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The Effect of Financial Constraint on Shareholder Taxes

and Firm Investments

Zhonglan Dai Yue (Layla) Ying Harold H. Zhang

February 2012

Zhonglan Dai (zdai@utdallas.edu), Layla Ying (yxy077100@utdallas.edu), and Harold H.

Zhang (harold.zhang@utdallas.edu) are from the Jindal School of Management at the

University of Texas at Dallas. Standard disclaimers apply.

mailto:zdai@utdallas.edumailto:zdai@utdallas.edumailto:zdai@utdallas.edumailto:yxy077100@utdallas.edumailto:yxy077100@utdallas.edumailto:yxy077100@utdallas.edumailto:harold.zhang@utdallas.edumailto:harold.zhang@utdallas.edumailto:harold.zhang@utdallas.edumailto:harold.zhang@utdallas.edumailto:yxy077100@utdallas.edumailto:zdai@utdallas.edu

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Abstract

We demonstrate that firms investment and job creation are influenced by

shareholder taxes on capital gains and dividend. More importantly, the relation between

shareholder taxes and firms investment and job creation varies with financial constraint

that firms face. Less financially constrained firms show larger increases in capital

investment than more financially constrained firms in association with shareholder tax

cut. For job creation, while non-financially constrained firms show increases in firms

number of employees when shareholder tax rates are cut, severely financially constrained

firms exhibit decreases in firms number of employees. Using the Taxpayer Relief Act of

1997 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 as our events of

study, we find evidence supporting our predictions. Further, we show that the effect of

shareholder tax change on firms capital investment also varies with firms dividend yield.

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1. IntroductionShareholder taxes on investment income are on the spotlight recently. The

astronomical US government debt has forced policymakers to look for additional

revenues, and taxes on investment income such as capital gains and dividends have

emerged as one of the most likely sources because they are primarily levied on well-to-do

households. While recognizing the double taxation nature of investment income taxes,

the media and the general public are becoming increasingly more critical on the lower tax

rate on investment income than other incomes.1Economists have long argued that

significant changes in personal and corporate taxation can have large effects on firms

investment decisions. Nonetheless, extensive studies on the effects of taxation on the cost

of (or returns to) investments have generated mixed empirical evidence.2

In this paper we investigate the effect of a shareholder taxes reduction on firms

investments and job creation, in particular for firms facing different financial constraints.

Using a simple theoretical framework we demonstrate that firms investment and job

creation vary with firms elasticity of demand for external capital in the event of a

shareholder tax rate change. We predict that less financially constrained firms experience

larger increases in investments and job creation in the event of a tax rate cut than more

financially constrained firms, even though the more financially constrained firms may

experience larger reduction in the cost of capital as shown in some studies (see for

example, Chen, et al., 2011).

1Billionaire Warrant Buffet openly criticizes that the current tax code is unfair because he pays a lower tax

rate than his secretary. Republican presidential candidate Mitt Romney is adversely affected by the lower

than 15% tax rate he paid on his income because they are from investment returns.2 Hassett and Hubbard (2002) provide a detailed review on the studies of tax policy and business

investment.

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Shareholder taxes on investment income have been used as an important fiscal policy

instrument by the government to influence the economy. For instance, the Jobs and

Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) drastically lowered the tax

rates on both dividends and long-term capital gains in order to stimulate investment and

to create job opportunities. The rationale for these policy changes is the belief that

shareholder taxes on investment income constitute an important component of the cost of

capital. Reducing the shareholder taxes on investment income will lower the cost of

capital and therefore lead to increases in investment and creation of new jobs. Indeed, the

existing empirical studies suggest that the tax cuts under JGTRRA lowered the cost of

equity capital (see for example, Dhaliwal, Krull, and Li, 2007, Guenther, Jung, and

Williams, 2005, Chen, et al., 2011, among others).

However, these studies do not investigate if and how the reduction on shareholder tax

rates on investment income also affects firms investment and job creation. Neoclassical

investment models predict that taxation on capital gains and dividends adversely affects

investment and capital formation but differs in their effects on the cost of capital (Hassett

and Hubbard, 2002). Empirical studies along these lines have primarily focused on the

relation among investment, capital formation and the user cost of capital, and have

produced mixed results. They attribute this to the endogeneity of investment and the cost

of capital, measurement error in fundamental variables such as the user cost of capital,

and misspecification of adjustment costs in capital formation. These considerations have

motivated researchers to examine exogenous cross-sectional variation in the user cost of

capital to investigate the tax effect on investment.

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For instance, Cummins, Hassett and Hubbard (1994) examine the effect of the Tax

Reform Act of 1986 on business investment using firm-level variation in key tax

parameters such as the effective rate of investment tax credit and the present value of

depreciation allowances. Carroll, Holtz-Eakin, Rider and Rosen (2000) show that the

cross-sectional variation in the change in personal tax rates following the Tax Reform

Act of 1986 is associated with the variation in investments by small businesses. Abel and

Eberly (1994, 1996) show that the firms investment behavior can be characterized by

three distinct regimes: positive gross investment, zero gross investment, and negative

gross investment, depending upon different levels of adjustment cost and irreversibility of

investment. Overall, existing studies document that the aggregate elasticity of investment

with respect to the tax-adjusted user cost of capital is between -0.5 and -1.0 with a large

variation among individual firms.

In contrast to the frictionless capital markets in the standard neoclassical model,

Meyer and Kuh (1957) stress the importance of financial considerations for business

investments. In particular, following Fazzari, Hubbard and Petersen (1988a, 1988b), by

classifying firms into groups as a priori financially constrained or financially

unconstrained, empirical studies show that proxies for internal funds have explanatory

power for investments, holding constant other determinants of investments including the

user cost of capital. This finding is widely interpreted as suggesting that tax policy may

have effects on investment by constrained firms beyond those predicted by neoclassical

investment models.

We empirically test our predictions using a difference-in-difference methodology.

Specifically, we focus on firms with different degrees of financial constraints and

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examine the differential changes in their investments (capital expenditures and combined

capital and R&D expenditures) and number of employees pre- and post-tax legislation

changes that have drastically changed shareholder tax rates on investment income such as

capital gains and dividends while other aspects of the tax code remained unchanged. We

identify two tax changes: The Tax Relief Act of 1997 and The Jobs and Growth Tax

Relief Reconciliation Act of 2003 as the events of our investigation.

Our empirical analyses demonstrate that firms facing low financial constraint

experience larger increases in capital expenditures and combined capital and R&D

expenditures than firms facing high financial constraint even though the latter

experiences larger reduction in the cost of capital than the former for both TRA and

JGTRRA as shown in Chen, et al (2011). The estimated coefficient implies that for a one

standard deviation increase in the predicted probability of financial constraint the

increase in firm capital expenditure would be reduced by 14 million for TRA and 21

million for JGTRRA (both in year 1982 dollar), respectively. These estimates represent

61% and 43% of the average changes in the capital expenditures after the tax cut for non-

financially constrained firms for TRA and JGTRRA, respectively.

While non-financially constrained firms show increases in the number of employees

after the tax rate cut for JGTRRA, financially constrained firms reduced their number of

employees following the tax rate cut on capital gains and/or dividends. Our estimation

results suggest that for a one standard deviation increase in the predicted probability of

financial constraint, firms facing strong financial constraint experienced a reduction of

295 employees. In the meantime, for a one standard deviation decrease in the predicted

probability of financial constraint, non-financially constrained firms experienced an

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increase of 17 employees. This is attributed to the relative change in the marginal

products of capital and labor. The estimation results for TRA show consistent signs with

our prediction but are statistically insignificant. Finally, we find that firms with higher

dividend yield experienced larger increases in capital expenditures and combined capital

and R&D expenditures for JGTRRA which reduced the tax rates on both capital gains

and dividends. On the other hand, this effect is insignificant for TRA which only reduced

the tax rate on capital gains. These empirical findings are all consistent with our predicted

effects on the impact of financial constraint on the relation between shareholder taxes and

capital investment and job creation. However, we find no significant effect of dividend

yield on the change of the number of employees associated with shareholder tax rate cut

for TRA or JGTRRA.

The remainder of the paper is organized as follows. Section 2 develops hypotheses on

the impact of financial constraint on the relation between shareholder taxes and firms

capital investment and job creation. Section 3 elaborates the empirical methodology.

Empirical results and discussions are provided in Section 4. We make concluding

remarks in Section 5.

2. Hypothesis DevelopmentTo aid our understanding of how firms financial constraints affect the relation

between shareholder taxes and firms investments and job creation, we use a simple

model based on firms demand for and supply of external capital in the presence of

shareholder taxes on investment income including capital gains and dividend. For ease of

exposition, we first derive implications of a shareholder tax rate change on firms

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investment. We then utilize firms optimality condition in a classical production model to

derive the effect of shareholder tax rate changes on firms decisions on labor input.

Figure 1 shows the determination of equilibrium capital investment and the cost of

equity capital in the presence of shareholder taxes on investment income following the

analysis of Hubbard (1998). The horizontal axis represents the capital investment and the

vertical axis represents the cost of equity capital for firms ( cr ) and the required expected

rate of return by investors ( rr ). We model a firms demand for investment as a decreasing

function of the cost of capital, i.e., 0 crD , and investors supply of capital as an

increasing function of required expected return by investors, i.e., 0 rrS . With no

shareholder taxes on investment income, firmsdemand for capital and investorssupply

of capital intersect at point A. The equilibrium cost of capital for firms and the required

expected rate of return by investors are identical, i.e., Arc rrr and the capital demand

equals capital supply )()( rcA rSrDK where Ar and AK are the equilibrium cost of

capital (rate of return) and quantity of capital investment, respectively.

