Electronic copy available at: http://ssrn.

com/abstract=2016561






The Effect of Financial Constraint on Shareholder Taxes
and Firm Investments




Zhonglan Dai Yue (Layla) Ying Harold H. Zhang

February 2012












Zhonglan Dai (zdai@utdallas.edu), Layla Ying (yxy077100@utdallas.edu), and Harold H.
Zhang (harold.zhang@utdallas.edu) are from the Jindal School of Management at the
University of Texas at Dallas. Standard disclaimers apply.
Electronic copy available at: http://ssrn.com/abstract=2016561
2



Abstract

We demonstrate that firms investment and job creation are influenced by
shareholder taxes on capital gains and dividend. More importantly, the relation between
shareholder taxes and firms investment and job creation varies with financial constraint
that firms face. Less financially constrained firms show larger increases in capital
investment than more financially constrained firms in association with shareholder tax
cut. For job creation, while non-financially constrained firms show increases in firms
number of employees when shareholder tax rates are cut, severely financially constrained
firms exhibit decreases in firms number of employees. Using the Taxpayer Relief Act of
1997 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 as our events of
study, we find evidence supporting our predictions. Further, we show that the effect of
shareholder tax change on firms capital investment also varies with firms dividend yield.
Electronic copy available at: http://ssrn.com/abstract=2016561
3

1. Introduction
Shareholder taxes on investment income are on the spotlight recently. The
astronomical US government debt has forced policymakers to look for additional
revenues, and taxes on investment income such as capital gains and dividends have
emerged as one of the most likely sources because they are primarily levied on well-to-do
households. While recognizing the double taxation nature of investment income taxes,
the media and the general public are becoming increasingly more critical on the lower tax
rate on investment income than other incomes.
1
Economists have long argued that
significant changes in personal and corporate taxation can have large effects on firms
investment decisions. Nonetheless, extensive studies on the effects of taxation on the cost
of (or returns to) investments have generated mixed empirical evidence.
2

In this paper we investigate the effect of a shareholder taxes reduction on firms
investments and job creation, in particular for firms facing different financial constraints.
Using a simple theoretical framework we demonstrate that firms investment and job
creation vary with firms elasticity of demand for external capital in the event of a
shareholder tax rate change. We predict that less financially constrained firms experience
larger increases in investments and job creation in the event of a tax rate cut than more
financially constrained firms, even though the more financially constrained firms may
experience larger reduction in the cost of capital as shown in some studies (see for
example, Chen, et al., 2011).

1
Billionaire Warrant Buffet openly criticizes that the current tax code is unfair because he pays a lower tax
rate than his secretary. Republican presidential candidate Mitt Romney is adversely affected by the lower
than 15% tax rate he paid on his income because they are from investment returns.
2
Hassett and Hubbard (2002) provide a detailed review on the studies of tax policy and business
investment.
4

Shareholder taxes on investment income have been used as an important fiscal policy
instrument by the government to influence the economy. For instance, the Jobs and
Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) drastically lowered the tax
rates on both dividends and long-term capital gains in order to stimulate investment and
to create job opportunities. The rationale for these policy changes is the belief that
shareholder taxes on investment income constitute an important component of the cost of
capital. Reducing the shareholder taxes on investment income will lower the cost of
capital and therefore lead to increases in investment and creation of new jobs. Indeed, the
existing empirical studies suggest that the tax cuts under JGTRRA lowered the cost of
equity capital (see for example, Dhaliwal, Krull, and Li, 2007, Guenther, Jung, and
Williams, 2005, Chen, et al., 2011, among others).
However, these studies do not investigate if and how the reduction on shareholder tax
rates on investment income also affects firms investment and job creation. Neoclassical
investment models predict that taxation on capital gains and dividends adversely affects
investment and capital formation but differs in their effects on the cost of capital (Hassett
and Hubbard, 2002). Empirical studies along these lines have primarily focused on the
relation among investment, capital formation and the user cost of capital, and have
produced mixed results. They attribute this to the endogeneity of investment and the cost
of capital, measurement error in fundamental variables such as the user cost of capital,
and misspecification of adjustment costs in capital formation. These considerations have
motivated researchers to examine exogenous cross-sectional variation in the user cost of
capital to investigate the tax effect on investment.
5

For instance, Cummins, Hassett and Hubbard (1994) examine the effect of the Tax
Reform Act of 1986 on business investment using firm-level variation in key tax
parameters such as the effective rate of investment tax credit and the present value of
depreciation allowances. Carroll, Holtz-Eakin, Rider and Rosen (2000) show that the
cross-sectional variation in the change in personal tax rates following the Tax Reform
Act of 1986 is associated with the variation in investments by small businesses. Abel and
Eberly (1994, 1996) show that the firms investment behavior can be characterized by
three distinct regimes: positive gross investment, zero gross investment, and negative
gross investment, depending upon different levels of adjustment cost and irreversibility of
investment. Overall, existing studies document that the aggregate elasticity of investment
with respect to the tax-adjusted user cost of capital is between -0.5 and -1.0 with a large
variation among individual firms.
In contrast to the frictionless capital markets in the standard neoclassical model,
Meyer and Kuh (1957) stress the importance of financial considerations for business
investments. In particular, following Fazzari, Hubbard and Petersen (1988a, 1988b), by
classifying firms into groups as a priori financially constrained or financially
unconstrained, empirical studies show that proxies for internal funds have explanatory
power for investments, holding constant other determinants of investments including the
user cost of capital. This finding is widely interpreted as suggesting that tax policy may
have effects on investment by constrained firms beyond those predicted by neoclassical
investment models.
We empirically test our predictions using a difference-in-difference methodology.
Specifically, we focus on firms with different degrees of financial constraints and
6

examine the differential changes in their investments (capital expenditures and combined
capital and R&D expenditures) and number of employees pre- and post-tax legislation
changes that have drastically changed shareholder tax rates on investment income such as
capital gains and dividends while other aspects of the tax code remained unchanged. We
identify two tax changes: The Tax Relief Act of 1997 and The Jobs and Growth Tax
Relief Reconciliation Act of 2003 as the events of our investigation.
Our empirical analyses demonstrate that firms facing low financial constraint
experience larger increases in capital expenditures and combined capital and R&D
expenditures than firms facing high financial constraint even though the latter
experiences larger reduction in the cost of capital than the former for both TRA and
JGTRRA as shown in Chen, et al (2011). The estimated coefficient implies that for a one
standard deviation increase in the predicted probability of financial constraint the
increase in firm capital expenditure would be reduced by 14 million for TRA and 21
million for JGTRRA (both in year 1982 dollar), respectively. These estimates represent
61% and 43% of the average changes in the capital expenditures after the tax cut for non-
financially constrained firms for TRA and JGTRRA, respectively.
While non-financially constrained firms show increases in the number of employees
after the tax rate cut for JGTRRA, financially constrained firms reduced their number of
employees following the tax rate cut on capital gains and/or dividends. Our estimation
results suggest that for a one standard deviation increase in the predicted probability of
financial constraint, firms facing strong financial constraint experienced a reduction of
295 employees. In the meantime, for a one standard deviation decrease in the predicted
probability of financial constraint, non-financially constrained firms experienced an
7

increase of 17 employees. This is attributed to the relative change in the marginal
products of capital and labor. The estimation results for TRA show consistent signs with
our prediction but are statistically insignificant. Finally, we find that firms with higher
dividend yield experienced larger increases in capital expenditures and combined capital
and R&D expenditures for JGTRRA which reduced the tax rates on both capital gains
and dividends. On the other hand, this effect is insignificant for TRA which only reduced
the tax rate on capital gains. These empirical findings are all consistent with our predicted
effects on the impact of financial constraint on the relation between shareholder taxes and
capital investment and job creation. However, we find no significant effect of dividend
yield on the change of the number of employees associated with shareholder tax rate cut
for TRA or JGTRRA.
The remainder of the paper is organized as follows. Section 2 develops hypotheses on
the impact of financial constraint on the relation between shareholder taxes and firms
capital investment and job creation. Section 3 elaborates the empirical methodology.
Empirical results and discussions are provided in Section 4. We make concluding
remarks in Section 5.

2. Hypothesis Development
To aid our understanding of how firms financial constraints affect the relation
between shareholder taxes and firms investments and job creation, we use a simple
model based on firms demand for and supply of external capital in the presence of
shareholder taxes on investment income including capital gains and dividend. For ease of
exposition, we first derive implications of a shareholder tax rate change on firms
8

investment. We then utilize firms optimality condition in a classical production model to
derive the effect of shareholder tax rate changes on firms decisions on labor input.
Figure 1 shows the determination of equilibrium capital investment and the cost of
equity capital in the presence of shareholder taxes on investment income following the
analysis of Hubbard (1998). The horizontal axis represents the capital investment and the
vertical axis represents the cost of equity capital for firms (
c
r ) and the required expected
rate of return by investors (
r
r ). We model a firms demand for investment as a decreasing
function of the cost of capital, i.e., 0 < c c
c
r D , and investors supply of capital as an
increasing function of required expected return by investors, i.e., 0 > c c
r
r S . With no
shareholder taxes on investment income, firms demand for capital and investors supply
of capital intersect at point A. The equilibrium cost of capital for firms and the required
expected rate of return by investors are identical, i.e.,
A
r c
r r r = = and the capital demand
equals capital supply ) ( ) (
r c
A
r S r D K = = where
A
r and
A
K are the equilibrium cost of
capital (rate of return) and quantity of capital investment, respectively.
Next, we introduce shareholder taxes on investment income in the form of either
dividend taxes or capital gains taxes or both. The tax rate on the investment income is
denoted by t . We assume that the taxes on capital income are levied directly on
investors and the marginal investors are tax-sensitive.
3
With the shareholder taxes on
investment income, investors effective supply of capital shifts to the left.
4
The firms
demand for capital and investors effective supply of capital intersect at point B. At this

3
It is debated on the tax status of the marginal investor. Given the large volume of empirical studies
documenting the effect of shareholder taxes on asset pricing (see Graham (2003) for a detailed review), we
assume that investors are tax sensitive in our analysis.
4
This is similar to the model analyzed in Hubbard (1998).
9

point, the cost of capital paid by firms, denoted by
c
r , is higher than the required after-tax
expected return to investors, denoted by , ) 1 (
c r
r r t = with the difference being the
shareholder taxes paid to the government, i.e.,
c r c
r r r = t . The equilibrium quantity of
capital investment is now ] ) 1 [( ) (
B
c
B
c
B
r S r D K t = = and .
A B
K K <
To derive the implications on the effect of a change in shareholder tax rate on capital
investment, let
e
r be the equilibrium market rate of return on capital. In equilibrium, we
have the demand for capital equals the supply of capital, i.e.,
]. ) 1 [( ) (
e e
r S r D t = (1)
Differentiating both sides of equation (1) with respect to the tax ratet and rearranging
terms, we arrive at
,
' ' ) 1 (
'
D S
S r r
e e

