The Relation between Firm Dividend Policy and the ...

The Relation between Firm Dividend Policy and the

Volatility of Cash Effective Tax Rates

Matthew Erickson

Virginia Tech

[email protected]

January 2018

This project is adapted from my dissertation. I am deeply grateful to my committee members,

Dan Dhaliwal (deceased), Katharine Drake (chair), Sandy Klasa, and Jeff Yu, for their

encouragement, support, and guidance. Additionally, this project has greatly benefitted from

workshop participants at the University of Arizona, Virginia Tech University, George

Washington University, the University of Georgia, and the Ohio State University. I also

appreciate helpful comments from Nathan Goldman, Shyam Sunder, Erin Towery, and the

Arizona Tax Reading Group. Finally, I am thankful for funding from the University of Arizona’s

Eller College of Management, the American Institute of Certified Public Accountants and

specifically contributors to the Accounting Doctoral Scholars program, and the Charles Koch

Foundation for their dissertation grant initiative.

mailto:[email protected]

The Relation between Firm Dividend Policy and the

Volatility of Cash Effective Tax Rates

Abstract:

I examine the relation between a firm’s dividend policy and its strategic tax decisions. I posit that

the capital market pressure associated with paying a dividend leads dividend-paying firms to

seek consistent cash flows. I specifically focus on one component of consistent cash flows, the

volatility of a firm’s cash effective tax rate (ETR), due to the observability, large size, variability,

and periodicity of cash tax payments. Consistent with dividend payments altering a firm’s

strategic tax preferences, I find robust evidence that dividend-paying firms exhibit less volatile

cash ETRs. This evidence comes from both broad tests on wide samples of firms designed to

demonstrate “on average” effects as well as tests on more narrow samples of firms designed to

mitigate endogeneity concerns and demonstrate robustness. Specifically, I find that the volatility

of a firm’s cash ETR is decreasing in its dividend yield, that the volatility of a dividend-initiating

(eliminating) firm’s cash ETR subsequently decreases (increases), and that financial constraint

moderates the negative relation between the volatility of a firm’s cash ETR and its dividend

yield. Importantly, my results hold after employing a wide range of econometric techniques

designed to address endogeneity as well as for firms initiating a dividend in response to the

exogenous shock of the Bush tax cuts. Finally, I also examine specific tax strategies dividend-

paying firms use to help increase the predictability of their cash tax payments. My results

contribute to the literature by examining whether, and how, dividend-paying firms alter their

strategic tax decisions.

JEL Codes: G35; H25; M40; M41; M48

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I. INTRODUCTION

In this study, I examine the relation between a firm’s need for consistent cash flow and its

strategic tax decisions. Specifically, I contend that dividend-paying firms make a strong

commitment to periodically return cash to equity investors and therefore require consistent cash

flows. While firms paying a regular dividend may implement many different strategies to help

support their dividend stream, I specifically focus on dividend-paying firms’ cash tax strategies

due to the observability, large size, extensive variation, and periodicity of cash tax payments. I

argue that, because dividend-paying firms value consistent cash flows, they attempt to reduce the

volatility of their cash tax payments. I test this relation across a broad sample of firms, in more

narrow settings around dividend initiations and eliminations, and in a cross-sectional analysis of

financially constrained firms. Additionally, I validate my findings using a variety of alternate

econometric techniques, examining a subsample of firms initiating a dividend payment in

response to the exogenous shock of the Bush tax cuts, and by exploring specific tax strategies

that dividend-paying firms use to achieve more predictable cash tax payments. My findings are

important to academics since they demonstrate a specific outcome of paying a dividend as well

as identify a reason why some firms might prioritize consistent cash tax payments as a strategic

objective. Likewise, my findings are of interest to policy makers and investors given the recent

trend in legislating firms’ ability to pay dividends.

Extensive evidence supports the idea that dividends are important to investors and that

managers take steps to ensure that dividend payments, once initiated, remain stable or steadily

increase (e.g., Lintner 1956). In a recent New York Times article Dr. Douglas Skinner reiterates

this idea and notes that “ ‘investors look at that record [of dividends], and they count on it…after

a while, the dividend becomes sacrosanct’ ” (Sommer 2016). Indeed, “some executives tell

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stories of selling assets, laying off a large number of employees, borrowing heavily, or bypassing

positive NPV projects, before slaying the sacred cow of cutting dividends” (Brav, Graham,

Harvey, and Michaely 2005, p. 500).

While I expect that dividend policy affects a variety of firm behaviors, I focus on firms’

cash tax strategies for several reasons.1 First, cash taxes paid represent a large, variable expense

and account for 27.0 (25.6) percent of a mean (median) firm’s pre-tax income with an

interquartile range of 25.2 percentage points (Dyreng, Hanlon, and Maydew 2008). Second,

similar to dividends, taxes must be paid in cash at regular, predictable intervals (quarterly) and

accordingly represent a recurring cash outlay that managers may attempt to stabilize. This

predictable periodicity is not present in many other major firm expenses such as capital

expenditures as these tend to be “lumpy” rather than “smooth” (Caballero and Engel 1999).

Finally, while prior research documents that firms manage the level of their GAAP ETRs

(Dhaliwal, Gleason, and Mills 2004; Krull 2004), more recent research examines the

sustainability of tax expense as an important strategic tax goal for some firms (McGuire,

Neuman, and Omer 2013; Neuman 2016).2 Because firms manage their GAAP tax expense in

certain circumstances and sustainability is an important goal for some firms, I expect that

dividend-paying firms also attempt to manage the volatility of their cash tax expense.

While the findings in prior research support the notion that dividend-paying firms should

exhibit less volatile cash ETRs, it is possible that my evidence will not support this contention or

that I will find evidence in favor of an opposite result. Specifically, to the extent that dividend-

1 I focus on the volatility of cash, not GAAP, tax expense since dividends are typically paid in cash and thus cash tax

expense is more relevant to my study. In untabulated analysis, I find that my results are generally robust (but

weaker) when examining the volatility of a firm’s GAAP tax expense. 2 These studies discuss the importance of a firm’s tax strategy in general but do not examine whether dividend

payments influence the firm’s tax strategy. My results help explain why certain firms emphasize a goal of

sustainable tax payments.

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paying firms have easy access to additional cash (e.g., via the public debt market; (Alli, Khan,

and Ramirez 1993; Aivazian, Booth, and Cleary 2006)), they may not attempt to reduce the

volatility of their cash tax payments and may instead focus on minimizing cash tax payments. If

this occurs, I may fail to find (or find a positive relation) between a firm’s dividend payments

and the volatility of its cash ETR.

Despite this tension, I find consistent evidence supporting the expectation that dividend-

paying firms exhibit less volatile cash tax payments. Using a sample of 57,578 observations from

1987 to 2015, I test the association between a firm’s dividend policy and the volatility of its cash

ETR. My results demonstrate a negative relation between the amount of regular, recurring

dividends paid by a firm and the volatility of the firm’s cash ETR. This relation is also

economically significant. My primary test implies that, for my mean firm, a doubling of its

dividend payout is associated with an 11.1% decrease in the volatility of its cash ETR. For

comparison, a doubling of my mean firm’s cash flow volatility is associated with a 17.9%

increase in the volatility of its cash ETR.

Further, I find consistent evidence that firms initiating (eliminating) a dividend payment

experience a subsequent decrease (increase) in the volatility of their cash ETRs; these results

help address endogeneity concerns inherent in the broad, pooled setting of my first specification.

Moreover, my tests demonstrate that firm-level financial constraint moderates the relation

between a firm’s dividend payments and the volatility of its cash ETR, consistent with the notion

that financially constrained dividend-paying firms prioritize obtaining immediate cash. While I

specifically focus on dividend-paying firms, this result builds on prior research demonstrating a

general relation between financial constraint and strategic changes in tax behavior (Akamah,

Omer, and Shu 2016; Edwards, Schwab, and Shevlin 2016).

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In additional analysis, I find that my results are robust to a variety of alternate

specifications designed to help address endogeneity concerns with respect to both correlated,

omitted variables and reverse causality. Specifically, I re-estimate my primary analysis using a

matched sample design, including firm-fixed effects, and employing an instrumental variables

specification. Additionally, I also use the 2003 Bush tax cuts as an exogenous shock to firms’

incentives to pay dividends since prior research demonstrates that firms did not anticipate this tax

cut and it also increased the likelihood that a firm initiated a dividend payment (Chetty and Saez

2005, 2006; Dhaliwal, Krull, and Li 2007). Moreover, I also employ counterfactual analysis

based on both special dividends and share repurchases since I expect that, unlike regular

dividends, special dividends and share repurchases return capital to shareholders without

imposing an expectation of consistent future dividends or repurchases and thus do not generate a

need for less volatile future cash flows.

Finally, I explore several strategies dividend-paying firms may use to help them achieve

less volatile cash ETRs. A firm may use many different types of tax planning strategies ranging

from those that produce completely certain tax benefits (e.g., excluding municipal bond interest)

to those that may produce highly variable tax benefits (e.g., employing tax strategies with a lack

of definitive guidance) (Hanlon and Heitzman 2010). I expect that dividend-paying firms are less

likely to engage in less certain tax strategies as such strategies may be overturned upon audit and

induce volatility in future cash tax payments. I find that, while firms that pay more in dividends

have higher total book-tax differences, they are less likely to engage in “extreme” forms of tax

planning as evidenced by lower discretionary book-tax differences (Frank, Lynch, and Rego

2009) and a lower likelihood of engaging in tax shelters (Wilson 2009).

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My results contribute to the academic literature in several ways. In general, prior research

focuses on why firms pay dividends; I examine a specific outcome of paying a dividend and thus

demonstrate a previously overlooked consequence of dividend payments.3 Additionally, my

results identify a strategic reason why firms might prefer less volatile cash tax payments even at

the potential cost of increasing total tax payments. This contributes to ongoing discussion over

whether and why some firms prefer a sustainable tax strategy (Weisbach 2002; Neuman 2016).

The remainder of my study proceeds as follows: in Section II, I provide background

information on the dividend literature with a specific focus on studies discussing the importance

of dividend payments. In Section III, I develop and formally state my hypotheses. Section IV

contains a summary of my research design. In Section V, I provide a summary of my primary

results. In Section VI, I discuss the results of additional analyses. Finally, in Section VII, I offer

some concluding thoughts.

II. LITERATURE REVIEW

Relevance and Valuation of Dividends

In their seminal analysis of payout policy and firm value, Miller and Modigliani (1961)

observe that, in perfect capital markets, “the irrelevance of dividend policy….is ‘obvious once

you think of it’” (p. 414).4 Early evidence supports this claim (Watts 1973; Black and Scholes

1974; Gonedes 1978; Watts 1976) even in the presence of asymmetric tax treatment between

dividends and capital gains (Miller and Scholes 1978). However, capital market imperfections

3 Bradley, Capozza, and Seguin (1998) represents an important exception; their study finds that dividend-paying

firms exhibit less cash flow volatility. In the next section, I discuss their results in more detail and argue that my

results are distinct from their study across several important dimensions. 4 Miller and Modigliani (1961) condition their claim on the level of a firm’s investment. Given that dividend payout

ratios tend to be conservative, many dividend-paying firms need not trade off investment for higher dividend

payments. However, managers at 66.9 percent of dividend-paying firms make investment plans after making

dividend decisions (Brav et al. 2005). This indicates that, for the majority of dividend-paying firms, dividend policy

supersedes even investment considerations.