Next, we introduce shareholder taxes on investment income in the form of either

dividend taxes or capital gains taxes or both. The tax rate on the investment income is

denoted by . We assume that the taxes on capital income are levied directly on

investors and the marginal investors are tax-sensitive.3 With the shareholder taxes on

investment income, investors effective supply of capital shifts to the left.4 The firms

demand for capital and investorseffective supply of capital intersect at point B. At this

3 It is debated on the tax status of the marginal investor. Given the large volume of empirical studies

documenting the effect of shareholder taxes on asset pricing (see Graham (2003) for a detailed review), we

assume that investors are tax sensitive in our analysis.4This is similar to the model analyzed in Hubbard (1998).

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point, the cost of capital paid by firms, denoted by cr , is higher than the required after-tax

expected return to investors, denoted by ,)1( cr rr with the difference being the

shareholder taxes paid to the government, i.e., crc rrr . The equilibrium quantity of

capital investment is now ])1[()( BcB

c

B rSrDK and .AB KK

To derive the implications on the effect of a change in shareholder tax rate on capital

investment, let er be the equilibrium market rate of return on capital. In equilibrium, we

have the demand for capital equals the supply of capital, i.e.,

].)1[()( ee rSrD (1)

Differentiating both sides of equation (1) with respect to the tax rate and rearranging

terms, we arrive at

,'')1(

'

DS

Srr ee

(2)

where 'S and 'D are the slope of the supply and demand curve evaluated at the

equilibrium market rate of capital, respectively. Since taxes are directly paid by the

investors, and not the firms, we have the equilibrium cost of capital and quantity of

capital investment denoted eK given by

e

c rr and ).( ee rDK

Utilizing the definition of the elasticity of demand for and supply of capital, we

have the following comparative static results on the effect of a change in shareholder tax

rate on the cost of capital:

,))(1( DS

S

e

c rr

(3)

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where D and S are the elasticity of demand for and supply of capital with respect to the

cost of capital and the required rate of return, respectively. Given the downward sloping

demand for capital and the upward sloping supply of capital, Equation (3) states that

when the taxation on capital income is reduced, the cost of equity capital for firms will be

lower. The effect of a change in shareholder tax rate on firms capital investment can be

similarly derived as follows:

.))(1(

)(

DS

DS

eeeee Kr

r

rKK

(4)

We can draw two implications from equation (4) on the effect of shareholder tax

rate cut on firms capital investment. First, holding everything else the same, firms

capital investment increases when shareholder tax rate is reduced. Second, the

shareholder tax effect on a firms capital investment increases in the elasticity of the

firms demand for capital ( || D ). Both predictions are consistent with the implications of

a neoclassical general equilibrium investment model such as Hassett and Hubbard (2002).

In reality, firms facing severe financial constraint have more pressing need for capital and

will be less sensitive to the cost of capital. These firms thus will have less elastic demand

for capital than firms facing less or no financial constraint.5The latter are more sensitive

to the cost of capital and have more elastic demand for capital. This leads to our first

hypothesis on the effect of shareholder tax cut on firms capital investment.

5Consider two extreme cases: (1) the firm is completely constrained with no access to external capital, and

(2) the firm is completely unconstrained in its access to external capital. In the first case, the firms demand

elasticity for external capital is zero because a change in the cost of equity capital has no effect on the

amount of capital it can raise. In the second case, the firms demand for ex ternal capital is very elastic

because it can access the external market any time and will only choose to raise external capital when the

cost of equity capital is low and refrain from using external capital when the cost of capital is high. Thus, a

small increase in the cost of capital may have a large impact on the amount of external capital raised by the

firm, leading to a high elasticity of demand for external capital.

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Hypothesis One: Ceteris Paribus, a shareholder tax rate cut on investment income will

increase the capital investment of less financially constrained firms more than that of

more financially constrained firms.

We next discuss the effect of shareholder tax rate change on firms use of labor

input. We assume that firms have a Cobb-Douglas production technology with constant

returns to scale with respect to two factor inputs: capital (K) and labor (L), i.e.,

.10,0,),( 1 LKLKQ (5)

Let rc and w be the cost of capital and wage rate, respectively. The cost minimization

condition for firms requires that firms allocate resources to capital and labor such that the

marginal product generated from spending the resources on capital and labor are equal,

i.e.,

,w

MP

r

MP L

c

K (6)

where the 11LKMPK and LKMPL )1( are the marginal product of

capital and labor, respectively. Substituting the marginal products of capital and labor

into equation (6), we arrive at the cost-minimization labor and capital utilization given by

.1

Kw

rL c

(7)

We assume that there exists a very competitive labor market so that the wage rate

is insensitive to the change in shareholder tax rate. Differentiating equation (7) with

respect to the shareholder tax rate gives us

).(11

Kr

rK

w

Lc

c (8)

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Substituting equations (3) and (4) into equation (8), we arrive at the effect of a

shareholder tax rate change on labor input given by

.))(1(

)1(1

DS

DS

e

w

KL

(9)

Equation (9) implies that the effect of a shareholder tax rate change is negative if firms

demand for capital is elastic ( 1D ) and positive if firms demand for capital is

inelastic ( 1D ). Therefore, we have the following predictions on the effect of a

shareholder tax rate cut on firms labor input.

Hypothesis Two: Holding everything else the same, a shareholder tax rate cut will

increase the labor input of non-financially constrained firms and decrease the labor input

of financially constrained firms.

The intuition behind hypothesis two is as follows. Capital and labor are

substitutes in the production process. Since a shareholder tax rate cut reduces the cost of

capital, less financially constrained firms (with more elastic demand for capital) will

increase their investments more than more financially constrained firms (with less elastic

demand for capital). The increase in capital input lowers the marginal product of capital

and raises the marginal product of labor (due to diminishing marginal return). When the

wage rate remains largely unchanged, equation (6) suggests that a firm increases its labor

input only if the marginal product of capital decreases more than the cost of capital (i.e.,

MPK/r

c decreases). A larger reduction in the incremental output from spending an

additional dollar on capital makes it more attractive for firms to hire more workers

because it produces more incremental output from spending the extra dollar on labor than

on capital. This occurs when the firms demand for capital is elastic and the amount of

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capital increases more than the cost of capital. On the other hand, if a shareholder tax rate

cut increases capital input by less than the percentage reduction in the cost of capital, the

marginal product of capital decreases by less than the cost of capital (i.e., MPK/rc

increases). When the wage rate remains unchanged, the marginal product of labor has to

increase to ensure that the optimal condition (equation (6)) holds. This leads to reduced

labor utilization.

Historically, dividends and capital gains are taxed at a different tax rate with dividend

tax rate higher than capital gains tax rate since 1990 until the JGTRRA in 2003, when the

maximum tax rate was dropped to 15% for both capital gains and dividends. To

investigate the differential effects of changes in capital gains and dividend tax rates, next,

we introduce both the capital gains taxes and the dividend taxes separately. Let g and

d be the tax rate on the capital gains and dividends, respectively, and ybe the fraction

of equilibrium return paid out as dividends. The equilibrium for the capital market

requires that

])1()1)(1[()( ede

g

e yrrySrD (10)

Differentiating both sides of equation (10) with respect to g and d , respectively,

and using the definition of the elasticity of demand for and supply of capital and ,ec rr

we have

,)]()1()1)(1[(

])()1[(

DSdg

Sgcgdc

g

c

yy

yrryr

(11)

.)]()1()1)(1[(

])([

DSdg

Sdcgdc

d

c

yy

yryrr

(12)

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When both capital gains and dividend tax rates are cut as in the case with JGTRRA,

the change in the cost of capital can be obtained as the sum of equations (11) and (12):

.)]()1()1)(1[(

}])()()[(])1{[(

DSdg

Scddgggddg

c

yy

rdydyyddydr

(13)

The effect of the changes on capital gains and dividends on the capital investment can be

obtained as

.)]()1()1)(1[(

}])()()[(])1{[(

DSdg

DS

e

ddgggddg

d

d

cg

g

c

ee

yy

Kdydyyddy

dr

dr

r

KdK

(14)

If we further omit the higher order term ( ])()()[( ddgggd dydy ), we

arrive at the approximation to the change in capital investment associated with

shareholder tax rate changes on capital gains and dividend given by

.))](()1[(

)]([

)]()1()1)(1[(

])1[(

DSgdg

DS

e

gdg

DSdg

DS

e

dge

y

Kddyd

yy

KyddydK

(15)

In addition to the shareholder tax effect stated in hypothesis one and two, equation

(15) suggests that when the reduction in dividend tax rate exceeds the tax rate cut on

capital gains, ceteris paribus, the increase in capital investment is larger for higher

dividend yield firms than for lower yield firms. This leads to the following hypothesis on

the relation between capital investment increases and firms dividend yield.

Hypothesis Three:When dividend tax rate cut exceeds capital gains tax rate cut, ceteris

paribus, the increase in capital investment is larger for higher yield firms than for lower

yield firms.

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Using equations (7) and (8), we can similarly write the change in labor input

associated with changes in both capital gains and dividend tax rate changes as follows

.11

11

ecc

e

d

d

e

g

g

e

cd

d

cg

g

c

e

dd

gg

dKw

rdr

w

K

dK

dK

w

rd

rd

r

w

K

d

L

d

L

dL

(16)

Substituting equations (13) and (14), we arrive at the change in labor input due to

changes in both capital gains and dividend tax rates

.)]()1()1)(1[(

])[(])1[()1(1

DSdg

d

d

g

g

gddg

DS

e

c

yy

dy

dy

yddy

w

KrdL

(17)

Omitting interactions of three small terms, we have the approximation of the change in

labor input due to changes in capital gains and dividend tax rates given by

.)]()1()1)(1[(

])1[()1(1

DSdg

dgDS

e

c

yy

yddy

w

KrdL

(18)

Equation (18) suggests that when the tax rate cut on dividend exceeds the tax rate cut on

capital gains, the increase in labor input will be larger for firms with elastic demand for

capital when the firms dividend yield is high than when the dividend yield is low.