=
c
c
t t
(2)
where ' S and ' D are the slope of the supply and demand curve evaluated at the
equilibrium market rate of capital, respectively. Since taxes are directly paid by the
investors, and not the firms, we have the equilibrium cost of capital and quantity of
capital investment denoted
e
K given by
e
c
r r = and ). (
e e
r D K =
Utilizing the definition of the elasticity of demand for and supply of capital, we
have the following comparative static results on the effect of a change in shareholder tax
rate on the cost of capital:
,
) )( 1 (
D S
S
e
c
r r
c c t
c
t
=
c
c
(3)
10

where
D
c and
S
c are the elasticity of demand for and supply of capital with respect to the
cost of capital and the required rate of return, respectively. Given the downward sloping
demand for capital and the upward sloping supply of capital, Equation (3) states that
when the taxation on capital income is reduced, the cost of equity capital for firms will be
lower. The effect of a change in shareholder tax rate on firms capital investment can be
similarly derived as follows:
.
) )( 1 (
) (
D S
D S
e e e e e
K r
r
r K K
c c t
c c
t t
=
c
c
c
c
=
c
c
(4)
We can draw two implications from equation (4) on the effect of shareholder tax
rate cut on firms capital investment. First, holding everything else the same, firms
capital investment increases when shareholder tax rate is reduced. Second, the
shareholder tax effect on a firms capital investment increases in the elasticity of the
firms demand for capital ( | |
D
c ). Both predictions are consistent with the implications of
a neoclassical general equilibrium investment model such as Hassett and Hubbard (2002).
In reality, firms facing severe financial constraint have more pressing need for capital and
will be less sensitive to the cost of capital. These firms thus will have less elastic demand
for capital than firms facing less or no financial constraint.
5
The latter are more sensitive
to the cost of capital and have more elastic demand for capital. This leads to our first
hypothesis on the effect of shareholder tax cut on firms capital investment.

5
Consider two extreme cases: (1) the firm is completely constrained with no access to external capital, and
(2) the firm is completely unconstrained in its access to external capital. In the first case, the firms demand
elasticity for external capital is zero because a change in the cost of equity capital has no effect on the
amount of capital it can raise. In the second case, the firms demand for external capital is very elastic
because it can access the external market any time and will only choose to raise external capital when the
cost of equity capital is low and refrain from using external capital when the cost of capital is high. Thus, a
small increase in the cost of capital may have a large impact on the amount of external capital raised by the
firm, leading to a high elasticity of demand for external capital.
11

Hypothesis One: Ceteris Paribus, a shareholder tax rate cut on investment income will
increase the capital investment of less financially constrained firms more than that of
more financially constrained firms.
We next discuss the effect of shareholder tax rate change on firms use of labor
input. We assume that firms have a Cobb-Douglas production technology with constant
returns to scale with respect to two factor inputs: capital (K) and labor (L), i.e.,
. 1 0 , 0 , ) , (
1
< < > =

o
o o
L K L K Q (5)
Let r
c
and w be the cost of capital and wage rate, respectively. The cost minimization
condition for firms requires that firms allocate resources to capital and labor such that the
marginal product generated from spending the resources on capital and labor are equal,
i.e.,
,
w
MP
r
MP
L
c
K
= (6)
where the
o o
o

=
1 1
L K MP
K
and
o o
o

= L K MP
L
) 1 ( are the marginal product of
capital and labor, respectively. Substituting the marginal products of capital and labor
into equation (6), we arrive at the cost-minimization labor and capital utilization given by
.
1
K
w
r
L
c
o
o
= (7)
We assume that there exists a very competitive labor market so that the wage rate
is insensitive to the change in shareholder tax rate. Differentiating equation (7) with
respect to the shareholder tax rate gives us
). (
1 1
t t o
o
t c
c
+
c
c
=
c
c K
r
r
K
w
L
c
c
(8)
12

Substituting equations (3) and (4) into equation (8), we arrive at the effect of a
shareholder tax rate change on labor input given by
.
) )( 1 (
) 1 ( 1
D S
D S
e
w
K L
c c t
c c
o
o
t
+
=
c
c
(9)
Equation (9) implies that the effect of a shareholder tax rate change is negative if firms
demand for capital is elastic ( 1 <
D
c ) and positive if firms demand for capital is
inelastic ( 1 >
D
c ). Therefore, we have the following predictions on the effect of a
shareholder tax rate cut on firms labor input.
Hypothesis Two: Holding everything else the same, a shareholder tax rate cut will
increase the labor input of non-financially constrained firms and decrease the labor input
of financially constrained firms.
The intuition behind hypothesis two is as follows. Capital and labor are
substitutes in the production process. Since a shareholder tax rate cut reduces the cost of
capital, less financially constrained firms (with more elastic demand for capital) will
increase their investments more than more financially constrained firms (with less elastic
demand for capital). The increase in capital input lowers the marginal product of capital
and raises the marginal product of labor (due to diminishing marginal return). When the
wage rate remains largely unchanged, equation (6) suggests that a firm increases its labor
input only if the marginal product of capital decreases more than the cost of capital (i.e.,
MP
K
/r
c
decreases). A larger reduction in the incremental output from spending an
additional dollar on capital makes it more attractive for firms to hire more workers
because it produces more incremental output from spending the extra dollar on labor than
on capital. This occurs when the firms demand for capital is elastic and the amount of
13

capital increases more than the cost of capital. On the other hand, if a shareholder tax rate
cut increases capital input by less than the percentage reduction in the cost of capital, the
marginal product of capital decreases by less than the cost of capital (i.e., MP
K
/r
c

increases). When the wage rate remains unchanged, the marginal product of labor has to
increase to ensure that the optimal condition (equation (6)) holds. This leads to reduced
labor utilization.
Historically, dividends and capital gains are taxed at a different tax rate with dividend
tax rate higher than capital gains tax rate since 1990 until the JGTRRA in 2003, when the
maximum tax rate was dropped to 15% for both capital gains and dividends. To
investigate the differential effects of changes in capital gains and dividend tax rates, next,
we introduce both the capital gains taxes and the dividend taxes separately. Let
g
t and
d
t be the tax rate on the capital gains and dividends, respectively, and y be the fraction
of equilibrium return paid out as dividends. The equilibrium for the capital market
requires that
] ) 1 ( ) 1 )( 1 [( ) (
e
d
e
g
e
yr r y S r D t t + = (10)
Differentiating both sides of equation (10) with respect to
g
t and
d
t , respectively,
and using the definition of the elasticity of demand for and supply of capital and ,
e
c
r r =
we have
,
) ]( ) 1 ( ) 1 )( 1 [(
] ) ( ) 1 [(
D S d g
S g c g d c
g
c
y y
y r r y
r
c c t t
c t t t
t +
c c +
=
c
c
(11)
.
) ]( ) 1 ( ) 1 )( 1 [(
] ) ( [
D S d g
S d c g d c
d
c
y y
y r yr
r
c c t t
c t t t
t +
c c +
=
c
c
(12)
14

When both capital gains and dividend tax rates are cut as in the case with JGTRRA,
the change in the cost of capital can be obtained as the sum of equations (11) and (12):
.
) ]( ) 1 ( ) 1 )( 1 [(
} ] ) ( ) ( )[ ( ] ) 1 {[(
D S d g
S c d d g g g d d g
c
y y
r d y d y yd d y
dr
c c t t
c t t t t t t t t
+
c c + c c + +
= (13)
The effect of the changes on capital gains and dividends on the capital investment can be
obtained as
.
) ]( ) 1 ( ) 1 )( 1 [(
} ] ) ( ) ( )[ ( ] ) 1 {[(
D S d g
D S
e
d d g g g d d g
d
d
c
g
g
c
e
e
y y
K d y d y yd d y
d
r
d
r
r
K
dK
c c t t
c c t t t t t t t t
t
t
t
t
+
c c + c c + +
=
(
(

c
c
+
c
c
c
c
=
(14)
If we further omit the higher order term ( ] ) ( ) ( )[ (
d d g g g d
d y d y t t t t t t c c + c c ), we
arrive at the approximation to the change in capital investment associated with
shareholder tax rate changes on capital gains and dividend given by
.
) )]( ( ) 1 [(
)] ( [
) ]( ) 1 ( ) 1 )( 1 [(
] ) 1 [(
D S g d g
D S
e
g d g
D S d g
D S
e
d g e
y
K d d y d
y y
K yd d y
dK
c c t t t
c c t t t
c c t t
c c t t

+
=
+
+
~ (15)
In addition to the shareholder tax effect stated in hypothesis one and two, equation
(15) suggests that when the reduction in dividend tax rate exceeds the tax rate cut on
capital gains, ceteris paribus, the increase in capital investment is larger for higher
dividend yield firms than for lower yield firms. This leads to the following hypothesis on
the relation between capital investment increases and firms dividend yield.
Hypothesis Three: When dividend tax rate cut exceeds capital gains tax rate cut, ceteris
paribus, the increase in capital investment is larger for higher yield firms than for lower
yield firms.
15

Using equations (7) and (8), we can similarly write the change in labor input
associated with changes in both capital gains and dividend tax rate changes as follows
.
1 1
1 1
e c
c
e
d
d
e
g
g
e
c
d
d
c
g
g
c
e
d
d
g
g
dK
w
r
dr
w
K
d
K
d
K
w
r
d
r
d
r
w
K
d
L
d
L
dL
o
o
o
o
t
t
t
t o
o
t
t
t
t o
o
t
t
t
t

=
(
(

c
c
+
c
c
+
(
(

c
c
+
c
c
=
(
(

c
c
+
c
c
=
(16)
Substituting equations (13) and (14), we arrive at the change in labor input due to
changes in both capital gains and dividend tax rates
.
) ]( ) 1 ( ) 1 )( 1 [(
] )[ ( ] ) 1 [(
) 1 ( 1
D S d g
d
d
g
g
g d d g
D S
e
c
y y
d
y
d
y
yd d y
w
K r
dL
c c t t
t
t
t
t
t t t t
c c
o
o
+
c
c
+
c
c
+ +
+
|
.
|

