The 2003 Dividend Tax Cut, Insider Equity Positions and Agency Costs: Were Changes in Dividend Payments Beneficial to Shareholders?

Abstract

The general consensus regarding the Jobs and Growth Tax Relief Reconciliation Act of 2003, which reduced the maximum tax rate on dividends for individual investors, is that aggregate dividend payments increased after passage of the act. Research also suggests that changes in dividend payments appear to have been influenced by insider equity positions where firms with larger management share ownership were more likely to increase dividends. Research has not addressed however, whether the increase in dividend payments was beneficial or detrimental for investors. We analyze shareholder returns in relation to unexpected dividends where the unexpected level of dividends is calculated using a variation of the Fama and French (2001) and DeAngelo et al. (2004; 2006) dividend models. Controlling for differences in financial characteristics among firms that have previously been identified in the literature as associated with dividends, we find a statistically significant positive relation between excess dividend payments and management share ownership in the period following implementation of the act. We also observe a negative relation between unexpected dividends and management options holdings in the post-act period. Neither of these relationships is evident in the pre-act period. We further find that buy-and-hold shareholder returns suffer when actual dividends differ from expected dividends, either in paying insufficient or excess dividends. This finding suggests that the relationship between the structure of insiders’ equity interests and the new dividend tax environment raises legitimate agency concerns.