However, for firms with inelastic demand for capital, the decrease in labor input will be

larger when the firms dividend yield is high than when the dividend yield is low.We

summarize this prediction in the following hypothesis.

Hypothesis Four:When dividend tax rate cut exceeds the tax rate cut on capital gains,

ceteris paribus, the increase (decrease) in labor input for non-financially (financially)

constrained firms is larger for high dividend yield firms than for low dividend yield firms.

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3. Empirical MethodologyTo assess the effect of financial constraint on the relation between shareholder taxes

and firms investment and job creation, we focus on the Taxpayer Relief Act of 1997

(TRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). TRA

reduced the maximum tax rate on capital gains from 28 percent to 20 percent on positions

held for more than 12 months while other tax code remains largely unchanged and

JGTRRA reduced the maximum tax rate on dividends from 39.6 percent to 15 percent

and the maximum tax rate on capital gains from 20 percent to 15 percent for positions

held longer than 12 months. These tax change events have the advantage of significantly

reducing the tax rates on investment income and the benefit of recency. The selection of

these two tax events also has the added benefit that they are decades apart and had very

different economic situations, so finding evidence in both events that support our

hypotheses would strengthen our explanation on the impact of financial constraint on the

relation between shareholder taxes and firms investment and job creation. Finally, by

contrasting the relative changes in capital investments and job creation across TRA and

JGTRRA we shed light on the effect of changing capital gains tax only versus changing

both capital gains and dividend taxes.

To test our hypotheses we adopt the difference-in-difference methodology and

focus on the variations in the changes of capital investment and job creation across firms

that face different financial constraints. The difference-in-difference approach is suitable

for our analysis because it allows us to mitigate the effect of other concurrent changes

that may have affected all firms. To achieve this goal, we introduce a dummy variable:

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Postt. For TRA97, the categorical variable tPost takes a value of zero on and before

3/31/1997 and value of one on and after 8/1/1997. For the JGTRRA in 2003, the

categorical variable tPost takes a value of zero on and before 4/1/2003 and value of one

on and after 7/1/2003.

We estimate firmsfinancial constraint based on the latest measure developed by

Hadlock and Pierce (2010).6Analyzing 1,848 firm-years from 1995 to 2004 for 356

randomly selected firms in COMPUSTAT, they use an elaborate process to classify the

financial constraint for each firm-year from 1-5, where 5 represents the most financially

constrained firms. Using this categorization, they estimate ordered logit models

predicting constraints as a function of different quantitative factors. After an extensive

investigation and critically evaluate methods commonly used in the literature, they

document that firm size and age are particularly useful predictors of financial constraint

levels, and propose a simple new measure of financial constraints that is based solely on

firm size (logarithm of inflation-adjusted assets) and age (the current year minus the first

year that the firm has an non-missing stock price on COMPUSTAT) which endures a

variety of robustness checks. We use this simple new measure of financial constraint as

our baseline measure in our empirical analysis.

Two other variables, cash flow and leverage, also been shown to have significant

and consistent effects in alternative methods such as Kaplan and Zingales (1997) and

Whited and Wu (2006). However, Hadlock and Pierce (2010) cast serious doubt on the

6Other candidates for measuring financial constraint include the Kaplan and Zingales (1997) index, which

amalgamates cash flow, Tobins Q, leverage, dividends and cash holding scaled by book value of assets

and the Whited and Wu (2006) index, which integrates cash flow, a dividend distribution dummy, leverage,

size, industry sales growth, and firm sales growth. As pointed out by Hadlock and Pierce (2010), some of

determinants used in Kaplan and Zingales (1997) and Whited and Wu (2006) may be endogenously

determined with the measure of financial constraint faced by a firm and sometimes have conflicting signs.

Thus, they are not suitable as determinants of a firms financial constraint measure.

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use of these variables as determinants of financial constraint because of their strong

endogeneity. As a robustness check, we also construct an alternative measure of financial

constraint using a specification similar to Kaplan and Zingales (1997) and Whited and

Wu (2006) by including cash flow (a firms operating income plus depreciation divided

by beginning-of-year book assets) and leverage (book value of long term debt divided by

current book assets) in addition to firm size and age in the ordered logit analysis. We

conduct robustness analysis on our findings using this alternative financial constraint

measure.

Specifically, we estimate the probability of being financially constrained for firm

iat period tas follows:

,04.0043.0737.0'

and)'exp(1

11)(Pr

24

itititit

it

it

AgeFirmSizeSizeX

CXdConstraineyFinanciallFC

(19)

where C4is the cut point for group four (likely financial constrained) and the associated

cut points for groups 1 to 4 are estimated at -5.310, -0.956, 0.355, and 0.454,

respectively.7

Hadlock and Pierces(2010) financial constraint classification process supersedes

its predecessors for several reasons. First, it uses qualitative information to categorize a

firms financial constraint status by carefully reading statements made by managers in

SEC filings such as the annual letter to shareholders and the management discussion and

analysis section. Second, the sampling period for Hadlock and Pierce (2010) covers both

of the two changes in shareholder taxes that we examine in this study. This facilitates the

use of their coefficient estimates in computing the probability of financial constraint for

7These estimates are taken from Column (2) of Table 6 in Hadlock and Pierce (2010) and we thank Joshua

Pierce for providing us the cut point estimates.

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firms in our sample. Third, the index based on firm size and age relies on factors that are

more exogenous than the alternatives.

The tax rate reductions for TRA and JGTRRA are only applied to income that is

reported on personal tax returns, i.e., dividends received and capital gains from the

selling of shares held directly by individuals or held indirectly by individuals in flow-

through entities, such as mutual funds, partnerships, trusts, S corporations, or limited

liability corporations that pass dividend income to investors personal tax returns.

Dividends and capital gains taxes are not levied on tax-deferred accounts (e.g., qualified

retirement plans, including pensions, IRAs and 401(k)), tax-exempt organizations, and

foreigners. To capture the group of investors who are the most sensitive to the changes in

shareholder taxes, we construct proxies for the percentage of tax sensitive investor

ownership of a stock (individual investors and/or mutual funds) using data on shares

outstanding and shares owned by institutional investors. The data on the institutional

investors ownership are obtained from their quarterly filings with the U.S. Securities and

Exchange Commission (known as Form 13F).

The above considerations lead us to formulate the basic empirical regression

specification on capital investment as follows:

,)1(9)1(8)1(7)1(6

)1(5)1(4)1(3)1(21

itittittititti

tittitittitit

ZNDivPostNDivYLDPostYLD

TSOPostTSOFCPostFCPostY

(20)

where the dependent variable Yit is taken to be various suitably deflated investment

measures (such as capital expenditure, R&D, etc.), tPost is a dummy variable which

takes a value of 0 before the tax cut and 1 after the tax cut, )1( tiFC is the measure for

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financial constraint of firm iat time t-1, )1( tiTSO measures the tax sensitive ownership of

firm i at time t-1, )1( tiYLD is firm is dividend yield at time t-1, )1( tiNDiv is a dummy

variable representing non-dividend-paying status, andit

Z represents the firm level

control variables.

Under the null of hypothesis that firms facing more financial constraint (inelastic

demand for capital) experience less increase in capital investment than firms facing less

financial constraint (elastic demand for capital), we will have .03 Further, when

dividend tax rate cut exceeds capital gains tax rate cut, ceteris paribus, the increase in

capital investment is larger for higher yield firms than for lower yield firms. This

suggests that we will expect a positive coefficient of YLDPost for JGTRRA which

reduced the dividend tax rate more drastically than the capital gains tax rate, but no such

effect for TRA which only cut the capital gains tax rate, i.e., 07 for JGTRRA but not

necessarily for TRA.

For labor inputs, we predict that shareholder tax cut will have the opposite effects

on firms facing strong financial constraint (inelastic capital demand) and non-financial

constraint (elastic capital demand). Thus, we include both interaction terms

FCPost and )1( FCPost to test our prediction. Specifically, we use various

specifications of the following regression model for our analysis on the impact of

financial constraint on the relation between shareholder taxes and firms job creation:

.

)1(

)1(9

)1(8)1(7)1(6)1(5

)1(4)1(3)1(2)1(1

itittit

titittitit

titittittiit

ZNDivPost

NDivYLDPostYLDTSOPost

TSOFCPostFCPostFCY

(21)

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Under the null of hypothesis that firms facing stronger financial constraints

(inelastic capital demand) will experience a decrease in labor input and firms facing non-

financial constraints (elastic capital demand) will experience an increase in labor input,

we will have a negative coefficient for FCPost and a positive coefficient for

)1( FCPost under JGTRRA but not necessarily for TRA. This suggests that we will

have 02 and 03 for JGTRRA.

Finally, to test the prediction that the increase (decrease) in labor input for non-

financially (financially) constrained firms is larger for high dividend yield firms than for

lower dividend yield firms, we extend equation (21) to include interactions between

dividend yield and financial constraint as follows:

.

)1(

)1(

)1(

)1(11)1(10

)1()1(9)1()1(8

)1()1(7)1()1(6)1(5

)1(4)1(3)1(2)1(1

itittitti

titittitit

tititititit

titittittiit

ZNDivPostNDiv

FCYLDPostFCYLDPost

FCYLDFCYLDTSOPost

TSOFCPostFCPostFCY

(22)

We interpret a negative coefficient for the interaction FCYLDPost and a

positive coefficient for the interaction )1( FCYLDPost as evidence supporting this

hypothesis.