\
|
= (17)
Omitting interactions of three small terms, we have the approximation of the change in
labor input due to changes in capital gains and dividend tax rates given by
.
) ]( ) 1 ( ) 1 )( 1 [(
] ) 1 [(
) 1 ( 1
D S d g
d g
D S
e
c
y y
yd d y
w
K r
dL
c c t t
t t
c c
o
o
+
+
+
|
.
|

\
|
~ (18)
Equation (18) suggests that when the tax rate cut on dividend exceeds the tax rate cut on
capital gains, the increase in labor input will be larger for firms with elastic demand for
capital when the firms dividend yield is high than when the dividend yield is low.
However, for firms with inelastic demand for capital, the decrease in labor input will be
larger when the firms dividend yield is high than when the dividend yield is low. We
summarize this prediction in the following hypothesis.
Hypothesis Four: When dividend tax rate cut exceeds the tax rate cut on capital gains,
ceteris paribus, the increase (decrease) in labor input for non-financially (financially)
constrained firms is larger for high dividend yield firms than for low dividend yield firms.
16


3. Empirical Methodology
To assess the effect of financial constraint on the relation between shareholder taxes
and firms investment and job creation, we focus on the Taxpayer Relief Act of 1997
(TRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). TRA
reduced the maximum tax rate on capital gains from 28 percent to 20 percent on positions
held for more than 12 months while other tax code remains largely unchanged and
JGTRRA reduced the maximum tax rate on dividends from 39.6 percent to 15 percent
and the maximum tax rate on capital gains from 20 percent to 15 percent for positions
held longer than 12 months. These tax change events have the advantage of significantly
reducing the tax rates on investment income and the benefit of recency. The selection of
these two tax events also has the added benefit that they are decades apart and had very
different economic situations, so finding evidence in both events that support our
hypotheses would strengthen our explanation on the impact of financial constraint on the
relation between shareholder taxes and firms investment and job creation. Finally, by
contrasting the relative changes in capital investments and job creation across TRA and
JGTRRA we shed light on the effect of changing capital gains tax only versus changing
both capital gains and dividend taxes.
To test our hypotheses we adopt the difference-in-difference methodology and
focus on the variations in the changes of capital investment and job creation across firms
that face different financial constraints. The difference-in-difference approach is suitable
for our analysis because it allows us to mitigate the effect of other concurrent changes
that may have affected all firms. To achieve this goal, we introduce a dummy variable:
17

Post
t
. For TRA97, the categorical variable
t
Post takes a value of zero on and before
3/31/1997 and value of one on and after 8/1/1997. For the JGTRRA in 2003, the
categorical variable
t
Post takes a value of zero on and before 4/1/2003 and value of one
on and after 7/1/2003.
We estimate firms financial constraint based on the latest measure developed by
Hadlock and Pierce (2010).
6
Analyzing 1,848 firm-years from 1995 to 2004 for 356
randomly selected firms in COMPUSTAT, they use an elaborate process to classify the
financial constraint for each firm-year from 1-5, where 5 represents the most financially
constrained firms. Using this categorization, they estimate ordered logit models
predicting constraints as a function of different quantitative factors. After an extensive
investigation and critically evaluate methods commonly used in the literature, they
document that firm size and age are particularly useful predictors of financial constraint
levels, and propose a simple new measure of financial constraints that is based solely on
firm size (logarithm of inflation-adjusted assets) and age (the current year minus the first
year that the firm has an non-missing stock price on COMPUSTAT) which endures a
variety of robustness checks. We use this simple new measure of financial constraint as
our baseline measure in our empirical analysis.
Two other variables, cash flow and leverage, also been shown to have significant
and consistent effects in alternative methods such as Kaplan and Zingales (1997) and
Whited and Wu (2006). However, Hadlock and Pierce (2010) cast serious doubt on the

6
Other candidates for measuring financial constraint include the Kaplan and Zingales (1997) index, which
amalgamates cash flow, Tobins Q, leverage, dividends and cash holding scaled by book value of assets
and the Whited and Wu (2006) index, which integrates cash flow, a dividend distribution dummy, leverage,
size, industry sales growth, and firm sales growth. As pointed out by Hadlock and Pierce (2010), some of
determinants used in Kaplan and Zingales (1997) and Whited and Wu (2006) may be endogenously
determined with the measure of financial constraint faced by a firm and sometimes have conflicting signs.
Thus, they are not suitable as determinants of a firms financial constraint measure.
18

use of these variables as determinants of financial constraint because of their strong
endogeneity. As a robustness check, we also construct an alternative measure of financial
constraint using a specification similar to Kaplan and Zingales (1997) and Whited and
Wu (2006) by including cash flow (a firms operating income plus depreciation divided
by beginning-of-year book assets) and leverage (book value of long term debt divided by
current book assets) in addition to firm size and age in the ordered logit analysis. We
conduct robustness analysis on our findings using this alternative financial constraint
measure.
Specifically, we estimate the probability of being financially constrained for firm
i at period t as follows:
, 04 . 0 043 . 0 737 . 0 '
and
) ' exp( 1
1
1 ) ( Pr
2
4
it it it it
it
it
Age Firm Size Size X
C X
d Constraine y Financiall FC
+ =
+
= =
|
| (19)
where C
4
is the cut point for group four (likely financial constrained) and the associated
cut points for groups 1 to 4 are estimated at -5.310, -0.956, 0.355, and 0.454,
respectively.
7

Hadlock and Pierces (2010) financial constraint classification process supersedes
its predecessors for several reasons. First, it uses qualitative information to categorize a
firms financial constraint status by carefully reading statements made by managers in
SEC filings such as the annual letter to shareholders and the management discussion and
analysis section. Second, the sampling period for Hadlock and Pierce (2010) covers both
of the two changes in shareholder taxes that we examine in this study. This facilitates the
use of their coefficient estimates in computing the probability of financial constraint for

7
These estimates are taken from Column (2) of Table 6 in Hadlock and Pierce (2010) and we thank Joshua
Pierce for providing us the cut point estimates.
19

firms in our sample. Third, the index based on firm size and age relies on factors that are
more exogenous than the alternatives.
The tax rate reductions for TRA and JGTRRA are only applied to income that is
reported on personal tax returns, i.e., dividends received and capital gains from the
selling of shares held directly by individuals or held indirectly by individuals in flow-
through entities, such as mutual funds, partnerships, trusts, S corporations, or limited
liability corporations that pass dividend income to investors personal tax returns.
Dividends and capital gains taxes are not levied on tax-deferred accounts (e.g., qualified
retirement plans, including pensions, IRAs and 401(k)), tax-exempt organizations, and
foreigners. To capture the group of investors who are the most sensitive to the changes in
shareholder taxes, we construct proxies for the percentage of tax sensitive investor
ownership of a stock (individual investors and/or mutual funds) using data on shares
outstanding and shares owned by institutional investors. The data on the institutional
investors ownership are obtained from their quarterly filings with the U.S. Securities and
Exchange Commission (known as Form 13F).
The above considerations lead us to formulate the basic empirical regression
specification on capital investment as follows:
,
) 1 ( 9 ) 1 ( 8 ) 1 ( 7 ) 1 ( 6
) 1 ( 5 ) 1 ( 4 ) 1 ( 3 ) 1 ( 2 1
it it t i t t i t i t t i
t i t t i t i t t i t it
Z NDiv Post NDiv YLD Post YLD
TSO Post TSO FC Post FC Post Y
c | | | |
| | | | | o
+ + + + + +
+ + + + + =



(20)
where the dependent variable Y
it
is taken to be various suitably deflated investment
measures (such as capital expenditure, R&D, etc.),
t
Post is a dummy variable which
takes a value of 0 before the tax cut and 1 after the tax cut,
) 1 ( t i
FC is the measure for
20

financial constraint of firm i at time t-1,
) 1 ( t i
TSO measures the tax sensitive ownership of
firm i at time t-1,
) 1 ( t i
YLD is firm is dividend yield at time t-1,
) 1 ( t i
NDiv is a dummy
variable representing non-dividend-paying status, and
it
Z represents the firm level
control variables.
Under the null of hypothesis that firms facing more financial constraint (inelastic
demand for capital) experience less increase in capital investment than firms facing less
financial constraint (elastic demand for capital), we will have . 0
3
< | Further, when
dividend tax rate cut exceeds capital gains tax rate cut, ceteris paribus, the increase in
capital investment is larger for higher yield firms than for lower yield firms. This
suggests that we will expect a positive coefficient of YLD Post for JGTRRA which
reduced the dividend tax rate more drastically than the capital gains tax rate, but no such
effect for TRA which only cut the capital gains tax rate, i.e., 0
7
> | for JGTRRA but not
necessarily for TRA.
For labor inputs, we predict that shareholder tax cut will have the opposite effects
on firms facing strong financial constraint (inelastic capital demand) and non-financial
constraint (elastic capital demand). Thus, we include both interaction terms
FC Post and ) 1 ( FC Post to test our prediction. Specifically, we use various
specifications of the following regression model for our analysis on the impact of
financial constraint on the relation between shareholder taxes and firms job creation:
.
) 1 (
) 1 ( 9
) 1 ( 8 ) 1 ( 7 ) 1 ( 6 ) 1 ( 5
) 1 ( 4 ) 1 ( 3 ) 1 ( 2 ) 1 ( 1
it it t i t
t i t i t t i t i t
t i t i t t i t t i it
Z NDiv Post
NDiv YLD Post YLD TSO Post
TSO FC Post FC Post FC Y
c |
| | | |
| | | | o
+ + +
+ + + +
+ + + + =

(21)
21

Under the null of hypothesis that firms facing stronger financial constraints
(inelastic capital demand) will experience a decrease in labor input and firms facing non-
financial constraints (elastic capital demand) will experience an increase in labor input,
we will have a negative coefficient for FC Post and a positive coefficient for
) 1 ( FC Post under JGTRRA but not necessarily for TRA. This suggests that we will
have 0
2
> | and 0
3
< | for JGTRRA.
Finally, to test the prediction that the increase (decrease) in labor input for non-
financially (financially) constrained firms is larger for high dividend yield firms than for
lower dividend yield firms, we extend equation (21) to include interactions between
dividend yield and financial constraint as follows:
.
) 1 (
) 1 (
) 1 (
) 1 ( 11 ) 1 ( 10
) 1 ( ) 1 ( 9 ) 1 ( ) 1 ( 8
) 1 ( ) 1 ( 7 ) 1 ( ) 1 ( 6 ) 1 ( 5
) 1 ( 4 ) 1 ( 3 ) 1 ( 2 ) 1 ( 1
it it t i t t i
t i t i t t i t i t
t i t i t i t i t i t
t i t i t t i t t i it
Z NDiv Post NDiv
FC YLD Post FC YLD Post
FC YLD FC YLD TSO Post
TSO FC Post FC Post FC Y
c | |
| |
| | |
| | | | o
+ + + +
+ +
+ + +
+ + + + =




