In 1997, the British government removed all tax exemptions for dividends. The purpose was to encourage firms to retain cash and reinvest of corporate profits. This indicates that the dividend policy matters, in contrast to the predictions under Modigliani and Miller (1958).
a. Outline possible reasons why the dividend payout policy matters.
b. With respect to the British government’s decision to slash all dividend tax exemptions, outline the possible problems of this policy.
c. How might such tax policy affect British firms’ capital structure?
d. In your opinion, would shareholders be better off with cash dividend payments or capital gains?