Does dividend tax impede competition for corporate charters?

• Published in: Journal of Comparative Economics 2017-12, Vol.45 (4), p.751-772
• Main Authors: Lai, Tat-kei, Ng, Travis
• Format: Article
• Language: English
• Subjects: Agency costs; Corporate charters; Corporate federalism; Corporate governance; Corporate law; Dividend payment; Dividend taxation; Economics and Finance; Humanities and Social Sciences; Investment; Jurisdictional competition; Takeover regulations; Tax law
• ISSN: 0147-5967; 1095-7227
• DOI: 10.1016/j.jce.2017.08.001

•Develop a model of jurisdictional competition for corporate charters among the states.•A corporation’s agency cost depends on federal dividend income tax and the takeover regulations of its domicile state.•Federal dividend income tax affects the states' intensity of competition and equilibrium level of takeover regulations.•Dividend tax weakens charters competition when dividend-paying and the market for corporate control are complementary.•Dividend tax weakens firms' corporate governance by disincentivizing states to improve their corporate laws. We develop a model of jurisdictional competition for corporate charters among the states in which a firm’s agency cost depends on the federal dividend income tax rate and the takeover regulations of its domicile state. When firms are mobile across states, the federal dividend income tax rate affects both the intensity of competition among the states and the equilibrium level of state takeover regulations. Our model shows that increasing dividend tax rate weakens the competition for corporate charters under a condition: dividend-paying and the market for corporate control are complementary corporate governance mechanisms. This condition holds empirically, suggesting that dividend tax not only discourages firms from paying dividends but also weakens their corporate governance by disincentivizing states to improve their corporate laws.