(22)
We interpret a negative coefficient for the interaction FC YLD Post and a
positive coefficient for the interaction ) 1 ( FC YLD Post as evidence supporting this
hypothesis.
For firm level control variables, we follow several recent studies on the tax effect
on the cost of capital for JGTRRA (such as Dhaliwal, Krull and Li, 2007) and include
firms book value-to-market value ratio (in logarithm), forecasted long-term growth of
earnings, the coefficient of variation of the one-year-ahead earnings per share forecast,
and firm size (in logarithm) at the end of the fourth quarter of the most recent past year.
Considering that capital and labor inputs may vary with the cost of capital, we may also
need to include measures of firms cost of capital in our regression analysis. Since these
22

variables are endogenously determined, we choose to include determinants of the cost of
capital for each firm in our regression specification. Specifically, we include firms risk
exposures to the market, the size, and the value factors measured by ,
MKT
| ,
SMB
| and
.
HML
| Following Dhaliwal, Krull and Li (2007), we estimate these risk factor loadings
using return data for the 48 months before the beginning of the calendar year. We include
the moving average daily turnover for each firm over past 250 days leading up to the end
of the most recent past quarter to control for liquidity related returns (see Sikes and
Verrecchia, 2011). Existing studies suggest that firms capital expenditures are related to
sales, we thus also control for changes in annual sales. As a robustness check, we include
the average cost of equity capital over the sample period for each industry using the
classification by Fama and French (1997) and find that our results are robust to the
inclusion of the industry average cost of capital.
8


4. Empirical Results and Discussions
4.1. Summary statistics
We obtain the data from three different sources. For various measures of firms
capital investment, the number of employees, and firms control variables, we use the
merged COMPUSTAT and CRSP database. For firms long-term earnings growth
forecasts and the dispersion of earnings forecasts, we use the I/B/E/S database. Finally,
we use the institutional ownership database from Thomson Financial to construct the
investor tax sensitive percentage ownership.

8
The results are not reported in the paper and are available upon request.
23

Table 1 presents the summary statistics for variables of our interest including the
changes in annual capital expenditure and number of employees and firm controls for the
period surrounding TRA and JGTRRA (Panel A) and the changes in these variables pre-
and post-tax cut (Panel B). The capital expenditure and the sum of capital and R&D
expenditures are in real term obtained by dividing the nominal terms by the producer
price index (1982=100). We then obtain the changes in annual capital expenditure
(CAPX) and sum of annual capital and R&D expenditure (CAPXRD) for each firm
from year t-1 to t. The change in real capital expenditure has a mean of 0.097 (an increase
of 9.7 million in 1982 dollar) with a standard deviation of 0.601 during TRA and a mean
of -0.018 (a decrease of 1.8 million in 1982 dollar) with a standard deviation of 0.881
during JGTRRA. Including R&D expenditure increases both the mean and the standard
deviation for both TRA and JGTRRA. The change in total number of employees is
measured in thousands for each firm at the end of year t. The average change in the
number of employees is 314 for TRA and 90 for JGTRRA across firms. Both the lower
average change in firm capital expenditure and the number of employees are probably
due to a larger number of smaller firms in the period surrounding JGTRRA than TRA.
The financial constraint is measured by the predicted probability that a firm is in the
category of likely financial constrained and is estimated using firm size and age (FCSA)
and using firm size, age, cash flow, and leverage (FCSACL), respectively. On average,
there are about 4.1% firms that are likely financially constrained during TRA and 3.1% to
3.3% during JGTRRA.
Most firm variables experienced significant changes after the tax cut event. Firms
capital expenditures and the combined capital and R&D expenditures show significant
24

increases for both TRA and JGTRRA. The same change is observed for job creation
measured by the number of employees. However, the probability of firms facing financial
constraints declined after the tax cut for both TRA and JGTRRA. Consistent with the
findings of Blouin, Raedy, and Shackelford (2010), we observe that more firms initiated
dividend payout even though dividend yield declined for JGTRRA.
4.2. Primary results and discussions
4.2.1. Univariate results
We begin with a univariate analysis of the change in firms investment and job
creation surrounding the tax cut events. Table 2 reports the changes in firms capital
expenditure, the combined capital and R&D expenditures, and the number of employees
(in thousands) pre- and post-TRA and JGTRRA for firms with different probability of
facing financial constraints as measured by the baseline FCSA (Panel A) and the
alternative FCSACL (Panel B). We divide firms into two groups using the median
predicted probability of being financially constrained and examine the changes in capital
investments and job creation pre- and post- the tax cuts. Our results show that for firms
with lower financial constraint (LFCfirms with the predicted probability of financial
constraint lower than the median), their capital expenditures, the combined capital and
R&D expenditures, and the number of employees all experienced significant increases for
both TRA and JGTRRA. For firms with higher financial constraint (HFCfirms with the
predicted probability of financial constraint higher than the median) we only observe
significant increases in capital investments and job creation for JGTRRA but not for TRA.
We further examine the difference-in-difference in the pre- and post-tax cut
changes across LFC and HFC groups. Our results indicate that the increases in firms
25

capital expenditures, capital and R&D expenditures, and the number of employees pre-
and post-tax cuts are significantly larger for the LFC group than for the HFC group. For
instance, the increase in the capital expenditure is 12.5 million (in year 1982 dollar) more
for LFC group than that for the HFC group for TRA and higher 25.2 million (in year
1982 dollar) for JGTRRA. The increase in the number of employees is 130 more for the
LFC group than that for the HFC group for TRA and higher at 219 for JGTRRA. These
results support our predictions on the impact of financial constraint on the effect of
shareholder taxes on firms capital investments and job creation. Our findings are robust
when firms financial constraint is measured by the alternative measure of the predicted
probability of financial constraint based on firm size, age, cash flow and leverage
(FCSACL) as shown in Panel B.
4.2.2. Panel regression results
In our regression analysis, we first investigate the predictions on the impact of
financial constraint on the effect of shareholder taxes on capital investments and job
creation under hypotheses one and two. We then incorporate dividend yield to investigate
hypotheses three and four.
Tables 3 and 4 present the results on the impact of financial constraint on the
change of capital expenditures pre- and post-tax cuts for TRA and JGTRRA. The
interaction FCSA Post is negative and significant at the 5% test level for both TRA and
JGTRRA. The estimated coefficient implies that for a one standard deviation increase in
the predicted probability of financial constraint the increase in firm capital expenditure
would be reduced by 0.140 for TRA and 0.209 for JGTRRA (14.0 and 20.9 million in
26

year 1982 dollar, respectively).
9
These estimates represent 61% and 43% of the average
changes in the capital expenditures after the tax cut for firms facing no financial
constraint for TRA and JGTRRA, respectively.
10
Thus, these effects are economically
very significant. When we perform the regression analysis to the combined capital and
R&D expenditures, we find similar result for JGTRRA but insignificant result for TRA.
This suggests that the impact of financial constraint on the relation between shareholder
taxes and investments is stronger for capital expenditures than on research and
development. One possible explanation is that firms may receive tax credit on research
and development expenditures. Therefore it reduces the effect of shareholder taxes on
research and development expenditures.
Table 5 presents the impact of financial constraint on the effect of shareholder
taxes on changes in firms employment pre- and post-tax cuts. Consistent with our
predictions on the impact of financial constraint on the effect of shareholder taxes on the
change in firms number of employees, we find that the coefficient is negative for the
interaction FCSA Post and positive for the interaction ) 1 ( FCSA Post for both TRA
and JGTRRA. The coefficient estimates are statistically significant at the 1% level for the
JGTRRA but insignificant for TRA. Thus, we have strong supporting evidence that
financially constrained firms experienced reductions in the number of employees and
non-financially constrained firms experienced increases in the number of employees for
JGTRRA. The estimated coefficients suggest that for a one standard deviation increase in
the predicted probability of financial constraint firms facing strong financial constraint

9
These estimates are calculated by multiplying the estimated coefficient for Post FCSA by the standard
deviation of FCSA.
10
These estimates are calculated by dividing the estimated reduction in the capital expenditures by the
coefficient estimate for Post.
27

experienced a reduction of 295 employees. In the meantime, for a one standard deviation
decrease in the predicted probability of financial constraint non-financially constrained
firms experienced an increase of 17 employees.
11

Table 6 reports robustness check analysis when the financial constraint measure
FCSA is replaced by the alternative FCSACL which is measured as the predicted
probability of financial constraint estimated using firm size, age, cash flow and leverage.
We find very similar effects of financial constraint on the changes in firms capital
expenditures, combined capital and R&D expenditures, and the number of employees for
both TRA and JGTRRA. These findings indicate that our findings are unlikely to be
altered by the inclusion of cash flow and leverage in constructing financial constraint
measures.
We now examine the impact of dividend yield on the effect of shareholder taxes
on capital investments and job creation under hypotheses three and four. Table 7 reports
the estimation results on the capital expenditures while Table 8 shows the estimation
results on combined capital and R&D expenditures. We find that the interaction
FCSA Post remains negative and significant in the regression analysis for the capital
expenditures for both TRA and JGTRRA and the coefficient estimates are very similar to
those reported in Table 3 and only significant for JGTRRA in the analysis on the
combined capital and R&D expenditures as in Table 4.
We find that the interaction YLD Post is positive and significant at the 10% test
level for firms capital expenditures and combined capital and R&D expenditures for
JGTRRA but not for TRA. Considering that JGTRRA reduced the tax rate on dividends
more drastically than on capital gains, this result provides some supporting evidence on

