A tax motivation for smoothing dividends

Lintner (1956) finds that managers perceive shareholders to value a smooth dividend stream. In response to this perception, managers smooth the dividend stream over time. In this paper, we demonstrate that personal income tax laws may provide managers with an additional reason to smooth the dividend...

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Bibliographic Details
Published in:The Quarterly review of economics and finance 1997-07, Vol.37 (2), p.563-578
Main Author: Rozycki, John J.
Format: Article
Language:English
Subjects:
Correlation analysis
Dividend distributions
Dividend policy
Dividends
Economic models
Hypotheses
Income taxes
Investments
Personal income
Present value
Shareholder relations
Shareholders wealth
Smoothing (Statistics)
Stockholders
Studies
Tax rates
Tax regulations
Taxable income
Taxation
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Summary:Lintner (1956) finds that managers perceive shareholders to value a smooth dividend stream. In response to this perception, managers smooth the dividend stream over time. In this paper, we demonstrate that personal income tax laws may provide managers with an additional reason to smooth the dividend stream. We find that dividend smoothing way increase wealth for a tax-paying investor by reducing the present value of the investor's future expected income tax liabilities. Dividend smoothing has no wealth effect for investors who do not pay taxes. We also find that smoothing the dividend stream is especially important to firms with volatile earnings. The potential increase in wealth from dividend smoothing is a function of the convexity of the income tax code. We apply the dividend model specified by Lintner (1956) to a nongrowing firm, and find that the optimal value for the speed of adjustment parameter is equal to zero. This corresponds to paying a fixed dividend. Finally, our model lends itself to a testable hypothesis regarding the smoothing of dividend income.
ISSN:1062-9769
1878-4259
DOI:10.1016/S1062-9769(97)90043-0