and individual tax rates, which correspond

to the top statutory rates. We then calculate the net individual tax rate, the tax rate on

dividends net of any relief or tax credit applicable to dividends, to find the overall tax rate

on dividends, which is the combined corporate and net individual tax rates applied to the

paid dividends, and the proportions of corporate and individual taxes paid on dividends.

Finally, we extract the capital gain tax rates applied to long-term gain realized by

individual resident on sold assets from Price Waterhouse: Corporate & Individual taxes:

A worldwide Summary. We estimate the following model:

tik

tiktititititi CONTROLLawTDPartialFullPayout ,

8

1,,4,3,2,10, εββββββ ++++++= ∑

=

(6)

7 We do not have data on the treatment of foreign income dividend. See Graham, Raedy

and Shackelford (2008) for some discussion on this issue.

19

In line with LLSV (2000b) and Ejie and Megginson (2008)), we use a country

random effect specification to account for cross correlation between error terms among

firms within the same country and accommodate the inclusion of time invariant variables,

such as System dummies and the EU dummy.8 Our data also led us to use the Tobit model

with country random effect, including industry dummies, in the following specification:

⎩⎨⎧ >

=Otherwise

PayoutifPayoutPayout titi

ti 00,,

,

We measure our dependent variables using both raw and industry-adjusted data.

We use dividends to total assets ratio (DIV/TA) and repurchases to total assets ratio

(Rep/TA) as measures of payout.9 We also provide robustness of our results using sales,

cash and net income as denominators of our payouts. We use three measures of dividend

taxation: Fullit, a dummy variable equals to 1 if the firm is located in full integration

country, and zero otherwise, Partialit, a dummy variable equals to 1 if the firm is located

in partial Integration country, and zero otherwise, and the tax discrimination variable TD.

We expect these three variables to be positive as payouts should be higher in partial and

full imputation systems, compared to the classical tax system, and when TD is high.

8 For further assurance, we also ran a country fixed effect model without the EU dummy

and employ Hausman and Hansen-Sargan tests to check for the validity of the random

effect which we find to be stronger than the fixed effect specification. 9 We include share repurchase as they account for a large proportion of cash return mainly

in the U.S. (e.g., Allen and Michaely (2003)). We recognise that in some countries, such

as Germany, share buybacks are allowed only recently, thus companies did not have a

choice in their form of cash returns to their shareholders. The tax impact on repurchases is

relatively mixed. For example, while, Dittmar (2000) finds no evidence that supports the

notion that tax changes had any significant effect on share repurchases, Rau and

Vermaelen (2002) find that tax changes do have a significant effect on share repurchases.

20

We also include a set of control variables, CONTROLSit, that are likely to affect

the payout ratio, namely: (i) profitability, measured by ROA, the ratio of the profit after

tax but before interest to total assets, (ii) size, measured by sales (ln(S)), (iii) growth,

measured by M/B, the market value of the firm (total assets - book value of equity +

market value of equity) divided by total assets, and %∆TA, the percentage change in total

assets, as in Fama and French (2001), (iv) financial risk, measured by leverage (D/E), the

ratio of long-term debt over market value of equity, (v) business risk, measured by cash

flow volatility (CFVOL) defined as the standard deviation of operating cash flow to total

assets, as in Chay and Suh (2009), and (vi) maturity, measured by the number of years the

firm in the database (AGE), following Grullon, Michaely and Swaminathan, (2002) and

DeAngelo, DeAngelo, and Stulz (2006). Finally, we use two relevant macro economic

variables: growth in GDP, gGDP, and Euro, a dummy variable equals to 1 if the firm

belongs to a country that is a member of the European Union (EU) since tax

harmonization practices in place may make the dividend taxation across the 16 EU

member states in our sample not independent.

We use DataStream to collect all the relevant share price and accounting data,

which are measured in US dollars and winsorized at the top and bottom 1% to reduce the

possibility of data errors. We test for robustness by including zero dividend firms,

analysing the impact of negative earnings, and using data in local currency rather than US

Dollars, to avoid exchange rate impact.

Our second test relates to the impact of taxation on the propensity to pay dividends

and on the decision to change dividend policy. We estimate the following probit model to

capture these effects:

tik

tiktititititi CONTROLLawTDPartialFulld ,

8

1,,4,3,2,10, )1Pr( εββββββ ++++++== ∑

=

(7)

21

Where itd is an indicator function of whether firms in our sample pay, increase, or

decrease their cash dividends. For share repurchases, itd indicates whether firm i in our

sample bought back the shares in year t. We use the same control variables as in Equation

(6). We also include Dividend Premium, the difference in the logs of value weighted

average market to book ratio of dividend payers and non-payers to account for the

catering theory (Baker and Wurgler (2004)). We expect firms that operate in strong

governance system, with high tax cost on cash dividends, i.e., those that operate in the

classical dividend tax system, and where TD is low, to buyback shares, instead of paying

cash dividends. Thus the propensity to pay and increase (decrease) dividends will be

positively (negatively) related to TD, Partial, Full, and Law. In contrast, we expected the

propensity to repurchase shares to be negatively related to TD, Partial, Full, but positively

related to Law to reflect strong investor protection, as managers will be inclined to

mitigate any agency conflicts over the free cash flow by returning the cash to the

shareholders rather than investing it in negative NPV projects.

3. Empirical Results

3.1. Dividend Payouts across Governance and Tax Systems

Table 1 reports summary statistics of the variables used in our analysis. The mean payout

ratio is 23% but the median is 8%, implying that this ratio is skewed. Similar skewness is

observed for dividend per share (DPS), earnings per share (EPS), and to a lesser extent

return on assets (ROA), suggesting that some companies do not pay dividends and the

profitability is relatively widely dispersed across our sample firms. We have also

computed but not reported for space considerations the correlations between the variables.

We find that dividend variables are all positively related to profitability (EPS and ROA)

22

and size (ln(S)), but negatively related to leverage (D/E). Similarly, high growth firms, as

measured by market-to-book (M/B) and change in total assets (%∆TA), and high risk

firms, i.e., firms with high cash flows volatility (CFVol) appear to pay low dividends.

These results suggest that these firms are likely to rely on internal financing, as

corroborated by the negative correlation between these growth and risk variables and D/E.

The tax discrimination ratio, TD, is negatively related to DPS and EPS, but positively

related to dividends payout ratios. Finally, LAW is positively related to all dividends

ratios but negatively related to DPS and EPS, suggesting that firms in strong investor

protection countries have higher payouts even though they are less profitable.

[Insert Table 1 here]

Table 2 presents the distribution statistics of variables ranked by governance and

tax systems. The results indicate that about 36% of the sample countries apply double

taxation of dividends, 24% use full integration, and 40% the partial integration system.

However, in terms of sample size, the respective proportions are 51%, 17%, and 32%,

respectively, as the vast majority of our sample firms are from the US (26%) and Japan

(11%) which apply the classical system. In the partial system, UK accounts for 16%,

followed by Canada, Germany and France. In full system, Australia and France have the

large sample size. The remaining countries are randomly distributed. Some countries,

such as France, Finland, Portugal, Spain, and Norway, are in more than one category,

because they switched their systems during the sample period.

It is interesting to note that the average TD is higher in some classical tax system

countries than their counterparts in full and partial integration countries. This is because

even though dividends are doubled-taxed, some classical system countries have higher

dividends tax advantage (higher tax discrimination ratio) than other countries that use full

23

or partial integration. Overall, the average TD is significantly higher in the partial

imputation system countries compared to the full imputation system and it is the lowest in

the classical system. While these figures are averages, we find some changes in the

corporate and individual tax rates during the sample period without any shift in the tax

system. For example, the individual tax rate has changed from 60% in 2000 to 30% in

2001 in the Netherlands, from 31% in 2002 to 16% in 2003 in the US, and from 35% in

2005 to 40% in 2006 in Turkey. We also find, but not report, that the average net

individual income tax in classical system countries of 27% is higher than that in partial

integration system of 24%, which in turn is higher than the 10% in full integration system.

Given that the tax rates variation within each country and across countries may play

distinctive role in shaping the dividend policy, we expect the combination of the tax

discrimination variable, together with the tax system, to provide a richer environment and

a unique opportunity to test whether the tax environment affects dividend policy.

We find a monotonic increase (decrease) in dividend payout (repurchases) as we

move from classical to full system in strong protection countries (Table 2, Panel A). The

average TD is highest in partial system (1.14) and lowest in classical system (0.93). Panel

A. also shows that EPS and DPS are higher in the classical tax system, and Panel B.

shows an increase in dividend payout in weak protection countries, as we move from the

classical to partial and full systems, but the magnitude of the increase although

significant, is rather small. In addition, the average repurchase ratio is not consistent with

the dividend tax disadvantages. Unlike Panel A, firms in the classical system country have

lower DPS and EPS in weak protection countries, and the average TD increases as we

move from the classical to full systems. Overall, our results show that the tax impact on

dividends and repurchases is stronger in strong, compared to weak protection countries.

24

[Insert Table 2 here]

Table 3 presents further evidence on the impact of taxation and governance on

payout ratios. We classify our sample into dividend tax systems (classical, partial and

full), tax discrimination ratios (high and low TD), and shareholder protection (strong and

weak). We test for differences in means using the t-test. The results indicate that in strong

governance countries, the average payout ratio is significantly higher than that of the

weak governance system. These results are consistent with previous evidence (e.g., LLSV

(2000b)) and suggest that in strong protection countries shareholders are likely to make

managers disgorge cash that might be used to undertake negative NPV projects. However,

the distribution of this ratio across tax systems and governance quality is not monotonic.

Interestingly, in the classical system the reverse is observed: the average payout in weak

governance system is significantly higher than that in the strong protection countries. For

the remaining tax systems, the results are consistent with the outcome hypothesis as firms

in strong pay higher amounts of dividends than those in the weak system. We also find,

but not report, similar results when we define payout as dividends over earnings, as firms

in the classical tax system and strong governance countries pay only 12% of their earnings

as dividends, compared to 26% for those in the weak system (p difference = 0.00), but the

respective average dividend payout ratios are 36% and 24% (p = 0.00) in full tax system,

and 27% and 24% in the partial tax system.

Table 3, Panel A. also shows that dividends in strong governance system are

affected by the taxation of dividends relative to capital gains (TD). In particular, the

average payout of companies with high TD is about twice that of low TD (p = 0.00). We

obtain similar results when we use dividend over earnings (0.25 vs. 0.13, p = 0.00). This

impact is also observed in weak governance countries. Finally, the last three columns

25

indicate that the average payout when TD is high (above the median TD) is significantly

higher than low TD firms, in all the tax systems. We note also that the average payout is

significantly higher in the full imputation compared to the classical tax system in both low

and particularly high TD groups, where the distribution of payout is monotonic. When we

divide dividends by earnings, we find similar results with a mean payout ratio of 26% in

high compared to 20% in low TD countries (p = 0.00), and the difference is more

pronounced when we account for the tax system.

