Equilibrium in the standard finance model implies that value-maximizing firms make taxable equity payouts, even when deferral effectively allows complete tax escape. Since tax deferral and consumption deferral are inherently jointly supplied goods, an excess aggregate supply of future consumption would result if firms followed conventional wisdom and adopted low or zero payout policies to capture tax deferral benefits. The market provides incentives for firms to supply both taxable payouts and capital gains by overriding any tax deferral advantage, just as it provided incentives for equity financing by overriding the corporate tax advantage of debt in "Debt and Taxes."

This paper studies the dividend policy adjustments of eighty NYSE firms to protracted financial distress as evidenced by multiple losses during 1980-85. Almost all sample firms reduced dividends, and more than half apparently faced binding debt covenants in years they did so. Absent binding debt covenants, dividends are cut more often than omitted, suggesting that managerial reluctance is to the omission and not simply the reduction of dividends. Moreover, managers of firms with long dividend histories appear particularly reluctant to omit dividends. Finally, some dividend reductions seem strategically motivated, e.g., designed to enhance the firm's bargaining positions with organized labor.

Reliable access to funding, as in Myers and Majluf (1984), is what really matters, but there are nontrivial indeterminacies in how such access is arranged and in the debt, cash-balance, and payout components of financial policy. These inferences are from a corporate “twins” comparison study of the financial policies of Henry Ford at Ford Motor Co. and Alfred P. Sloan, Jr. at General Motors Corp. The documented testimony of Ford and Sloan indicates that both focused on funding their business, with debt as a funding tool, not an element of an optimized leverage ratio. Their financial policies differ in five important respects, including (i) the use of debt versus large cash balances to meet funding needs and (ii) a commitment to paying large dividends versus a strong aversion to payouts. The data also point to the importance of the inability of managers to identify optimal policies with reliable precision.

An important piece of the capital structure puzzle has been missing, and it is not a contracting friction. It is recognition that managers do not have sufficient knowledge to optimize capital structure with any real precision. The literature critique in this paper i) identifies the conceptual sources of the main empirical failures of the leading models of capital structure and ii) shows how those failures can be repaired by taking into account imperfect managerial knowledge and several other factors. The analysis yields a compact set of principles for thinking about capital structure in an empirically supported way.

ABSTRACT Equilibrium in the standard finance model implies that value‐maximizing firms make taxable equity payouts, even when deferral effectively allows complete tax escape. Since tax deferral and consumption deferral are inherently jointly supplied goods, an excess aggregate supply of future consumption would result if firms followed conventional wisdom and adopted low or zero payout policies to capture tax deferral benefits. The market provides incentives for firms to supply both taxable payouts and capital gains by overriding any tax deferral advantage, just as it provides incentives for equity financing by overriding the corporate tax advantage of debt in “Debt and Taxes.”

The Times Mirror Company, a NYSE-listed Fortune 500 firm controlled for 100 years by the Chandler family, hired an industry outsider as CEO in 1995 following an extended period of poor operating and stock price performance under non-family management. This change was apparently an unintended consequence of actions taken by old management to fund its capital expansion plans while satisfying the family's desire for dividends. Specifically, in 1994 old management agreed to (1) sell TM's cable business and reinvest most of the $1.3 billion proceeds in new technology, and (2) maintain the Chandlers’ dividends while radically cutting those to minority stockholders. While Wall Street reacted favorably to the cable sale, it punished TM's stock when it later learned about management's reinvestment plans. Shortly thereafter TM's board brought in a noted financial disciplinarian, who as CEO substantially increased stockholder value by terminating low return investments and distributing free cash flow. While pressure to pay dividends and monitoring by large block stockholders ultimately improved TM's performance, the path to this outcome was slow and circuitous, so that these disciplinary forces were weaker than theory typically implies.

Pacific Lumber was acquired in 1986 by MAXXAM, whose decision to double PL's harvest of old-growth redwoods precipitated 11 years of environmental protests. Intense media coverage blames the Drexel-financed takeover for threatening Headwaters Forest, the largest privately owned ancient redwood forest. This ‘Wall Street greed’ portrayal aroused such public outrage that the Clinton administration agreed to pay $380 million for Headwaters weeks before the 1996 election. We establish that the threat to Head-waters is not attributable to MAXXAM's junk bond-financed takeover. Government's response to dramatic crises encourages interest groups to use emotional appeals to influence resource allocation.

This paper studies managerial compensation, financial reporting, and dividend policies of the seven major domestic steel producers during requests for union concessions. Substantial layoffs, reported losses, and sacrifices by nonunion stakeholders buttressed managers' case for union concessions. From 1980 to 1988, sample firms reduced their work force by about 300,000 (almost two-thirds) and annual wage payments from 16.1 to 8.6 billion. Reported income is lower during union negotiations, controlling for cash flows, as is managerial pay, with average CEO salary plus bonus declining 18%. Dividend reductions and white-collar pay cuts are substantial, pervasive, and clustered during union negotiations.