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unwind the “irrelevance view” and lead to a variety of theoretical explanations and empirical

support for a relation between dividend policy and firm value. Importantly, in my setting, it is

unnecessary to identify the specific reason dividend payout policy matters to investors as my

hypotheses only assume that managers recognize and act as though dividend policy does matter

to investors.

Investors may value dividends for several reasons. Since dividends reduce the size of a

firm by distributing cash to shareholders, they reduce agency costs by: limiting a manager’s

ability to waste idle cash on value-decreasing investments (Jensen 1986); forcing managers to

more frequently access the capital markets to fund new investments (Myers and Majluf 1984);

and improving shareholder monitoring of firm actions (Easterbrook 1984). Additionally,

dividends reduce information asymmetry between managers and shareholders by allowing

managers to credibly signal current cash flow (Miller and Rock 1985), future cash flow

(Bhattacharya 1979), and/or other valuable private information about future investments (John

and Williams 1985; Aggarwal, Cao, and Chen 2012). Finally, the existence of taxes and tax

clienteles may explain the importance of dividend policy to investors. Since different classes of

investors face different marginal tax rates on income from dividends, firms with a high dividend

yield are less attractive to individuals with a relatively high tax rate on dividend income (e.g.,

short-term, high-income individual investors) and more attractive to individuals with a relatively

low tax rate on dividends (e.g., corporations, tax-exempt investors) (Elton and Gruber 1970;

Litzenberger and Ramaswamy 1979; Dhaliwal, Erickson, and Trezevant 1999; Baker and

Wurgler 2004; Graham and Kumar 2006).

While evidence remains divided concerning why dividend policy should matter to

investors, evidence also clearly demonstrates that dividend policy does matter to investors and

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that managers actively seek to maintain a consistent dividend policy. This is important to my

study because it helps explain why a firm might change its actions to accommodate a specific

dividend payout strategy. Specifically, investors react strongly to changes in dividend policy and

this reaction is asymmetric with dividend decreases resulting in a more extreme reaction than

dividend increases (Asquith and Mullins Jr 1983; Benesh, Keown, and Pinkerton 1984). On

average, market reactions to dividend increases (decreases) are approximately 3 percent (-7

percent) and continue to drift upward (downward) (Michaely, Thaler, and Womack 1995).

Similarly, there is a positive relation between dividend announcement returns and subsequent

earnings changes; this implies that investors rationally interpret dividend announcements as

“good news” (Healy and Palepu 1988; Lipson, Maquieira, and Megginson 1998). Moreover,

dividend reductions are more likely to occur for loss firms. However, demonstrating the

reluctance of managers to cut dividends, losses are “a necessary, but not sufficient, condition for

dividend reductions” and managers strongly attempt to avoid dividend reductions or omissions

even in the presence of losses (DeAngelo, DeAngelo, and Skinner 1992, p. 1838). Collectively,

these studies indicate that investors expect consistency in a firm’s dividend policy and react

strongly to any deviation from their expectation.

Dividend Policy and Strategic Firm Decisions

Prior research also demonstrates that managers understand the importance investors place

on consistent dividends and seek to maintain or gradually increase dividend payout ratios. Early

work by Lintner (1956) finds that managers target a long-term dividend payout ratio and

therefore dividend payments tend to be relatively sticky. This result persists over time; Brav et

al. (2005) survey mangers of dividend-paying firms and find that 88.1 percent of managers

perceive negative consequences to reducing dividends and 89.6 percent try to maintain a

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consistent dividend stream from year to year. Empirical evidence demonstrates this as well.

Allen and Michaely (2003) examine trends in payout policy over time and observe that “during

the entire 1972-1998 period, aggregate dividends fell only twice…Firms usually increase

dividends gradually and rarely cut them” (p. 349). Demonstrating that managers are reluctant to

cut dividends is important in my setting because it provides a plausible explanation for a relation

between dividend payout policy and firm policy – managers may structure firm policy to help

minimize the risk that the firm will decrease or omit future dividend payments.

Existing evidence supports the idea that firm attributes and strategy change in response to

dividend policy. Skinner and Soltes (2011) find that earnings are more persistent for dividend

paying firms and that losses are less persistent. Likewise Venkatesh (1989) finds that stock

returns are less volatile following the initiation of dividends; similarly, Sant and Cowan (1994)

find that dividend omissions precede an increase in earnings volatility, stock return volatility,

beta, and analyst forecast dispersion. Most related to my study is Bradley et al. (1998) who find a

negative relation between dividend payout policy and the volatility of a firm’s cash flows. I

differ from Bradley et al. (1998) in that I examine the volatility of a firm’s cash effective tax rate

and not the volatility of a firm’s cash flow. Additionally, Bradley et al. (1998) limit their analysis

to the REIT sector; I exclude REIT firms from my sample since these firms have unique tax

incentives that limit their generalizability. Finally, to further distinguish my findings, I include

the volatility of a firm’s overall cash flow as a control variable in my regressions.

While these studies provide general evidence that specific firm characteristics change in

response to dividend policy, surveys of managers provide the most persuasive evidence of

dividend policy influencing firm actions. In Brav et al. (2005)’s survey, managers of dividend-

paying firms clearly admit that maintaining a consistent dividend policy influences their actions.

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Specifically, to maintain dividends, managers are willing to pass up positive NPV projects, raise

costly external funds, sell assets, and even terminate employees. I argue that, while it is difficult

to observe these types of extreme actions, it is relatively easy to measure the volatility of a firm’s

cash ETR and that prior literature suggests that managers manage the tax account to achieve

strategic firm objectives (Dhaliwal et al. 2004; Krull 2004; McGuire et al. 2013; Higgins, Omer,

and Phillips 2015; Neuman 2016).

In summary, prior evidence strongly supports the idea that dividend policy matters to

investors, that managers implement sustainable, consistent dividend policies, and that managers

are willing to change a firm’s tax policy to accomplish a strategic objective. Next, I present

specific hypotheses exploring the relation between dividend payout policy and firm tax strategy.

III. HYPOTHESES

Based on the above discussion, I expect that the capital market pressure from paying a

dividend leads dividend-paying firms to take steps to avoid reducing or omitting a dividend

payout. In a recent Wall Street Journal article on the importance of dividends, a Wal-Mart

spokesperson expressed this sentiment by observing that “the company has ‘a meaningful

dividend that has grown for 43 consecutive years…[we] are committed to strong returns for

shareholders’” (Eisen 2016). Similarly, prior studies show that a firm aligns its tax strategy with

its business strategy (Higgins et al. 2015; Neuman 2016). Alignment between tax and business

strategy is especially important because some tax strategies are only available for a single time

period or provide non-recurring tax benefits (Drake, Lusch, and Stekelberg 2017) and,

accordingly, may not increase the consistency of a firm’s cash tax payments on an ongoing basis.

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Thus, I specifically expect that firms alter their tax strategies to decrease the volatility of their

cash tax payments5 and state this relation as my first hypothesis as follows:

H1: There is a negative relation between the volatility of a firm’s cash effective tax rate and

the firm’s dividend yield.

One concern with my first hypothesis is that the relation between dividend payout policy

and tax strategy is endogenous. In particular, not all firms are equally likely to pay a dividend

(Fama and French 2001; Denis and Osobov 2008) and firm characteristics also influence tax

strategies (Gupta and Newberry 1997; Rego 2003; Dyreng et al. 2008; Wilson 2009). Thus, in

my second hypothesis, I examine whether the volatility of a firm’s cash tax payment changes

around the initiation and/or elimination of a dividend.

I expect that, subsequent to the initiation of a dividend, dividend-paying firms attempt to

decrease the volatility of their cash ETR in response to capital market pressure. This is consistent

with Michaely et al. (1995)’s view that initiating a dividend payment represents a substantial

change in corporate policy. I present this contention as the first part of my second hypothesis as

follows:

H2A: The volatility of a firm’s cash effective tax rate decreases following the initiation of a

dividend payment.

Likewise, if the capital market pressure associated with paying a dividend leads a

dividend-initiating firm to decrease the volatility of its cash ETR, then I also expect that the

removal of this pressure is associated with a subsequent increase in the volatility of a firm’s cash

5 While cash tax expense and GAAP tax expense are positively correlated, GAAP tax rules may artificially smooth

the volatility of GAAP tax expense since GAAP tax rates are influenced by reserves for potentially unfavorable tax

outcomes such as settlements with the IRS. Overall, GAAP tax rates measure tax expense associated with current

period accounting income while cash tax rates capture outlays of cash (Hanlon and Heitzman 2010).

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ETR following the elimination of its dividend. I present this contention as the second part of my

second hypothesis as follows:

H2B: The volatility of a firm’s cash effective tax rate increases following the elimination of a

dividend payment.

Importantly, to the extent that managers only consider initiating (eliminating) a dividend

when the firm’s operations and cash flows are less (more) volatile, firms with less (more) volatile

cash ETRs may be more likely to initiate (eliminate) a dividend. If this is true, changes in the

volatility of a dividend initiating (eliminating) firm’s cash ETR may occur prior to the initiation

(elimination) of a dividend. If this occurs, I may fail to find results for my second hypothesis

even if firms change their behavior in response to paying a dividend. Likewise, it is also possible

that firms with less (more) volatile cash ETRs are more likely to pay an initial dividend

(eliminate their dividend) and that (removing) the capital market pressure associated with this

decision incentivizes (de-incentivizes) these firms to further decrease the volatility of their cash

ETRs subsequent to the initiation (elimination) of their dividend. If this occurs, I may find results

for my second hypothesis but “miss” the portion of a firm’s change in behavior that occurs prior

to the change in its dividend policy. While I do not develop a formal hypothesis to address this, I

discuss the design and results of tests examining this possibility in subsequent sections to provide

a more complete understanding of changes in a firm’s behavior in response to initiating

(eliminating) a dividend payment.

Finally, while my first hypothesis postulates a negative relation between the volatility of

a firm’s cash ETR and its dividend payout policy, I expect that financially constrained dividend-

paying firms may focus less on the volatility of their cash ETRs. As previously discussed,

reducing dividends incurs a steep capital market penalty and firms go to great lengths to avoid

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this penalty (DeAngelo and DeAngelo 1990; DeAngelo et al. 1992; Christie 1994; Brav et al.

2005). Additionally, Leone (2008) outlines 16 different tax strategies companies can employ to

generate additional cash while Law and Mills (2015) and Edwards et al. (2016) specifically show

that financially constrained firms reduce short-term tax payments in an attempt to provide

immediate cash. Importantly, Akamah et al. (2016) extends these studies and demonstrates that

financially constrained firms also exhibit more volatile cash ETRs.

While prior research (Law and Mills 2015; Akamah et al. 2016; Edwards et al. 2016)

demonstrates how financial constraint influences the tax strategies of broad samples of firms, the

majority of dividend paying firms are not financially constrained relative to non-dividend paying

firms. Accordingly, I extend this logic to constrained versus unconstrained dividend-paying

firms. In contrast to my second hypothesis which focuses on examining whether dividend

initiating (eliminating) firms alter the volatility of their cash tax payments, my third hypothesis

focuses on the actions of constrained (but not necessarily dividend-ceasing) firms. Consequently,

I propose my third hypothesis as follows:

H3: For dividend-paying firms, financial constraint moderates the negative relation between

the volatility of the firm’s cash effective tax rate and its dividend yield.