Table 3, Panel B. reports the distribution of repurchases over total assets. The

results indicate clearly that, in strong governance countries, repurchases are the highest in

the classical and lowest in the full imputation tax system, and they are also statistically

higher in low TD countries. In the weak governance system, repurchases are not evenly

distributed across the tax system and, in contrast to our predictions, they are higher in

high TD groups. The distribution of repurchases across TD groups reported in the last

three columns is also not as expected.

Overall, our results suggest that payouts are affected by a combination of

governance and tax systems. In countries with strong governance and where the classical

tax system operates, companies prefer not to pay cash dividends to their shareholders as

they will be tax penalised. Instead they recur to share repurchases to maximise the after-

tax returns of their shareholders. In the weak governance system, firms pay small

dividends and buyback smaller amount of shares, and the relationship between payouts

and taxation is not strong and as expected. These results provide an early support for the

outcome, not substitution model.

[Insert Table 3 here]

26

3.2. Impact of taxation on the payout ratios

In Table 4, we run a set of regressions to explain the levels of payouts. The dependent

variable is cash dividends in Model (1) to (3) and share repurchases in Model (4) to (6),

both scaled by total assets.10 We present the results based on random effect econometric

specification. We define the dependent variable as raw and industry-adjusted data and we

run Tobit model, as specified in Equation (6). Consistent with previous evidence (e.g.,

LLSV (2000b)), we find that Law, a dummy equal to one for strong shareholder

protection countries based on anti-self-dealing index, is positive and significant in all our

specifications, suggesting that in good corporate governance countries, firms are likely to

pay high cash dividends and also to buyback shares.11 However, this variable does not tell

us how firms chose between dividends and share repurchases, and whether managers

destroy shareholder value by paying dividends. Thus, investor protection variable does

not appear to be a clear determinant of the firm’s payout decisions. We overcome this

drawback by assessing whether firms pay cash dividends (repurchase shares) when the tax

cost on dividends is low (high) and whether, taxes and shareholder protection are joint

determinants of firms’ dividend payment across our countries.

The tax coefficients in Table 4 provide a strong indication that companies in the

full and partial imputation system countries pay significantly higher dividends than those

in the classical system. In Model (1) and (3), the results also indicate that the impact of

10 We also use alternative measures for payout using sales, net income and cash flow as

scaling factors for both cash dividends and repurchases. Our results, discussed more in

robustness section, are qualitatively similar. 11 With almost similar set of controlling variables and similar sample period, Eije and

Megginson (2008) report no significant effect of legal environment on dividend policy of

EU member countries. We also find strong impact when we use other investor protection

variables, such legal origin or anti director rights, reported in robustness checks section.

27

the full system on cash dividends is higher than that in the partial, as the coefficients of

Full are economically higher. However, when we use dividend payers only (Model (2)),

the coefficients of Full and Partial are relatively the same. The coefficient of the tax

discrimination variable, TD, is not significant in Model (2), but it is, as expected, positive

and significant in the remaining models. In Model (4) to (6), the relationship between

repurchases and taxation is even stronger. As expected, the results indicate that companies

that operate in the full and partial tax system, and whose shareholders are taxed at a higher

rate on dividends relative to capital gains, repurchase significantly less. These results are

independent of the specification we use. We note, however, that the coefficients of Full

and Partial are economically relatively similar, suggesting that there is not much

difference in the amount of repurchases between full and partial systems.

The results also indicate that cash dividends and share repurchases are substitutes,

not complementary, as the coefficients of repurchases (cash dividends) are negative in the

dividend (repurchases) regressions, in line with some previous studies (Jagannathan,

Stephens and Weisbach (2001) and Grullon and Michaely, (2002)). Although firms may

have other motives to buy back shares,12 our results suggest that they are likely to do so to

minimise the tax liability of their shareholders, as our regressions control for all other

likely fundamental factors.

12 Vermaelen (1981) points out the conditions under which repurchases can also be taxed as

dividends and thus may not work as perfect substitutes. Dittmar (2000) finds that

repurchasing firms do not necessarily have lower dividend payout ratios. Brennan and

Thakor (1990) argue that repurchases can carry a significant information asymmetry cost that

may washout any tax advantage from them, especially when firms are perceived to be taking

advantage of shareholders.

28

Our results contribute to the controversial debate and mixed results in the literature

on the impact of taxation on dividends (see, e.g., Graham (2008) for a review). For

example, Pattenden and Twite (2008) investigate the changes in dividend policy around

the introduction of a dividend imputation tax system in Australia in 1987 and find a

significant increase in dividend payout and dividend initiation after switching form

classical to imputation system. Akhtar (2008) compares the determinants of dividend

payout ratio across Australia, U.S., Japan, U.K. and Malaysia and reports a higher

dividend payout in firms in imputation tax system countries (Australia and U.K.) relative

to firms in the other countries that apply classical tax system. However, unlike the results

of previous studies (e.g., LLSV (2000b) and Ejie and Megginson (2008)), the tax

discrimination ratio, TD, is positive (negative) and significant in all our dividend

(repurchases) specifications, suggesting that shareholder tax preferences affect dividends.

Thus, we contribute to previous evidence by showing that both the tax system and

shareholders’ personal taxes affect firms’ payout ratios.

The coefficients of the control variables are relatively as expected. Profitability

(ROA) is positive and significant, implying that profitable firms have higher payout ratios

than less profitable companies. The coefficient of debt to equity ratio (D/E) is negative

and significant, suggesting that either high leverage constrain companies from paying

high dividends through debt covenants, or that high levered firms suffer less from the free

cash flow problem, and thus do not need to disgorge cash to their shareholders (Jensen

(1986)). The negative and significant coefficient of the percentage change in total assets

(%∆TA) indicates that firms with higher investment needs have lower payout ratio. The

negative and significant coefficient of the cash flow uncertainty (CFVol) support the

findings of Chay and Suh (2009) that firms with high cash flow uncertainty are risky, thus

29

less able to payout dividends.13 In addition, AGE is positive and significant, in line with

the life cycle theory (DeAngelo, DeAngelo, and Stulz (2006)) and firm's maturity effect

(Grullon, Michaely and Swaminathan, (2002)). However, the results are not significant in

all specifications. Unlike Eije and Megginson (2008), the dummy variable (Euro) is

positive in our dividend but negative in repurchases regressions. These results suggest that

firms in the Euro zone pay higher dividends but repurchase less than other OECD

countries. Finally, GDP growth rate is mainly negative, reflecting the need for internal

funding in growing economy, but it is not always significant.

It is interesting to note that the coefficient of market-to-book is positive and

significant in most specifications, suggesting that high growth firms pay high dividends

and buyback more shares. Similarly, in Model (2) the coefficient of size (ln(S)) is

negative and significant,14 suggesting that smaller firms have higher payout ratio. These

results are not consistent with previous evidence (e.g., Fama and French (2001)) where

large and mature companies have higher payouts. However, the negative size effect

applies only when non-dividend paying firms, which are usually the smallest, are

excluded from the sample.

[Insert Table 4 here]

3.3. The interaction between Taxation and Investor Protection

In this section we examine whether taxation affects payouts in a similar way in firms

across strong and weak governance countries. We divide our sample firms into two

subsamples based on the level of investor protection. A strong protection subsample

includes firms in countries with above average anti self-dealing index while weak

13 We find similar results when we use the standard deviation of ROA. 14 We also obtain similar results when we use the log of total assets to proxy for size.

30

protection subsample includes the remaining firms. The results, reported in Table 5 are

based on industry-adjusted data country random effect (Equation (1)), and Tobit model

with random effect (Equation (2)) for both cash dividends and repurchases.

The first column shows that, in line with previous results, in strong shareholder

protection countries, firms that operate in full and partial imputation systems pay higher

dividends than those in the classical system. The coefficient of Full is higher than that of

Partial, suggesting that, economically, firms in the full system pay the highest amount of

dividends, followed by those in the partial, and in the classical the payout is lowest. TD is

also positive and significant, suggesting that the tax system at both firm and shareholder

levels affect dividend payments. However, companies do not substitute cash dividends for

repurchases as Rep/TA is negative but not significant. We obtain similar results in column

3 with the Tobit specification, except that TD is positive but not significant. Similarly, in

the repurchases regressions, reported in columns (5) and (7), TD, is not significant, but the

coefficients of Full and Partial are negative and significant, suggesting that firms that

operate in the full and partial system are less likely to buyback their stock, compared to

those in the classical system. Overall, these results suggest that, although TD may not

have a strong effect on dividends and repurchases in the strong shareholder protection

countries, firms that operate in the classical tax system are less likely to pay cash

dividends, but they recur to share repurchases to maximise their shareholders’ after-tax

return. The results are consistent with the agency theory of dividend taxation developed

by Chetty and Saez (2010) and Morck and Yeung (2005), which postulates that lower

dividend taxes mitigate the free cash flow agency problem since managers cannot use the

tax burden of dividends as an excuse to hoard cash. The low dividends taxes lead

managers to use the excess cash efficiently in strong shareholder protection countries.

31

In contrast, in weak shareholder protection countries, the relationship between

payouts and taxation is relatively weak. In columns (2) the coefficients of the dividend tax

system are not significant and TD is negative, in contrast to the predictions of the tax

effect. In column (4), all the tax variables are not significant. In the repurchases

regressions, reported in columns (6) and (8), the tax variables are negative but not always

significant. Moreover, cash dividends appear to be complementary, not substitutes, to

share repurchases, as the coefficients of Rep/TA and Div/TA are positive and significant,

suggesting that firms that pay cash dividends are also to buyback shares.

The remaining results are relatively similar to those reported in the previous

section. We note, however, that the coefficient of ROA is significantly higher in low

protection environment relative to strong protection countries, suggesting that firms in

strong investor protection countries tend to smooth dividends more, consistent with the

agency model of Allen et al. (2000) and the findings of Leary and Michaely (2008) that

tight monitoring, and in our case strong power in the hand of investors, predict higher

dividends smoothing as managers will be reluctant to cut them.

[Insert Table 5 here]

In Table 6 we assess the impact of shareholder protection in countries with

classical and imputation systems. For space considerations, we split our firms into two tax

groups and run a set of regressions as in Equation (6). The first subsample includes all

firms that operate in the classical dividend tax system. The remaining firms are included

in the second subsample, referred to as Imputation, since they operate in the full and

partial imputation systems. We find same qualitative results when the full and partial

imputation systems are separated. Model (1) shows that, in both tax systems, dividends are

positively related to TD. However, the relationship between dividends, law, and

32

repurchases differs across the two tax systems. In the classical system, repurchases are

positively related to dividends. These results suggest that these two payment methods are

complementary, and thus not consistent with the tax hypothesis. However, as shown

above dividends are significantly lower in the classical tax system where firms pay

minimum amount of dividends necessary to signal or reduce agency costs. Therefore, in

the classical tax system, companies pay cash dividends and supplement them with share

repurchases, which are more tax efficient. These arguments are consistent with Allen et al.

