Taxation and Financial Decision Making

Understanding the effects of taxes on the financial decision making process sheds light on the process itself and has important ramifications for policymakers. In this thesis, I study these effects in three different contexts: international acquisitions, executive compensation, and dividend payout. In Chapter 1, I investigate the possibility that tax rather than productivity differences are driving international acquisition decisions. A theoretical model of this process yields two testable implications of tax-induced sorting: that, relative to high-tax domestic bidders, low-tax foreign bidders will specialize in both high profitability target firms and those with low levels of tax deductions. I find support for both of these effects in the U.S. acquisition market using cross-sectional variation in target profitability and industry-level variation in deductions from the tax reform of bonus depreciation. Counterfactual simulations show that this reform induced a large drop in foreign acquisitions, leading to a significant loss of aggregate wealth. In Chapter 2, I study a recent increase in the tax rate on stock options for a subset of firms to learn about the effects of taxation on executive compensation. Using novel executive compensation data, I find that this tax increase resulted in an immediate reduction in both option grants and the share of options in total compensation. There appears to have been limited, if any, substitution towards other components of compensation. Hence, the burden of the tax increase must have been substantially borne by the affected executives. In Chapter 3, I use a 2006 tax cut in Canada to study the effects of dividend taxes on corporate payout. Analysis of discrete dividend events suggest little effect from the reform, in stark contrast with recent evidence from the United States. Difference-in-differences estimates using control groups comprised of firms which were exogenously unlikely to be affected by the reform suggest a small positive effect on net dividend initiations. Finally, fixed effect models of regular dividends reveal a small increase around the reform. However, the type of firms responding casts serious doubt on taxes as the cause. Overall, these results are consistent with the small and open nature of the Canadian economy.Ph