In summary, I examine the link between firm dividend policy and the volatility of a

firm’s cash ETR. I hypothesize a negative relation between dividend payouts and the volatility of

cash ETRs, investigate whether this relation changes for dividend initiating or eliminating firms,

and examine whether financial constraint mitigates any negative relation. In the next section, I

present the specific equations I use to test these hypotheses.

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IV. RESEARCH DESIGN

Empirical Design

To test my first hypothesis examining whether dividend-paying firms exhibit less volatile

cash ETRs, I regress the volatility of a firm’s cash effective tax rate on a firm’s dividend payout

as well as a variety of control variables from prior research (Brown, Drake, and Wellman 2015;

Guenther, Matsunaga, and Williams 2017). Specifically, I employ the following equation:

VOL_CETRit-2,t = α + β1 DIVi,t + β2 VOL_CFit-2,t + β3 PT_ROAi,t + β4 VOL_PT_ROAit-2,t

+ β5 SIZEi,t + β6 PP&Ei,t + β7 R&Di,t + β8 LEVi,t + β9 MTBi,t + β10 IND_CETRi,t + β11

CASHi,t + Ʃ Industry and Year Fixed Effects + εi,t (1)

All equations cluster standard errors by firm; subscripts i and t represent firm i at time t.

VOL_CETR is the three-year standard deviation from t-2 to t of the firm’s cash ETR (total taxes

paid divided by pre-tax income less any special items) and captures the volatility of a firm’s cash

tax expense. DIV is the amount of the firm’s per-share dividends divided by its stock price.

Consistent with prior research, I use Compustat to calculate control variables but CRSP to

determine dividends. Specifically, I only include regular, periodic dividends on common stock

(CRSP distribution codes of 1200-1259).6 To the extent that dividend-paying firms exhibit less

volatile cash tax payments, I expect a negative and significant coefficient on DIV across all three

specifications.

I define VOL_CF as the three-year standard deviation from t-2 to t of the firm’s cash flow

from operations scaled by total assets and include it to control for the overall volatility of a

firm’s cash flows. I measure PT_ROA as the firm’s pre-tax net income divided by total assets;

6 Codes 1200-1259 represent ordinary (i.e., not as a result of a liquidation, reorganization, stock split, etc…) cash

dividends paid in U.S. dollars with a monthly, quarterly, semi-annual, annual, unknown, or unspecified frequency.

In additional analysis, I also consider the effect of special dividends (CRSP dividend distribution codes of 1270-

1299) as well as share repurchases (calculated from Compustat/CRSP data but with no specific dividend distribution

code).

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this variable controls for the possibility that more profitable firms may make greater investments

in tax planning. I use pre-tax income to avoid any potential mechanical correlation issues given

that my variable of interest is the volatility of a firm’s cash tax expense. VOL_PT_ROA is the

three-year standard deviation from t-2 to t of the firm’s PT_ROA and serves as an additional

control to capture the overall predictability of a firm’s operations. I measure SIZE as the natural

logarithm of the firm’s total assets and note that this variable captures potential “economies of

scale” with respect to a firm’s ability to engage in tax planning activities. I define PP&E, R&D,

and LEV as the firm’s property, plant, and net equipment, research and development spending,

and total debt respectively; I scale each of these variables by total assets and include them as

they represent deductible or creditable expenses that reduce a firm’s tax payments. MTB is the

ratio of the firm’s market value of equity to its book value of equity and captures differences

between the equity market’s value of a firm and the current accounting book value of a firm.

IND_CETR is the firm’s cash ETR (cash taxes paid divided by pre-tax income less the effect of

any special items) minus the average cash ETR for other firms in the same industry and year.7

CASH is the amount of a firm’s cash and cash equivalents scaled by total assets and controls for

the liquid resources available to a firm for investment in tax planning activities. The appendix

contains a detailed description of all variables.

I test this equation on three sets of firms: all firms with available data; all firms with

available data that are not small firms, firms with extreme cash ETR, or firms with negative pre-

tax income; and only firms paying a positive dividend. In particular, by limiting the third sample

to only firms that pay a positive dividend, I partially address concerns that any relation observed

7 Consistent with prior research, I control for a firm’s industry-adjusted cash ETR to capture the tax planning of the

firm relative to other similar firms (Guenther et al. 2017). In untabulated analysis, I find that my inferences are

unchanged if I control for a firm’s unadjusted cash ETR. As I only adjust cash ETR by industry, it is still appropriate

to include industry fixed effects. My inferences are unchanged if I remove industry fixed effects.

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in my first two samples stems from dividend-paying firms generally exhibiting more

predictability in their operations (i.e., a life cycle effect (Mueller 1972; Porter 1980; Anthony

and Ramesh 1992; Grullon, Michaely, and Swaminathan 2002; Dickinson 2011)).

In the first part of my second hypothesis, I test whether the volatility of a firm’s cash

ETR decreases subsequent to the initiation of a dividend. To test this relation, I isolate a

subsample of firms that begin paying a dividend during my sample period and examine the

volatility of those firms’ cash ETRs during the period immediately before and immediately after

the initiation of the dividend using the control variables from equation (1) as follows:


+ β5 SIZEi,t + β6 PP&Ei,t + β7 R&Di,t + β8 LEVi,t + β9 MTBi,t + β10 IND_CETRi,t

+ β11 CASHi,t + Ʃ Industry and Year Fixed Effects + εi,t (2A)

For this test, I only examine firms that begin paying a dividend at some point during my

sample period; I exclude firms that either always pay a dividend or never pay a dividend. I then

examine the volatility of these firms’ cash ETRs starting three years prior to the initiation of the

dividend and ending three years after the initiation of the dividend. Because, by definition, a firm

does not pay a dividend in the pre-period, my DIV variable does not capture any decreases in the

volatility of a firm’s cash ETR in the pre-period but instead represents the effect of initiating a

dividend payment. Thus, H2A predicts a negative relation between the volatility of the firm’s

cash ETR and the amount of dividends paid by the newly paying dividend firm. Accordingly, I

expect a negative and significant coefficient on DIV.

Likewise, for the second part of my second hypothesis, I examine whether the volatility

of a firm’s cash ETR decreases subsequent to the elimination of a dividend. Similar to the first

portion of my second hypothesis, I isolate a subsample of firms that stop paying a dividend

during my sample period and examine the volatility of those firms’ cash ETRs during the period

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immediately before and immediately after the elimination of their dividend using the control

variables from equation (1) as follows:


+ β5 SIZEi,t + β6 PP&Ei,t + β7 R&Di,t + β8 LEVi,t + β9 MTBi,t + β10 IND_CETRi,t

+ β11 CASHi,t + Ʃ Industry and Year Fixed Effects + εi,t (2B)

Consistent with H2B, I predict that dividend-eliminating firms experience a subsequent

increase in the volatility of their cash ETRs. Because, by definition, DIV is equal to zero once a

firm eliminates its dividend (i.e., in the post-elimination period), an increase in volatiltiy occurs

to the extent that I find a positive and significant coefficient on DIV.

As previously discussed, I am also interested in investigating whether any change in

volatility occurs before, after, or both before and after a firm initiates (eliminates) its dividend. I

test this by examining whether firms with less (more) volatile cash effective tax rates are more

likely to initiate (eliminate) a dividend payment. Since Fama and French (2001) identify several

key factors that explain whether or not a firm begins paying a dividend, I test this by adding

these factors to the control variables included in equation (1) and present this specification as

equation (2C) which employs the following logistic equation:

P(NEW_DIV=1)i,t [P(STOP_DIV=1)i,t]= α + β1 VOL_CETRit-2,t + β2 PT_ROAi,t + β3

MTBi,t + β4 MK_PCTKi,t + β5 AT_GROWTHit-1,t + β6 VOL_CFit-2,t + β7 VOL_PT_ROAit-2,t

+ β8 SIZEi,t + β9 PP&Ei,t + β10 R&Di,t + β11 LEVi,t + β12 IND_CETRi,t + β13 CASHi,t

+ Ʃ Industry and Year Fixed Effects + εi,t (2C)

In this equation, P(NEW_DIV=1)i,t is an indicator variable coded as one if a firm pays a dividend

in the current year but not in either of the two prior years. Alternatively, P(STOP_DIV=1)i,t is an

indicator variable coded as one if a firm does not pay a dividend in the current year but did in

both of the two prior years. MK_PCTL represents the percentage of all publicly traded firms that

17

have the same or smaller market capitalization while AT_GROWTH represents the growth in the

firm’s assets from t-1 to t. All other variables are as previously defined.

Since I am interested in the likelihood that a firm initiates (eliminates) a dividend

payment, I examine a sample of firms that do not (do) pay a dividend when they first enter my

sample. Specifically, I exclude all firms that began (did not begin) continuously paying a

dividend before they entered my sample period. Additionally, once a firm begins (ceases) paying

a dividend, I remove it from the sample for all subsequent years.

I test this equation on three samples of firms; all firms with available data, a sample of

dividend initiating (eliminating) and non-dividend initiating (eliminating) firms in the same

industry and year matched by size and profitability, and an entropy-balanced sample of all firms

with available data (Hainmueller and Xu 2013).8 While I do not make a formal prediction, I note

that, if the volatility of a firm’s cash ETR changes before initiating (eliminating) a dividend

payment, I should observe a negative (positive) and significant coefficient on VOL_CETR.

Finally, my third hypothesis tests whether financially constrained dividend-paying firms

exhibit relatively more volatile cash ETRs as compared to financially unconstrained dividend-

paying firms. To test this hypothesis, I isolate a sample of dividend-paying firms and add an

interaction variable for financial constraint to equation (1) as follows:

8 Entropy balancing “can be used to create balanced samples…where the control group data can be reweighted to

match the covariate moments in the treatment group (Hainmueller and Xu 2013).” Specifically, one concern with

analyzing equation (2C) on a broad sample of firms is that the control sample contains firms with disperse

characteristics. An entropy-balanced sample addresses this concern by re-weighting the control variables such that

they are similar for dividend initiating (eliminating) and non-dividend initiating (eliminating) firms. One advantage

of entropy balancing relative to a matched sample design is that it does not discard “non-matching” observations. In

untabulated analysis, I also re-estimate equation (1) on my primary sample using entropy balancing and find that my

inferences remain unchanged. I do not tabulate this analysis because I also run equation (1) on a sample of only

firms with positive dividend-payments which eliminates the need to control for potential differences between

dividend-paying and non-dividend-paying firms.