(2000) who develop a model in which firms pay dividends to attract untaxed institutional

clientele, and show that dividends and repurchases are not substitutes, and firms are

expected to use dividends rather than repurchases for signalling and agency reduction

motives. Since their model is based on dividend tax clientele, it is only working if

dividends are taxed (as in classical system). Therefore, based on their model's prediction,

dividends and repurchases need not be substitutes in classical system and thus the

coefficient on repurchase needs not be negative. We find that in the imputation system,

the relationship is negative, suggesting that firms pay high cash dividends but repurchase

less, thus they use dividends and repurchases equally to distribute excess cash, and one

method reduces the dependence on the other. However, in the classical system, while

repurchases reduce taxes, they do not necessarily lead to a reduction in dividend, which

are already set at an optimal level.

In Model (2), the results are consistent with the tax hypothesis, except that TD is is

positive and significant under imputation system, but it is insignificant under the classical

system. The general weak performance of the TD variable here and in previous literature

may be partly due to the inaccuracy of its measure under the classical relative to the

imputation system, as it is based on top statutory rather than effective tax rates of

33

marginal investors. Thus, when the process of indentifying the marginal investor and

measuring her effective tax rate are complex, the statutory rate is less representative, and

the TD ratio becomes weaker (Graham (2008)). In classical system, investors are

motivated to pursue different ways to avoid dividend taxes. For example, investors can

invest through tax-exempt entities or hold their investments in a tax-exempt account. In

addition, the relatively high taxation of dividends under the classical system creates

dividend clientele that makes the process of identifying the marginal investor less uniform

among firms. These measurement difficulties of the marginal investor’s effective tax rate

lessen the accuracy of the statuary tax rate as a proxy for the marginal unobserved tax

rate, and weaken the significance of the TD ratio. In contrast, the imputation system

lowers (or eliminate) the tax burden of dividends and thus investors are less (or not)

motivated to pursue strategies that significantly change their effective tax rates. Therefore,

in the absence of tax clientele and tax avoidance strategies, the statutory tax rate can

proxy for the marginal tax rate with more precision, and thus TD ratio will show stronger

impact on dividends.

Interestingly, Law is negative and significant in the classical but positive in the

imputation tax system. The results suggest that in strong shareholder protection countries,

firms pay high dividend in the imputation but low dividends in the classical system, to

maximise the wealth of their shareholders. However, in the case of share repurchases, the

impact is positive in both the classical and imputation tax systems, except the non-

significance of Law in the last column. These results suggest that in strong shareholder

protection countries, companies buy back shares independently of the tax system in which

they operate.

34

The agency theory suggests that dividends are a manifestation of shareholders'

wealth maximization on the part of the manager, and, thus, the more aligned the

objectives of managers with those of shareholders, the higher the payout (e.g., LLSV

(2000b), Fenn and Liang (2001), and Desai, Foley, and Hines (2007)). Our results are

consistent with these arguments, as in the classical tax system, paying dividends carries a

tax disadvantage that reduces the wealth of shareholders. In a strong shareholders

protections environment, a shareholders' wealth maximizing manager is expected to

reduce dividend payout. In contrast, when dividends suffer no (or less) tax disadvantage, a

manager is expected to increase dividend payout as investor protection increases. In

addition, the lack of impact of taxation in weak governance countries support the outcome

model that managers in those countries not only pay less dividends but ignore the tax

disadvantages assumed by their investors. Managers can get away with such practice not

only because investors’ rights are not well protected but also because investors are more

concerned about extracting cash than about the tax consequences of such extraction.

These results provide an additional perspective to the agency theory explanation of

dividend payout and show the interrelation between agency and taxation in explaining

dividend payout.

Similar results are reported for repurchases in the last four columns. The remaining

explanatory variables are similar to Table 3 and 4. We note, however, that the coefficient

of ROA is significantly higher (at 0.01 level) under the imputation than classical system,

suggesting that dividends are less sensitive to profitability in classical system as firms

smooth dividends more, i.e. have slower speed of adjustment.15

15 The low speed of adjustment found in classical system relative to other systems is

consistent with the argument in Rozycki (1997) that dividend taxation encourages

35

[Insert Table 6 here]

In Table 7, we assess the joint effects of shareholder protection and taxation on

dividends and share repurchases. As in the previous table, we group the full and partial

imputation systems into Imputation for space considerations, and we report the random effect

model and the Tobit model for both cash dividends and share repurchases scaled by total

assets. The results indicate that it is not tax and shareholder protection separately that

explain payouts. The interaction variables provide stronger results. For example, Law x

Imputation is positive in cash dividend but negative in repurchases regressions. These

results suggest that firms that operate in strong protection and imputation system are

significantly more likely to pay higher cash dividends but repurchase less than other firms

in the classical tax system and in weak shareholder protection. Similarly, Repurchase x

Imputation is negative in dividend regressions and Dividend x Imputation is negative in

repurchases equations. The results suggest that firms prefer to pay cash dividends instead

of repurchasing shares in the imputation system, while they do the reverse in the classical

system, in line with the tax hypothesis. Finally, TD x Imputation is positive and

significant in the dividend equations, suggesting that companies that operate in an

imputation system and where shareholders are taxed less on dividends than capital gains

pay the highest amount of dividends. The relationship of this variable in the repurchases

regressions is not significant. Overall, these results provide some evidence that dividends

and shareholder protection affect payouts.

[Insert Table 7 here]

managers to smooth dividends, i.e. slow down the speed of adjustment, to reduce the

present value of expected income tax liabilities of their investors.

36

3.4. Changes in Dividends across Dividend Tax Systems

In this section we focus on the impact of taxation and shareholder protection on the

decision to pay, increase and decrease cash dividends and repurchase shares.16 We include

the tax and governance variables as well as their interactions. The results reported in

Table 8 indicate that companies that operate in the full and partial tax systems are more

likely to pay dividends. TD is also positive suggesting that when shareholders are taxed

less on dividends than capital gains, firms pay dividends, in line with Ejie and Megginson

(2008) who find positive effect of TD on the probability to pay dividends. However, Law

is negative and insignificant, but Law x Imputation is positive and significant suggesting

that firms that operate in an imputation tax system and in strong shareholder protection

are more likely to pay dividends than their counterparts in other systems. The coefficient

of TD x Imputation is negative and significant, not consistent with the tax hypothesis,

while Repurchase x Imputation is negative and significant. The results for dividend

increases and reductions are relatively similar and suggest that the interaction between

shareholder protection and taxation affect significantly the decision to pay and to change

cash dividend payments. However, for the decision to repurchase shares the results are

relatively weak.

16 The foreign exchange bias may affect our classification of firms as dividend increasers

and cutters. For example, it is possible that we incorrectly classify a firm as dividend

cutter, even if the company continues to pay the same dividend in local currency, but due

to the U.S. dollar slide, the dividends appear to have gone down. Although we control for

that by including the Euro dummy, we also re-run probit model using data measured in

local currencies. The Probit results based on local currencies provide further support to

our earlier conclusions.

37

We also find, but not report, that 56% of the firms in our overall sample are paying

dividends. However, the proportion of 60% is relatively higher in the full compared to the

remaining two systems. Similarly, while the average proportion of companies that

increased their dividends during our sample period is 31%, it is statistically higher in the

partial and the full systems compared to the classical system. The probability of initiating

dividends is also statistically higher in the full, followed by the partial and it is the lowest

in the classical system. In contrast, the probability of never paying dividends is the lowest

in full imputation system, followed by the partial and then the classical system. Overall,

these results provide support for the tax impact on dividends and suggest that firms are

more willing to pay, initiate, and increase dividends and less likely to never pay dividends

in a more favourable tax environment. In contrast, the results for dividend cut and

omission are not consistent with our tax hypothesis. The probability of omitting or cutting

dividends is significantly higher in the full system compared to the classical system.

The coefficients of the remaining variables are relatively consistent with previous

studies (e.g., Fama and French (2001), Denis and Osobov (2008), Ejie and Megginosn

(2008) and Chay and Suh (2009)). The significance of the coefficient of size (ln(S)) and

profitability (ROA) variables suggests that larger and profitable firms are more likely to

pay and increase dividends and they are less likely to reduce or cut dividends. Dividend

premium is not significant, and when it is, its sign is not as expected, inconsistent with the

catering theory of dividend (Baker and Wurgler (2004)). These results are in line with

Denis and Osobov (2008) and Ejie and Megginson (2008) who show that dividend

premium consistently carries the wrong sign in some countries in their samples, and do

not support Ferris, Jayaraman and Sabhel (2009) who find that while in civil law countries

catering does not explain dividends, in common law countries shareholders extract

38

dividends by putting a premium on dividend paying firms.17 Cash flow volatility (CFVol)

is negatively related to the likelihood of paying and increasing dividends, but positively

related to the probability of cutting dividend. The negative coefficient of M/B in paying

and increasing dividends and the positive coefficient in reducing dividends are consistent

with the need to fund growth. Other studies report mixed evidence of the impact of M/B

on dividend changes. For example, Denis and Osobov (2008) report a negative coefficient

for M/B in U.S., Canada, and U.K. and a positive coefficient in Germany, France, and

Japan. Similarly, Chay and Suh (2009) show inconsistent impact of M/B ratio as they

report nonnegative or insignificant M/B coefficient in many countries.

[Insert Table 8 here]

4. Robustness checks

In this section we assess whether our results are driven by our sample specifications and

the measurements of our variables. We report the tax and investor protection variables

when we re-run the regression results reported in Table 4 in Table 9 and those in Tables 5

and 7 in Table 10. The remaining variables are not reported for space considerations.

4.1. Impact of zero dividends and negative earnings

We first use only dividend paying companies. The results reported in the baseline

regression shows that the measurement of the dependent variable does not affect our main

findings in Table 4 as dividend payout ratios are higher in the full and partial compared to

the imputation system, and in countries with strong shareholder protection. We then

17 Hoberg and Prabhala (2009) investigate the role of dividend premium in explaining

dividend decisions to find that dividend premium is not significant and with a wrong sign.

39

include non-paying firms, we re-run our baseline regression.18 The results in Table 9 show

that the tax system dummies are still significant with the correct sign for dividends19

(model A1). In (B1), the partial tax system dummy and the tax discrimination (TD) for

repurchases are significant with the predicted negative sign. However, the full tax dummy

variable lost its significance, although it is signed correctly.

We also run the regressions excluding negative earnings (models A2 and B2). We

find similar results as the tax system dummies are significant with the correct signs for

dividends and repurchases. However TD switched to negative sign in the dividend

regression and became significant.20 These findings explain the negative and significant

coefficient of TD in Eije and Megginson (2008) who follow Julio and Ikenberry (2005)

and set the dividend payout ratio equal to one if earnings are negative. Finally, in all

regressions, the variable Law is qualitatively not affected by including non-payers or by

excluding negative earnings. Thus, in spite of some impacts of non-payers and negative

earners, our main tax dummies perform well specially in explaining dividends and TD

variables kept its power in explaining repurchases.