For firm level control variables, we follow several recent studies on the tax effect

on the cost of capital for JGTRRA (such as Dhaliwal, Krull and Li, 2007) and include

firms book value-to-market value ratio (in logarithm), forecasted long-term growth of

earnings, the coefficient of variation of the one-year-ahead earnings per share forecast,

and firm size (in logarithm) at the end of the fourth quarter of the most recent past year.

Considering that capital and labor inputs may vary with the cost of capital, we may also

need to include measures of firms cost of capital in our regression analysis. Since these

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variables are endogenously determined, we choose to include determinants of the cost of

capital for each firm in our regression specification. Specifically, we include firms risk

exposures to the market, the size, and the value factors measured by ,MKT ,SMB and

.HML Following Dhaliwal, Krull and Li (2007), we estimate these risk factor loadings

using return data for the 48 months before the beginning of the calendar year. We include

the moving average daily turnover for each firm over past 250 days leading up to the end

of the most recent past quarter to control for liquidity related returns (see Sikes and

Verrecchia, 2011). Existing studies suggest that firms capital expenditures are related to

sales, we thus also control for changes in annual sales. As a robustness check, we include

the average cost of equity capital over the sample period for each industry using the

classification by Fama and French (1997) and find that our results are robust to the

inclusion of the industry average cost of capital.8

4. Empirical Results and Discussions4.1.Summary statistics

We obtain the data from three different sources. For various measures of firms

capital investment, the number of employees, and firms control variables, we use the

merged COMPUSTAT and CRSP database. For firms long-term earnings growth

forecasts and the dispersion of earnings forecasts, we use the I/B/E/S database. Finally,

we use the institutional ownership database from Thomson Financial to construct the

investor tax sensitive percentage ownership.

8The results are not reported in the paper and are available upon request.

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Table 1 presents the summary statistics for variables of our interest including the

changes in annual capital expenditure and number of employees and firm controls for the

period surrounding TRA and JGTRRA (Panel A) and the changes in these variables pre-

and post-tax cut (Panel B). The capital expenditure and the sum of capital and R&D

expenditures are in real term obtained by dividing the nominal terms by the producer

price index (1982=100). We then obtain the changes in annual capital expenditure

(CAPX) and sum of annual capital and R&D expenditure (CAPXRD) for each firm

from year t-1to t. The change in real capital expenditure has a mean of 0.097 (an increase

of 9.7 million in 1982 dollar) with a standard deviation of 0.601 during TRA and a mean

of -0.018 (a decrease of 1.8 million in 1982 dollar) with a standard deviation of 0.881

during JGTRRA. Including R&D expenditure increases both the mean and the standard

deviation for both TRA and JGTRRA. The change in total number of employees is

measured in thousands for each firm at the end of year t. The average change in the

number of employees is 314 for TRA and 90 for JGTRRA across firms. Both the lower

average change in firm capital expenditure and the number of employees are probably

due to a larger number of smaller firms in the period surrounding JGTRRA than TRA.

The financial constraint is measured by the predicted probability that a firm is in the

category of likely financial constrained and is estimated using firm size and age (FCSA)

and using firm size, age, cash flow, and leverage (FCSACL), respectively. On average,

there are about 4.1% firms that are likely financially constrained during TRA and 3.1% to

3.3% during JGTRRA.

Most firm variables experienced significant changes after the tax cut event. Firms

capital expenditures and the combined capital and R&D expenditures show significant

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increases for both TRA and JGTRRA. The same change is observed for job creation

measured by the number of employees. However, the probability of firms facing financial

constraints declined after the tax cut for both TRA and JGTRRA. Consistent with the

findings of Blouin, Raedy, and Shackelford (2010), we observe that more firms initiated

dividend payout even though dividend yield declined for JGTRRA.

4.2.Primary results and discussions4.2.1. Univariate resultsWe begin with a univariate analysis of the change in firms investment and job

creation surrounding the tax cut events. Table 2 reports the changes in firms capital

expenditure, the combined capital and R&D expenditures, and the number of employees

(in thousands) pre- and post-TRA and JGTRRA for firms with different probability of

facing financial constraints as measured by the baseline FCSA (Panel A) and the

alternative FCSACL (Panel B). We divide firms into two groups using the median

predicted probability of being financially constrained and examine the changes in capital

investments and job creation pre- and post- the tax cuts. Our results show that for firms

with lower financial constraint (LFCfirms with the predicted probability of financial

constraint lower than the median), their capital expenditures, the combined capital and

R&D expenditures, and the number of employees all experienced significant increases for

both TRA and JGTRRA. For firms with higher financial constraint (HFCfirms with the

predicted probability of financial constraint higher than the median) we only observe

significant increases in capital investments and job creation for JGTRRA but not for TRA.

We further examine the difference-in-difference in the pre- and post-tax cut

changes across LFC and HFC groups. Our results indicate that the increases in firms

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capital expenditures, capital and R&D expenditures, and the number of employees pre-

and post-tax cuts are significantly larger for the LFCgroup than for theHFCgroup. For

instance, the increase in the capital expenditure is 12.5 million (in year 1982 dollar) more

for LFC group than that for the HFC group for TRA and higher 25.2 million (in year

1982 dollar) for JGTRRA. The increase in the number of employees is 130 more for the

LFCgroup than that for the HFCgroup for TRA and higher at 219 for JGTRRA. These

results support our predictions on the impact of financial constraint on the effect of

shareholder taxes on firms capital investments and job creation.Our findings are robust

when firms financial constraint is measured by the alternative measure of the predicted

probability of financial constraint based on firm size, age, cash flow and leverage

(FCSACL) as shown in Panel B.

4.2.2. Panel regression resultsIn our regression analysis, we first investigate the predictions on the impact of

financial constraint on the effect of shareholder taxes on capital investments and job

creation under hypotheses one and two. We then incorporate dividend yield to investigate

hypotheses three and four.

Tables 3 and 4 present the results on the impact of financial constraint on the

change of capital expenditures pre- and post-tax cuts for TRA and JGTRRA. The

interaction FCSAPost is negative and significant at the 5% test level for both TRA and

JGTRRA. The estimated coefficient implies that for a one standard deviation increase in

the predicted probability of financial constraint the increase in firm capital expenditure

would be reduced by 0.140 for TRA and 0.209 for JGTRRA (14.0 and 20.9 million in

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year 1982 dollar, respectively).9These estimates represent 61% and 43% of the average

changes in the capital expenditures after the tax cut for firms facing no financial

constraint for TRA and JGTRRA, respectively.10

Thus, these effects are economically

very significant. When we perform the regression analysis to the combined capital and

R&D expenditures, we find similar result for JGTRRA but insignificant result for TRA.

This suggests that the impact of financial constraint on the relation between shareholder

taxes and investments is stronger for capital expenditures than on research and

development. One possible explanation is that firms may receive tax credit on research

and development expenditures. Therefore it reduces the effect of shareholder taxes on

research and development expenditures.

Table 5 presents the impact of financial constraint on the effect of shareholder

taxes on changes in firms employment pre- and post-tax cuts. Consistent with our

predictions on the impact of financial constraint on the effect of shareholder taxes on the

change in firms number of employees, we find that the coefficient is negative for the

interaction FCSAPost and positive for the interaction )1( FCSAPost for both TRA

and JGTRRA. The coefficient estimates are statistically significant at the 1% level for the

JGTRRA but insignificant for TRA. Thus, we have strong supporting evidence that

financially constrained firms experienced reductions in the number of employees and

non-financially constrained firms experienced increases in the number of employees for

JGTRRA. The estimated coefficients suggest that for a one standard deviation increase in

the predicted probability of financial constraint firms facing strong financial constraint

9These estimates are calculated by multiplying the estimated coefficient for Post FCSAby the standard

deviation ofFCSA.10 These estimates are calculated by dividing the estimated reduction in the capital expenditures by the

coefficient estimate forPost.

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experienced a reduction of 295 employees. In the meantime, for a one standard deviation

decrease in the predicted probability of financial constraint non-financially constrained

firms experienced an increase of 17 employees.11

Table 6 reports robustness check analysis when the financial constraint measure

FCSA is replaced by the alternative FCSACL which is measured as the predicted

probability of financial constraint estimated using firm size, age, cash flow and leverage.

We find very similar effects of financial constraint on the changes in firms capital

expenditures, combined capital and R&D expenditures, and the number of employees for

both TRA and JGTRRA. These findings indicate that our findings are unlikely to be

altered by the inclusion of cash flow and leverage in constructing financial constraint

measures.

We now examine the impact of dividend yield on the effect of shareholder taxes

on capital investments and job creation under hypotheses three and four. Table 7 reports

the estimation results on the capital expenditures while Table 8 shows the estimation

results on combined capital and R&D expenditures. We find that the interaction

FCSAPost remains negative and significant in the regression analysis for the capital

expenditures for both TRA and JGTRRA and the coefficient estimates are very similar to

those reported in Table 3 and only significant for JGTRRA in the analysis on the

combined capital and R&D expenditures as in Table 4.

We find that the interaction YLDPost is positive and significant at the 10% test

level for firms capital expenditures and combined capital and R&D expenditures for

JGTRRA but not for TRA. Considering that JGTRRA reduced the tax rate on dividends

more drastically than on capital gains, this result provides some supporting evidence on

11These estimates are obtained by multiplying the coefficient estimate by the standard deviation of FCSA.