18

VOL_CETRit-2,t = α + β1 DIVi,t + β2 CONSTRAINi,t + β3 DIVi,t * CONSTRAINi,t

+ β4 VOL_CFit-2,t + β5 PT_ROAi,t + β6 VOL_PT_ROAit-2,t + β7 SIZEi,t + β8 PP&Ei,t

+ β9 R&Di,t + β10 LEVi,t + β11 MTBi,t + β12 IND_CETRi,t + β13 CASH

+ Ʃ Industry and Year Fixed Effects + εi,t (3)

I use Z_SCORE, the firm’s Z-score following Altman (1968), to determine financial constraint. I

multiply a firm’s Z-Score by negative one so that higher values of Z_SCORE represent relatively

greater financial constraint.9 CONSTRAIN is a dummy variable set equal to one if a dividend-

paying firm’s Z_SCORE is in the top half for all dividend-paying firms. Consistent with my first

hypothesis, I expect a negative coefficient on DIV. This implies that the volatility of a firm’s

cash tax payments is decreasing in its dividend payments. Conversely, I expect a positive a

significant coefficient on the interaction of DIV * CONSTRAIN which implies that financial

constraint moderates the general decrease in the volatility of cash tax payments from dividend

payments.

Sample Selection and Characteristics

For my primary tests, I begin with a sample of all Compustat firms with a non-missing

primary identifier (GVKEY), positive assets, and a post SFAS 95 (post 1987) statement of cash

flows. I eliminate firms in either the utility (SIC codes 4900-4999) or financial services (SIC

codes 6000-6999) industries as these firms are heavily regulated and have different incentives.

Since I examine the three-year volatility of a firm’s cash ETR, I also remove firm-years for firms

without two consecutive previous years of data. I also remove firm-years for firms missing

9 I select this measure of financial constraint because it does not rely on whether a firm pays a dividend to compute

the degree of firm financial constraint. Other techniques such as those developed in Whited and Wu (2006) or the

KZ-index as proposed by Kaplan and Zingales (1997) and implemented in Lamont, Polk, and Saá-Requejo (2001)

use dividend payments to partially determine whether a firm is financially constrained. In contrast, I focus on

whether a dividend-paying firm is relatively constrained as compared to other dividend-paying firms.

19

information necessary to calculate variables of interest or control variables. Further, I remove

firm-years with extreme cash ETRs (single-year cash ETRs greater than 1 or less than 0) as these

firms exhibit abnormal tax behavior.10 Additionally, I remove firm-years for small firms as

defined by Fama and French (2001) (those with total assets of less than $500,000 or with book

equity less than $250,000) since these firms likely face a different set of tax planning

opportunities relative to larger firms. Finally, I remove firm-years for firms with a three-year

cumulative loss as loss firms exhibit different tax behavior. This results in a final sample of

57,578 firm-year observations. I summarize my sample selection process in Table 1.

[Insert Table 1 Here]

I present descriptive statistics in Table 2; these align well with prior research.

Approximately 37% of firm-years in my sample pay a dividend and the average VOL_CETR is

18.89%.


Similarly, in Table 3, I provide a correlation matrix for key variables of interest. While

this is a univariate analysis, I note a negative correlation between DIV and VOL_CETR (p<0.01),

indicating that dividend-paying firms exhibit less volatile cash ETRs. Additionally, there is a

positive correlation between VOL_CETR and both VOL_CF (p<0.01) and VOL_PT_ROA

(p<0.01). This further underscores the need to control for the general volatility of the firm. Next,

I turn to a formal analysis of my hypotheses.


10 In untabulated analysis, I winsorize cash ETRs at 0 and 1 and find that my inferences are unchanged.

20

V. RESULTS

In Table 4, I present the result of testing my first hypothesis that there is a negative

relation between the volatility of a firm’s cash ETR and the firm’s dividend yield. I employ three

specifications examining the relation between DIV and VOL_CETR. The first column contains

the result for a sample prior to the elimination of small firms, firms with extreme cash ETRs, and

loss firms.11 In the second column, I provide the result with respect to my primary sample that

excludes these small, extreme cash ETR, or loss firms. The third column contains the result for

only the sample of firms that pay a positive dividend.12 Consistent with my expectation, in all

three cases I note a negative and significant relation between dividend payments and the

volatility of a firm’s cash ETR (p<0.01 in all three specifications).13 This implies that firms

paying higher dividends exhibit less volatile cash ETRs.


Next, I examine the result of my second hypothesis exploring the change in the volatility

of a dividend-initiating (ceasing) firm’s cash ETR. Before I discuss these results in detail, I graph

the average volatility of a firm’s cash ETR from five years prior to an event date (either the

initiation or the elimination of a dividend) until five years after the event date.14 In Panel A of

Figure 1, I present the result of graphing the volatility of my mean dividend-initiating firm’s cash

ETR before and after the initiation of a dividend. For ease of interpretation, I also include a solid

11 In general, I exclude these firms from my analyses. However, I include them in the first column of Table 4 to

demonstrate the result of my first hypothesis on a broad sample of firms. 12 To further demonstrate that my results hold even when only examining dividend-paying firms, in untabulated

analysis I drop all non-dividend paying firms as well as the bottom half of dividend-paying firms and find that my

inferences are unchanged. 13 In untabulated analysis, I also employ quantile regression to test for non-linearity in this relation. I examine my

relation at the 25th, 50th, and 75th quantiles and find similar inferences as in my primary specification. The pattern of

coefficients from this analysis does not suggest non-linearity in my primary results. 14 To provide stronger identification, my tests only use a three-year window surrounding the event date. However, I

graph a five-year window to provide better insight into any long-term patterns. My formal tests are robust to

employing a five-year window instead of a three-year window.

21

line representing the volatility of my mean dividend-initiating firm’s cash ETR at t -5, five years

before the initiation of a dividend. In four out of five years preceding the initiation of a dividend,

the average volatility of a dividend-initiating firm’s cash ETR is the same or higher than the

volatility at t -5. In contrast, in all five years following the initiation of a dividend, the average

volatility of a dividend-initiating firm’s cash ETR is lower than the volatility at t -5. This

indicates that, on average, the volatility of a dividend-initiating firm’s cash ETR declines

subsequent to the initiation of a dividend.

Similarly, in Panel B of Figure 1, I present the result of graphing the volatility of my

mean dividend-eliminating firm’s cash ETR before and after the cessation of a dividend. As in

Panel A, I also include a solid line representing the average volatility of my mean dividend-

eliminating firm’s cash ETR at t = -5, five years before the elimination of a dividend. In general,

the volatility of a dividend-eliminating firm’s cash ETR remains relatively consistent prior to t =

0, the year in which the firm eliminates its dividend payment. In contrast, in all five years

following the cessation of a dividend, the average volatility of a dividend-eliminating firm’s cash

ETR is higher than in the pre-elimination period. This indicates that, on average, the volatility of

a dividend-eliminating firm’s cash ETR increases subsequent to the elimination of a dividend.

While these graphs are not a formal test of my second hypothesis, they provide preliminary

evidence consistent with my expectations.

[Insert Figure 1 Here]

In Table 5, Panel A, I provide the result of testing the first part of my second hypothesis

that dividend-initiating firms experience less volatile cash ETRs after initiating their dividend.

To test this, I isolate only those firms that begin paying a dividend at some point during my

sample period and examine these firms for a period of three years prior to the initiation of a

22

dividend until three years following the initiation of a dividend. I then estimate equation (2A)

and examine whether dividend-paying firms exhibit less volatile cash ETRs subsequent to the

initiation of a dividend. Since I use the period immediately before and immediately after the

initiation of a dividend, any effect I find in this test is incremental to managers’ efforts to

decrease the volatility of cash tax payments prior to the initiation of a new dividend. I find results

consistent with the first part of my second hypothesis that dividend-initiating firms exhibit less

volatile cash ETRs after the initiation of a dividend (p<0.05).

Likewise, in Table 5, Panel B, I present the result of testing the second portion of my

second hypothesis. Similar to Panel A, I isolate only those firms that cease paying a dividend at

some point during my sample period and examine these firms for a period of three years prior to

the elimination of their dividend until three years after the elimination of their dividend. I then

estimate equation (2B) and examine whether dividend-eliminating firms exhibit more volatile

cash ETRs subsequent to the cessation of their dividend payment. I find results consistent with

the second part of my second hypothesis that dividend-eliminating firms exhibit more volatile

cash ETRs after the elimination of their dividend (p<0.01).

Finally, in Table 5, Panel C, I provide the results of examining whether dividend

initiating (eliminating) firms alter their tax behavior prior to the initiation (elimination) of their

dividend. To test this relation using equation (2C), I first remove all firms that already pay (do

not pay) a dividend when they enter my sample. Additionally, once a firm begins (stops) paying

a dividend, I remove all subsequent (but not preceding) firm-year observations for that firm.

Thus, my sample only contains those firms that either never (always) pay a dividend or those that

initiate (eliminate) a dividend payment at some point in my sample. Additionally, in contrast to

the majority of my tests where the coefficient on DIV is the primary coefficient of interest, in this

23

test I focus on the coefficient on VOL_CETR since it examines whether firms with less (more)

volatile cash tax payments are more likely to initiate (eliminate) a dividend.

The first three columns contain the result of this analysis for the sample of dividend

initiating firms. In the first column examining the full sample of firms with available data, I find

evidence that firms with less volatile cash ETRs are more likely to initiate a dividend (p<0.10).

However, in the second and third columns examining a matched sample of dividend-initiating

and non-dividend-initiating firms and an entropy-balanced sample of all firms, I find no evidence

of a relation between the volatility of a firm’s cash ETR and the likelihood that it initiates a

dividend payment.

I present results with respect to dividend eliminating firms in the fourth, fifth, and sixth

columns. The fourth column contains the result of examining the full sample of firms with

available data; I find evidence that firms with more volatile cash ETRs are more likely to

eliminate a dividend (p<0.01). However, in the fifth and sixth columns examining a matched

sample15 and an entropy-balanced sample respectively, I find only limited evidence of a relation

between the volatility of a firm’s cash ETR and the likelihood that it eliminates a dividend

payment. Specifically, in the fifth column the coefficient on VOL_CETR is not statistically

significant at the 10% level; however, in the sixth column, the positive coefficient on

VOL_CETR is statistically significant (p<0.05).

15 Dividend-eliminations are extremely rare events and are substantially more rare than dividend initiations. Due to

the small sample size (170 firm pairs), the matched sample analysis for dividend eliminations does not converge

when I include year and industry fixed effects. When I remove fixed effects from the equation, I obtain convergence

and thus report results without any fixed effects for this specification.

24

Collectively, these results fail to indicate consistent evidence that managers attempt to

decrease (increase) the volatility of cash tax payments prior to initiating (eliminating) a dividend.

Additionally, generally failing to find results in these specifications also partially addresses

endogeneity concerns with respect to reverse causality. However, the results in Table 5, Panels A

and B provide strong and consistent evidence that, once initiated (eliminated), the volatility of

these firms’ cash ETRs decreases (increases). Collectively, I interpret these findings as evidence

that managers seek to decrease the volatility of a firm’s cash tax expense in the presence of a

dividend payment.


Table 6 contains the result of testing my third hypothesis. I find evidence that, relative to

financially unconstrained dividend-paying firms, financially constrained dividend-paying firms

exhibit a less negative relation between the volatility of their cash ETR and their dividend

payment. Specifically, I find that the interaction of dividend payments and financial constraint is

positive and significant (p<0.01). When combined with my previously reported results, this

result suggests that the volatility of a firm’s cash ETRs is decreasing in its dividend payment.

However, when a dividend-paying firm is relatively more financially constrained, this relation

weakens (becomes relatively less negative). I interpret this as evidence of financially constrained

dividend-paying firms prioritizing sustaining their dividend payment at the partial expense of the

long-term volatility of their cash tax expense.