4.2. Impact of U.S. data

U.S. firm/year observations represent 54%, 48%, and 27% in the classical, strong

protection, and overall sample respectively. With the relatively heavy presence of U.S.

18 We do not truncate our ratios as we adjust all firm level data by their industry averages. 19 In unreported results we find that size (ln(S)) coefficient is positive and significant,

suggesting that large companies in our overall sample are more likely to have high payout

ratios, but amongst the payers, large firms have lower payout policies. 20 We note that the coefficient of M/B in the payout regression is positive and significant

after excluding negative earnings.

40

data in our sample, it is important to know whether our results are driven by the behavior

of U.S. firms. For example, it is possible that the lower payout ratio in classical system

countries is driven by the lower propensity to pay dividends in the U.S. (Fama and French

(2001)), especially since in other countries many firms still pay dividends (Denis and

Osobov (2008)). To address this issue, we follow Brockman and Unlu (2009) and

Ferreira, Massa, and Matos (2010) and re-run our regression without U.S. data. The

results in (A3) and (B3) show that our tax dummies are qualitatively unaffected by

dropping US data in dividend regression, however they lost significance in repurchases

regression. Interestingly, in (A3) Law is larger and more significant after dropping the US.

4.3. Impact of ownership structure

In a recent work, Ferreira et al. (2010) show that foreign institutional investors press for

fewer dividends since most countries impose a withholding tax on their dividends. Even if

it is possible to credit those taxes against home country taxes, many institutional investors

are tax exempt and cannot take advantage of such credit. Unlike foreign institutional

investors, local institutional investors are expected to press for higher payout to mitigate

agency and information asymmetry costs. Using the institutional ownership data used by

Ferreira et al. (2010), we find that foreign institutional ownership is lower in classical

system countries (correlation -0.49), while domestic institutional ownership is higher in

those countries (correlation 0.56). We find the opposite in full and partial system

countries where the correlations between full and partial system dummies with foreign

institutional ownership are 0.10 and 0.45, respectively, while their respective correlations

with domestic institutional ownership are -0.31 and -0.35. These results indicate the

41

existence of country level dividend clienteles where foreign investors prefer countries

with some tax relief.

To the extent that foreign (domestic) institutional investors impact dividend

payout negatively (positively), our results may be biased downward as we dot not control

for institutional ownership. In addition, ownership concentration impacts the sensitivity of

payout to tax advantage of dividends, as large shareholders are likely to encourage

dividend payments if they perceive dividends to have a lower tax cost.21 Finally, countries

with low protection have higher ownership concentration, and since both variables impact

payouts, our results for the Law variable may be biased by omitting a relevant variable.

We address this issue by adding two variables to our regression: (i) country level

percentage of total institutional ownership relative to total market capitalization, and (ii)

an interaction term between the first variable and a dummy that equals one if the

proportion of foreign institutional investors is larger than 60% (the sample mean). We use

the same data as Ferreira et al. (2010) and re-run our main regression by adding these two

additional variables for dividends (A4) and repurchases (B4). Finally, we control for

country level ownership concentration measured by the average percentage of common

shares owned by the top three shareholders in the ten largest non-financial, privately-

owned domestic firms in a given country using La Porta et al. (2006) data.

In dividends regression (A4) our tax systems kept their significance especially the

full tax dummy which is stronger in magnitude and level of significance. TD in (A4) and

Law in (B4) are also highly significant. In unreported results, we find a positive and

significant coefficient for ownership concentration, in line with the proposition that large

21 Blouin et al. (2004) and Jacob and Jacob (2010) show that in the presence of dividend

tax disadvantage, shareholders concentration is likely to drive dividend increases.

42

shareholders monitor managers and reduce the agency cost of free cash flow (Shleifer and

Vishny (1986)). In line with Ferreira et al. (2010), we also find, but do not report, that

institutional ownership variable is positive and significant, while the foreign ownership

dummy is negative and significant when we exclude the U.S. data in the dividend

regression (A4), but when we include U.S. data, both variables are negative and foreign

dummy is insignificant. In the repurchases equation (B4), the two institutional ownership

variables are positive and significant, suggesting that foreign institutional investors are

more disadvantaged with dividends than repurchases.

4.4. Additional Country Specific Controls

We control for several country specific variables that are shown to have an effect on

payout policy to insure that our results are not biased by omitting variables. We control

for the following institutional variables. First, risk of expropriation as firms in high

expropriation risk countries are encouraged to hold less liquid assets and payout more

cash to reduce the chance of expropriation (Faccio et al. (2001)). Second, creditors’ rights

as countries with poor creditors rights are expected to have lower payout to substitute for

such weak rights (Brockman and Unlu (2009)). Third, rule of law as countries with higher

score for rule of law are expected to have higher dividends based on the outcome model

(LLSV (2000b)). Fourth, stock market development measured as stock market

capitalization relative to GDP, as firms in countries with less developed stock markets are

more likely to pay lower dividends and accumulate more cash. Fifth, accounting

disclosure quality as it affects payout policy (Brockman and Unlu (2008)). The data on all

of the above variables is extracted from LLSV (1998).

43

Models (A5) and (B5) show that our tax variables are stronger in magnitude and

significance when we control for the above variables. However, Law becomes

insignificant in dividend regression. Further analysis shows that this is due mainly to the

inclusion of creditors’ rights which support the argument of Brockman and Unlu (2009)

that the agency cost of debt has a stronger impact on dividends policies than agency cost

of equity. In repurchases regression, Law is significant after controlling for country

specific variables. We also find, but not report, that in dividend regression, all the

additional country specific variables are significant except accounting discloser quality

which was not significant, while in repurchases all the five variables are not significant.

4.5. Alternative investor protection measures

In this section we use alternative measures of investor protection to assess whether our

results are robust. In models (A6) and (B6), we replace the anti-self dealing index with the

revised anti-directors rights index from Djankov et al. (2008). In addition, in models (A7)

and (B7) we replace the anti-self dealing index with a dummy indicating civil law origin

for the country. The tax system variables in both the dividend and repurchases regressions

are significant, and in the repurchases regression TD is also significant. However, the

anti-directors rights is insignificant, in line with the argument of Djankov et al. (2008) that

anti-self dealing index provides a superior measurement for investor protection than anti-

directors rights. Consistent with LLSV (2000b), the civil law dummy affects dividends

and repurchases.

44

4.6. Alternative Payout Measures

Our main results are based on dividends to total assets. The baseline regression above

tested for robustness using dividends over earnings. In this section we try two alternative

ratios: dividends over sales and dividends over operating cash flows. In models (A8) and

(A9), our tax system dummies are still significant, but the Law variable is not significant

when we use dividends to sales as a dependent variable. We also take the log of dollar

dividends as a dependent variable in (A10). The results show that all the main variables

are significant with the expected sign.

In Panel B., we use two alternative measures for repurchases to make sure our

main results are not biased towards specific measures. In model (B8), we use the

percentage of repurchases relative to total payout which include repurchases and

dividends. We still find that our tax variables and Law are significant. We get similar

results when we measure repurchases in terms dollars (in log form) in model (B9).

[Insert Table 9]

4.7. Joint impact of taxation and governance on payout

In Table 10 we re-run the regressions in Table 5 and 7 while experimenting with different

samples (excluding some countries), alternative payout measures of dividends,

repurchases, and Law variables, and additional country level controls. The dividends

results (Part I) are similar to our original regressions specially the taxation effect and the

joint effect of taxes and governance on dividends. The coefficient on repurchases seems to

be sensitive to the inclusion of some countries. In particular, when we exclude UK or

Japan, repurchases in strong investor protection countries became independent of

dividends but when we exclude both countries and US, repurchases become substitutes

for dividends. The results on repurchases (Part II) also show strong tax impact. However,

45

the joint impact of taxation and governance on repurchases became insignificant when we

use anti-directors rights as a measure for governance quality and when we include

intuitional and foreign ownership structures as control variables. In addition, the impact of

taxation on repurchases seems to be driven by US firms. When we exclude the US, firms

in full and partial system repurchase more shares than those in classical system countries

and TD become insignificant. Our overall results support the separate and joint effects of

taxation and governance on dividends and repurchases, especially on dividends.

[Insert Table 10]

5. Conclusion

We analyze the dividend payout policy of companies listed in 24 OECD member

countries under different tax systems of dividends and level of investor protection. We

reassess previous evidence that firms in high investor protection countries pay higher

dividends in the presence of tax costs of dividends. More specifically, we test whether

firms in strong investor protection countries pay dividends when their tax cost is high, or

whether they substitute them for share repurchases to maximize their shareholders’ after

tax return. We also assess whether in weak investor protection countries, investors prefer

to receive dividends, even if they incur high tax cost, to mitigate the appropriation of

private benefits by controlling shareholders.

Consistent with previous studies (e.g., LLSV (2000b), we show that firms in high

investor protection countries pay higher dividends, but the distribution of payouts across

tax systems is not homogeneous. In the classical tax system, firms in strong investor

protection countries pay significantly lower dividends than their counterparts in weak

investor protection countries, but they buyback significantly more shares than other firms;

and as the tax cost of dividends decreases, they pay higher dividends but buyback fewer

46

shares. However, in weak protection countries, payouts and repurchases are lower and the

impact of taxation is weak. Our results suggest that in strong protection countries,

shareholders accept less dividends and more repurchases when the tax cost of dividend

outweigh the benefit of reducing the agency cost; and managers maximize their

shareholders’ after tax return by substituting cash dividends for repurchases. In contrast,

in weak investor protection countries, managers appear to be able to set dividend policies

that are independent of tax costs as governance is poor and investors aim at extracting

cash than about the implied tax consequences. Thus, investors in such countries are likely

to suffer from the private benefits of expropriations, but also from the tax costs of

dividend payments. Overall, our results provide an alternative explanation of dividends

that combines the agency theory and taxation, as the interrelation between governance and

taxation provides a stronger explanation of dividend payouts across firms and countries.

While we provide further insight into this ongoing and controversial theoretical

and empirical question using a relatively large and more recent data, our analysis may

suffer from a number of limitations beyond our control. First, we do not have data on firm

level shareholding to compute fully the tax discrimination variable using the effective tax

rates of each category of shareholders. We rely on the standard and effective personal

income taxes of mainly individuals. Second, we assume that firms are subject to taxes of

their country of registration and quotation, while many companies are international and

may pay dividends from their foreign income. Forth, companies may have other ways of

managing their tax liability, particularly if they operate internationally. While these issues

are beyond the scope of our research because of data unavailability, the extent to which

their inclusion will strengthen or alter our results is a subject of further research.