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the prediction under hypothesis three. The estimated coefficient implies that for a one

standard deviation increase in dividend yield the incremental change is 0.10 in firms

capital expenditures and 0.16 in firms combined capital and R&D expenditures. The

estimates correspond to 10 million and 16 million in year 1982 dollar.

Table 9 reports the estimation results on the impact of dividend yield on the effect

of shareholder taxes on the change in number of firms employees for TRA and JGTRRA.

Lending support to the predicted effect of financial constraint on firms job creation, the

interactions FCSAPost and )1( FCSAPost show consistent signs and statistical

significance as those reported in Table 5. However, we find no evidence that the impact

of financial constraint on the relation between shareholder taxes and firms job creation

vary with dividend yield.

4.2.3. The comparison of the impact of TRA and JGTRRAThe results reported in Tables 7 and 8 suggest that stocks with higher dividend

yields experienced larger increases in capital and combined capital and R&D

expenditures under JGTRRA but not TRA. We next provide a formal test on the relative

impact of TRA and JGTRRA. To achieve this goal, we introduce a dummy variable D03

which takes a value of zero if an observation belongs to the TRA event periods (year

1996 to year 1998) and a value of one if it belongs to the JGTRRA event periods (year

2002 to year 2004). We then extend the specifications (21) and (22) to include interaction

terms between the event dummy variableD03and all the regressors in equations (21) and

(22).

Table 10 presents the estimation results of the extended specifications. For both

the capital expenditures and the combined capital and R&D expenditures, we find that the

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interaction YLDPostD 03 is positive and statistically significant at the 1% test level.

This indicates that higher dividend yield firms experienced larger increases in capital and

combined capital and R&D expenditures under JGTRRA than under TRA. The result

lends support to hypothesis three because the dividend tax rate cut under JGTRRA (from

39.6% to 15%) is much larger in magnitude than the capital gains tax rate cut (from 20%

to 15%) while only the capital gains tax rate was cut under TRA (from 28% to 20%).

Non-dividend paying stocks also experienced larger increases in capital and combined

capital and R&D expenditures under JGTRRA than under TRA. This may reflect the fact

that the market is forward looking and stocks that currently are non-dividend paying may

be in a transitional period and will initiate dividend distribution in the future. If the

dividend tax rate cut is expected to last for a long enough time period, stocks that are

currently non-dividend paying may also respond to changes in dividend tax rate in

addition to the capital gains tax rate cut under JGTRRA. For example, Chetty and Saez

(2005) and Blouin, Raedy, and Shackelford (2011) document that more firms initiated

dividend distribution after JGTRRA. Our finding is consistent with the results reported in

Auerbach and Hassett (2006) which document that non-dividend-paying stocks

experienced larger price responses than dividend-paying stocks and high dividend yield

stocks show larger changes in price reaction than lower yield stocks. However, we find

no significant incremental impact on the change in firms number of employees under

JGTRRA relative to TRA. Finally, for changes in both capital investments and the

number of employees, firms with higher tax sensitive investor ownership show larger

increases in the capital and combined capital and R&D expenditures and the number of

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employees under JGTRRA than under TRA. This is consistent with JGTRRA being a

more dramatic tax legislature change on investment income than TRA.

5. Concluding RemarksWe demonstrate that shareholder taxes have significant effects on firms capital

investments and job creation depending on the level of financial constraint faced by

different firms. Less financially constrained firms will experience larger increases in

capital investments than more financially constrained firms after shareholder tax rate cut.

In the meantime, while a shareholder tax rate cut increases job creation for non-

financially constrained firms, it may decrease job creation for financially constrained

firms. This is because non-financially constrained firms experience a larger increase in

labor productivity due to their larger capital investment increases than financially

constrained firms.

Using both the Taxpayer Relief Act of 1997 and the Jobs and Growth Tax Relief

Reconciliation Act of 2003, we find supporting evidence for the predicted effects of

firms financial constraint on the relation between shareholder taxes and capital

investments and job creation. We also find some evidence that the impact of financial

constraint on the relation between shareholder taxes and capital investments and job

creation varies with firms dividend yield when the tax rate cut on dividends is much

larger than the tax rate cut on capital gains as for the JGTRRA. Our findings provide

useful guidance on the potential effect on firm investments and job creation when

policymakers contemplate shareholder tax rate increase as a source of tax revenue and a

way to reduce the disparity in tax payments.

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References

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Abel, A.B. and J.C. Eberly, 1996, Optimal investment with costly irreversibility,Reviewof Economic Studies3, 581-593.

Auerbach, A.J. and K.A. Hassett, 2006, The 2003 dividend tax cuts and the value of thefirm: an event study. In: Auerbach, A., Slemrod, J. (Eds.), Taxing Corporate Income in

the 21stCentury. Cambridge University Press, Cambridge.

Blouin, J.L., Raedy, J.S., Shackelford, D.A., 2011, Dividends, share repurchases, and taxclienteles: Evidence from the 2003 reductions in shareholder taxes, Accounting Review

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Carroll, R., D. Holtz-Eakin, M. Rider and H.S. Rosen, 2000, Entrepreneurs, income taxes,

and investment, in: Joel Slemrod, ed., Does Atlas Shrug? The Economic Consequences of

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Chen, C., Z. Dai, D. Shackelford, H. Zhang, 2011, Do financial constraints affect

shareholder taxes and the cost of equity capital? Working paper, University of North

Carolina and University of Texas at Dallas.

Chetty, R. and E. Saez, 2005, Dividend taxes and corporate behavior: evidence from the

2003 dividend tax cut, Quarterly Journal of Economics120, 791-833.

Cummins, J.G., K.A. Hassett, and R.G. Hubbard, 1994, A reconsideration of investment

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Dhaliwal, D., L. Krull, and O. Li, 2007, Did the 2003 tax act reduce the cost of equity

capital?Journal of Accounting and Economics43, 121-150.

Fama, E. and K. French, 1997, Industry cost of equity, Journal of Financial Economics

43, 153-193.

Fazzari, S.M., R.G. Hubbard, and B.C. Petersen, 1988a, Financing constraints and

corporate investment,Brookings Papers on Economic Activity1, 141-195.

Fazzari, S.M., R.G. Hubbard, and B.C. Petersen, 1988b, Investment, financing decisions,and tax policy,American Economic Review78, 200-205.

Graham, J., 2003, Taxes and corporate finance: A review,Review of Financial Studies16,1075-1129.

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Guenther, D., B. Jung, and M. Williams, 2005, The effect of the 2003 dividend tax rate

reduction on corporations cost of equity capital, working paper.

Hadlock, C. and J. Pierce, 2010, New evidence on measuring financial constraints:Moving beyond the KZ index,Review of Financial Studies23, 1909-1940.

Hassett, K. and R.G. Hubbard, 2002, Tax policy and business investment, Handbook ofPublic Economics3, Edited by A.J. Auerbach and M. Feldstein, 1294-1343.

Hubbard, R.G., 1998, Capital-market imperfections and investment, Journal of Economic

Literature36, 193-225.

Kaplan, S. and L. Zingales, 1997, Do investment-cash flow sensitivities are not valid

measures of financial constraints, Quarterly Journal of Economics112, 159-216.

Meyer, J. R., and E. Kuh, 1957, The investment decision, Cambridge: Harvard University

Press.

Naranjo, A., M. Nimalendran, and M. Ryngaert, 1998, Stock returns, dividend yields, and

taxes,Journal of Finance53, 2029-2057.

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of return, working paper, Wharton School, University of Pennsylvania.

Whited, T. and G. Wu, 2006, Financial constraints risk, Review of Financial Studies19,531-559.

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Table 1 Summary statistics of firm variables

This table reports summary statistics for firm characteristics for the period surrounding TRA and

JGTRRA for the full sample (Panel A) and the pre- and post- subsamples (Panel B). CAPX is the

change in capital expenditure from year t1 to year t; CAPXRD is the change in the sum of capital

expenditure and R&D expenditure from year t1 to year t; EMP is the change in number of

employees (in thousands) from year t1to year t;FCSA andFCSACLare the predicted probability ofa firm being financially constrained in the most recent quarter in year t using Hadlock and Pierce

(2010)s SA index and the alternative measure estimated using firm size, age, cash flow and leverage,

respectively; YLDis four times the dividends declared in the most recent past quarter divided by the

end of quarter price as in Naranjo, Nimalendran and Ryngaert (1998); TSO is one minus the

percentage ownership by institutional investors; NDIV is an indicator variable that equal to 1 if

common stock dividends in year t1is non-positive and 0 otherwise;AVEr is the average of cost of

capital in year t1; dSALEQ is the change in sales from year t1 to year t; Turnover is the moving

average of the past 250 daily volume scaled by the shares outstanding;LogBMis the logarithm of the

book-to-market ratio; LogLTG is the logarithm of the forecasted long-term earnings growth rate;

LogDisp is the logarithm of the dispersion of the forecasted long-term growth rate; LogSize is the

logarithm of a firms market capitalization; mkt , smb , and hml are the beta coefficient relative to

the market, the SMB, and the HML factor, respectively. CAPXand dSALEQare deflated by PPI. The

sample spans 1996 to 1998 for TRA and 2002 to 2004 for JGTRRA.

