Fundamentals of shareholder tax capitalization

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jacceco.2006.03.005 Byline: David A. Guenther (a), Richard Sansing (b)(c) Keywords: Dividend tax capitalization; Valuation; Clienteles; Tobin's q Abstract: We investigate how shareholder-level taxes are capitalized into stock prices using a model that incorporates the investment and payout decisions of a firm and the investment alternatives available to investors. Shareholder taxes affect stock prices both indirectly, via the effect of taxes on corporate investment decisions, and directly, by reducing both the mean and variance of after-tax returns. In our model, tax capitalization is not eliminated by the presence of tax-exempt investors, does not depend on whether equity is composed of contributed capital or retained earnings, and does not depend on the tax rate faced by a hypothetical marginal investor. Author Affiliation: (a) Lundquist College of Business, University of Oregon, Eugene, OR 97403, USA (b) Tuck School of Business, Dartmouth College, Hanover, NH 03755, USA (c) Tilburg University, Tilburg, The Netherlands Article Note: (footnote) [star] We thank Jennifer Blouin, Robert Bushman, Dan Collins, Dan Dhaliwal, John Graham (the referee), Michelle Hanlon, Jim Hines, Deen Kemsley, S.P. Kothari (the editor), Bob Lipe, Reed Smith, Sam Tiras, Michael Williams, and workshop participants at Connecticut, Iowa, Oklahoma, SUNY-Buffalo, Tilburg, Washington University, the 2002 Colorado Accounting Research Conference, and the 2003 North Carolina Tax Conference for helpful comments.