47

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54

Table 1: Descriptive Statistics of the Variables

Panel A presents summary statistics of the main variables and Panel B presents a correlation matrix of tax, law, and

payout variables. The sample includes 44, 194 firm/year observations from 24 OECD countries from 2000 to 2007. N

Obs. is for the number of firm-year. DPS is for dividend per share, EPS is earnings per share, Div/NI s the ratio of

dividends over earnings. Div/S is the ratio of dividends to sales, Div/TA is the ratio of dividends to total assets, Div/CF

is the ratio of dividends to cash flow from operation. Rep/NI is the ratio of repurchased shares during the year over

earnings. Rep/TA is the ratio of repurchased shares during the year over total assets. Rep/TP is the ratio of repurchases

over the sum of dividends and repurchases. ROA is profit after tax but before interest to total assets. Ln(S) is the

natural logarithm of sales. D/E is long-term debt divided by the market value of equity. M/B is market value to book

value of the firm. % Δ TA is the percentage change in total assets. Law is the score of anti self-dealing index reported

in Djankov et al. (2008). CFVol is the standard deviation of the log of operating cash flow. Repurchases is the ratio if

repurchased shares during the year to total assets. Age is the number of years the firm is in the database. TD is the tax

discrimination variable, the ratio of the after-tax dividend income to after-tax capital gains. DP is the dividend

premium, the difference in the logs of value weighted average market to book ratio of dividend payers and non payers.

gGDP is the growth in real GDP. Euro is a dummy variable that equals one if the country is an EU member and zero

otherwise. All accounting variables are measured in US dollars for all firms. All accounting variables are winsorized at

the top and bottom 1%. All correlations coefficients in panel B are significant at 1% level except the ones in bold.  

 

Panel A: Summary Statistics

Variables N Mean Median SD Min Max

DPS 44,194 0.29 0.04 0.69 0.00 14.53 EPS 44,194 0.92 0.34 2.11 -5.47 14.97 Div/NI 44,194 0.23 0.08 0.41 -1.42 3.44 Div/CF 42,627 0.12 0.04 0.20 -0.66 1.49 Div/TA 44,194 0.01 0.00 0.02 0.00 0.16 Div/S 44,194 0.01 0.00 0.03 0.00 0.33 Rep/TA 42,953 0.00 0.00 0.01 0.00 0.14 Rep/NI 42,953 0.06 0.00 0.21 -0.30 1.80 Rep/TP 42,953 0.18 0.00 0.35 0.00 1.00 ROA 44,194 0.01 0.03 0.13 -1.03 0.27 ln(S) 44,194 6.08 6.19 2.02 0.01 11.71 D/E 44,194 0.38 0.18 0.6 0.00 5.08 M/B 44,194 1.79 1.29 0.97 0.56 9.39 %Δ TA 39,238 0.18 0.05 1.89 -0.99 173.9 CFVol 42,361 0.06 0.04 0.05 0.00 2.22 Age 44,194 13.76 12.00 5.93 1.00 30.00 DP 44,194 0.06 0.11 0.31 -0.85 1.33 TD 44,194 0.96 0.97 0.19 0.40 1.51 Law 44,194 0.59 0.64 0.21 0.17 0.95 gGDP 44,194 2.52 2.51 1.33 -5.70 9.36 Euro 44,194 0.38 0.00 0.48 0.00 1.00

55

Panel B: Correlation Matrix of Selected Variable 

  TD  Law  DPS  EPS  Div/NI  Div/CF  Div/S  Div/TA  Rep/TA  Rep/NI  Rep/TP 

Classical    ‐0.40  ‐0.20  ‐0.02  ‐0.04  ‐0.11  ‐0.02  ‐0.18  ‐0.19  0.16  0.18  0.07 Partial   0.28  0.25  ‐0.00  ‐0.05  0.05  0.01  0.08  0.10  ‐0.11  ‐0.12  ‐0.06 Full   0.18  ‐0.04  0.03  0.01  0.08  0.01  0.14  0.14  ‐0.09  ‐0.09  ‐0.02 TD  1  0.64  ‐0.15  ‐0.17  0.09  0.01  0.13  0.17  ‐0.02  ‐0.05  ‐0.09 Law    1  ‐0.24  ‐0.23  0.04  0.01  0.07  0.09  0.04  0.02  ‐0.06 DPS      1  0.66  0.31  0,03  0.32  0.38  0.05  0.03  ‐0.11 EPS        1  0.10  0.00  0.12  0.16  0.13  0.09  ‐0.05 Div/NI          1  0.03  0.48  0.55  0.00  0.05  ‐0.17 Div/CF            1  0.04  0.05  ‐0.00  ‐0.00  ‐0.01 Div/S              1  0.74  0.05  0.02  ‐0.15 Div/TA                1  0.09  0.03  ‐0.18 Rep/TA                  1  0.79  0.43 Rep/NI                    1  0.45 Rep/TP                      1 

56

Table 2: Distribution of Dividend and Tax Variables across Countries and Tax Systems

The sample includes 44,194 firm/year observations from 24 OECD countries from 2000 to 2007. Strong (weak) protection

sample is for countries with Anti-self dealing index (Law) greater (lower) than the mean, using the score of anti self-dealing

index reported in Djankov et al. (2008). TD is the tax discrimination variable, the ratio of the after-tax dividend income to

after-tax capital gains. No. firms if for the number of firms in each country; No. Obs. is for the number of firm-year. DPS

(EPS) is for dividend (earnings) per share, Div is dividends, NI is earnings, TA is total assets. Rep is repurchased shares

during the year, TP is the sum of dividends and repurchases. All accounting variables are measured in US dollars for all

firms and winsorized at the top and bottom 1%. * indicate significant at 1% or 5% level between strong and weak

protection. The letters a, b, and c indicate significant difference at 1% or 5% level between classical vs. Partial, Classical

vs. Full, and Partial vs. Full, respectively.

Country No. Firms 

No. Obs. 

TD  Law  DPS  EPS  Div/NI Div/TA 

% Rep/NI 

Rep/TA % 

Rep/TP 

Panel A: Strong Protection Countries a) Classical Tax System Ireland   59  291  0.72  0.79  0.10  0.42  0.19  1.30  0.03  0.16  0.10 U S A  2,612  12,093  0.94  0.65  0.21  0.98  0.12  0.67  0.13  0.90  0.23   2,671  12,384  0.93  0.65  0.21  0.97  0.12  0.68  0.13  0.88  0.23 b) Partial Imputation Tax System Canada  769  3,021  0.93  0.64  0.21  0.67  0.17  1.06  0.04  0.26  0.15 UK  1,573  6,063  1.25  0.95  0.12  0.20  0.31  1.84  0.03  0.22  0.12   2,342  9,084  1.14  0.85  0.15  0.36  0.26  1.58  0.03  0.23  0.13 c) Full Imputation Tax System Australia  880  3,478  1.05  0.76  0.08  0.11  0.35  2.31  0.02  0.15  0.12 New Zealand  66  310  1.49  0.95  0.11  0.14  0.50  3.25  0.02  0.12  0.12   946  3,788  1.09  0.78  0.08  0.11  0.36  2.39  0.02  0.15  0.12 

Panel B: Weak Protection Countries a) Classical Tax System Austria  75   291   0.75  0.21  0.99  2.85  0.26  1.10  0.04  1.72  0.14 Belgium  76   357   0.85  0.54  1.03  2.61  0.24  1.38  0.06  3.98  0.19 Denmark  99   467   0.57  0.46  1.04  2.91  0.24  1.31  0.69  0.69  0.24 Netherlands  168   824   0.67  0.20  0.74  1.69  0.29  1.65  0.05  0.37  0.16 Japan  1,051   6,291   0.86  0.50  0.13  0.46  0.25  0.65  0.07  0.22  0.19 Poland  113   377   1.00  0.29  0.32  1.09  0.18  1.29  0.02  0.11  0.18 Portugal  46   94   0.84  0.44  0.17  0.42  0.26  1.14  0.06  0.27  0.24 Spain  118   71   0.96  0.37  0.43  1.46  0.23  1.41  0.05  0.22  0.20 Sweden  179   837   1.00  0.33  0.43  0.91  0.33  2.24  0.06  0.43  0.12 Switzerland  143   512   0.59  0.27  1.28  3.97  0.24  1.25  0.06  0.44  0.20   2,068   10,121   0.83  0.43  0.37  1.06  0.26  1.00  0.09  0.45  0.18 b) Partial Imputation Tax System Finland  113  232  1.15  0.46  0.71  1.24  0.44  3.82  0.00  0.01  0.12 France  623  1,027  0.91  0.38  0.97  2.84  0.24  1.30  0.00  0.01  0.14 Germany  467  1,906  0.76  0.28  0.57  1.55  0.22  1.00  0.00  0.02  0.22 Italy  218  578  0.94  0.42  0.24  0.57  0.26  1.13  0.00  0.01  0.19 Luxembourg  18  83  0.80  0.28  0.40  1.24  0.14  1.22  0.09  0.54  0.22 Norway  94  62  1.24  0.42  0.28  0.70  0.23  1.10  0.09  0.50  0.26 Portugal  46  149  0.89  0.44  0.11  0.27  0.25  0.94  0.05  0.20  0.19 Spain  118  530  0.91  0.37  0.42  1.33  0.27  1.48  0.03  0.16  0.14 Turkey  154  685  0.77  0.43  0.18  0.43  0.18  1.50  0.00  0.01  0.21   1,851  5,252  0.85  0.36  0.53  1.46  0.24  1.31  0.01  0.05  0.19 c) Full Imputation Tax System Finland  113  371  1.41  0.46  0.72  1.17  0.46  2.68  0.01  0.04  0.13 France  623  1,942  0.85  0.38  0.89  2.90  0.21  1.11  0.01  0.02  0.20 Italy  218  460  0.96  0.42  0.14  0.21  0.27  1.02  0.01  0.02  0.25 Mexico  97  523  1.00  0.17  0.04  0.20  0.15  1.09  0.07  0.47  0.28 Norway  94  269  1.39  0.42  0.42  0.93  0.30  1.52  0.03  0.14  0.12   1,145  3,565  0.99  0.37  0.62  1.83  0.24  1.29  0.02  0.10  0.20 

57

Panel C: Overall Sample  All Strong  5,959   25,256   1.03 abc  0.74 abc  0.17 abc  0.62 abc  0.21 abc  1.26 abc  0.08 abc  0.54 abc  0.18 ab All Weak  5,064   18,938   0.87 abc  0.40 abc  0.46 abc  1.32 abc  0.25 ab  1.14 ab  0.06 abc  0.27 abc  0.19 bc All Classical   4,739  22,505  0.89  0.53  0.28  1.01  0.18  0.83  0.10  0.61  0.21 All Partial  4,193  14,336  1.04  0.69  0.29  0.76  0.26  1.49  0.02  0.17  0.15 All Full  2,091  7,353  1.04  0.58  0.34  0.94  0.30  1.86  0.02  0.13  0.16 All Sample  11,032  44,194  0.96*ab  0.59*abc  0.29*bc  0.92*abc  0.23*abc  1.21*abc  0.06*abc  0.38*abc  0.18*abc 

58

Table 3: Payout Ratio across Dividend Tax and Governance Systems

The table reports the mean dividend (Panel A) and repurchases (Panel B) over total assets for 6 subsamples based on three

tax systems (Classical/Partial/Full) and two TD levels (high/low). Each country/year is classified into the three main

dividend tax treatment classes: Classical System (Classical), Full integration system (Full), Partial integration System

(Partial). TD is tax discrimination ratio measured as the after tax individual income from dividend divided by the after tax

individual income from capital gain. A country is classified as high (low) TD in certain period if its TD is larger (smaller)

than the median TD of the broader sample. The overall sample includes 44, 194 firm/year observations from 24 OECD

member countries between 2000 and 2007. p‐χ2  is p-values of Chi-square statistics to test for homogeneity across the tax

groups. Payout ratios are winsorized at the top and bottom 1%. The letters a, b,and c, indicate significant difference at 1%

level between classical vs. Partial, Classical vs. Full, and Partial vs. Full, respectively. *,**,and *** indicate significance at

10,5, and 1 percent levels, respectively. 

