This article evaluates the efficiency of existing dividend distribution tax in India from the perspective of investors’ preference pattern, as revealed in the market. It investigates the announcement effect of dividend in India in the presence of dividend distribution tax with specific legislative intent of discouraging dividend distribution. Using data on large profitable firms, we show that despite firm-level tax, higher dividend payout announcement leads to significant rise in share price. This implies that despite being tax-disadvantaged, investors of large profitable firms prefer higher payout, because it mitigates agency cost of retention. This shows that dividend distribution tax is inefficient.
Al-YahyaeeK. H.PhamT. M.WalterT. S. (2011a). The information content of cash dividend announcements in a unique environment. Journal of Banking & Finance, 35(3), 606–612.
2.
Al-YahyaeeK. H.PhamT. M.WalterT. S. (2011b). Dividend smoothing when firms distribute most of their earnings as dividends. Applied Financial Economics, 21(16), 1175–1183.
3.
AmihudY.MurgiaM. (1997). Dividends, taxes, and signaling: Evidence from Germany. The Journal of Finance, LII(1), 397–408.
4.
AuerbachAlan. (1979). Wealth maximization and the cost of capital. Quarterly Journal of Economics, 93(3), 433–446.
5.
BakerH. K.FarrellyG. E.EdelmanR. B. (1985). A survey of management views on dividend policy. Financial Management, 14(3), 78–84.
6.
BhattacharyaS. (1979). Imperfect information, dividend policy, and ‘the bird in the hand’ fallacy. The Bell Journal of Economics, 10(1), 259–270.
7.
BlackF. (1976). The dividend puzzle. Journal of Portfolio Management, 4(1), 5–8.
8.
BlackF. (1986). Noise. The Journal of Finance, 41(3), 529–543.
9.
CampbellJ. Y.LoA. W.MacinlayA. C. (2006). The econometrics of financial markets. New Delhi: New Age Publishers.
10.
CatonG, L.GohJ.KohersN. (2003). Dividend Omissions and Intra-industry Information Transfers. Journal of Financial Research, 26(1), 51–64.
11.
ChettyRajSaezEmmanuel. (2007). An agency theory of dividend taxation. NBER Working Paper No. 13538.
12.
DeAngeloH.DeAngeloL. (2006). The irrelevance of the MM dividend irrelevance theorem. Journal of Financial Economics, 79(2), 293–315.
13.
DeAngeloH.DeAngeloL.SkinnerD. J. (2004). Are dividends disappearing? Dividend concentration and the consolidation of earnings. Journal of Financial Economics, 72(3), 425–456.
14.
DeAngeloH.DeAngeloL.StulzR. M. (2006). Dividend policy and the earned/contributed capital mix: A test of the life-cycle theory. Journal of Financial Economics, 81(2), 227–254.
15.
DenisD. J.OsobovI. (2008). Why do firms pay dividends? International evidence on the determinants of dividend policy. Journal of Financial Economics, 89(1), 62–82.
16.
EasterbrookF. H. (1984). Two agency-cost explanations of dividends. The American Economic Review, 74(4), 650–659.
17.
FamaE. F. (1970). Efficient capital market: A review of theory and empirical work. The Journal of Finance, 25(2), 383–417.
18.
FeldsteinM.GreenJ. (1983). Why do companies pay dividend?The American Economic Review, 73(1), 17–30.
19.
GanguliS. K. (2011). Tax on dividend distribution, agency problem and firm value—Unique Indian perspective. The Business Review, Cambridge, 18(2), 132–140.
20.
GordonR. H.DavidF. B. (1980). Taxation and the stock market valuation of capital gains and dividends: Theory and empirical results. Journal of Public Economics, 14(2), 109–136.
21.
HarbergerA. C. (1962). The incidence of the corporation income tax. Journal of Political Economy, 70(3), 215–240.
22.
HealyP.PalepuK. (1986). Earnings Information Conveyed by Dividend Initiations and Omissions. Journal of Financial Economics, 21(2), 149–175.
23.
HowtonS.HowtonS. (2006). The corporate response to the 2003 dividend tax cut. Journal of Applied Finance, 16(1), Spring/Summer2006. Retrieved on INovember, 2013 from http://ssrn.com/abstract=926174
24.
JensenM. C. (1986). Agency cost of free cash flow, corporate finance, and takeovers. American Economic Review, 76(2), 323–329.
25.
JensenM. C.MecklingW. H. (1976). Theory of the firm: Managerial behaviour, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305–360.
26.
La PortaR.Lopez-de-SilanesF.ShleiferA.VishnyR. W. (1998). Law and finance. Journal of Political Economy, 106(6), 1113–1155.
27.
MacKinlayA. C. (1997). Event studies in economics and finance. Journal of Economic Literature, 35(1), 13–39.
28.
MillerM. H.Modigliani.F. (1961). Dividend Policy, Growth, and the Valuation of Shares. The Journal of Business, 34(4), 411–433.
29.
WhiteH. (1980). A heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity. Econometrica, 48(4), 817–838.
