“If a company pays a dividend, the investor is liable for tax on the total value of the dividend.

If instead the company distributes the cash by stock repurchase, the investor is liable for tax only on any capital gain rather than on the entire amount. Therefore, even if the tax rates on dividend income and capital gains are the same, stock repurchase is always preferable to a dividend payment.” Explain with a simple example why this is not the case.

(Ignore the fact that capital gains may be postponed.)

47 E. J. Elton and M. J. Gruber, “Marginal Stockholders’ Tax Rates and the Clientele Effect,” Review of Economics and Statistics 52

(1970), pp. 68–74.

Visit us at www.mhhe.com/bma Chapter 16 Payout Policy 417 AppendixLO1