System  All 

Protection Tax discrimination

Strong  Weak  Strong ‐ Weak  High  Low High ‐ Low 

Panel A:  Mean Div/TA (%) ‐ Overall Sample

Classical Partial Full p‐χ2  High TD Low TD High ‐ Low  All 

0.825 1.490 1.856 0.000      1.212 abc 

0.682 1.581 2.389 0.000  1.530 0.725 0.805***  1.262 ab 

1.000 1.333 1.290 0.000  1.301 1.073 0.228***  1.147 ab 

‐0.318*** 0.248*** 1.099***   0.229*** ‐0.348***   0.115*** 

0.873 1.797 2.211 0.000      1.469abc 

0.785 1.149 1.088 0.000      0.935 ab 

0.088*** 0.648*** 1.123***       0.534*** 

Panel B:  Mean Rep/TA (%) ‐ Overall Sample

Classical Partial Full p‐χ2  High TD Low TD t High ‐ Low  All 

0.098 0.024 0.019 0.000      0.459 abc 

1.047 0.282 0.188 0.000  0.545 0.827 ‐0.282***  0.639 abc 

0.344 0.054 0.124 0.000  0.296 0.188 0.108***  0.222abc 

0.703*** 0.228*** 0.064***   0.249*** 0.636***   0.417*** 

0.743 0.291 0.216 0.000      0.478 abc 

0.713 0.096 0.030 0.000      0.439abc 

0.030 0.195*** 0.186***       0.039 

59

Table 4: Dividend Payout Ratio, Governance, and Dividend Tax Systems The table reports the regression results of dividends and buybacks over total assets on tax, governance and

control variables. The data includes 44,194 observations from 23 OECD countries in 2000-2007. The

dependent variables are: Equation (1) industry-adjusted data - country random effect; Equation (2) Industry-

adjusted data - country random Effect using dividends payers only; (3) Tobit model with country random

effect; Equations (4) to (5) are for repurchases with (5) including only repurchasing firms. The remaining

variables are as defined in Table 1. Standard errors are in parentheses. ***, **, * Significant at 0.01, 0.05 and

0.1 level, respectively.

Dependent   

Div/TA  Rep/TA 

Model  (1)  (2)  (3)  (4)  (5)  (6) 

Intercept  

‐0.019*** (0.001) 

‐0.007***

(0.002) ‐0.045***

(0.003) ‐0.001(0.001) 

‐0.012*** (0.003) 

‐0.032***

(0.004) Full   

0.011*** (0.000) 

0.004***

(0.001) 0.016***

(0.001) ‐0.003***

(0.000) ‐0.007*** (0.001) 

‐0.007***

(0.001) Partial   

0.004*** (0.000) 

0.005***

(0.001) 0.006***

(0.001) ‐0.004***

(0.000) ‐0.008*** (0.001) 

‐0.008***

(0.001) TD  

0.003*** (0.001) 

‐0.001(0.001) 

0.004***

(0.001) ‐0.002***

(0.001) ‐0.005*** (0.001) 

‐0.003**

(0.002) Law  

0.009*** (0.000) 

0.012***

(0.004) 0.012***

(0.002) 0.008***

(0.001) 0.025*** (0.001) 

0.004***

(0.002) 

Rep ‐0.006*** (0.000) 

‐0.010**

(0.004) ‐0.019*

(0.011)      

 Div 

     ‐0.001***

(0.002) ‐0.002*** (0.000) 

‐0.001**

(0.000) ROA  

0.039*** (0.001) 

0.102***

(0.006) 0.179***

(0.007) 0.012***

(0.000) 0.011*** (0.002) 

0.039***

(0.003) ln(S)  

0.001*** (0.000) 

‐0.001***

(0.000) 0.002***

(0.000) 0.001***

(0.000) 0.002*** (0.000) 

0.003***

(0.000) D/E  

‐0.004*** (0.000) 

‐0.003***

(0.000) ‐0.006***

(0.000) ‐0.001***

(0.000) ‐0.002*** (0.000) 

‐0.001***

(0.000) %ΔTA  

‐0.001*** (0.000) 

‐0.003**

(0.001) ‐0.002***

(0.001) ‐0.000***

(0.000) ‐0.006*** (0.001) 

‐0.016***

(0.001) M/B  

0.004*** (0.000) 

0.007***

(0.000) 0.002***

(0.000) 0.002***

(0.000) 0.009*** (0.000) 

0.000(0.000) 

CFVol  

‐0.011*** (0.002) 

‐0.011**

(0.005) ‐0.075***

(0.008) 0.002(0.001) 

0.011*** (0.004) 

‐0.002(0.005) 

Age  

0.001*** (0.001) 

0.001***

(0.000) 0.001***

(0.000) ‐0.000***

(0.000) ‐0.001*** (0.000) 

0.000(0.000) 

gGDP  

0.001*** (0.000) 

‐0.000(0.000) 

0.001***

(0.000) ‐0.000(0.000) 

0.001*** (0.000) 

‐0.000(0.000) 

Euro  

0.004*** (0.000) 

0.005***

(0.000) 0.006***

(0.001) ‐0.011***

(0.000) ‐0.000 (0.000) 

‐0.003***

(0.001) Wald  λ2   (F)  9345.9*** 3768.2*** (55.39)*** 3538.2*** 3472.1***  (27.31)***

Adj (Pseudo)R2    0.46  0.50 (0.24) 0.27 0.33  (0.11)N  38,246  22,113 38,246 38,246 14,755  38,246

60

Table 5: Dividend Payout Determinants across Governance Systems

The table reports the regression results of dividends and buybacks over total assets on tax and control variables, split into

strong and weak shareholder protection. The data includes 44,194 observations from 23 OECD countries in 2000-2007.

The dependent variables are: Equation (1) industry-adjusted data - country random effect; Equation (2) Tobit model with

county random effect; Equations (3) and (4) are for repurchases. The remaining variables are as defined in Table 1.

Standard errors are in parentheses. ***, **, * Significant at 0.01, 0.05 and 0.1 level, respectively.

Indep.                                           Div/TA                                    Rep/TA      Model  (1)  (2)  (3)  (4) 

Law System  Strong   Weak   Strong   Weak   Strong   Weak   Strong   Weak  Intercept  

‐0.010*** (0.001) 

0.005** (0.003) 

‐0.057***

(0.007) ‐0.018(0.014) 

0.005***

(0.001) ‐0.002*** (0.001) 

‐0.056***

(0.013) ‐0.008**

(0.004) Full   

0.021*** (0.001) 

0.000 (0.001) 

0.040***

(0.003) ‐0.002(0.002) 

‐0.004***

(0.000) ‐0.001*** (0.000) 

‐0.012***

(0.002) ‐0.003(0.002) 

Partial   

0.006*** (0.000) 

0.001 (0.001) 

0.013***

(0.001) ‐0.001(0.002) 

‐0.004***

(0.000) ‐0.003*** (0.000) 

‐0.008***

(0.002) ‐0.006***

(0.001) TD  

0.004*** (0.001) 

‐0.002*** (0.001) 

0.003(0.003) 

0.012(0.010) 

0.001(0.001) 

‐0.003*** (0.001) 

0.008 (0.006) 

‐0.005*

(0.003) Rep/TA  

‐0.005 (0.003) 

0.020*** (0.003) 

0.010(0.028) 

0.065**

(0.031)  

  

Div/TA  

     ‐0.001***

(0.000) 0.001* (0.000) 

‐0.003***

(0.001) 0.001***

(0.000) ROA  

0.028*** (0.001) 

0.072*** (0.003) 

0.152***

(0.034) 0.230***

(0.048) 0.120***

(0.001) 0.007*** (0.001) 

0.055*

(0.027) 0.009(0.007) 

ln(S)  

0.002*** (0.000) 

0.001** (0.000) 

0.005***

(0.001) 0.001**

(0.000) 0.002***

(0.000) 0.001*** (0.000) 

0.004***

(0.001) 0.001*

(0.000) D/E  

‐0.004*** (0.000) 

‐0.003*** (0.000) 

‐0.005***

(0.002) ‐0.005***

(0.001) ‐0.002***

(0.000) ‐0.007*** (0.000) 

‐0.001(0.002) 

‐0.001(0.000) 

%ΔTA  

‐0.001*** (0.000) 

‐0.001*** (0.000) 

‐0.002***

(0.000) ‐0.003***

(0.001) ‐0.001***

(0.000) ‐0.001*** (0.000) 

‐0.024***

(0.001) ‐0.008***

(0.002) M/B  

0.004*** (0.000) 

0.005*** (0.000) 

0.002(0.002) 

0.003(0.001) 

0.002***

(0.000) 0.001*** (0.000) 

0.000 (0.001) 

‐0.001(0.001) 

CFVol  

‐0.014*** (0.002) 

‐0.012*** (0.003) 

‐0.082***

(0.017) ‐0.061***

(0.013) ‐0.001(0.002) 

‐0.001 (0.001) 

‐0.002(0.010) 

‐0.002(0.006) 

Age  

0.001*** (0.000) 

0.001*** (0.000) 

0.000(0.000) 

0.000(0.000) 

0.001***

(0.000) 0.000(0.002) 

0.001**

(0.000) 0.000(0.000) 

gGDP  

‐0.001*** (0.000) 

‐0.000 (0.001) 

‐0.000**

(0.000) ‐0.000(0.000) 

‐0.001**

(0.000) 0.001*** (0.000) 

‐0.000(0.001) 

0.000(0.000) 

Euro  

0.006*** (0.001) 

0.003 (0.002) 

0.016***

(0.003) 0.005***

(0.002) ‐0.002***

(0.000) ‐0.001* (0.000) 

‐0.009***

(0.003) ‐0.003**

(0.001)  Chow test 

 (0.000) 

 (0.000) 

 (0.000)  (0.000) 

   

Wald  λ2   (F)  5709.1***  2911.4***    1807.2*** 713.61***   Adj (Pseudo)R2    0.99  0.08  0.42  0.18 0.75 0.35 0.33  0.05N  21,651  16,595  21,651 16,595 21,651 16,595  21,651 16,595

61

Table 6: Dividend Payout Determinants across Dividend Tax Systems

The table reports the regression results of dividends and buybacks over total assets on governance and control variables,

split into tax systems. The data includes 44,194 observations from 23 OECD countries in 2000-2007. The dependent

variables are: Equation (1) industry-adjusted data - country random effect; Equation (2) Tobit model with country random

effect; Equations (3) and (4) are for repurchases. The remaining variables are as defined in Table 1. For space

considerations we group the full and partial imputation systems into Imputation. Standard errors are in parentheses. ***, **, * Significant at 0.01, 0.05 and 0.1 level, respectively.