Panel A: Summary statistics for the full sample

TRA JGTRRA

Mean Median Std Dev Mean Median Std Dev

CAPX 0.0971 0.0022 0.6011 -0.0180 0.0000 0.8810

CAPXRD 0.1262 0.0061 0.6609 0.0106 0.0000 0.8950

EMP 0.3138 0.0210 1.5380 0.0895 0.0040 1.6515FCSA 0.0410 0.0298 0.0337 0.0310 0.0243 0.0241

FCSACL 0.0406 0.0309 0.0345 0.0328 0.0249 0.0290TSO 0.6941 0.7520 0.2522 0.6426 0.6845 0.2850YLD 0.0252 0.0000 0.3228 0.0485 0.0006 0.2156

NDIV 0.5671 1.0000 0.4955 0.4980 0.0000 0.5000

Control Variables

AVEr 0.1050 0.1057 0.0138 0.0950 0.0914 0.0125

dSALEQ 0.2157 0.0142 1.1987 0.2177 0.0034 1.8186

Turnover 0.0052 0.0030 0.0061 0.0062 0.0033 0.0086LogBM -0.3315 -0.2337 0.7438 -0.2391 -0.1429 0.7715

LogLTG 2.7958 2.7726 0.5500 2.7088 2.7081 0.5614

LogDisp -1.6399 -1.6386 0.6607 -1.4330 -1.4553 0.7169

LogSize 4.9012 4.7942 1.8647 5.4277 5.3747 1.9792

mkt 0.9395 0.8556 1.1771 0.9925 0.8721 0.8965

smb 0.8430 0.6156 1.3860 0.5773 0.3927 0.9018

hml 0.1290 0.2881 1.8553 0.1927 0.3416 1.1297

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Panel B: pre- and post-tax cut comparison

TRA JGTRRAPre Post Pr(diff=0) Pre Post Pr(diff=0)

CAPX 0.0724 0.1210

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Table 2 Changes in investments and job creation for firms with different financial constraints

This table presents firms change in investments from year t1to year tbefore and after the tax cut forTRA (JGTRRA) in terms of capital expenditure (CAPX), capital and research and development

expenditure (CAPXRD) and number of employees (EMP) for high financial constrained (HFC) and

low financial constrained (LFC) firms. HFC (LFC) represents firm-quarters when the predicted

financial constraint is above (below) the median financial constraint for the quarter before the tax cut(1995Q4 for TRA and in 2001Q4 for JGTRRA). Panel A and Panel B show the results using FCSA

andFCSACLmeasures respectively. * significant at 10%, ** significant at 5%, and *** significant at1% level.

Panel A: Financial Constraints measured by FCSA

TRA JGTRRAPre Post Diff (Post-Pre) Pre Post Diff (Post-Pre)

CAPX

LFC 0.1272 0.2517 0.1246*** -0.1800 0.0993 0.2794***HFC 0.0176 0.0171 -0.0006 -0.0111 0.0166 0.0277***

Diff-in-Diff 0.1252*** 0.2516***CAPXRD

LFC 0.1884 0.3246 0.1361*** -0.0972 0.1205 0.2177***HFC 0.0226 0.0238 0.0011 -0.0155 0.0152 0.0307***Diff-in-Diff 0.1350*** 0.1870***

EMP

LFC 0.4510 0.5912 0.1401** -0.0387 0.2751 0.3137***HFC 0.1090 0.1190 0.0100 0.0163 0.1114 0.0951***Diff-in-Diff 0.1301** 0.2186***

Panel B: Financial Constraints measured by FCSACLTRA JGTRRA

Pre Post Diff (Post-Pre) Pre Post Diff (Post-Pre)

CAPX

LFC 0.1245 0.2645 0.1400*** -0.1756 0.0970 0.2726***HFC 0.0201 0.0266 0.0065 -0.0258 0.0217 0.0475***Diff-in-Diff 0.1335*** 0.2251***

CAPXRD

LFC 0.2111 0.3246 0.1135*** -0.0802 0.1205 0.2007***HFC 0.0178 0.0238 0.0059 -0.0322 0.0152 0.0474***

Diff-in-Diff 0.1075*** 0.1533***EMP

LFC 0.4998 0.6231 0.1232* -0.0102 0.3012 0.3114***

HFC 0.0763 0.0958 0.0195 -0.0107 0.0973 0.1079***Diff-in-Diff 0.1037 0.2034***

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Table 3 The impact of financial constraint on capital expenditures

This table presents ordinary least squares regression results for the dependent variable CAPX. The

regression specification is

1,61,51,41,31,21, titittitittitti NDIVTSOPostTSOFCSAPostFCSAPostCAPX

1,7 tit NDIVPost + Controls (when applicable) + Constant + ti

,

For TRA, we use data from 1996 to 1998, andPosttakes a value of zero before 1997 and value of one

after 1997. For JGTRRA in 2003, we use data from 2002 to 2004, and Post takes a value of zero

before 2003 and value of one after 2003.CAPXis the change in capital expenditure from year t1toyear t;FCSA is the predicted probability of a firm being financially constrained in the most recent pastquarter in year t using Hadlock and Pierce (2010)s SA index, TSO is one minus the percentage

ownership by institutional investors. Regression (1) does not include control variables and Regression

(2) includes control variables listed in Table 1. All variables are winsorized at 1% and 99% levels. The

standard errors are in parentheses. They are robust to heteroskedasticity, and are clustered at the firm

level. *, **, and *** represent significance at the 10%, 5%, and 1% level, respectively.

TRA JGTRRA

Variable (1) (2) (1) (2)

Post 0.155*** 0.223*** 0.401*** 0.455***

(0.045) (0.076) (0.058) (0.108)

FCSA -0.412** 5.641*** 2.089*** 0.757(0.166) (1.611) (0.405) (2.642)

Post FCSA -0.992*** -4.189** -2.208*** -8.756**

(0.287) (1.715) (0.610) (3.849)TSO -0.253*** -0.015 0.125** -0.154

(0.038) (0.089) (0.050) (0.133)

Post TSO -0.051 -0.011 -0.217*** 0.080

(0.054) (0.121) (0.070) (0.187)NDIV -0.000 0.117** 0.000 -0.033(0.018) (0.049) (0.033) (0.081)

Post NDIV -0.064** -0.085 -0.059 -0.051

(0.028) (0.063) (0.043) (0.103)

Firm controls No Yes No Yes

N 11,646 3,586 9,647 3,441

Adjusted R2 0.029 0.131 0.014 0.067

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Table 4 The impact of financial constraint on capital and R&D expenditures

This table presents ordinary least squares regression results for the dependent variable CAPXRD. The

regression specification is

1,51,41,31,21, tittitittitti TSOPostTSOFCSAPostFCSAPostCAPXRD

1,71,6

titti NDIVPostNDIV + Controls (when applicable) + Constant + ti,

For TRA, we use data from 1996 to 1998, andPosttakes a value of zero before 1997 and value of one

after 1997. For JGTRRA in 2003, we use data from 2002 to 2004, and Post takes a value of zero

before 2003 and value of one after 2003. CAPXRD is the change in the sum of capital expenditureand R&D expenditure from year t1 to year t; FCSA is the predicted probability of a firm being

financially constrained in the most recent quarter in year t using Hadlock and Pierce (2010)s SA

index, TSOis one minus the percentage ownership by institutional investors. Regression (1) does not

include control variables and Regression (2) includes control variables listed in Table 1. All variables

are winsorized at 1% and 99% levels. The standard errors are in parentheses. They are robust to

heteroskedasticity, and are clustered at the firm level. *, **, and *** represent significance at the 10%,

5%, and 1% level, respectively.

TRA JGTRRAVariable (1) (2) (1) (2)

Post 0.179** 0.178 0.304*** 0.513***

(0.072) (0.115) (0.081) (0.153)

FCSA -0.550** 7.418*** 2.520*** 2.102(0.217) (2.734) (0.566) (3.751)

Post FCSA -0.370 -0.505 -2.760*** -13.801***

(0.363) (2.356) (0.774) (4.564)

TSO -0.323*** 0.052 -0.040 -0.457**(0.051) (0.128) (0.065) (0.185)

Post TSO -0.131* -0.148 -0.087 0.556*(0.076) (0.169) (0.089) (0.301)

NDIV -0.068** 0.014 -0.079 0.007(0.030) (0.066) (0.051) (0.120)

Post NDIV -0.064 -0.111 -0.022 -0.096

(0.049) (0.095) (0.062) (0.141)

Firm controls No Yes No Yes

N 6,277 1,845 5,677 1,976

Adjusted R2 0.047 0.216 0.011 0.104

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Table 5 The impact of financial constraint on firm employment

This table presents ordinary least squares regression results for the dependent variable EMP. The

regression specification is

1,51,41,31,21, tittitittitti TSOPostTSOFCSAPostFCSAPostCAPX

1,71,6

titti NDIVPostNDIV + Controls (when applicable) + Constant + ti,

For TRA, we use data from 1996 to 1998, andPosttakes a value of zero before 1997 and value of one

after 1997. For JGTRRA in 2003, we use data from 2002 to 2004, and Post takes a value of zero

before 2003 and value of one after 2003. EMPis the change in number of employees (in thousands)from year t1 to year t;FCSA is the predicted probability of a firm being financially constrained in themost recent quarter in year t using Hadlock and Pierce (2010)s SA index, TSO is one minus the

percentage ownership by institutional investors. Regression (1) does not include control variables and

Regression (2) includes control variables listed in Table 1. All variables are winsorized at 1% and

99% levels. The standard errors are in parentheses. They are robust to heteroskedasticity, and are

clustered at the firm level. *, **, and *** represent significance at the 10%, 5%, and 1% level,respectively.

