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Research Focus
Are Dividend Taxes Capitalized into Share Prices? Real Estate Department Professor Christopher Mayer (with William Gentry and Deen Kemsley) has authored Zell/Lurie Working Paper #326 which uses the REIT market to examine a number of important issues in real estate and corporate finance. In particular, the paper investigates whether changes in the size of the depreciation shields of properties owned by REITs can help explain changes in firm value. The answer is yes. For REITs, the evidence suggests that each dollar of future tax depreciation deductions is associated with an additional 20 cents of firm value. Stated differently, the extent of the inside build up of depreciation shields associated with the properties REITs own has an important impact on the valuation of the firm. This work also has important implications for corporations in general, as it addresses a long-standing debate in corporate finance about how shareholder-level taxes should influence corporate policy. The evidence for REITs indicates that investors fully capitalize future dividend taxes into share prices at the top federal tax rate for individuals. To the extent this finding can be generalized to other industries, it suggests that current dividends do not impose an incremental tax penalty on shareholders. Thus, it helps explain why so many dividends are paid out by firms even though they are tax disadvantaged relative to retaining earnings.
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