Indep.                                           Div/TA                                    Rep/TA      Model  (1)  (2)  (3)  (4) 

Tax System  Classical  Imputation  Classical  Imputation  Classical  Imputation  Classical Imputation 

Intercept  

‐0.003*** (0.001) 

‐0.010*** (0.002) 

‐0.014***

(0.004) ‐0.047***

(0.004) ‐0.019***

(0.002) ‐0.018** (0.016) 

‐0.028***

(0.007) ‐0.021***

(0.004) TD  

0.005*** (0.001) 

0.004** (0.002) 

0.002(0.002) 

0.018***

(0.003) ‐0.008***

(0.003) ‐0.006*** (0.002) 

‐0.013***

(0.003) 0.002(0.002) 

Law  

‐0.006*** (0.001) 

0.018*** (0.003) 

‐0.014***

(0.003) 0.014***

(0.002) 0.017**

(0.003) 0.011*** (0.002) 

0.024***

(0.004) ‐0.001(0.002) 

Rep/TA  

0.020*** (0.003) 

‐0.009** (0.004) 

‐0.010***

(0.001) ‐0.038***

(0.001)  

  

Div/TA  

     0.002***

(0.002) ‐0.004*** (0.001) 

0.001**

(0.001) ‐0.000(0.000) 

ROA  

0.023*** (0.001) 

0.051*** (0.002) 

0.134***

(0.008) 0.206***

(0.010) 0.017***

(0.003) 0.001 (0.002) 

0.087***

(0.007) 0.013***

(0.002) ln(S)  

0.001*** (0.000) 

0.002*** (0.000) 

0.002***

(0.000) 0.003***

(0.000) 0.002***

(0.000) 0.002*** (0.000) 

0.004***

(0.000) 0.001***

(0.000) D/E  

‐0.003*** (0.000) 

‐0.005*** (0.000) 

‐0.004***

(0.000) ‐0.007***

(0.001) ‐0.002***

(0.000) ‐0.000 (0.000) 

‐0.003***

(0.001) 0.001***

(0.000) %ΔTA  

‐0.001*** (0.000) 

‐0.001*** (0.000) 

‐0.006***

(0.001) ‐0.002***

(0.001) ‐0.001***

(0.000) ‐0.001* (0.000) 

‐0.019***

(0.003) ‐0.126***

(0.001) M/B  

0.003*** (0.000) 

0.006*** (0.000) 

0.001***

(0.000) 0.004***

(0.000) 0.002***

(0.000) 0.002*** (0.000 

0.002***

(0.001) ‐0.002***

(0.000) CFVol  

‐0.007*** (0.003) 

‐0.020*** (0.003) 

‐0.062***

(0.011) ‐0.080***

(0.010) 0.004(0.003) 

‐0.012** (0.005) 

‐0.022*

(0.012) 0.006*

(0.003) Age  

0.001*** (0.000) 

0.000 (0.000) 

0.000***

(0.000) 0.000***

(0.000) 0.000(0.000) 

0.001*** (0.000) 

0.000(0.000) 

0.000(0.000) 

gGDP  

0.000 (0.000) 

‐0.000(0.000) 

‐0.000(0.000) 

0.001***

(0.000) ‐0.001**

(0.000) 0.000 (0.000) 

‐0.003***

(0.001) 0.000(0.000) 

Euro  

0.008*** (0.000) 

‐0.001(0.001) 

0.009***

(0.001) ‐0.003***

(0.000) 0.001(0.001) 

‐0.016*** (0.001) 

‐0.002(0.002) 

‐0.001*

(0.001)  Chow test 

 (0.000) 

 (0.000) 

 (0.000)  (0.000) 

   

Wald  λ2   (F)  2956.2***  4292.8***  (22.23)*** (49.14)*** 579.75*** 933.37***  (17.71)*** (8.91)***

Adj (Pseudo)R2    0.43  0.54  0.20 0.36 0.32 0.32  0.12 0.07N  19,909  18,337  19,909 18,337 19,909 18,337  19,909 18,337

62

Table 7: Interaction Effects on Dividend Payouts The table reports the regressions of dividends and buybacks to total assets on tax, governance and

control variables. The data includes 44,194 observations from 23 OECD countries in 2000-2007. The

dependent variables are: industry-adjusted data - country random effect (1); Tobit model with country

random effect (2); Equations (3) and (4) are for repurchases. The other variables are in Table 1.

Standard errors in parentheses. ***, **, * Significant at 0.01, 0.05 and 0.1, respectively.

  (1)  (2)  (3)  (4) Dividend Decision  Div/TA  Div/TA  Rep/TA  Rep/TA 

Intercept  

0.002*** (0.001) 

‐0.012*** (0.001) 

‐0.011*** (0.001) 

‐0.091*** (0.016) 

Imputation  

‐0.021***

(0.001) ‐0.034***

(0.003) ‐0.000(0.002) 

0.014**

(0.007) 

TD  

‐0.003***

(0.001) ‐0.004*

(0.002) 0.001(0.004) 

0.005(0.007) 

LAW  

‐0.018***

(0.001) ‐0.038***

(0.003) 0.023***

(0.006) 0.024**

(0.011) 

Repurchase   

0.005***

(0.002) 0.004***

(0.000)     

Dividend   

   0.021*** (0.003) 

0.016*** (0.005) 

TD x Imputation  

0.016***

(0.002) 0.019***

(0.004) 0.002(0.004) 

0.006(0.008) 

Law x Imputation  

0.024***

(0.001) 0.053***

(0.004) ‐0.016*** (0.006) 

‐0.036***

(0.008) 

Repurchase x Imputation 

‐0.007**

(0.003) ‐0.003***

(0.001)     

Dividend  x Imputation  

   ‐0.026*** (0.003) 

‐0.028*** (0.007) 

M/B  

0.004 ***

(0.000)0.002***

(0.000)0.004 *** (0.000)

0.002 (0.002)

D/E  ‐0.004***

(0.000)‐0.006***

(0.000)‐0.001*** (0.000)

0.001(0.001)

Ln(S)  

0.001***

(0.000)0.003***

(0.000)0.001***

(0.000)0.004***

(0.001)ROA  

0.040***

(0.001) 0.180***

(0.007) 0.023***

(0.002) 0.093***

(0.012) 

CFVol  

‐0.011***

(0.002) ‐0.076***

(0.008) 0.004(0.004) 

‐0.003(0.011) 

%ΔTA  

‐0.000*** (0.000) 

‐0.002*** (0.001) 

‐0.000*** (0.000) 

‐0.043*** (0.008) 

Age  

0.000***

(0.000) 0.000***

(0.000) ‐0.000**

(0.000) 0.000***

(0.000) 

gGDP  

0.001***

(0.000) 0.001***

(0.000) 0.000(0.001) 

‐0.001***

(0.000) 

Euro 0.000(0.000) 

0.001(0.001) 

‐0.001(0.000) 

‐0.003**

(0.001) 

Wald  λ2   (F)  7955.7***  (54.31)***  1734.3***  (8.22)*** Adj(Pseudo) R2    0.58  (0.25) 0.26 (0.25)N  38,618  38,617 38,618 38,617

63

Table 8: Probit Regressions for Discrete Dividend Decisions

The table shows the likelihood of paying and changing dividends, and repurchases, with country

random effect. Full (Partial) system is a dummy equals 1 if the tax system is full (partial)

integration, and zero otherwise. TD is tax discrimination ratio measured as the after tax income from

dividend over the after tax returns from capital gain. Law is a dummy variable equals one if the firm

has above median anti-directors right score and zero otherwise using the index reported in Djankov

et al (2008). Repurchase Dummy indicates if the firm repurchase shares in year t. Dividend Dummy

indicates if the firm pay dividend in year t. ROA is profit after tax but before extraordinary items

divided by total assets. ln(S) is the natural logarithm of sales. D/E is long-term debt divided by the

market value of equity. M/B is market value to book value of the firm. CFVol is the standard

deviation of the log of operating cash flow. gGDP is the GDP growth rate. DP is Dividend

Premium, the difference in the logs of value weighted average market to book ratio of dividend

payers and non-payers. All accounting variables are in US dollars for all firms and winsorized at the

top and bottom 1%. Robust standard errors are in parenthesis. *,**,and *** significant at 10%, 5%, and

1% levels, respectively.

Dividend Decision  Pay  Increase  Decrease  Repurchase Intercept  

‐2.089*** (0.206) 

‐2.015*** (0.171) 

2.207*** (0.176) 

‐0.801*** (0.148) 

Full System  

0.958*** (0.220) 

0.854*** (0.190) 

‐0.803*** (0.196) 

0.411** (0.163) 

Partial System  

0.871*** (0.219) 

0.753*** (0.189) 

‐0.786*** (0.195) 

0.120 (0.161) 

TD  

0.820*** (0.128) 

0.650*** (0.110) 

‐0.655*** (0.110) 

‐0.188* (0.102) 

LAW  

‐0.357 (0.310) 

‐0.163 (0.217) 

0.052 (0.230) 

‐0.301** (0.152) 

Repurchase Dummy  

0.228*** (0.022) 

0.131*** (0.020) 

‐0.157*** (0.020) 

 

Dividend Dummy  

     0.406***

(0.021) TD x Imputation  

‐0.923***

(0.203) ‐0.742*** (0.178) 

0.833*** (0.182) 

0.097 (0.158) 

Law x Imputation  

0.840** (0.371) 

0.482* (0.263) 

‐0.519* (0.277) 

‐0.001 (0.186) 

Repurchase x Imputation 

‐0.233***

(0.032) ‐0.210*** (0.030) 

0.260*** (0.030) 

 

Dividend  x Imputation 

     ‐0.589*** (0.028) 

M/B  

‐0.145***

(0.010) ‐0.113*** (0.010) 

0.160*** (0.010) 

‐0.143*** (0.008) 

D/E  

‐0.335***

(0.014) ‐0.232*** (0.015) 

0.340*** (0.015) 

0.051*** (0.011) 

Ln(S)  

0.286*** (0.005) 

0.180*** (0.005) 

‐0.224*** (0.005) 

0.047*** (0.004) 

ROA  

6.624*** (0.130) 

8.270*** (0.158) 

‐7.301*** (0.153) 

0.470*** (0.066) 