25

VI. ADDITIONAL ANALYSES

Tests Addressing Endogeneity

While my primary findings support my hypotheses, one important concern is that the

endogenous nature of firm dividend policy and firm tax strategy may drive my findings. In this

section, I explicitly address endogeneity concerns and perform a variety of tests to strengthen the

inferences I draw from my primary tests. Specifically, I employ three alternate econometric

techniques designed to mitigate endogeneity concerns and present the results of these tests in

Table 7.

I begin by re-estimating equation (1) on a sample of dividend-paying firms and a matched

control sample of non-dividend-paying firms of comparable size and profitability and in the

same industry and year.16 A matched sample design helps alleviate the concern that, on average,

dividend-paying firms are larger and more profitable than non-dividend-paying firms and that

larger, more profitable firms implement different types of tax planning strategies and thus exhibit

less volatile cash ETRs. I present the result of this test in the first column of Table 7 and continue

to find a negative and significant relation between the amount of dividends paid by a firm and

the volatility of a firm’s cash ETR (p<0.01).

Alternatively, I re-estimate equation (1) on my primary sample and include firm-fixed

effects. Firm-fixed effects control for unobserved, time-invariant characteristics of a firm and

help mitigate the concern that dividend-paying firms tend to be large, stable firms. I present this

16 Specifically, for each dividend-paying firm-year I match 1:1 without replacement a control firm-year in the same

SIC 2-digit industry and year. From this pool of potential matches, I select the firm-year with the closest mix (evenly

weighted) of size and profitability with a maximum acceptable difference of +/- five percent on each of these

categories. This matching procedure yields a sample of 8,700 firm-year pairs (17,400 firm-year observations).

26

result in Table 7, column two, and continue to find a negative and significant relation between

the amount of dividends paid by a firm and the volatility of a firm’s cash ETR (p<0.01).17

Finally, I employ a two-stage least squares instrumental variables specification to

estimate a modified form of equation (1). I select the firm’s sales growth as my instrument as this

variable is uncorrelated with the volatility of a firm’s cash ETR but negatively correlated with

the probability that a firm pays a dividend.18 An instrumental variables specification helps

address endogeneity by developing a predicted value for a firm’s dividend payments that should

be uncorrelated with my error term (the first-stage regression) and then regressing the volatility

of a firm’s cash ETR on the predicted value of dividend payments as well as control variables

(the second-stage regression). Table 7, column three contains the result of this test; I find a

negative and significant relation between the predicted dividends paid by a firm and the volatility

of a firm’s cash ETR (p<0.01). Collectively, these tests demonstrate that my results are robust to

a variety of alternate econometric specifications designed to mitigate concerns with respect to

endogeneity.


Additionally, I employ analysis of an exogenous shock as well as counterfactual analysis

to help further address endogeneity concerns. Koo, Ramalingegowda, and Yu (2016) employ a

conceptually similar approach by using SEC rule changes as an exogenous shock to financial

17 In general, I also find that my inferences are unchanged when including firm-fixed effects in equations (2C) and

(3). However, due to the short time series used in equations (2A) and (2B), I find that, when including firm-fixed

effects, my results are directionally consistent but not statistically significant unless I use a five-year window on

either side of a dividend initiation or elimination instead of a three-year window. When I use a longer window, I

continue to find statistically significant results even when including firm-fixed effects. I attribute the lack of

statistical significance when examining a three-year window to not having a sufficient number of observations (and

therefore variation) per firm to detect an effect in the presence of firm fixed effects. 18 I select sales growth in part because taxes are based on income, not revenue, and thus a change in sales should be

less related than a change in pre-tax income to a firm’s cash tax payments. Additionally, to the extent that additional

sales do not change a firm’s tax planning opportunities, they should be unrelated to the volatility of a firm’s cash

ETR. I do not tabulate the first stage of my IV procedure but this is available upon request.

27

reporting quality and demonstrating that firms with better financial reporting quality pay higher

dividends. I rely on prior research that identifies the 2003 Bush tax cuts as an unexpected shock

to firms given that these tax cuts were unanticipated and that their final passage was uncertain

(Brown, Liang, and Weisbenner 2007; Dhaliwal et al. 2007; Campbell, Chyz, Dhaliwal, and

Schwartz Jr. 2013).19 Further, prior research also demonstrates that, relative to preceding years,

an abnormally large number of firms began paying dividends following the passage of these tax

cuts (Chetty and Saez 2005, 2006). Additionally, the Bush tax cuts did not change the corporate

tax rate and thus there is no mechanical relation between their passage and changes in the

volatility of firms’ cash ETRs.20 Accordingly, I use the setting of the Bush tax cuts to address

endogeneity concerns by examining a sample of firms that suddenly and unexpectedly initiated a

dividend payment.

To use the Bush tax cuts as an exogenous shock in my setting, I isolate a subsample of

only those firms that started paying a dividend in either 2003 or 2004. I then examine a three-

year window on either side of the Bush tax cuts and test whether firms that began paying a

dividend in response to the Bush tax cuts subsequently exhibit more predictable cash ETRs.21

Additionally, while my dividend payout variable only captures regular dividends, many firms

also paid a special (one-time) dividend in response to the Bush tax cuts. I create an additional

variable, SPEC_DIV, equal to the amount of special dividends paid by the firm divided by its

19 Specifically, the bill containing these tax cuts, the Jobs and Growth Tax Relief Reconciliation Act of 2003, passed

in the House of Representatives with 53.6 percent of the vote (231-200). The vote in the Senate ended in a 50-50 tie.

Vice President Dick Cheney broke the tie in favor of passing this bill. 20 The Bush tax cuts allowed firms to claim more generous depreciation deductions; I control for any potential

impact of these provisions by including a firm’s PP&E intensity as a control variable. Further, if a firm uses these

provisions to decrease its cash ETR, this would, ceteris paribus, be associated with a more volatile cash ETR and

thus bias against finding a decrease in the volatility of a dividend-initiating firm’s cash ETR. 21 In untabulated analysis, I examine the year prior to the Bush tax cuts and use a t-test to examine the average cash

ETR volatility for firms that initiated a dividend in response to the Bush tax cuts and a matched sample of non-

dividend-initiating firms based on industry, size, and profitability. I fail to find a statistically significant difference in

the average cash ETR volatility of these two groups.

28

stock price, and analyze whether firms paying a special dividend also exhibit less volatile cash

ETRs.22 I then re-estimate equation (2A) on this sample and expect that regular, but not special,

dividends initiated in response to the Bush tax cuts are associated with less volatile cash ETRs as

I expect that only regular dividends generate capital market pressure to decrease the volatility of

a firm’s cash ETR.

I find evidence consistent with this expectation and report this result in the first column

of Table 8. Regular dividend payments initiated in response to the 2003 Bush tax cuts are

negatively related to the subsequent volatility of a firm’s cash ETR (p<0.05). In contrast, special

dividends exhibit no statistically significant relation to the volatility of a firm’s cash ETR.23

Building on the idea that there no relation between special dividend payouts and the

volatility of a firm’s cash ETR, I also examine the relation between share repurchases and the

volatility of a firm’s cash ETR. To the extent that managers view both share repurchases and

special dividends as non-recurring events, I expect that managers will not respond to them by

attempting to decrease the volatility of a firm’s cash tax payments. To test this assertion, I

examine my primary sample of dividend-paying and non-dividend-paying firms and re-estimate

equation (1) with the inclusion of an additional explanatory variable, REP. I define this variable

as the per-share amount of a firm’s stock repurchases divided by its stock price.24

The second column of Table 8 contains the result of this test. I continue to find a negative

relation between dividend payments and the volatility of the firm’s cash ETR (p<0.01); however,

22 I classify a dividend as a special dividend if the distribution code from CRSP is between 1270 and 1299 inclusive.

Codes 1270-1299 represent ordinary (i.e., not as the result of a liquidation, reorganization, stock split, etc…) cash

dividends paid in U.S. dollars with an extra, special, interim, or non-recurring frequency. 23 Additionally, I use an F-test to evaluate whether the coefficients on DIV and SPEC_DIV are different from each

other and find that this is the case (p<0.01). 24 Specifically, I follow Fama and French (2001)’s definition of stock repurchases as the annual change in a firm’s

treasury stock. If this amount is not available or it is less than 0, I define stock repurchases as the difference between

purchases and sales of common stock.

29

I fail to identify a statistically significant relation between the amount of stock repurchases made

by the firm and the volatility of the firm’s cash ETR.25 I interpret this as evidence that regular

dividends, but not share repurchases, are associated with less volatile cash tax payments.


Tax Strategies Used by Dividend-Paying Firms

While my previous tests support the idea that dividend payments decrease the volatility

of firms’ cash tax expense, they do not explore how firms might accomplish this objective. In

this section, I examine several tax strategies firms may use to decrease the volatility of their

future cash tax expense. In general, I contend that relatively more aggressive forms of tax

planning are more uncertain and more volatile (Inger 2014; Saavedra 2015). Thus, I expect that

firms paying relatively more in dividends engage in relatively less of these types of tax strategies

as they do not align with the strategic objective of decreasing the volatility of future tax cash

flows.

In Table 9, I examine three specific tax strategies. I begin by examining the amount of a

firm’s book-tax differences, BTD, a proxy for total tax planning (Mills 1998). Further, because I

am interested in the tax planning activities of dividend-paying firms, I restrict my sample to only

firms that pay a dividend. If dividend-paying firms actively manage their cash ETR to decrease

its volatility, I expect that this behavior is associated with higher overall amounts of tax planning

and thus higher book-tax differences.

I also examine two specific proxies for aggressive tax planning. First, I use DTAX, the

amount of discretionary book-tax differences as defined by Frank et al. (2009). In contrast to

total book-tax differences, higher discretionary book-tax differences imply that a firm engages in

25 As in the first column, I use an F-test to evaluate whether the coefficients on DIV and REP are different from each

other and find that this is the case (p<0.01).

30

more aggressive tax planning strategies (Desai and Dharmapala 2006; Frank et al. 2009; Chen,

Chen, Cheng, and Shevlin 2010). As in my test examining BTD, I limit my sample in this test to

firms that pay a dividend. Second, I use SHELTER, the probability that a firm engages in a tax-

shelter per Wilson (2009). Tax shelters represent an extremely aggressive (and potentially

illegal) form of tax planning (Wilson 2009; Lisowsky 2010; Lisowsky, Robinson, and Schmidt

2013). I argue that both of these metrics represent aggressive forms of tax planning that may be

disallowed upon audit thus resulting in a more volatile cash ETR. Additionally, in this test, I also

examine the difference between dividend-paying and non-dividend paying firms by matching my

sample of dividend paying firms to a sample of otherwise similar non-dividend-paying firms

based on industry, year, and size. If dividend-paying firms avoid aggressive forms of tax

planning, I expect that they exhibit lower discretionary book-tax differences as well as a lower

likelihood of engaging in a tax shelter.

