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The Cost of Misaligned Tax Incentives: Evidence from Tax-Motivated Special Dividends

Prior research finds that firms pay special dividends before dividend tax increases. We examine the real effects of this decision, finding that firms incur costs to pay these tax-motivated special dividends. Specifically, firms reduce investment and repurchases to pay tax-motivated special dividends. Further, the source of funding varies with the tax-incentives of shareholders. When the dividend is likely influenced by (tax-insensitive) institutional investors for the benefit of shareholders other than insiders, firms reduce repurchases and capital expenditures. Conversely, misaligned tax incentives between insiders and outside shareholders are associated with a reduction in R&D, consistent with managerial myopia which erodes shareholder value. Tests using total factor productivity support these conclusions. These findings add to our understanding of tax-based agency issues influencing real corporate decisions. Electronic copy available at: https://ssrn.com/abstract=3541067