Individual investors’ dividend tax reform and investment efficiency

Abstract

This paper examines the effect of individual investors' dividend tax on corporate investment efficiency. Investment efficiency is closely related to increases in firm value and investor wealth, but the effect of tax incentive on investment efficiency is relatively unknown. By introducing plausibly exogenous dividend tax reform (DTR) for individual investors in China, we find that reducing dividend tax for individual investors significantly improves corporate investment efficiency. From the perspective of individual investor supervision, we find that the effect is particularly pronounced for firms with severe agency problems and inadequate supervision. Furthermore, evidence from firm innovation shows that DTR increases the attention on the firm's long-term development. Finally, we find that DTR reduces the level of investment but promotes the financialization of firms, implying that DTR primarily encourages firms to increase investment in high-return projects. Overall, our findings suggest that taxation can be used as an incentive to encourage individual shareholders to take on a supervisory role and thus improve the efficiency of resource allocation.