Agency Costs and Dividends in Presence of Dividend Taxes: Evidence from Seos

Abstract

We examine the interaction of dividends, agency costs and taxes on SEO valuations using the 2003 dividend tax cut as a natural experiment. We find the difference in SEO announcement-day returns between dividend- and non-dividend-paying firms disappears after the tax cut evidencing dividend status dependent revaluations. Incorporation of agency costs reveals the marginal impact of excess cash flows on stock prices increases for high-growth, non-dividend-paying firms after the tax cut. Simultaneously, book leverage for non-dividend-paying firms decreases suggesting the shareholders expect to corner a greater proportion of returns in future. Overall, our findings support that dividend payouts lower agency costs.