I find results consistent with these expectations. Specifically, in the first column of Table

9, I find a positive and significant relation between the amount of dividends a firm pays and total

book-tax differences (p<0.01). This suggests that dividend-paying firms do no forego all types of

tax planning activities. However, in the second and third columns, I find a negative and

significant relation between the amount of dividends a firm pays and two measures of aggressive

tax planning: discretionary book-tax differences (p<0.10) and the probability that a firm engages

in a tax shelter (p<0.01). Collectively, I interpret these results as evidence that dividend-paying

firms select specific tax strategies designed to provide long-term, predictable cash tax benefits

and avoid highly aggressive tax strategies that tend to be uncertain.


31

Relative Importance of Dividend Payments

In untabulated analysis, I re-estimate my primary specification examining the relation

between the volatility of a firm’s cash ETR and its dividend payments based on standardized

coefficients. Specifically, I standardize all variables to have a mean of zero and a standard

deviation of one. This permits a direct comparison on the relative importance of my proposed

determinants of the volatility of a firm’s cash ETR. I then re-estimate equation (1) and rank all

variables by the absolute magnitude of the resulting coefficient. Out of the eleven proposed

determinants, I find that the firm’s dividend payments are the fifth most important factor. In

order, PT_ROA, VOL_PT_ROA, SIZE, and IND_CETR have a larger coefficient than the

coefficient on a firm’s dividend payment. In contrast, VOL_CF, PP&E, MTB, R&D, LEV, and

CASH have a smaller coefficient than the coefficient on a firm’s dividend payment.26 While I do

not have an ex-ante expectation as to the relative importance of a firm’s dividend payments in

explaining the volatility of a firm’s cash ETR, this analysis implies that it is important to

consider a firm’s dividend policy as this variable appears to be of similar or greater importance

than many variables commonly used to explain the volatility of a firm’s cash ETR.

Dividend Payments and the Level of a Firm’s Cash ETR

Additionally, in untabulated analysis, I re-estimate my primary specification examining

the relation between the volatility of a firm’s cash ETR and its dividend payments but substitute

the average three-year level of a firm’s cash ETR instead of the volatility of its three-year cash

ETR. To the extent that less volatile cash ETRs also imply lower mean cash ETRs, dividend-

26 I also test whether dividend yield is statistically different in absolute magnitude from the other determinants

included in this specification. I find that dividend yield is significantly smaller in absolute magnitude than

IND_CETR and all other variables of higher importance (p<.01), not statistically different in absolute magnitude

than VOL_CF, and significantly greater in absolute magnitude than PP&E and all other variables of lower

importance (p<.01).

32

paying firms may attempt to increase firm value by reducing their average cash tax burden rather

than attempt to decrease the volatility of their cash tax payments (Smith and Stulz 1985; Nance,

Smith, and Smithson 1993; Graham and Smith 1999). However, in contrast, it is also possible

that there is no relation between the volatility of a firm’s cash ETR and the level of its cash ETR

and thus no association between dividends and levels of cash ETR (Graham and Rogers 2002;

Guenther et al. 2017; Guenther, Wilson, and Wu 2016). In my setting, I fail to identify a relation

between the amount of dividends a firm pays and the level of its cash ETR. Thus, my results are

consistent with the idea that dividend-paying firms seek less volatile cash payments but not

necessarily lower cash tax payments.

Alternate Specifications

Finally, in untabulated analysis, I also examine a variety of alternate variable definitions

and model specifications. First, I note that, in my primary analysis, I use a one-year measure for

a firm’s dividend payments but a three-year measure for the volatility of a firm’s cash ETR.

Thus, if a firm changes its dividend policy and tax strategy in time t, my measure of dividends

immediately captures this change but my measure of the volatility of the firm’s cash ETR only

captures approximately one-third of this change. I re-estimate my primary tests using the average

amount of dividends paid by the firm over three years and I find consistent results. Second, I

acknowledge that managers may focus on dividends per share instead of dividend yield.

Accordingly, I re-estimate my primary tests using the firm’s per-share amount of dividends

instead of its dividend yield and, in untabulated analysis, I find consistent results. Third, I

recognize that paying a dividend represents a strong commitment to capital market participants

to continue paying a dividend and that tax strategies may take several years to implement.

Accordingly, I perform my analyses using five-year measures of cash ETR volatility and

33

dividends and find that my inferences remain unchanged. Fourth, while prior literature generally

scales tax payments by pre-tax income, this specification makes it difficult to draw inferences

from loss firms as well as introduces potential denominator effects. To partially address this

issue, I re-test my primary specifications and scale total cash tax payments by total assets and

find that my inferences remain unchanged. Fifth, mechanically volatility has a fixed, finite lower

bound at zero but, theoretically, an infinite upper bound; accordingly, attempts to reduce

volatility likely suffer from diminishing marginal returns. In addition to previously discussed

quartile analysis, I re-test my primary specifications after ranking firms by the volatility of their

cash ETR and eliminating the bottom (and, alternatively, the top and bottom) ten-percent of firm-

years. I find that my inferences remain unchanged. Sixth, prior literature finds that the cash tax

benefit associated with employee stocks options significantly impacts the volatility of a firm’s

cash tax expense (Brown et al. 2015; Guenther et al. 2017). Since this variable is not reliably

populated, especially early in my sample period, I do not include it in my primary analysis.

However, my inferences remain unchanged if I include this variable in my analysis.27 Seventh, as

another way to differentiate my findings from those of Bradley et al. (1998) I partition my

primary sample on the volatility of a firm’s overall cash flows. I find that my inferences remain

unchanged in both the low cash flow volatility and the high cash flow volatility subsamples.

VII. CONCLUSION

Dividend payments are extremely important to capital market participants and the subject

of extensive academic research. In this study, I add to prior literature by identifying the relation

between dividend payments and a specific firm strategy, the volatility of a firm’s cash tax

27 This is true whether I assign missing values of the employee stock expense variable a value of 0 or whether (at the

cost of a large portion of my sample) I restrict my sample to only observations with a non-zero value for this

variable.

34

expense. I find a negative relation between the amount of dividends a firm pays and the volatility

of its cash tax expense. This result holds across a wide range of settings including alternate

econometric specifications designed to mitigate endogeneity concerns as well when examining

the effect of the exogenous shock to dividend incentives of the 2003 Bush tax cuts.

Additionally, I find strong evidence that the volatility of a firm’s cash ETR decreases

(increases) after the initiation (elimination) of a dividend payment. Moreover, I find that, for

dividend-paying firms, relative financial constraint moderates the negative relation between a

firm’s dividend payments and the volatility of its cash ETR. Finally, I find that, while dividend-

paying firms engage in more overall tax planning, this planning tends to focus on strategies that

are relatively less aggressive.

My results contribute to the literature in several ways. I demonstrate a link between

dividend payments and a specific firm strategy, the volatility of a firm’s cash ETR. I also extend

the literature examining why some firms may choose to pursue a tax strategy focused on

sustainability and volatility. Finally, I contribute to ongoing public policy debates by

highlighting a benefit of dividend payments – these payments are associated with less volatile

future cash tax payments. Such a finding is especially timely given the large number of recent

proposals designed to either incentivize or de-incentivize dividend payments.

35

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39

Appendix A: Variable Definitions

Dependent Variables Definition

VOL_CETR The three-year standard deviation of a firm's cash effective tax rate

(TXPD/(PI-SPI)) from t-2 to t.

NEW_DIV An indicator variable equal to one if a firm pays a dividend in the

current year but did not pay a dividend in either t-2 or t-1.

STOP_DIV An indicator variable equal to one if a firm does not pay a dividend in

the current year but did pay a dividend in both t-2 and t-1.

BTD

The difference between a firm's book income and its taxable income

scaled by total assets (AT). Book income is a firm's pre-tax income

(PI). Taxable income is a firm's tax expense (either TXFED + TXFO -

(TLCF - lag TLCF) or, for missing/zero values of TXFED, TXT -

TXDI - TXS - TXO) scaled by the top corporate income tax rate.

DTAX The amount of a firm's discretionary book-tax differences following

Frank et al. (2009).

SHELTER The firm's tax shelter score following Wilson (2009).

Independent

Variables of Interest

DIV

The sum of all of a firm's per-share dividend payments from CRSP

(DIVAMT) for the fiscal year divided by the firm's stock price. Only

regular dividends (DISTCD 1200-1259 inclusive) are included.

Z_SCORE

The firm's Z-Score calculated following Altman (1968) and

implemented as follows:

Z_SCORE = 3.3*(PI+XINT)/at + 1.2*(WCAP/AT) +

0.99*(SALE/AT) + 1.4*(RE/AT) + 0.6*(MKVALT/LT)

This variable is multiplied by negative one so that higher values for

Z_SCORE imply greater financial distress.

CONSTRAIN An indicator variable equal to one if a dividend-paying firm's Z-

SCORE is in the top half of Z-SCOREs for all dividend-paying firms.

SPEC_DIV

The sum of all of a firm's per-share special dividend payments from

CRSP (DIVAMT) for the fiscal year divided by the firm's stock price.

Only special dividends (DISTCD 1270-1299 inclusive) are included.

40

REP

The firm's per-share repurchases following Fama and French (2001)

divided by the firm's stock price. Specifically, repurchases are the

annual change in treasury stock (TSTKC - lag TSTKC). If this amount

is less than or equal to zero, repurchases are the difference between

purchases and sales of common stock (PRSTKC - SSTK).

Control Variables

VOL_CF The three-year standard deviation of a firm's cash flows from

operations scaled by total assets (OANCF/AT) from t-2 to t.

PT_ROA The firm's pre-tax return on assets (PI/AT).

VOL_PT_ROA The three-year standard deviation of a firm's pre-tax return on assets

(PT_ROA) from t-2 to t.

SIZE The natural logarithm of a firm's total assets (log(AT)).

PP&E The firm's net property, plant, and equipment scaled by total assets

(PPENT/AT).

R&D The firm's research and development expense scaled by total assets

(XRD/AT). If this variable is missing, I set it equal to zero.

LEV The firm's long term debt scaled by total assets (DLTT/AT).

MTB The firm's market value of equity scaled by the firm's book value of

equity (MKVALT/CEQ).

IND_CETR

The firm's cash effective tax rate (TXPD/(PI-SPI)) less the average

cash effective tax rate for other firms in the same industry (Fama-

French 48 classification) and year.

CASH The firm's total cash holdings scaled by total assets (CHE/AT).

MK_PCTL

The firm's size based on its relative market value - specifically, the

percentage of all firm's in Compustat with a smaller market

capitalization (MKVALT).

AT_GROWTH The firm's growth in total assets ((AT - lag AT)/lag AT).

41

Figure 1

Notes: These graphs depict the average volatility of a firm’s cash ETR from five years prior to an event date (the

initiation or the elimination of a dividend) until five years after the event date.

Panel A contains the result of graphing the volatility of a dividend-initiating firm’s cash ETR before and after the

initiation of a dividend. For ease of interpretation, I also include a solid line representing the volatility of my mean

dividend-initiating firm’s cash ETR at t = -5, five years before the initiation of a dividend.

Panel B contains the result of graphing the volatility of a dividend-eliminating firm’s cash ETR before and after the

cessation of a dividend. For ease of interpretation, I also include a solid line representing the volatility of my mean

dividend-eliminating firm’s cash ETR at t = -5, five years before the elimination of a dividend.

