A valid reason for a ﬁrm to reduce or eliminate its cash dividends is if the tax laws have recently
changed such that dividends are taxed at an investor's marginal rate while capital gains are tax
exempt.

Question

Quizplus · Accepted Answer

If tax laws have changed such that capital gains are tax exempt and dividends are taxable at an investor's marginal rate, then it may make more sense for a firm to retain its earnings and invest them in capital projects or pay down debt instead of paying out cash dividends. This is because investors will prefer to receive returns through capital gains rather than dividends, as they will not be taxed on capital gains. Therefore, reducing or eliminating cash dividends may be a valid strategy for the firm to respond to the changing tax laws.

A Valid Reason for a ﬁRm to Reduce or Eliminate