11
These estimates are obtained by multiplying the coefficient estimate by the standard deviation of FCSA.
28

the prediction under hypothesis three. The estimated coefficient implies that for a one
standard deviation increase in dividend yield the incremental change is 0.10 in firms
capital expenditures and 0.16 in firms combined capital and R&D expenditures. The
estimates correspond to 10 million and 16 million in year 1982 dollar.
Table 9 reports the estimation results on the impact of dividend yield on the effect
of shareholder taxes on the change in number of firms employees for TRA and JGTRRA.
Lending support to the predicted effect of financial constraint on firms job creation, the
interactions FCSA Post and ) 1 ( FCSA Post show consistent signs and statistical
significance as those reported in Table 5. However, we find no evidence that the impact
of financial constraint on the relation between shareholder taxes and firms job creation
vary with dividend yield.
4.2.3. The comparison of the impact of TRA and JGTRRA
The results reported in Tables 7 and 8 suggest that stocks with higher dividend
yields experienced larger increases in capital and combined capital and R&D
expenditures under JGTRRA but not TRA. We next provide a formal test on the relative
impact of TRA and JGTRRA. To achieve this goal, we introduce a dummy variable D03
which takes a value of zero if an observation belongs to the TRA event periods (year
1996 to year 1998) and a value of one if it belongs to the JGTRRA event periods (year
2002 to year 2004). We then extend the specifications (21) and (22) to include interaction
terms between the event dummy variable D03 and all the regressors in equations (21) and
(22).
Table 10 presents the estimation results of the extended specifications. For both
the capital expenditures and the combined capital and R&D expenditures, we find that the
29

interaction YLD Post D 03 is positive and statistically significant at the 1% test level.
This indicates that higher dividend yield firms experienced larger increases in capital and
combined capital and R&D expenditures under JGTRRA than under TRA. The result
lends support to hypothesis three because the dividend tax rate cut under JGTRRA (from
39.6% to 15%) is much larger in magnitude than the capital gains tax rate cut (from 20%
to 15%) while only the capital gains tax rate was cut under TRA (from 28% to 20%).
Non-dividend paying stocks also experienced larger increases in capital and combined
capital and R&D expenditures under JGTRRA than under TRA. This may reflect the fact
that the market is forward looking and stocks that currently are non-dividend paying may
be in a transitional period and will initiate dividend distribution in the future. If the
dividend tax rate cut is expected to last for a long enough time period, stocks that are
currently non-dividend paying may also respond to changes in dividend tax rate in
addition to the capital gains tax rate cut under JGTRRA. For example, Chetty and Saez
(2005) and Blouin, Raedy, and Shackelford (2011) document that more firms initiated
dividend distribution after JGTRRA. Our finding is consistent with the results reported in
Auerbach and Hassett (2006) which document that non-dividend-paying stocks
experienced larger price responses than dividend-paying stocks and high dividend yield
stocks show larger changes in price reaction than lower yield stocks. However, we find
no significant incremental impact on the change in firms number of employees under
JGTRRA relative to TRA. Finally, for changes in both capital investments and the
number of employees, firms with higher tax sensitive investor ownership show larger
increases in the capital and combined capital and R&D expenditures and the number of
30

employees under JGTRRA than under TRA. This is consistent with JGTRRA being a
more dramatic tax legislature change on investment income than TRA.

5. Concluding Remarks
We demonstrate that shareholder taxes have significant effects on firms capital
investments and job creation depending on the level of financial constraint faced by
different firms. Less financially constrained firms will experience larger increases in
capital investments than more financially constrained firms after shareholder tax rate cut.
In the meantime, while a shareholder tax rate cut increases job creation for non-
financially constrained firms, it may decrease job creation for financially constrained
firms. This is because non-financially constrained firms experience a larger increase in
labor productivity due to their larger capital investment increases than financially
constrained firms.
Using both the Taxpayer Relief Act of 1997 and the Jobs and Growth Tax Relief
Reconciliation Act of 2003, we find supporting evidence for the predicted effects of
firms financial constraint on the relation between shareholder taxes and capital
investments and job creation. We also find some evidence that the impact of financial
constraint on the relation between shareholder taxes and capital investments and job
creation varies with firms dividend yield when the tax rate cut on dividends is much
larger than the tax rate cut on capital gains as for the JGTRRA. Our findings provide
useful guidance on the potential effect on firm investments and job creation when
policymakers contemplate shareholder tax rate increase as a source of tax revenue and a
way to reduce the disparity in tax payments.
31

References

Abel, A.B. and J.C. Eberly, 1994, A unified model of investment under uncertainty,
American Economic Review 84, 1369-1384.

Abel, A.B. and J.C. Eberly, 1996, Optimal investment with costly irreversibility, Review
of Economic Studies 3, 581-593.

Auerbach, A.J. and K.A. Hassett, 2006, The 2003 dividend tax cuts and the value of the
firm: an event study. In: Auerbach, A., Slemrod, J. (Eds.), Taxing Corporate Income in
the 21
st
Century. Cambridge University Press, Cambridge.

Blouin, J.L., Raedy, J.S., Shackelford, D.A., 2011, Dividends, share repurchases, and tax
clienteles: Evidence from the 2003 reductions in shareholder taxes, Accounting Review
86, forthcoming.

Carroll, R., D. Holtz-Eakin, M. Rider and H.S. Rosen, 2000, Entrepreneurs, income taxes,
and investment, in: Joel Slemrod, ed., Does Atlas Shrug? The Economic Consequences of
Taxing the Rich (MIT Press, Cambridge), 427-455.

Chen, C., Z. Dai, D. Shackelford, H. Zhang, 2011, Do financial constraints affect
shareholder taxes and the cost of equity capital? Working paper, University of North
Carolina and University of Texas at Dallas.

Chetty, R. and E. Saez, 2005, Dividend taxes and corporate behavior: evidence from the
2003 dividend tax cut, Quarterly Journal of Economics 120, 791-833.

Cummins, J.G., K.A. Hassett, and R.G. Hubbard, 1994, A reconsideration of investment
behavior using tax reforms as natural experiments, Brookings Papers on Economic
Activity 2, 1-74.

Dhaliwal, D., L. Krull, and O. Li, 2007, Did the 2003 tax act reduce the cost of equity
capital? Journal of Accounting and Economics 43, 121-150.

Fama, E. and K. French, 1997, Industry cost of equity, Journal of Financial Economics
43, 153-193.

Fazzari, S.M., R.G. Hubbard, and B.C. Petersen, 1988a, Financing constraints and
corporate investment, Brookings Papers on Economic Activity 1, 141-195.

Fazzari, S.M., R.G. Hubbard, and B.C. Petersen, 1988b, Investment, financing decisions,
and tax policy, American Economic Review 78, 200-205.

Graham, J., 2003, Taxes and corporate finance: A review, Review of Financial Studies 16,
1075-1129.
32


Guenther, D., B. Jung, and M. Williams, 2005, The effect of the 2003 dividend tax rate
reduction on corporations cost of equity capital, working paper.

Hadlock, C. and J. Pierce, 2010, New evidence on measuring financial constraints:
Moving beyond the KZ index, Review of Financial Studies 23, 1909-1940.

Hassett, K. and R.G. Hubbard, 2002, Tax policy and business investment, Handbook of
Public Economics 3, Edited by A.J. Auerbach and M. Feldstein, 1294-1343.

Hubbard, R.G., 1998, Capital-market imperfections and investment, Journal of Economic
Literature 36, 193-225.

Kaplan, S. and L. Zingales, 1997, Do investment-cash flow sensitivities are not valid
measures of financial constraints, Quarterly Journal of Economics 112, 159-216.

Meyer, J. R., and E. Kuh, 1957, The investment decision, Cambridge: Harvard University
Press.

Naranjo, A., M. Nimalendran, and M. Ryngaert, 1998, Stock returns, dividend yields, and
taxes, Journal of Finance 53, 2029-2057.

Sikes, S. and R. Verrecchia, 2011, Liquidity, investor-level tax rates, and expected rates
of return, working paper, Wharton School, University of Pennsylvania.

Whited, T. and G. Wu, 2006, Financial constraints risk, Review of Financial Studies 19,
531-559.




33

Table 1 Summary statistics of firm variables

This table reports summary statistics for firm characteristics for the period surrounding TRA and
JGTRRA for the full sample (Panel A) and the pre- and post- subsamples (Panel B). CAPX is the
change in capital expenditure from year t1 to year t; CAPXRD is the change in the sum of capital
expenditure and R&D expenditure from year t1 to year t; EMP is the change in number of
employees (in thousands) from year t1 to year t; FCSA and FCSACL are the predicted probability of
a firm being financially constrained in the most recent quarter in year t using Hadlock and Pierce
(2010)s SA index and the alternative measure estimated using firm size, age, cash flow and leverage,
respectively; YLD is four times the dividends declared in the most recent past quarter divided by the
end of quarter price as in Naranjo, Nimalendran and Ryngaert (1998); TSO is one minus the
percentage ownership by institutional investors; NDIV is an indicator variable that equal to 1 if
common stock dividends in year t1 is non-positive and 0 otherwise;
AVE
r is the average of cost of
capital in year t1; dSALEQ is the change in sales from year t1 to year t; Turnover is the moving
average of the past 250 daily volume scaled by the shares outstanding; LogBM is the logarithm of the
book-to-market ratio; LogLTG is the logarithm of the forecasted long-term earnings growth rate;
LogDisp is the logarithm of the dispersion of the forecasted long-term growth rate; LogSize is the
logarithm of a firms market capitalization;
mkt
| ,
smb
| , and
hml
| are the beta coefficient relative to
the market, the SMB, and the HML factor, respectively. CAPX and dSALEQ are deflated by PPI. The
sample spans 1996 to 1998 for TRA and 2002 to 2004 for JGTRRA.

