On the Marginal Source of Investment Funds

Alan Auerbach and Kevin Hassett

No 7821, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Under the new view' of dividend taxation developed in Auerbach (1979), Bradford (1981) and King (1977) the marginal source of finance for new investment projects is retained earnings. In this case, the tax advantage of retentions precisely offsets the double taxation of subsequent dividends: taxes on dividends have no impact on the investment incentives of firms using retentions as a marginal source of funds and paying dividends with residual cash flows. We find evidence that dividends do respond to investment and cash flow for the nonfinancial corporate sector as a whole in a manner consistent with the new view. We also find that this dividend pattern is weaker for firms with better access to capital markets, as measured by bond rating and the number of analysts following them. Finally, we find that, although new share issues and repurchases respond to the same firm characteristics as dividends do, the pattern of these responses is consistent with a broader interpretation of the new view that preserves the main result of dividend-tax irrelevance with respect to the cost of capital.

JEL-codes: G35 H32 (search for similar items in EconPapers)
Date: 2000-08
New Economics Papers: this item is included in nep-cfn, nep-fin and nep-pub
Note: CF PE
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Citations: View citations in EconPapers (26)

Published as Auerbach, Alan J. and Kevin A. Hassett. "On The Marginal Source Of Investment Funds," Journal of Public Economics, 2003, v87(1,Jan), 205-232.

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