At the Top, Pennies Per Share Add Up

Companies Boost Dividends After Tax Cut

Author: Jonathan Weisman

Published: April 8, 2005

Like many companies in Silicon Valley, Xilinx Inc. liked its cash -- for expansion, for investment and for stock buybacks that boosted its share prices. But when Congress and President Bush slashed the tax rate on dividends in 2003, the San Jose chipmaker had a change of heart.

Last April, for the first time, Xilinx offered shareholders a quarterly dividend of 5 cents. As of June, company president, chairman and chief executive Willem P. Roelandts held 3.66 million shares, which would allow him to reap nearly three-quarters of a million dollars in the dividend's first year. His tax savings, thanks to the dividend cut, could total $172,913.

"To be honest, what helped [the decision] was the Bush reduction in dividend taxes," said Maria Quillard, senior director of investor relations at Xilinx. But, she hastened to add, Roelandts's windfall "never entered into our equation, never." She said, "Our CEO is a very humble guy. He drives a [Ford] Taurus."

Two tax seasons after the dividend tax cut went into effect, its impact on corporate behavior and investors' taxes is beginning to come into focus. Since 2003, 37 companies in the Standard & Poor's 500-stock index have declared initial dividends, according to Howard Silverblatt, an analyst at Standard & Poor's. Last year, a total of 247 S&P 500 companies significantly boosted their dividends.

Personal income from dividends climbed to $441 billion last year from $393 billion in 2003 and $388 billion in 2002, according to the Commerce Department.

While the benefits were widely spread, new research suggests the increased dividends were motivated at least in part by the self-interest of America's corporate titans. Companies with stock ownership concentrated among a few top managers have been the most likely to initiate dividend offerings or substantially increase dividend values in the wake of the tax cut.

"I was not at all surprised by the finding, because I'm one of those economists that believes people respond rationally to incentives," said University of Illinois professor Jeffrey R. Brown, a former senior economist in the Bush White House who co-authored one of the new dividend studies. "If anything, I may have been surprised by how robust the response was. It was definitely there and very strong."

When Bush first proposed eliminating what he called the double taxation of dividends, supporters said the move would be a boon to shareholders and the economy at large. With little to no tax penalty in their future, shareholders would pressure companies hoarding cash to dole out that money as dividends, injecting a much-needed cash infusion into consumers' wallets. Executives would be less likely to use cash in the corporate kitty for the kind of abuses that had come to light in scandals like that at Tyco International Ltd. Instead of manipulating stock prices with share repurchases, companies would have to focus on steady, fundamental growth to keep the dividends flowing.

But opponents said the proposal would be a windfall for the affluent, expanding the already growing gap between rich and poor. Congress did not accept the president's proposal wholesale, instead cutting the tax rate on dividends from a maximum 38.6 percent to 15 percent, while lowering the tax rate on most capital gains to 15 percent as well, a cut of unparalleled magnitude, according to a paper by Jennifer L. Blouin of the University of Pennsylvania and Jana Smith Raedy and Douglas A. Shackelford of the University of North Carolina at Chapel Hill.

The 2003 tax cut's income tax component sliced the top tax bracket from 38.6 percent to 35 percent, but with so much of their income coming from dividends and capital gains, the wealthy had their effective tax rate fall far more than that. That year, the joint Urban Institute-Brookings Institution Tax Policy Center estimated that 46 percent of the benefits of the dividend and capital gains tax cuts would go to the 0.2 percent of households with incomes over $1 million this year. Nearly three-quarters of the benefits were projected to go to the 3.1 percent of households making more than $200,000.

Two tax seasons later, it appears both the proponents and opponents were right.

Since Bush began his dividend push in January 2003, "the level of total regular dividends has surged by approximately 20 percent," according to Raj Chetty and Emmanuel Saez, economists at the University of California at Berkeley. One-time special dividends also rose sharply, and companies accelerated a shift from offering employees stock options to offering special dividends.

At the same time, both the Chetty-Saez research and Brown's paper, co-authored by Federal Reserve Board economist Nellie Liang and University of Illinois economist Scott Weisbenner, found evidence that executives were buttering their own bread. Firms whose executives held only stock, instead of unvested stock options, were 20 percentage points more likely to have increased dividends after the tax cut passed, the Brown paper found.

"We find that about one-half of the unexpected rise in the likelihood of a dividend increase observed in 2003 can be attributed to the composition of holdings of the top five executives," the authors wrote in a paper posted on the National Bureau of Economic Research's Web site in December but still awaiting peer review.

Chetty and Saez, in a separate review, concluded, "Firms where top executives held more shares and fewer unexercised stock options were much more likely to initiate dividend payments, revealing the importance of top executives' self-interests in determining corporate responses to taxation."

In 2003, Microsoft's top five executives raked in $138 million from the company's first-ever dividend, according to the study by Brown. When Alabama communications equipment maker Adtran Inc. offered its first dividend in 2003, $28.2 million went to the company's chairman and chief executive, Mark C. Smith.

In 2004, similar windfalls fell to the top executives of lumber company Louisiana-Pacific Corp., Costco Wholesale Corp. and fast-food giant Yum Brands Inc., owner of Kentucky Fried Chicken, Pizza Hut and Taco Bell.

"The firms most likely to initiate dividends were firms where executives owned a whole lot of stock," Weisbenner said.

Companies that offered their first dividends in the wake of the tax cuts strongly deny any executive self-interest. But they do not deny the windfalls. Costco's two founders, chief executive James D. Sinegal and Chairman Jeffrey H. Brotman, were strong supporters of Bush's Democratic opponent in the 2004 presidential race, Sen. John F. Kerry (Mass.). Sinegal, in particular, spoke out strongly against the president's tax cuts, saying they unfairly benefited the rich.

But based on the company's most recent proxy statement, when Costco offered its first quarterly dividend a year ago, Brotman and Sinegal could have reaped nearly $2 million over the past four quarters. That would equal tax savings topping $470,000.

"We have two significant shareholders: the two founders of the company," said Costco's chief financial officer, Richard A. Galanti. "As a logical statement, that's correct" that they earned a windfall.

But Galanti said Costco offered its dividend because its cash income is outstripping its capital expenditures by $500 million and shareholders have been clamoring for the cash.

"I don't think it had much to do with changes in tax law," he said. "That was more an afterthought."

When Louisiana-Pacific declared a 10-cent quarterly dividend last year, it proved to be a generous parting gift for retiring chairman and chief executive Mark A. Suwyn. Company documents show he owns 972,685 shares, giving him $389,074 in dividends over the past year. But in July, the company's compensation committee decided to fully vest all of Suwyn's stock options, incentive shares and restricted shares "in anticipation of his retirement," taking a $10.7 million charge to finance the move. If he continued to own those shares, his dividend take would have exploded.

"It was a board determination," said Mary Cohn, a Louisiana-Pacific spokeswoman, strongly denying any link between the company's decisions and the tax cut. "I just don't see how you can make that connection."

None of those payouts could compare to the mountain of cash that Microsoft has pushed out its door since 2003. In July, the software giant announced it would ante up $32 billion for a one-time, $3-per-share special dividend and an additional $14 billion to double the regular dividend it had first declared a year before. That payout actually exceeded the tax refund of 2001 that President Bush says helped lift the nation from recession.

Already the richest man in the world, Microsoft Chairman Bill Gates didn't much need his $3 billion in dividends. He donated the money to the Bill and Melinda Gates Foundation.