Panel A: Summary statistics for the full sample
TRA JGTRRA
Mean Median Std Dev Mean Median Std Dev

CAPX 0.0971 0.0022 0.6011 -0.0180 0.0000 0.8810
CAPXRD 0.1262 0.0061 0.6609 0.0106 0.0000 0.8950
EMP 0.3138 0.0210 1.5380 0.0895 0.0040 1.6515
FCSA 0.0410 0.0298 0.0337 0.0310 0.0243 0.0241
FCSACL 0.0406 0.0309 0.0345 0.0328 0.0249 0.0290
TSO 0.6941 0.7520 0.2522 0.6426 0.6845 0.2850
YLD 0.0252 0.0000 0.3228 0.0485 0.0006 0.2156
NDIV 0.5671 1.0000 0.4955 0.4980 0.0000 0.5000

Control Variables
AVE
r 0.1050 0.1057 0.0138 0.0950 0.0914 0.0125
dSALEQ 0.2157 0.0142 1.1987 0.2177 0.0034 1.8186
Turnover 0.0052 0.0030 0.0061 0.0062 0.0033 0.0086
LogBM -0.3315 -0.2337 0.7438 -0.2391 -0.1429 0.7715
LogLTG 2.7958 2.7726 0.5500 2.7088 2.7081 0.5614
LogDisp -1.6399 -1.6386 0.6607 -1.4330 -1.4553 0.7169
LogSize 4.9012 4.7942 1.8647 5.4277 5.3747 1.9792
mkt
| 0.9395 0.8556 1.1771 0.9925 0.8721 0.8965
smb
| 0.8430 0.6156 1.3860 0.5773 0.3927 0.9018
hml
| 0.1290 0.2881 1.8553 0.1927 0.3416 1.1297

34

Panel B: pre- and post-tax cut comparison
TRA JGTRRA
Pre Post Pr(diff=0) Pre Post Pr(diff=0)

CAPX 0.0724 0.1210 <.0001 -0.0956 0.0652 <.0001
CAPXRD 0.1055 0.1456 0.0130 -0.0563 0.0828 <.0001
EMP 0.2800 0.3465 0.0170 -0.0112 0.1992 <.0001
FCSA 0.0422 0.0398 <.0001 0.0324 0.0295 <.0001
FCSACL 0.0411 0.0400 0.0590 0.0347 0.0307 <.0001
TSO 0.7079 0.6806 <.0001 0.6589 0.6253 <.0001
YLD 0.0237 0.0267 0.0240 0.0523 0.0445 0.0420
NDIV 0.5589 0.5751 0.0430 0.5320 0.4618 <.0001

Control Variables

AVE
r 0.1043 0.1057 <.0001 0.1010 0.0886 <.0001
dSALEQ 0.1740 0.2566 <.0001 0.2115 0.2246 0.7000
Turnover 0.0051 0.0053 0.0250 0.0055 0.0069 <.0001
LogBM -0.2994 -0.3626 <.0001 -0.1740 -0.3104 <.0001
LogLTG 2.7298 2.8485 <.0001 2.8176 2.5984 <.0001
LogDisp -1.6231 -1.6529 0.1390 -1.4429 -1.4223 0.3530
LogSize 4.7441 5.0560 <.0001 5.2097 5.6609 <.0001
mkt
| 0.9407 0.9384 0.9090 0.9870 0.9983 0.4800
smb
| 0.8821 0.8047 0.0010 0.6198 0.5315 <.0001
hml
| 0.2138 0.0459 <.0001 0.2018 0.1829 0.3510

35

Table 2 Changes in investments and job creation for firms with different financial constraints

This table presents firms change in investments from year t1 to year t before and after the tax cut for
TRA (JGTRRA) in terms of capital expenditure (CAPX), capital and research and development
expenditure (CAPXRD) and number of employees (EMP) for high financial constrained (HFC) and
low financial constrained (LFC) firms. HFC (LFC) represents firm-quarters when the predicted
financial constraint is above (below) the median financial constraint for the quarter before the tax cut
(1995Q4 for TRA and in 2001Q4 for JGTRRA). Panel A and Panel B show the results using FCSA
and FCSACL measures respectively. * significant at 10%, ** significant at 5%, and *** significant at
1% level.

Panel A: Financial Constraints measured by FCSA
TRA JGTRRA
Pre Post Diff (Post-Pre) Pre Post Diff (Post-Pre)
CAPX

LFC 0.1272 0.2517 0.1246*** -0.1800 0.0993 0.2794***
HFC 0.0176 0.0171 -0.0006 -0.0111 0.0166 0.0277***
Diff-in-Diff 0.1252*** 0.2516***
CAPXRD

LFC 0.1884 0.3246 0.1361*** -0.0972 0.1205 0.2177***
HFC 0.0226 0.0238 0.0011 -0.0155 0.0152 0.0307***
Diff-in-Diff 0.1350*** 0.1870***
EMP

LFC 0.4510 0.5912 0.1401** -0.0387 0.2751 0.3137***
HFC 0.1090 0.1190 0.0100 0.0163 0.1114 0.0951***
Diff-in-Diff 0.1301** 0.2186***

Panel B: Financial Constraints measured by FCSACL
TRA JGTRRA
Pre Post Diff (Post-Pre) Pre Post Diff (Post-Pre)
CAPX

LFC 0.1245 0.2645 0.1400*** -0.1756 0.0970 0.2726***
HFC 0.0201 0.0266 0.0065 -0.0258 0.0217 0.0475***
Diff-in-Diff 0.1335*** 0.2251***
CAPXRD

LFC 0.2111 0.3246 0.1135*** -0.0802 0.1205 0.2007***
HFC 0.0178 0.0238 0.0059 -0.0322 0.0152 0.0474***
Diff-in-Diff 0.1075*** 0.1533***
EMP

LFC 0.4998 0.6231 0.1232* -0.0102 0.3012 0.3114***
HFC 0.0763 0.0958 0.0195 -0.0107 0.0973 0.1079***
Diff-in-Diff 0.1037 0.2034***

36

Table 3 The impact of financial constraint on capital expenditures

This table presents ordinary least squares regression results for the dependent variable CAPX. The
regression specification is
1 , 6 1 , 5 1 , 4 1 , 3 1 , 2 1 ,
+ + + + + = A
t i t i t t i t i t t i t t i
NDIV TSO Post TSO FCSA Post FCSA Post CAPX | | | | | |
1 , 7
+
t i t
NDIV Post | + Controls (when applicable) + Constant +
t i,
c
For TRA, we use data from 1996 to 1998, and Post takes a value of zero before 1997 and value of one
after 1997. For JGTRRA in 2003, we use data from 2002 to 2004, and Post takes a value of zero
before 2003 and value of one after 2003. CAPX is the change in capital expenditure from year t1 to
year t; FCSA is the predicted probability of a firm being financially constrained in the most recent past
quarter in year t using Hadlock and Pierce (2010)s SA index, TSO is one minus the percentage
ownership by institutional investors. Regression (1) does not include control variables and Regression
(2) includes control variables listed in Table 1. All variables are winsorized at 1% and 99% levels. The
standard errors are in parentheses. They are robust to heteroskedasticity, and are clustered at the firm
level. *, **, and *** represent significance at the 10%, 5%, and 1% level, respectively.

TRA JGTRRA
Variable (1) (2) (1) (2)

Post 0.155*** 0.223*** 0.401*** 0.455***
(0.045) (0.076) (0.058) (0.108)
FCSA -0.412** 5.641*** 2.089*** 0.757
(0.166) (1.611) (0.405) (2.642)
Post FCSA -0.992*** -4.189** -2.208*** -8.756**
(0.287) (1.715) (0.610) (3.849)
TSO -0.253*** -0.015 0.125** -0.154
(0.038) (0.089) (0.050) (0.133)
Post TSO -0.051 -0.011 -0.217*** 0.080
(0.054) (0.121) (0.070) (0.187)
NDIV -0.000 0.117** 0.000 -0.033
(0.018) (0.049) (0.033) (0.081)
Post NDIV -0.064** -0.085 -0.059 -0.051
(0.028) (0.063) (0.043) (0.103)

Firm controls No Yes No Yes

N 11,646 3,586 9,647 3,441
Adjusted R
2
0.029 0.131 0.014 0.067

37

Table 4 The impact of financial constraint on capital and R&D expenditures

This table presents ordinary least squares regression results for the dependent variable CAPXRD. The
regression specification is
1 , 5 1 , 4 1 , 3 1 , 2 1 ,
+ + + + = A
t i t t i t i t t i t t i
TSO Post TSO FCSA Post FCSA Post CAPXRD | | | | |
1 , 7 1 , 6
+ +
t i t t i
NDIV Post NDIV | | + Controls (when applicable) + Constant +
t i,
c
For TRA, we use data from 1996 to 1998, and Post takes a value of zero before 1997 and value of one
after 1997. For JGTRRA in 2003, we use data from 2002 to 2004, and Post takes a value of zero
before 2003 and value of one after 2003. CAPXRD is the change in the sum of capital expenditure
and R&D expenditure from year t1 to year t; FCSA is the predicted probability of a firm being
financially constrained in the most recent quarter in year t using Hadlock and Pierce (2010)s SA
index, TSO is one minus the percentage ownership by institutional investors. Regression (1) does not
include control variables and Regression (2) includes control variables listed in Table 1. All variables
are winsorized at 1% and 99% levels. The standard errors are in parentheses. They are robust to
heteroskedasticity, and are clustered at the firm level. *, **, and *** represent significance at the 10%,
5%, and 1% level, respectively.

TRA JGTRRA
Variable (1) (2) (1) (2)

Post 0.179** 0.178 0.304*** 0.513***
(0.072) (0.115) (0.081) (0.153)
FCSA -0.550** 7.418*** 2.520*** 2.102
(0.217) (2.734) (0.566) (3.751)
Post FCSA -0.370 -0.505 -2.760*** -13.801***
(0.363) (2.356) (0.774) (4.564)
TSO -0.323*** 0.052 -0.040 -0.457**
(0.051) (0.128) (0.065) (0.185)
Post TSO -0.131* -0.148 -0.087 0.556*
(0.076) (0.169) (0.089) (0.301)
NDIV -0.068** 0.014 -0.079 0.007
(0.030) (0.066) (0.051) (0.120)
Post NDIV -0.064 -0.111 -0.022 -0.096
(0.049) (0.095) (0.062) (0.141)

Firm controls No Yes No Yes

N 6,277 1,845 5,677 1,976
Adjusted R
2
0.047 0.216 0.011 0.104
38

Table 5 The impact of financial constraint on firm employment

This table presents ordinary least squares regression results for the dependent variable EMP. The
regression specification is
1 , 5 1 , 4 1 , 3 1 , 2 1 ,
+ + + + = A
t i t t i t i t t i t t i
TSO Post TSO FCSA Post FCSA Post CAPX | | | | |
1 , 7 1 , 6
+ +
t i t t i
NDIV Post NDIV | | + Controls (when applicable) + Constant +
t i,
c
For TRA, we use data from 1996 to 1998, and Post takes a value of zero before 1997 and value of one
after 1997. For JGTRRA in 2003, we use data from 2002 to 2004, and Post takes a value of zero
before 2003 and value of one after 2003. EMP is the change in number of employees (in thousands)
from year t1 to year t; FCSA is the predicted probability of a firm being financially constrained in the
most recent quarter in year t using Hadlock and Pierce (2010)s SA index, TSO is one minus the
percentage ownership by institutional investors. Regression (1) does not include control variables and
Regression (2) includes control variables listed in Table 1. All variables are winsorized at 1% and
99% levels. The standard errors are in parentheses. They are robust to heteroskedasticity, and are
clustered at the firm level. *, **, and *** represent significance at the 10%, 5%, and 1% level,
respectively.