64

CFVol  

‐4.800***

(0.201) ‐3.966*** (0.210) 

5.213*** (0.220) 

‐0.078 (0.140) 

Age  

0.020*** (0.001) 

0.004** (0.001) 

‐0.010*** (0.001) 

0.010*** (0.001) 

gGDP  

‐0.005 (0.009) 

0.003 (0.010) 

0.007 (0.010) 

0.012 (0.008) 

DP ‐0.066* (0.034) 

‐0.032 (0.030) 

‐0.005 (0.030) 

‐0.069** (0.027) 

Wald  Chisq  9546***  6690.3***  7672.7***  2370.1*** N  42,359  42,359  42,359  42,359

65

Table 9: Robustness checks on the predictably power of dividend taxation The table presents several model specifications for explaining dividend (Panel A) and repurchases

(Panel B). The dependent variable is dividends or repurchases over net income. Models (A0) and (B0)

presents the baselines results Equation 6 for dividends and repurchases, respectively. All models are

run using a regression similar to the one in Table 4 except for the robustness changes. In Models (A1)

and (B1) we include non-payers. In models (A2) and (B2) we exclude firms with negative earnings. In

models (A3) and (B3) we exclude U.S. firms. In models (A4) and (B4) we include ownership structure

controls, namely country level percentage of total institutional ownership relative to total market

capitalization, and an interaction term between the previous variable and a dummy that equals one if

the proportion of foreign institutional investors is larger than 60%. In models (A5) and (B5) we add

additional country specific institutional variables, namely risk of expropriation, creditor’s rights, rule of

law, stock market capitalization relative to GDP, accounting disclosure quality. All data on these

variables is extracted from LLSV (1998). In models (A6) and (B6) we measure the Law variable by

anti-directors rights index from Djankov et al. (2008). In models (A7) and (B7) the Law variable is

measured by a dummy that equals one if the company is originating in a common law country, and

zero otherwise. In models (A8), (A9), and (A10) the dividend payout is mastered as dividend to sales

ratio, dividend to operating cash flow ratio, and Log of dollar dividends, respectively. In models (B8)

and (B9), repurchases payout is measured by repurchases divided by the sum of repurchases and

dividends, and by the log of dollar amount of repurchases, respectively.

 

Robustness (Model No.)

Full System

Partial System

TD Law

Panel A: Dividends Baseline Regression (A0)

0.052*** (0.022)

0.057*** (0.021)

0.016 (0.029)

0.116** (0.056)

Sample: 1. Include non-payers

(A1)

0.0624*** (0.018)

0.0387** (0.016)

0.0107 (0.022)

0.1655*** (0.045)

2. Exclude negative earnings (A2)

0.0866*** (0.022)

0.0962*** (0.020)

-0.0914*** (0.026)

0.2475*** (0.054)

3. Exclude US data (A3)

0.0469*** (0.019)

0.0390** (0.017)

0.0426 (0.029)

0.1558*** (0.043)

Additional control variables: 1. Ownership structure

(A4) 2. Country specific variables

(A5)

0.1145*** (0.012) 0.1447*** (0.014)

0.0379*** (0.012) 0.1043*** (0.012)

0.0539** (0.026) 0.0239 (0.025)

0.2228*** (0.028) -0.0035 (0.032)

Alternative measures of Law 1. Law variable measured by anti-

directors Rights (A6) 0.0712*** (0.019)

0.0682*** (0.017)

0.0402 (0.027)

-0.0057 (0.010)

2. Law variable measured by 0.0722*** 0.0662*** 0.0310 0.0447**

66

common law dummy (A7) (0.019) (0.017) (0.027) (0.021) Alternative measures of Dividends

1. Dividends payout measured as dividends to Sales ratio (A8)

0.0082*** (0.002)

0.0085*** (0.002)

-0.0028 (0.001)

0.0045 (0.005)

2. Dividends payout measured as dividends to cash flow ratio (A9)

0.0724*** (0.026)

0.0726*** (0.024)

-0.0261 (0.026)

0.1491*** (0.058)

3. Dividends measured in dollars (A10)

0.2280*** (0.065)

0.3837*** (0.066)

0.2319*** (0.052)

0.2959** (0.153)

Panel B: Repurchases Baseline Regression (A0)

-0.002** (0.001)

-0.002*** (0.001)

-0.003*** (0.001)

0.001 (0.002)

Sample: 4. Include non-payers

(A1)

-0.0007 (0.001)

-0.0015** (0.001)

-0.0015** (0.001)

0.0010 (0.002)

5. Exclude negative earnings (A2)

-0.0024*** (0.001)

-0.0030*** (0.001)

-0.0029*** (0.001)

0.0022 (0.002)

6. Exclude US data (A3)

-0.0010 (0.001)

-0.0014 (0.001)

-0.0028*** (0.001)

0.0004 (0.000)

Additional control variables: 1. Ownership structure

(A4)

-0.0017*** (0.001)

-0.0051*** (0.001)

-0.0021*** (0.001)

0.0147*** (0.002)

2. Country specific variables (A5)

-0.0030*** (0.001)

-0.0037*** (0.001)

-0.0037*** (0.001)

0.0051* (0.003)

Alternative measures of Law 3. Law variable measured by anti-

directors Rights (A6)

-0.0019** (0.001)

-0.0026*** (0.001)

-0.0029*** (0.001)

-0.0001 (0.000)

4. Law variable measured by common law dummy (A7)

-0.0024*** (0.001)

-0.0030*** (0.001)

-0.0028*** (0.001)

0.0026*** (0.001)

Alternative measures of Repurchases : 1. Repurchases/(repurchases + div)

(B8)

-0.2864** (0.012)

-0.0431*** (0.011)

-0.1251*** (0.015)

0.0786*** (0.028)

2. Repurchases measured in dollars (B9)

-0.6689*** (0.283)

-1.052*** (0.272)

-1.3623*** (0.229)

1.6570** (0.874)

67

Table 10: Robustness Checks: Investor protection and dividend taxation The table presents re-runs of regressions appeared in Tables 5 and 7 with several model specifications for explaining dividend (Part I) and

repurchases (Part II). The dependent variable is dividends or repurchases over total assets. Panel A reports the main coefficients for different

samples that exclude US, UK, and Japan. Panel B reports the main coefficients with different measures of the dependent variable. In

dividend (Part I) the dependent variables are measured by the dividends scaled by earnings (NI), sales, or operating cash flows (CF). In

repurchases (Part II) the dependent variables is measured by repurchases divided by the sum of repurchases and dividends or repurchases

scaled by net income. In Panel C we use other measures for the Law variable, namely, the anti-directors rights index from Djankov et al.

(2008) or a dummy that equals one if the company is originating in a common law country, and zero otherwise. In Panel D, we include

ownership structure controls, namely country level percentage of total institutional ownership relative to total market capitalization, and an

interaction term between the previous variable and a dummy that equals one if the proportion of foreign institutional investors is larger than

60%. We also we add additional country specific institutional variables, namely risk of expropriation, creditor’s rights, rule of law, stock

market capitalization relative to GDP, accounting disclosure quality. All data on these variables is extracted from LLSV (1998). . ***, **, *

represent significance at 0.01, 0.05 and 0.1 level, respectively.

Part I: The dependent variable is Div/TA in Panels A, C and D)

Table 5 Table 7 Strong Weak

Full Partial TD Repurchases Full Partial TD Repurchases Law x Imp Panel A. Sample Selection

Excluding US Excluding UK Excluding Japan Excluding All above

0.021*** 0.021*** 0.021*** 0.023***

0.006*** 0.006*** 0.006*** 0.006***

0.006*** 0.004*** 0.004*** 0.006***

-0.012*** -0.001 -0.001 -0.019***

0.000 0.000 0.001 0.001

0.001 0.001 0.001 0.001

-0.002** -0.002** -0.003 -0.002

0.008*** 0.009*** 0.008*** 0.008***

0.027*** 0.034*** 0.028*** 0.031***

Panel B. Definition of Dependent Variable Div/NI Div/NI No negative Div/Sales Div/CF

0.307*** 0.329*** 0.025*** 0.197***

0.089*** 0.105*** 0.008*** 0.054***

0.078*** 0.073*** 0.010*** 0.044**

-0.519*** -0.616*** 0.005 -0.153***

0.017 0.027 0.002 0.012

0.010 0.018 0.004 0.028**

-0.026 -0.183** -0.000 0.020

0.485* 0.778*** 0.111*** -0.003

0.415*** 0.464*** 0.021*** 0.219***

68

Panel C. Definition of Law Variable

anti‐directors Rights Common law dummy 

0.021***

0.021*** 0.006***

0.006*** 0.006***

0.003*** ‐0.004*

‐0.001 0.000 0.000 

0.0020.001 

‐0.002‐0.002** 

0.009***

0.009*** 0.004*** 0.005*** 

Panel D. Additional Control Variables

Ownership structure Country specific 

0.022***

0.014*** 0.009***

0.020*** 0.003***

0.003* 0.0000.001 

‐0.004***

0.004*** ‐0.002***

0.005*** 0.004***

0.006*** 0.009***

0.008*** 0.026*** 0.009*** 

Part II: The dependent variable is Rep/TA in Panels A, C and D)

Table 5 Table 7 Strong Weak

Full Partial TD Dividends Full Partial TD Dividends Law x Imp Panel A. Sample Selection

Excluding US Excluding UK Excluding Japan Excluding All above

0.003*** -0.005*** -0.005*** 0.004***

0.003*** -0.005*** -0.004*** 0.005***

-0.001 -0.004*** 0.000 -0.003***

-0.001** -0.001*** -0.001*** -0.001**

-0.001*** -0.001*** -0.003*** -0.003***

-0.003*** -0.003*** -0.004*** -0.004***

-0.004*** -0.004*** -0.001* -0.001*

0.001*** 0.001*** 0.001** 0.001**

0.004*** -0.015*** -0.006*** -0.004***

Panel B. Definition of Dependent Variable Rep/(Rep+Div) Rep/NI Rep/NI No negative

-0.055*** -0.011*** -0.011***

-0.044*** -0.009*** -0.011***

-0.007 0.001 0.007

-2.772*** -0.029 -0.039

0.013 -0.006* -0.002

-0.006 -0.003 -0.002

-0.139*** -0.003 -0.009*

-2.522*** 0.163*** 0.106***

-0.016*** -0.014*** -0.015***

Panel C. Definition of Law Variable anti-directors Rights Common law dummy

-0.002*** -0.004***

-0.001*** -0.004***

0.000 0.001

-0.000 -0.001***

-0.003*** -0.001***

-0.004*** -0.003***

0.005*** -0.003***

-0.000 0.000*

-0.001 -0.005***

Panel D. Additional Control Variables Ownership structure Country specific

-0.005*** -0.005***

-0.003*** -0.002

0.005*** 0.005***

-0.001*** -0.001***

-0.003*** -0.002***

-0.004*** -0.003***

-0.000 -0.000

0.000 0.000

-0.002 -0.022***

69