0

0.1

0.2

0.3

0.4

-5 -4 -3 -2 -1 0 1 2 3 4 5

VO

L_C

ET

R

Year Relative to Dividend Initiation

Panel A: Average VOL_CETR Before and After Initiating a Dividend

VOL CETR T-5 VOL_CETR

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

1.1

-5 -4 -3 -2 -1 0 1 2 3 4 5

VO

L_C

ET

R

Year Relative to Dividend Elimination

Panel B: Average VOL_CETR Before and After Eliminating a Dividend

VOL_CETR T-5 VOL_CETR

42

TABLE 1

Sample Selection

1987 through 2015 firm years with a valid primary identifier, positive assets, a post

SFAS 95 statement of cash flows, and not in a regulated industry (SIC 6000-6999 or

SIC 4900-4999)

180,349

Less: firm years lacking information necessary to compute lagged values -40,183

Less: firms missing dependent or independent variables of interest, control variables,

or with extreme cash ETRs (cash ETRs < 0 or cash ETRs > 1)

-66,778

Total observations with all required information 73,388

Less: firm years for loss firms (negative cumulative 3-year pre-tax income) or small

firms (assets<$500,000 or book equity < $250,000)

-15,810

Total Observations for Primary Tests 57,578

Notes: I summarize my sample selection process in this table.

All variables are defined in the Appendix and taken from Compustat with the exception of firm dividends, which are taken

from CRSP. Only CRSP dividends with a distribution code (DISTCD) between 1200 and 1259 inclusive are included.

A post SFAS 95 statement of cash flows is necessary to compute several variables, including a firm's cash ETR. I remove

firms with extreme cash ETRs following Guenther et al. (2017). I remove small firms following Fama and French (2001).

43

TABLE 2

Descriptive Statistics

Variable N Mean Std Dev P25 Median P75

VOL_CETR 57,578 0.1889 0.4061 0.0401 0.0831 0.1688

DIV 57,578 0.0082 0.0151 0.0000 0.0000 0.0119

VOL_CF 57,578 0.0492 0.0448 0.0191 0.0355 0.0632

PT_ROA 57,578 0.0979 0.0869 0.0455 0.0862 0.1411

VOL_PT_ROA 57,578 0.0485 0.0545 0.0158 0.0309 0.0589

SIZE 57,578 6.0523 2.0733 4.5736 5.9697 7.4544

PP&E 57,578 0.2795 0.2252 0.1023 0.2153 0.3978

R&D 57,578 0.0257 0.0455 0.0000 0.0000 0.0319

LEV 57,578 0.1620 0.1619 0.0045 0.1270 0.2676

MTB 57,578 2.8968 2.7641 1.3107 2.0835 3.3926

IND_CETR 57,578 0.0900 0.3494 -0.0617 0.0809 0.2187

CASH 57,578 0.1526 0.1693 0.0254 0.0865 0.2240

NEW_DIV 57,578 0.0252 0.1567 0.0000 0.0000 0.0000

STOP_DIV 57,578 0.0069 0.0825 0.0000 0.0000 0.0000

MK_PCTL 57,578 66.0610 24.4130 49.5403 71.0480 86.2231

AT_GROWTH 57,578 0.1915 0.3735 0.0104 0.0928 0.2300

Z_SCORE 52,323 -5.1914 4.8930 -5.8847 -3.8026 -2.5312

CONSTRAIN 22,142 0.4951 0.4988 0.0000 0.0000 1.0000

SG 57,498 0.1607 0.2796 0.0140 0.1008 0.2331

SPEC_DIV 57,578 0.0082 0.0151 0.0000 0.0000 0.0119

REP 57,576 0.0129 0.0306 0.0000 0.0000 0.0089

BTD 47,006 0.0207 0.1273 -0.0092 0.0168 0.0490

DTAX 25,818 0.2656 1.7419 -0.0363 0.0053 0.0940

SHELTER 47,006 -0.2128 1.5824 -1.1952 -0.2375 0.7816 Notes: I present descriptive statistics with respect to the full sample of firms in this table. See Table 1 for the sample selection

process.

See the Appendix for a more detailed discussion of each variable. All continuous variables are winsorized at the 1% and 99%

levels.

44

TABLE 3

Correlation Matrix (n=57,578)

Variable (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

(1) VOL_CETR 1

(2) DIV -0.06 1

(3) VOL_CF 0.08 -0.15 1

(4) PT_ROA -0.14 0.00 0.11 1

(5) VOL_PT_ROA 0.11 -0.10 0.44 0.00 1

(6) SIZE -0.09 0.20 -0.40 -0.09 -0.24 1

(7) PP&E -0.04 0.16 -0.18 -0.07 -0.11 0.15 1

(8) R&D 0.01 -0.13 0.11 0.04 0.19 -0.11 -0.30 1

(9) LEV 0.01 0.11 -0.21 -0.31 -0.12 0.30 0.32 -0.28 1

(10) MTB -0.07 -0.02 0.05 0.36 0.08 0.11 -0.08 0.16 0.05 1

(11) IND_CETR 0.04 0.00 -0.01 0.03 -0.02 0.01 -0.02 -0.02 -0.04 -0.03 1

(12) CASH 0.00 -0.13 0.19 0.24 0.21 -0.20 -0.37 0.40 -0.44 0.16 0.00 1

Notes: This table contains Pearson correlations among variables of interest and control variables. See Table 1 for the sample selection process.

Correlations in bold are statistically significant in at the 5% level or better. See the Appendix for a more detailed discussion of each variable. I winsorize all continuous

variables at the 1% and 99% levels.

45

TABLE 4

Effect of Dividends on Volatility of Cash ETRs

(1) (2) (3)

All Firms No Small/Loss Firms Dividend-Paying Firms

Dependent Variable = VOL_CETR Coefficient Coefficient Coefficient

t-stat t-stat t-stat

INTERCEPT 0.2432*** 0.3028*** 0.2420*** 8.14 8.07 5.46

DIV -1.6218*** -1.0780*** -0.7316***

-10.98 -7.75 -6.35

VOL_CF -0.0402*** 0.3062*** 0.7030*** -5.11 4.88 6.68

PT_ROA 0.0110*** -0.6812*** -0.6873*** 4.98 -23.72 -18.83

VOL_PT_ROA -0.0164*** 0.5787*** 0.9689*** -5.87 10.69 11.12

SIZE -0.0039*** -0.0114*** -0.0107*** -3.42 -8.51 -7.52

PP&E -0.0715*** -0.0423*** -0.0036 -5.49 -2.99 -0.24

R&D -0.0937*** -0.0689 0.1103 -3.76 -1.02 1.07

LEV 0.0552*** 0.0277 -0.0152 4.44 1.56 -0.82

MTB -0.0037*** -0.0024*** -0.0015 -10.05 -2.88 -1.64

IND_CETR 0.0791*** 0.0646*** 0.0195***

14.2 11.84 4.30

CASH -0.0167 0.0124 0.0275

-1.23 0.72 1.35

Industry and Year Fixed Effects Yes Yes Yes

Clustered Standard Errors Firm Firm Firm

Observations 73,388 57,578 21,512

Adjusted R-Squared 2.04% 4.79% 9.56% Notes: This table contains the result of estimating equation (1) to test my first hypothesis; I expect a negative relation between DIV

and VOL_CETR.

In the first column, I present the result with respect to a sample that includes loss firms (cumulative three-year loss) and small firms

(< $500,000 in assets or < $250,000 in book equity). In the second column, I present the result based on a sample excluding these

firms. In the third column, I present the result for a sample of dividend-paying firms (DIV > 0).

See the Appendix for a more detailed discussion of each variable. I winsorize all continuous variables at the 1% and 99% levels. The

symbols *, **, and *** denote statistical significance at the 10%, 5%, and 1% levels respectively. I include industry and year fixed

effects and cluster standard errors at the firm level.

46

TABLE 5

Panel A: Effect of Dividends on Volatility of Cash ETRs Pre- and Post- Dividend Initiation

(1)

Dividend-Initiating Firms

Dependent Variable = VOL_CETR Coefficient

t-stat

INTERCEPT 0.2020*** 4.81

DIV -0.8695**

-4.01

VOL_CF 0.2697* 1.92

PT_ROA -0.6775*** -8.79

VOL_PT_ROA 0.8402*** 6.54

SIZE -0.0115*** -3.62

PP&E -0.0359 -1.54

R&D -0.0051 -0.02

LEV 0.0037 0.11

MTB 0.0037 1.27

IND_CETR 0.0335***

3.51

CASH 0.0132

0.35

Industry and Year Fixed Effects Yes

Clustered Standard Errors Firm

Observations 6,382

Adjusted R-Squared 7.00%

47

TABLE 5

Panel B: Effect of Dividends on Volatility of Cash ETRs Pre- and Post- Dividend Elimination

(1)

Dividend-Eliminating Firms


t-stat

INTERCEPT 0.6206** 2.25

DIV -1.8578***

-5.24

VOL_CF 0.5288 1.44

PT_ROA -0.4622*** -3.40

VOL_PT_ROA 0.0029 0.02

SIZE -0.0174** -2.12

PP&E -0.1777** -2.02

R&D 0.7352 1.18

LEV -0.0640 -1.01

MTB -0.0056*** -2.84

IND_CETR 0.0243

0.61

CASH -0.1411

-1.24



Observations 2,723

Adjusted R-Squared 3.20%

48

TABLE 5

Panel C: Effect of Volatility of Cash ETRs on the Likelihood of Dividend Initiations and Eliminations

Analysis of Dividend Initiations Analysis of Dividend Eliminations

(1) (2) (3) (4) (5) (6)

Dependent Variable = P(NEW_DIV=1)

Full

Controls

Matched

Sample

Entropy-

Balanced

Full

Controls

Matched

Sample

Entropy-

Balanced

Coefficient Coefficient Coefficient Coefficient Coefficient Coefficient

z-stat z-stat z-stat z-stat z-stat z-stat

INTERCEPT -4.6909*** -0.5838 0.0500 -4.5459*** -1.2849** -0.5161 -28.57 -1.54 0.07 -16.46 -2.00 -0.80

VOL_CETR -0.1366* -0.0982 -0.0169 0.5160*** -0.0071 0.1306**

-1.86 -0.79 -0.94 5.28 -0.07 2.45

PT_ROA 4.6783*** 2.2727* -0.1137 -4.8323*** 1.2813 1.5215*** 11.54 1.86 -0.28 -7.39 0.55 2.78

MTB -0.0245* -0.0160 -0.0008 -0.0424 -0.0197 0.0008 -1.68 -0.48 -0.43 -1.45 -0.88 0.44

MK_PCTL 0.0057* 0.0003 0.0069** -0.0579*** -0.0162* -0.0636***

1.65 0.04 2.19 -13.03 -1.67 -12.29

AT_GROWTH -0.8138*** -0.7796*** 0.1381 -0.0071 -0.3525 0.0557 -5.41 -3.41 1.38 -0.05 -0.85 0.37

VOL_CF -0.5642 -1.7268 0.1717 6.7987*** 4.5578 -0.1862 -0.70 -1.02 0.26 4.87 1.16 -0.14

VOL_PT_ROA -0.8733 -1.3400 -0.0271 6.6655*** 15.4308*** 0.7493 -1.45 -0.87 -0.09 7.21 3.68 1.19

SIZE 0.1349*** -0.0191 -0.1012*** 0.4474*** 0.2212* 0.6994*** 3.16 -0.18 -2.59 8.00 1.87 10.27

PP&E 0.4302** 0.9888** -0.0124 -0.5374* -0.5344 -0.2152 2.28 2.38 -0.07 -1.82 -0.87 -0.69

R&D -5.2862*** -3.1043* 0.2904 2.4357 -1.1975 3.0465 -5.04 -1.86 0.29 1.30 -0.30 1.46

LEV 0.5420** -0.1681 0.0851 1.6335*** 0.2316 0.2091 2.39 -0.35 0.40 4.99 0.37 0.98

49

IND_CETR -0.0184 0.1127 0.0074 -0.1535 -0.1590 -0.0774

-0.21 0.65 0.51 -1.36 -0.36 -0.82

CASH 0.3858* -0.1891 -0.0490 0.5817 1.4931 0.7445

1.80 -0.45 -0.22 1.27 1.20 1.45

Industry and Year Fixed Effects Yes Yes Yes Yes No Yes

Clustered Standard Errors Firm Firm Firm Firm Firm Firm

Observations 35,296 1,396 35,296 21,741 340 21,741

Pseudo R-Squared 10.23% 7.50% 5.69% 26.34% 15.36% 6.47%

Area Under ROC Curve 74.80% 63.30% 65.70% 84.70% 69.60% 75.10% Notes: This table contains the result of estimating equations (2A-2C) to test my second hypothesis.