TRA JGTRRA
Independent variables (1) (2) (1) (2)

FCSA -1.980*** -7.687** 1.121* -3.131
(0.463) (3.560) (0.653) (4.315)
Post FCSA -1.448** -3.204 -3.024*** -12.261**
(0.715) (4.049) (0.960) (5.701)
Post (1 FCSA) 0.141 0.017 0.451*** 0.689***
(0.104) (0.171) (0.107) (0.189)
TSO -0.852*** -0.261 -0.206** -0.242
(0.102) (0.209) (0.084) (0.207)
Post TSO -0.057 0.104 -0.191 0.199
(0.131) (0.253) (0.119) (0.308)
NDIV 0.063 0.313*** 0.109** 0.245**
(0.047) (0.120) (0.049) (0.124)
Post NDIV 0.002 -0.086 -0.038 -0.092
(0.064) (0.148) (0.067) (0.158)

Firm controls No Yes No Yes

N 11,515 3,542 10,607 3,402
Adjusted R
2
0.030 0.249 0.009 0.127

39

Table 6 Robustness check using the alternative financial constraint measure

This table reproduces Table 3, 4 and 5 using the FCSACL measure as the firms probability of facing
financial constraints. NDIV and Post NDIV included but not reported.

TRA JGTRRA
Independent variables (1) (2) (1) (2)
CAPX
Post 0.172*** 0.217*** 0.424*** 0.458***
(0.049) (0.080) (0.061) (0.110)
FCSACL -0.486** 4.925*** 2.203*** 0.562
(0.193) (1.392) (0.427) (2.038)
Post FCSACL -1.258*** -6.338*** -2.817*** -11.115***
(0.305) (1.679) (0.607) (3.398)
TSO -0.263*** -0.050 0.085* -0.166
(0.040) (0.094) (0.051) (0.136)
Post TSO -0.048 0.066 -0.169** 0.092
(0.056) (0.124) (0.070) (0.189)

Firm controls No Yes No Yes
N 10,208 3,366 9,023 3,320
Adjusted R
2
0.035 0.135 0.016 0.072

CAPXRD
Post 0.210*** 0.188 0.332*** 0.471***
(0.081) (0.117) (0.089) (0.156)
FCSACL -0.927*** 2.942 1.704*** 0.920
(0.264) (1.995) (0.560) (2.664)
Post FCSACL -0.689* -3.195 -2.675*** -13.873***
(0.395) (2.307) (0.729) (4.296)
TSO -0.332*** 0.083 -0.052 -0.506***
(0.056) (0.137) (0.065) (0.191)
Post TSO -0.118 -0.051 -0.049 0.575*
(0.081) (0.172) (0.089) (0.300)

Firm controls No Yes No Yes
N 5,393 1,743 5,266 1,910
Adjusted R
2
0.060 0.215 0.012 0.108

EMP
FCSACL -2.572*** 0.242 0.897 1.432
(0.551) (2.973) (0.639) (3.419)
Post FCSACL -1.779** -4.316 -3.564*** -20.107***
(0.756) (3.405) (0.838) (4.991)
Post (1 FCSACL) 0.116 0.016 0.467*** 0.682***
(0.113) (0.176) (0.112) (0.193)
TSO -0.874*** -0.333 -0.247*** -0.324
(0.109) (0.224) (0.083) (0.212)
Post TSO -0.006 0.118 -0.175 0.307
(0.139) (0.268) (0.114) (0.317)

Firm controls No Yes No Yes
N 10,166 3,329 9,869 3,285
Adjusted R
2
0.034 0.245 0.010 0.130
40

Table 7 The impact of financial constraint on capital expenditures of firms with different dividend yields
This table presents ordinary least squares regression results for the dependent variable CAPX. The regression specification is
t i t i t
t i t i t t i t i t t i t i t t i t t i
NDIV Post
NDIV YLD Post YLD TSO Post TSO FCSA Post FCSA Post CAPX
, 1 , 9
1 , 8 1 , 7 1 , 6 1 , 5 1 , 4 1 , 3 1 , 2 1 ,
Constant ) applicable (when Controls c |
| | | | | | | |
+ + + +
+ + + + + + + = A

For TRA, we use data from 1996 to 1998, and Post takes a value of zero before 1997 and value of one after 1997. For JGTRRA in 2003, we use data from 2002
to 2004, and Post takes a value of zero before 2003 and value of one after 2003. CAPX is the change in capital expenditure from year t 1 to year t; FCSA is the
predicted probability of a firm being financially constrained in the most recent past quarter in year t using Hadlock and Pierce (2010)s SA index, TSO is one
minus the percentage ownership by institutional investors. Regression (1) does not include control variables and Regression (2) includes control variables listed
in Table 1. All variables are winsorized at 1% and 99% levels. The standard errors are in parentheses. They are robust to heteroskedasticity, and are clustered at
the firm level. *, **, and *** represent significance at the 10%, 5%, and 1% level, respectively.

TRA JGTRRA
Independent Full Sample Subsample (div-paying) Full Sample Subsample (div-paying)
variables (1) (2) (1) (2) (1) (2) (1) (2)
Post 0.172*** 0.234*** 0.219*** 0.265* 0.389*** 0.414*** 0.477*** 0.371*
(0.046) (0.078) (0.077) (0.141) (0.059) (0.108) (0.095) (0.191)
FCSA -0.400** 5.588*** -0.692 9.764*** 2.210*** 0.941 6.846*** 5.368
(0.166) (1.612) (0.702) (3.591) (0.406) (2.649) (1.734) (6.619)
Post FCSA -0.947*** -4.094** -5.324*** -10.319** -2.297*** -9.268** -6.232*** -10.177
(0.287) (1.716) (1.394) (4.657) (0.609) (3.856) (2.339) (8.641)
TSO -0.250*** -0.016 -0.350*** -0.012 0.132*** -0.170 0.058 -0.357
(0.038) (0.089) (0.074) (0.170) (0.051) (0.133) (0.115) (0.290)
Post TSO -0.040 -0.009 0.018 0.088 -0.222*** 0.098 -0.264* 0.195
(0.053) (0.121) (0.112) (0.232) (0.070) (0.186) (0.152) (0.346)
YLD -0.122 0.219 -0.082 0.151 -0.165*** -0.463*** -0.205*** -0.485***
(0.087) (0.330) (0.089) (0.331) (0.055) (0.174) (0.057) (0.177)
Post YLD -0.330** -0.342 -0.225 -0.268 0.101 0.473* 0.147* 0.517*
(0.143) (0.407) (0.147) (0.406) (0.079) (0.295) (0.082) (0.311)
NDIV -0.008 0.125** -0.027 -0.089
(0.019) (0.050) (0.036) (0.084)
Post NDIV -0.091*** -0.101 -0.039 0.001
(0.031) (0.066) (0.046) (0.106)
Firm controls No Yes No Yes No Yes No Yes
N 11,646 3,586 4,139 1,700 9,647 3,441 3,833 1,597
Adjusted R
2
0.030 0.131 0.026 0.111 0.014 0.069 0.014 0.075
41

Table 8 The impact of financial constraint on capital and R&D expenditures of firms with different dividend yields
This table presents ordinary least squares regression results for the dependent variable CAPXRD. The regression specification is
t i t i t
t i t i t t i t i t t i t i t t i t t i
NDIV Post
NDIV YLD Post YLD TSO Post TSO FCSA Post FCSA Post CAPXRD
, 1 , 9
1 , 8 1 , 7 1 , 6 1 , 5 1 , 4 1 , 3 1 , 2 1 ,
Constant ) applicable (when Controls c |
| | | | | | | |
+ + + +
+ + + + + + + = A

For TRA, we use data from 1996 to 1998, and Post takes a value of zero before 1997 and value of one after 1997. For JGTRRA in 2003, we use data from 2002
to 2004, and Post takes a value of zero before 2003 and value of one after 2003. CAPXRD is the change in the sum of capital expenditure and R&D expenditure
from year t1 to year t; FCSA is the predicted probability of a firm being financially constrained in the most recent past quarter in year t using Hadlock and
Pierce (2010)s SA index; TSO is one minus the percentage ownership by institutional investors. Regression (1) does not include control variables and
Regression (2) includes control variables listed in Table 1. All variables are winsorized at 1% and 99% levels. The standard errors are in parentheses. They are
robust to heteroskedasticity, and are clustered at the firm level. *, **, and *** represent significance at the 10%, 5%, and 1% level, respectively.
TRA JGTRRA
Independent Full Sample Subsample (div-paying) Full Sample Subsample (div-paying)
variables (1) (2) (1) (2) (1) (2) (1) (2)
Post 0.199*** 0.208* 0.277** 0.348 0.277*** 0.437*** 0.312** 0.128
(0.076) (0.118) (0.131) (0.212) (0.083) (0.157) (0.137) (0.325)
FCSA -0.535** 7.243*** -4.437*** 11.922* 2.723*** 2.599 10.015*** 17.792
(0.216) (2.727) (1.538) (6.677) (0.570) (3.750) (3.069) (12.869)
Post FCSA -0.342 -0.206 -5.300* -6.394 -2.937*** -14.571*** -10.223*** -20.414
(0.362) (2.352) (2.924) (8.172) (0.773) (4.555) (3.911) (15.013)
TSO -0.319*** 0.055 -0.424*** 0.214 -0.033 -0.487*** -0.331* -1.331**
(0.051) (0.127) (0.131) (0.312) (0.065) (0.187) (0.117) (0.561)
Post TSO -0.117 -0.151 -0.114 -0.303 -0.089 0.582* 0.085 1.550*
(0.076) (0.168) (0.204) (0.439) (0.089) (0.301) (0.227) (0.800)
YLD -0.192* 0.475 -0.031 0.364 -0.285*** -0.570** -0.345*** -0.668***
(0.115) (0.451) (0.118) (0.443) (0.100) (0.239) (0.107) (0.228)
Post YLD -0.335 -0.791 -0.178 -0.502 0.207* 0.742** 0.282** 0.844**
(0.224) (0.569) (0.229) (0.572) (0.115) (0.329) (0.120) (0.322)
NDIV -0.082** 0.034 -0.126** -0.081
(0.033) (0.069) (0.055) (0.124)
Post NDIV -0.095* -0.150 0.015 -0.005
(0.053) (0.099) (0.067) (0.145)

