The Effect of the Nineties' Tax Reforms on the Shareholders' Remuneration Policies Implemented by the Italian Unlisted Firms

Abstract

The amount and timing of dividends distributed to firms' shareholders are strategic decisions undertaken by managers of listed corporations. Unlisted firms are characterized by having their ownership performing, in most of the cases, the managerial function; the distribution of dividends often represents an occasional destination of the residual profits following the internal financing of the firm's growth. The size of the payout ratio is also related to the shareholders' preferences concerning their income stream. They crucially depend on how alternative methods of income distribution are subject to taxation. The Italian tax system, up to the early nineties', was clearly in favour of dividend distribution with respect to profit retention by the firm. This was a serious problem for medium and small firms with an ambitious target of expansion. Bank financing, the only source of financing effectively available to those firms, was extremely expensive. This paper extends the model proposed by Dessy (1994) by analysing the impact of the tax reforms realized in Italy during the nineties' on the preferences of the firm-shareholders in terms of the remuneration policies implemented by the unlisted corporations. Our numerical results clearly show that those reforms went into the right direction of encouraging profit retention by the firms and their consequent expansion. A positive side-effect related to such a phenomenon has been the growth of the Italian stock market.