Question
You are a consultant that has been hired to recommend a payout policy for UBT Corp. UBTs shareholders are almost exclusively pension funds and other
You are a consultant that has been hired to recommend a payout policy for UBT Corp. UBTs shareholders are almost exclusively pension funds and other corporations. No shareholder of UBT owns more than 20% of all outstanding shares. You have compiled a table with the current tax rates that different types of investors might face (see below). With the information provided, how would you recommend that UBT structure its payout policy. Should it only pay dividend to shareholders, should it only repurchase stock, or should it do some combination of both (explain your answer).
Investor Type Tax Rate on Dividends Tax Rate on Capital Gains d * Buy and hold individual investor 20% 0% 20.0% One-year individual investor 20% 20% 0.0% Pension fund 0% 0% 0.0% Corporation with less than 20% ownership 10.5% 21% -13.3%
Since the shareholders of UBT consist of pension funds and corporations, a policy of paying predominantly dividends would be advisable in this case. The reason for this is that share repurchases will result in capital gains for corporations and corporations will have a preference for dividends, given the lower tax rate they pay on dividend income relative to capital gains (see the negative effective dividend tax or realize that the tax rate on dividends is lower than on capital gains). At the same time pension funds are tax-exempt and will not be taxed on either dividends or capital gains. So they should be indifferent between dividends and capital gains.
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