Firm controls No Yes No Yes No Yes No Yes
N 6,277 1,845 1,835 720 5,677 1,976 1,821 728
Adjusted R
2
0.049 0.216 0.039 0.216 0.013 0.107 0.010 0.117

42

Table 9 The impact of financial constraint on firm employment for firms with dividend yields
This table presents ordinary least squares regression results for the dependent variable EMP. The regression specification is
) 1 ( ) 1 (
1 , 1 , 7 1 , 1 , 6 1 , 5 1 , 4 1 , 3 1 , 2 1 , 1 ,
+ + + + + + = A
t i t i t i t i t i t t i t i t t i t t i t i
FCSA YLD FCSA YLD TSO Post TSO FCSA Post FCSA Post FCSA EMP | | | | | | |
1 , 11 1 , 10 1 , 1 , 9 1 , 1 , 8
) 1 (

+ + + +
t i t t i t i t i t t i t i t
NDIV Post NDIV FCSA YLD Post FCSA YLD Post | | | | + Controls (when applicable) + Constant +
t i,
c
For TRA, we use data from 1996 to 1998, and Post takes a value of zero before 1997 and value of one after 1997. For JGTRRA in 2003, we use data from 2002
to 2004, and Post takes a value of zero before 2003 and value of one after 2003. EMP is the change in number of employees (in thousands) from year t1 to year t; FCSA
is the predicted probability of a firm being financially constrained in the most recent past quarter in year t using Hadlock and Pierce (2010)s SA index; TSO is one minus the
percentage ownership by institutional investors. Regression (1) does not include control variables and Regression (2) includes control variables listed in Table 1. All variables are
winsorized at 1% and 99% levels. The standard errors are in parentheses. They are robust to heteroskedasticity, and are clustered at the firm level. *, **, and *** represent
significance at the 10%, 5%, and 1% level, respectively.

TRA JGTRRA
Independent Full Sample Subsample (div-paying) Full Sample Subsample (div-paying)
variables (1) (2) (1) (2) (1) (2) (1) (2)

FCSA -2.181*** -7.853** -8.354*** -7.300 0.924 -3.268 5.808** 10.540
(0.472) (3.682) (2.356) (8.388) (0.671) (4.319) (2.790) (12.312)
Post FCSA -1.362* -3.313 -4.010 -8.168 -2.959*** -12.783** -7.487* -26.533*
(0.726) (4.228) (3.292) (10.802) (0.979) (5.721) (3.819) (14.686)
Post (1 FCSA) 0.114 -0.018 0.111 -0.003 0.442*** 0.682*** 0.618*** 1.023***
(0.107) (0.178) (0.180) (0.309) (0.109) (0.193) (0.178) (0.372)
TSO -0.827*** -0.250 -0.732*** -0.017 -0.204** -0.254 -0.075 -0.231
(0.102) (0.211) (0.186) (0.347) (0.084) (0.207) (0.156) (0.423)
Post TSO -0.066 0.089 0.028 0.220 -0.190 0.212 -0.333 -0.018
(0.131) (0.256) (0.249) (0.436) (0.119) (0.308) (0.225) (0.563)
YLD FCSA 28.325*** 45.844 43.654*** 16.231 8.148*** 9.007 4.245 -9.262
(9.086) (109.789) (12.254) (115.124) (2.235) (14.456) (2.722) (18.129)
YLD (1 FCSA) -2.443*** -1.774 -2.838*** -1.086 -0.547*** -0.552 -0.468*** -0.277
(0.570) (3.385) (0.640) (3.460) (0.127) (0.428) (0.136) (0.463)
Post YLD FCSA -12.096 -21.354 -9.652 8.837 0.354 14.005 4.190 24.286
(10.513) (99.945) (14.324) (104.231) (3.572) (21.591) (4.298) (25.618)
Post YLD (1 FCSA) 1.087 1.519 1.072 0.684 0.013 -0.206 -0.066 -0.272
(0.682) (3.181) (0.749) (3.217) (0.194) (0.556) (0.207) (0.608)
NDIV -0.018 0.291** 0.078 0.201
(0.052) (0.126) (0.052) (0.130)
Post NDIV 0.029 -0.040 -0.033 -0.075
(0.071) (0.157) (0.070) (0.163)
Firm controls No Yes No Yes No Yes No Yes
N 11,515 3,542 4,203 1,686 10,607 3,402 4,755 1,562
Adjusted R
2
0.033 0.249 0.021 0.238 0.010 0.127 0.008 0.137

43

Table 10 The comparison of the impact of TRA and JGTRRA

This table reports the estimation results of the comparison of the impact on the changes
of firms capital investment and employment under TRA and JGTRRA. We extend the
specifications (21) and (22) by introducing interactions of the regressors in these
equations with a dummy variable D03 representing the tax event of JGTRRA. The
dummy variable takes a value of zero if an observation belongs to the tax event of TRA
and a value of one if it belongs to the tax event of JGTRRA. The sample consists of all
firms on the merged CRSP and COMPUSTAT database for year 1996 and 1998 for TRA
and for year 2002 and 2004 for JGTRRA. We exclude 1997 for TRA and 2003 for
JGTRRA to avoid transient effect. Model (1) excludes firm level control variables and
model (2) includes the firm controls. The robust clustered standard errors are reported in
parentheses.
*
significant at 10%,
**
significant at 5%, and
***
significant at 1%.
44


Variable CAPX CAPXRD

Variable EMP
(1) (2) (1) (2)

(1) (2)

Post

0.443***

0.614***

0.448***

0.597***


FCSA

-3.096***

-15.511***

(0.046) (0.077) (0.072) (0.118)

(0.472) (3.548)
FCSA -0.921*** -3.131** -1.055*** -5.726**

Post*FCSA 0.065 -5.183

(0.171) (1.569) (0.234) (2.556)

(0.722) (4.202)
Post*FCSA -0.426 -5.798*** 0.178 -0.208

Post*(1-FCSA) 0.626*** 0.567***

(0.289) (1.766) (0.369) (2.331)

(0.100) (0.161)
TSO 0.072* 0.314*** -0.033 0.404***

TSO -0.211** 0.419**

(0.037) (0.089) (0.054) (0.140)

(0.085) (0.197)
Post*TSO -0.363*** -0.475*** -0.402*** -0.655***

Post*TSO -0.681*** -0.620**

(0.056) (0.123) (0.078) (0.179)

(0.125) (0.255)
YLD 0.119 0.546 0.060 0.863

YLD*FCSA 19.470** -33.103

(0.091) (0.395) (0.118) (0.541)

(8.426) (93.479)
Post*YLD -0.572*** -0.883* -0.586** -1.438**

YLD*(1-FCSA) -1.646*** 0.510

(0.147) (0.456) (0.228) (0.633)

(0.556) (2.874)
NDIV 0.055*** 0.118** -0.010 0.081

Post*YLD*FCSA -3.241 58.218

(0.019) (0.050) (0.030) (0.069)

(10.101) (83.468)
Post*NDIV -0.154*** -0.165** -0.167*** -0.286***

Post*YLD*(1-FCSA) 0.291 -1.088

(0.031) (0.067) (0.051) (0.101)

(0.684) (2.692)
D03*Post -0.284*** -0.477*** -0.375*** -0.487***

NDIV 0.094* 0.330***

(0.049) (0.087) (0.079) (0.139)

(0.051) (0.124)
D03*FCSA 3.463*** 10.519*** 4.189*** 16.983***

Post*NDIV -0.083 -0.137

(0.455) (2.680) (0.658) (3.736)

(0.071) (0.158)
D03*Post*FCSA -2.203*** -0.004 -3.526*** -12.002**

D03*FCSA 4.442*** 13.355***

(0.673) (4.076) (0.867) (4.957)

(0.796) (4.965)
D03*TSO -0.187*** -0.774*** -0.202*** -1.199***

D03*Post*FCSA -3.863*** -1.194

(0.050) (0.144) (0.079) (0.234)

(1.203) (7.185)
D03*Post*TSO 0.388*** 0.821*** 0.515*** 1.468***

D03*Post*(1-FCSA) -0.601*** -0.320*

(0.078) (0.216) (0.115) (0.343)

(0.113) (0.187)
D03*YLD -0.356*** -1.080** -0.428*** -1.535**

D03*TSO -0.451*** -1.385***

(0.107) (0.436) (0.156) (0.596)

(0.076) (0.261)
D03*Post*YLD 0.745*** 1.430*** 0.876*** 2.301***

D03*Post*TSO 0.949*** 1.378***

(0.165) (0.546) (0.255) (0.717)

(0.151) (0.392)
D03*NDIV -0.164*** -0.225** -0.208*** -0.258**

D03*YLD*FCSA -9.030 51.225

(0.036) (0.089) (0.051) (0.126)

(8.785) (94.315)
D03*Post*NDIV 0.196*** 0.239** 0.273*** 0.421***

D03*YLD*(1-FCSA) 0.895 -1.404

(0.049) (0.116) (0.073) (0.159)

(0.568) (2.894)
Constant -0.002 0.017 0.159*** -0.356

D03*Post*YLD*FCSA 1.303 -59.805

(0.027) (0.193) (0.041) (0.350)

(10.834) (85.651)

D03*Post*YLD*(1-FCSA) -0.075 1.358
Firm controls No Yes No Yes

(0.713) (2.735)
Observations 21,293 7,027 11,954 3,821

D03*NDIV -0.150** -0.176
Adjusted R-square 0.020 0.081 0.028 0.130

(0.064) (0.166)

D03*Post*NDIV 0.184* 0.151


Constant
(0.094)
0.467***
(0.059)
(0.221)
-1.679***
(0.398)


Firm controls
Observations

No
22,122

Yes
6,944

Adjusted R-squared 0.022 0.171
45


Figure 1
Capital Investment and Shareholder Taxation

This figure illustrates the effect of shareholder taxes on the investment income on firms
cost of capital and investment. With shareholder taxes on investment income, the cost of
capital is increased and the capital investment is decreased.


Capital Investment
r
c
, r
r
D
S
r
c
r
r
A
S
B
r
r

K
A
K
B