TRA JGTRRAIndependent variables (1) (2) (1) (2)

FCSA -1.980*** -7.687** 1.121* -3.131(0.463) (3.560) (0.653) (4.315)

Post FCSA -1.448** -3.204 -3.024*** -12.261**

(0.715) (4.049) (0.960) (5.701)Post (1 FCSA) 0.141 0.017 0.451*** 0.689***

(0.104) (0.171) (0.107) (0.189)

TSO -0.852*** -0.261 -0.206** -0.242

(0.102) (0.209) (0.084) (0.207)

Post TSO -0.057 0.104 -0.191 0.199(0.131) (0.253) (0.119) (0.308)

NDIV 0.063 0.313*** 0.109** 0.245**(0.047) (0.120) (0.049) (0.124)

Post NDIV 0.002 -0.086 -0.038 -0.092

(0.064) (0.148) (0.067) (0.158)

Firm controls No Yes No Yes

N 11,515 3,542 10,607 3,402Adjusted R

2 0.030 0.249 0.009 0.127

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Table 6 Robustness check using the alternative financial constraint measure

This table reproduces Table 3, 4 and 5 using theFCSACLmeasure as the firms probability of facing

financial constraints.NDIVandPost NDIVincluded but not reported.

TRA JGTRRA

Independent variables (1) (2) (1) (2)CAPX

Post 0.172*** 0.217*** 0.424*** 0.458***

(0.049) (0.080) (0.061) (0.110)

FCSACL -0.486** 4.925*** 2.203*** 0.562

(0.193) (1.392) (0.427) (2.038)

Post FCSACL -1.258*** -6.338*** -2.817*** -11.115***

(0.305) (1.679) (0.607) (3.398)

TSO -0.263*** -0.050 0.085* -0.166

(0.040) (0.094) (0.051) (0.136)

Post TSO -0.048 0.066 -0.169** 0.092

(0.056) (0.124) (0.070) (0.189)

Firm controls No Yes No YesN 10,208 3,366 9,023 3,320

Adjusted R2 0.035 0.135 0.016 0.072

CAPXRD

Post 0.210*** 0.188 0.332*** 0.471***

(0.081) (0.117) (0.089) (0.156)

FCSACL -0.927*** 2.942 1.704*** 0.920

(0.264) (1.995) (0.560) (2.664)

Post FCSACL -0.689* -3.195 -2.675*** -13.873***

(0.395) (2.307) (0.729) (4.296)

TSO -0.332*** 0.083 -0.052 -0.506***

(0.056) (0.137) (0.065) (0.191)

Post TSO -0.118 -0.051 -0.049 0.575*

(0.081) (0.172) (0.089) (0.300)

Firm controls No Yes No Yes

N 5,393 1,743 5,266 1,910

Adjusted R2 0.060 0.215 0.012 0.108

EMP

FCSACL -2.572*** 0.242 0.897 1.432

(0.551) (2.973) (0.639) (3.419)

Post FCSACL -1.779** -4.316 -3.564*** -20.107***

(0.756) (3.405) (0.838) (4.991)

Post (1 FCSACL) 0.116 0.016 0.467*** 0.682***

(0.113) (0.176) (0.112) (0.193)

TSO -0.874*** -0.333 -0.247*** -0.324(0.109) (0.224) (0.083) (0.212)

Post TSO -0.006 0.118 -0.175 0.307

(0.139) (0.268) (0.114) (0.317)

Firm controls No Yes No Yes

N 10,166 3,329 9,869 3,285

Adjusted R2 0.034 0.245 0.010 0.130

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40

Table 7 The impact of financial constraint on capital expenditures of firms with different dividend yields

This table presents ordinary least squares regression results for the dependent variable CAPX. The regression specification is

titit

titittitittitittitti

NDIVPost

NDIVYLDPostYLDTSOPostTSOFCSAPostFCSAPostCAPX

,1,9

1,81,71,61,51,41,31,21,

Constant)applicable(whenControls

For TRA, we use data from 1996 to 1998, and Posttakes a value of zero before 1997 and value of one after 1997. For JGTRRA in 2003, we use data from 2002

to 2004, andPosttakes a value of zero before 2003 and value of one after 2003. CAPXis the change in capital expenditure from year t 1 to year t;FCSA is thepredicted probability of a firm being financially constrained in the most recent past quarter in year tusing Hadlock and Pierce (2010)s SA index, TSOis one

minus the percentage ownership by institutional investors. Regression (1) does not include control variables and Regression (2) includes control variables listedin Table 1. All variables are winsorized at 1% and 99% levels. The standard errors are in parentheses. They are robust to heteroskedasticity, and are clustered at

the firm level. *, **, and *** represent significance at the 10%, 5%, and 1% level, respectively.

TRA JGTRRAIndependent Full Sample Subsample (div-paying) Full Sample Subsample (div-paying)

variables (1) (2) (1) (2) (1) (2) (1) (2)

Post 0.172*** 0.234*** 0.219*** 0.265* 0.389*** 0.414*** 0.477*** 0.371*

(0.046) (0.078) (0.077) (0.141) (0.059) (0.108) (0.095) (0.191)

FCSA -0.400** 5.588*** -0.692 9.764*** 2.210*** 0.941 6.846*** 5.368

(0.166) (1.612) (0.702) (3.591) (0.406) (2.649) (1.734) (6.619)

Post FCSA -0.947*** -4.094** -5.324*** -10.319** -2.297*** -9.268** -6.232*** -10.177

(0.287) (1.716) (1.394) (4.657) (0.609) (3.856) (2.339) (8.641)

TSO -0.250*** -0.016 -0.350*** -0.012 0.132*** -0.170 0.058 -0.357

(0.038) (0.089) (0.074) (0.170) (0.051) (0.133) (0.115) (0.290)

Post TSO -0.040 -0.009 0.018 0.088 -0.222*** 0.098 -0.264* 0.195

(0.053) (0.121) (0.112) (0.232) (0.070) (0.186) (0.152) (0.346)

YLD -0.122 0.219 -0.082 0.151 -0.165*** -0.463*** -0.205*** -0.485***(0.087) (0.330) (0.089) (0.331) (0.055) (0.174) (0.057) (0.177)

Post YLD -0.330** -0.342 -0.225 -0.268 0.101 0.473* 0.147* 0.517*

(0.143) (0.407) (0.147) (0.406) (0.079) (0.295) (0.082) (0.311)

NDIV -0.008 0.125** -0.027 -0.089

(0.019) (0.050) (0.036) (0.084)

Post NDIV -0.091*** -0.101 -0.039 0.001

(0.031) (0.066) (0.046) (0.106)

Firm controls No Yes No Yes No Yes No Yes

N 11,646 3,586 4,139 1,700 9,647 3,441 3,833 1,597

Adjusted R2 0.030 0.131 0.026 0.111 0.014 0.069 0.014 0.075

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41

Table 8 The impact of financial constraint on capital and R&D expenditures of firms with different dividend yields

This table presents ordinary least squares regression results for the dependent variable CAPXRD. The regression specification is

titit

titittitittitittitti

NDIVPost

NDIVYLDPostYLDTSOPostTSOFCSAPostFCSAPostCAPXRD

,1,9

1,81,71,61,51,41,31,21,

Constant)applicable(whenControls

For TRA, we use data from 1996 to 1998, and Posttakes a value of zero before 1997 and value of one after 1997. For JGTRRA in 2003, we use data from 2002

to 2004, andPosttakes a value of zero before 2003 and value of one after 2003. CAPXRDis the change in the sum of capital expenditure and R&D expenditurefrom year t1 to year t; FCSA is the predicted probability of a firm being financially constrained in the most recent past quarter in year tusing Hadlock and

Pierce (2010)s SA index; TSO is one minus the percentage ownership by institutional investors. Regression (1) does not include control variables andRegression (2) includes control variables listed in Table 1. All variables are winsorized at 1% and 99% levels. The standard errors are in parentheses. They are

robust to heteroskedasticity, and are clustered at the firm level. *, **, and *** represent significance at the 10%, 5%, and 1% level, respectively.TRA JGTRRA

Independent Full Sample Subsample (div-paying) Full Sample Subsample (div-paying)

variables (1) (2) (1) (2) (1) (2) (1) (2)

Post 0.199*** 0.208* 0.277** 0.348 0.277*** 0.437*** 0.312** 0.128

(0.076) (0.118) (0.131) (0.212) (0.083) (0.157) (0.137) (0.325)

FCSA -0.535** 7.243*** -4.437*** 11.922* 2.723*** 2.599 10.015*** 17.792

(0.216) (2.727) (1.538) (6.677) (0.570) (3.750) (3.069) (12.869)

Post FCSA -0.342 -0.206 -5.300* -6.394 -2.937*** -14.571*** -10.223*** -20.414

(0.362) (2.352) (2.924) (8.172) (0.773) (4.555) (3.911) (15.013)

TSO -0.319*** 0.055 -0.424*** 0.214 -0.033 -0.487*** -0.331* -1.331**

(0.051) (0.127) (0.131) (0.312) (0.065) (0.187) (0.117) (0.561)

Post TSO -0.117 -0.151 -0.114 -0.303 -0.089 0.582* 0.085 1.550*

(0.076) (0.168) (0.204) (0.439) (0.089) (0.301) (0.227) (0.800)

YLD -0.192* 0.475 -0.031 0.364 -0.285*** -0.570** -0.345*** -0.668***

(0.115) (0.451) (0.118) (0.443) (0.100) (0.239) (0.107) (0.228)

Post YLD -0.335 -0.791 -0.178 -0.502 0.207* 0.742** 0.282** 0.844**(0.224) (0.569) (0.229) (0.572) (0.115) (0.329) (0.120) (0.322)

NDIV -0.082** 0.034 -0.126** -0.081

(0.033) (0.069) (0.055) (0.124)

Post NDIV -0.095* -0.150 0.015 -0.005

(0.053) (0.099) (0.067) (0.145)