In Panel A, I present the result of the first part of my second hypothesis. I expect a negative relation between DIV and VOL_CETR. I test this relation using a sample of firms

that begin paying a dividend at some point during my sample. I then isolate a period of three years prior to the initiation of the dividend until three years after the initiation of

the dividend.

In Panel B, I present the result of the second part of my second hypothesis. I expect a negative relation between DIV and VOL_CETR. I test this relation using a sample of firms

that stop paying a dividend at some point during my sample. I then isolate a period of three years prior to the cessation of the dividend until three years after the cessation of the

dividend.

In Panel C, I present the results of analyzing a sample of prior to the initiation (elimination) of a dividend in columns one, two, and three (columns four, five, and six). I test this

relation using a sample of firms that do not (do) pay a dividend during my sample period and those that start (stop) paying a dividend during my sample period. Once a firm

begins (ceases) paying a dividend, I remove all subsequent firm-years for that firm from my analysis. The first (last) three columns contain the result of estimating equation 2(C)

on a sample of all firms with available data, a sample of dividend-initiating (eliminating) and non-dividend-initiating (eliminating) firms in the same industry and year matched

by firm size and profitability, and a sample of all firms with available data using entropy-balanced re-weighted coefficients for all control variables respectively.

See the Appendix for a more detailed discussion of each variable. I winsorize all continuous variables at the 1% and 99% levels. The symbols *, **, and *** denote statistical

significance at the 10%, 5%, and 1% levels respectively. I include industry and year fixed effects and cluster standard errors at the firm level. Z-statistics (Panel C) are the

positive square root of the equivalent Wald Chi-Square statistic multiplied by the sign of the associated coefficient.

50

TABLE 6

Influence of Financial Constraint on Relation between Dividends and Volatility of Cash ETRs

Dividend-Paying Firms


t-stat

INTERCEPT 0.2424*** 5.34

DIV -0.9825***

-8.19

CONSTRAIN 0.0224***

3.27

DIV*CONSTRAIN 0.5298***

2.61

VOL_CF 0.7136*** 6.64

PT_ROA -0.6229*** -17.19

VOL_PT_ROA 0.8131*** 9.38

SIZE -0.0121*** -8.07

PP&E -0.0031 -0.21

R&D 0.1549 1.44

LEV -0.0402** -2.26

MTB -0.0010 -1.14

IND_CETR 0.0222***

4.75

CASH 0.0549***

2.58

Test: Total Effect of DIV -0.4527**

-2.50

Test: Total Effect of CONSTRAIN 0.5522***

2.78



Observations 22,142

Adjusted R-Squared 9.74% Notes: This table contains the result of estimating equation (3) to test my third hypothesis; I expect that CONSTRAIN moderates the negative relation

between DIV and VOL_CETR. I test this relation using a sample of dividend-paying firms.

See the Appendix for a more detailed discussion of each variable. I winsorize all continuous variables at the 1% and 99% levels. The symbols *, **, and *** denote statistical significance at the 10%, 5%, and 1% levels respectively. I include industry and year fixed effects and cluster standard

errors at the firm level.

51

TABLE 7

Alternate Econometric Specifications: Effect of Dividends on Volatility of Cash ETRs

(1) (2) (3)

Matched Sample Firm Fixed Effects IV

Dep. Variable = VOL_CETR Coefficient Coefficient Coefficient


INTERCEPT 0.2556*** 0.3051** 0.2103*** 8.21 2.53 6.27

DIV -0.7321*** -1.1295***

-3.83 -6.35

PRED_DIV -3.7561***

-3.35

VOL_CF 0.4413*** 0.3622*** 0.2703*** 3.79 6.84 4.21

PT_ROA -1.1107*** -0.5776*** -0.6968*** -16.33 -21.54 -23.57

VOL_PT_ROA 1.2133*** 0.5881*** 0.6232*** 10.26 14.66 11.65

SIZE -0.0122*** -0.0384*** -0.0099*** -5.37 -10.24 -5.46

PP&E -0.0258 -0.0291 -0.0061 -1.23 -1.12 -0.36

R&D 0.0261 -0.2960*** -0.0495 0.25 -2.78 -0.73

LEV -0.0173 0.0518*** 0.0430** -0.64 2.68 2.43

MTB -0.0004 -0.0018** -0.0015* -0.25 -1.97 -1.82

IND_CETR 0.0531*** 0.1312*** 0.2725***

5.91 11.72 20.65

CASH 0.0082 0.0135 0.2051***

0.34 0.79 6.09


Firm Fixed Effects No Yes No


Observations 17,478 57,578 57,578

Adjusted R-Squared 6.42% 23.97% 5.04% Notes: This table contains the result of re-estimating alternate econometric specifications with respect to my first hypothesis; across all specifications, I expect a negative relation between DIV and VOL_CETR.

In the first column, I re-estimate equation (1) on a matched sample of dividend-paying firms and non-dividend-paying control firms. I match without replacement every dividend-paying firm-year to a control firm in the same year and industry with the closest (equal weighted) match

based on SIZE and PT_ROA. Matches must be within +/- 5% on both of these dimensions to be accepted. In the second column, I re-estimate

equation (1) and include firm fixed effects. In the third column, I re-estimate equation (1) based on a 2SLS IV specification. I do not tabulate the first stage of this regression. I use sales growth, SG to satisfy the exclusion restriction. Untabulated analysis indicates that SG is negatively

correlated with DIV but uncorrelated with VOL_CETR.

See the Appendix for a more detailed discussion of each variable. I winsorize all continuous variables at the 1% and 99% levels. The symbols

*, **, and *** denote statistical significance at the 10%, 5%, and 1% levels respectively. I include industry and year fixed effects in all specifications. I include firm fixed effects in the second column. I cluster standard errors at the firm level.

52

TABLE 8

Alternate Samples: Effect of Dividends on Volatility of Cash ETRs

(1) (2)

Bush Tax Cuts Share Repurchases

Dependent Variable = VOL_CETR Coefficient Coefficient

t-stat t-stat

INTERCEPT 0.3967*** 0.3034*** 3.61 8.10

DIV -2.2186** -0.0562

-2.47 -0.90

SPEC_DIV 0.5628

1.11

REP -1.0752***

-7.73

VOL_CF 0.1211 0.3057*** 0.31 4.87

PT_ROA -0.6037*** -0.6793*** -3.48 -23.60

VOL_PT_ROA 0.8717** 0.5793*** 2.45 10.70

SIZE -0.0177* -0.0113*** -1.74 -8.44

PP&E -0.1520** -0.0426*** -1.98 -3.02

R&D 0.3392 -0.0675 0.46 -1.00

LEV -0.0002 0.0283 -0.00 1.59

MTB -0.0003 -0.0024*** -0.05 -2.94

IND_CETR 0.0191 0.0647***

0.76 11.84

CASH -0.2005*** 0.0124

-2.91 0.73

Test: DIV - SPEC_DIV -2.7813***

-2.68

Test: DIV - REP -1.0191***

-6.57

Industry and Year Fixed Effects Yes Yes

Clustered Standard Errors Firm Firm

Observations 1,128 57,578

Adjusted R-Squared 6.38% 4.80% Notes: This table contains the result of estimating my results on alternate samples; across all specifications, I expect a negative relation between

DIV and VOL_CETR. In the first column, I re-estimate equation (2B) on a sample of firms that initiate a new dividend in response to the Bush

tax cuts. In the second column, I re-estimate equation (1) and include an additional explanatory variable for share repurchases, REP.

See the Appendix for a more detailed discussion of each variable. I winsorize all continuous variables at the 1% and 99% levels. The symbols *, **, and *** denote statistical significance at the 10%, 5%, and 1% levels respectively. I include industry and year fixed effects and cluster

standard errors at the firm level.

53

TABLE 9

Effect of Dividends on Firm Tax Strategies

(1) (2) (3)

Dividend-Paying Firms Dividend-Paying Firms Matched Sample

Dependent Variable = BTD DTAX SHELTER

Coefficient Coefficient Coefficient


INTERCEPT -0.0459*** 0.4969*** -0.1662 -4.42 4.74 -0.73

DIV 0.1643*** -1.0110* -5.6645***

3.12 -1.69 -5.3

VOL_CF 0.0620** -0.2393 -5.7367*** 2.54 -0.54 -14.79

PT_ROA 0.2593*** 1.5639*** 3.8442*** 16.69 9.58 18.66

VOL_PT_ROA -0.0850*** 0.5510 -2.2206*** -3.08 1.47 -6.59

SIZE 0.0021*** -0.0106

4.42 -1.37

PP&E 0.0325*** -0.1269* 0.3016*** 7.66 -1.75 2.89

R&D 0.0128 -1.0157** 3.3925*** 0.31 -2.19 6.10

LEV 0.0437*** -0.0661 -0.1327 7.75 -0.79 -1.33

MTB -0.0013*** 0.0033 0.0373*** -3.61 0.72 6.15

IND_CETR -0.0146*** 0.0560* -0.1390***

-9.69 1.79 -5.06

CASH 0.0121* -0.1551 -0.5772***

1.71 -1.43 -4.66



Observations 18,438 10,232 19,172

Adjusted R-Squared 11.30% 59.72% 26.27% Notes: This table contains the result of re-estimating slightly modified forms of equation (1) on different dependent variables.

In the first column, I use BTD as the dependent variable and estimate this regression on a sample of dividend-paying firms.

In the second column, I use DTAX as the dependent variable and estimate this regression on a sample of dividend-paying firms.

In the third column, I use SHELTER as the dependent variable and estimate this regression on a matched by industry, year, and size sample

of divided-paying firms and non-dividend paying control firms. I exclude SIZE from this regression as it is a primary input in the

calculation of SHELTER.

See the Appendix for a more detailed discussion of each variable. I winsorize all continuous variables at the 1% and 99% levels. The

symbols *, **, and *** denote statistical significance at the 10%, 5%, and 1% levels respectively. I include industry and year fixed effects

and cluster standard errors at the firm level.

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