Firm controls No Yes No Yes No Yes No Yes

N 6,277 1,845 1,835 720 5,677 1,976 1,821 728

Adjusted R2 0.049 0.216 0.039 0.216 0.013 0.107 0.010 0.117

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Table 9 The impact of financial constraint on firm employment for firms with dividend yieldsThis table presents ordinary least squares regression results for the dependent variable EMP. The regression specification is

)1()1( 1,1,71,1,61,51,41,31,21,1, tititititittitittittiti FCSAYLDFCSAYLDTSOPostTSOFCSAPostFCSAPostFCSAEMP

1,111,101,1,91,1,8 )1( tittititittitit NDIVPostNDIVFCSAYLDPostFCSAYLDPost + Controls (when applicable) + Constant + ti,

For TRA, we use data from 1996 to 1998, and Posttakes a value of zero before 1997 and value of one after 1997. For JGTRRA in 2003, we use data from 2002

to 2004, andPosttakes a value of zero before 2003 and value of one after 2003. EMPis the change in number of employees (in thousands) from year t1to year t;FCSAis the predicted probability of a firm being financially constrained in the most recent past quarter in year tusing Hadlock and Pierce (2010)s SA index; TSOis one minus the

percentage ownership by institutional investors. Regression (1) does not include control variables and Regression (2) includes control variables li sted in Table 1. All variables are

winsorized at 1% and 99% levels. The standard errors are in parentheses. They are robust to heteroskedasticity, and are clustered at the firm level. *, **, and *** representsignificance at the 10%, 5%, and 1% level, respectively.

TRA JGTRRAIndependent Full Sample Subsample (div-paying) Full Sample Subsample (div-paying)variables (1) (2) (1) (2) (1) (2) (1) (2)

FCSA -2.181*** -7.853** -8.354*** -7.300 0.924 -3.268 5.808** 10.540

(0.472) (3.682) (2.356) (8.388) (0.671) (4.319) (2.790) (12.312)

Post FCSA -1.362* -3.313 -4.010 -8.168 -2.959*** -12.783** -7.487* -26.533*

(0.726) (4.228) (3.292) (10.802) (0.979) (5.721) (3.819) (14.686)

Post (1 FCSA) 0.114 -0.018 0.111 -0.003 0.442*** 0.682*** 0.618*** 1.023***

(0.107) (0.178) (0.180) (0.309) (0.109) (0.193) (0.178) (0.372)

TSO -0.827*** -0.250 -0.732*** -0.017 -0.204** -0.254 -0.075 -0.231

(0.102) (0.211) (0.186) (0.347) (0.084) (0.207) (0.156) (0.423)

Post TSO -0.066 0.089 0.028 0.220 -0.190 0.212 -0.333 -0.018

(0.131) (0.256) (0.249) (0.436) (0.119) (0.308) (0.225) (0.563)

YLD FCSA 28.325*** 45.844 43.654*** 16.231 8.148*** 9.007 4.245 -9.262

(9.086) (109.789) (12.254) (115.124) (2.235) (14.456) (2.722) (18.129)

YLD (1 FCSA) -2.443*** -1.774 -2.838*** -1.086 -0.547*** -0.552 -0.468*** -0.277(0.570) (3.385) (0.640) (3.460) (0.127) (0.428) (0.136) (0.463)

Post YLD FCSA -12.096 -21.354 -9.652 8.837 0.354 14.005 4.190 24.286(10.513) (99.945) (14.324) (104.231) (3.572) (21.591) (4.298) (25.618)

Post YLD (1 FCSA) 1.087 1.519 1.072 0.684 0.013 -0.206 -0.066 -0.272

(0.682) (3.181) (0.749) (3.217) (0.194) (0.556) (0.207) (0.608)

NDIV -0.018 0.291** 0.078 0.201(0.052) (0.126) (0.052) (0.130)

Post NDIV 0.029 -0.040 -0.033 -0.075

(0.071) (0.157) (0.070) (0.163)

Firm controls No Yes No Yes No Yes No YesN 11,515 3,542 4,203 1,686 10,607 3,402 4,755 1,562

Adjusted R2 0.033 0.249 0.021 0.238 0.010 0.127 0.008 0.137

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Table 10 The comparison of the impact of TRA and JGTRRA

This table reports the estimation results of the comparison of the impact on the changes

of firms capital investment and employment underTRA and JGTRRA. We extend the

specifications (21) and (22) by introducing interactions of the regressors in these

equations with a dummy variable D03 representing the tax event of JGTRRA. The

dummy variable takes a value of zero if an observation belongs to the tax event of TRA

and a value of one if it belongs to the tax event of JGTRRA. The sample consists of all

firms on the merged CRSP and COMPUSTAT database for year 1996 and 1998 for TRA

and for year 2002 and 2004 for JGTRRA. We exclude 1997 for TRA and 2003 for

JGTRRA to avoid transient effect. Model (1) excludes firm level control variables and

model (2) includes the firm controls. The robust clustered standard errors are reported in

parentheses.*significant at 10%,

**significant at 5%, and

*** significant at 1%.

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Variable CAPX CAPXRD Variable EMP

(1) (2) (1) (2) (1) (2)

Post 0.443*** 0.614*** 0.448*** 0.597*** FCSA -3.096*** -15.511***(0.046) (0.077) (0.072) (0.118) (0.472) (3.548)

FCSA -0.921*** -3.131** -1.055*** -5.726** Post*FCSA 0.065 -5.183(0.171) (1.569) (0.234) (2.556) (0.722) (4.202)

Post*FCSA -0.426 -5.798*** 0.178 -0.208 Post*(1-FCSA) 0.626*** 0.567***(0.289) (1.766) (0.369) (2.331) (0.100) (0.161)

TSO 0.072* 0.314*** -0.033 0.404*** TSO -0.211** 0.419**(0.037) (0.089) (0.054) (0.140) (0.085) (0.197)

Post*TSO -0.363*** -0.475*** -0.402*** -0.655*** Post*TSO -0.681*** -0.620**(0.056) (0.123) (0.078) (0.179) (0.125) (0.255)

YLD 0.119 0.546 0.060 0.863 YLD*FCSA 19.470** -33.103(0.091) (0.395) (0.118) (0.541) (8.426) (93.479)

Post*YLD -0.572*** -0.883* -0.586** -1.438** YLD*(1-FCSA) -1.646*** 0.510(0.147) (0.456) (0.228) (0.633) (0.556) (2.874)

NDIV 0.055*** 0.118** -0.010 0.081 Post*YLD*FCSA -3.241 58.218

(0.019) (0.050) (0.030) (0.069) (10.101) (83.468)Post*NDIV -0.154*** -0.165** -0.167*** -0.286*** Post*YLD*(1-FCSA) 0.291 -1.088

(0.031) (0.067) (0.051) (0.101) (0.684) (2.692)D03*Post -0.284*** -0.477*** -0.375*** -0.487*** NDIV 0.094* 0.330***

(0.049) (0.087) (0.079) (0.139) (0.051) (0.124)D03*FCSA 3.463*** 10.519*** 4.189*** 16.983*** Post*NDIV -0.083 -0.137

(0.455) (2.680) (0.658) (3.736) (0.071) (0.158)D03*Post*FCSA -2.203*** -0.004 -3.526*** -12.002** D03*FCSA 4.442*** 13.355***

(0.673) (4.076) (0.867) (4.957) (0.796) (4.965)D03*TSO -0.187*** -0.774*** -0.202*** -1.199*** D03*Post*FCSA -3.863*** -1.194

(0.050) (0.144) (0.079) (0.234) (1.203) (7.185)D03*Post*TSO 0.388*** 0.821*** 0.515*** 1.468*** D03*Post*(1-FCSA) -0.601*** -0.320*

(0.078) (0.216) (0.115) (0.343) (0.113) (0.187)D03*YLD

-0.356***

-1.080**

-0.428***

-1.535**

D03*TSO

-0.451***

-1.385***

(0.107) (0.436) (0.156) (0.596) (0.076) (0.261)D03*Post*YLD 0.745*** 1.430*** 0.876*** 2.301*** D03*Post*TSO 0.949*** 1.378***

(0.165) (0.546) (0.255) (0.717) (0.151) (0.392)D03*NDIV -0.164*** -0.225** -0.208*** -0.258** D03*YLD*FCSA -9.030 51.225

(0.036) (0.089) (0.051) (0.126) (8.785) (94.315)D03*Post*NDIV 0.196*** 0.239** 0.273*** 0.421*** D03*YLD*(1-FCSA) 0.895 -1.404

(0.049) (0.116) (0.073) (0.159) (0.568) (2.894)Constant -0.002 0.017 0.159*** -0.356 D03*Post*YLD*FCSA 1.303 -59.805

(0.027) (0.193) (0.041) (0.350) (10.834) (85.651)D03*Post*YLD*(1-FCSA) -0.075 1.358

Firm controls No Yes No Yes (0.713) (2.735)Observations 21,293 7,027 11,954 3,821 D03*NDIV -0.150** -0.176Adjusted R-square 0.020 0.081 0.028 0.130 (0.064) (0.166)

D03*Post*NDIV 0.184* 0.151

Constant(0.094)

0.467***

(0.059)

(0.221)

-1.679***

(0.398)

Firm controls

ObservationsNo

22,122Yes

6,944Adjusted R-squared 0.022 0.171

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Figure 1

Capital Investment and Shareholder Taxation

This figure illustrates the effect of shareholder taxes on the investment income on firms

cost of capital and investment. With shareholder taxes on investment income, the cost of

capital is increased and the capital investment is decreased.

Capital Investment

rc, rr

D

Src

rr

A

S

B

rr

K

K