CAPITAL STRUCTURE AND DIVIDEND POLICY IN SINGAPORE : A STUDY OF THE TAX EFFECTS AND RELATIONSHIP BETWEEN CAPITAL STRUCTURE AND DIVIDEND POLICY OF SES LISTED COMPANIES

Abstract

The existent financial literature suggests that a firm's value is dependent on its capital structure and / or dividend policy, which in turn are affected by the tax environment. As such, we expect to see changes in the firm's capital structure and / or dividend policy when there are changes in the tax laws. There have been a number of cuts in the income tax rates in Singapore smce 1986. It is these changes in tax rates that have triggered this study. There are two major objectives of this study: 1. Assess the financial leverage as well as dividend payout ratio changes in response to the two cuts in income tax rates (announced in 1986 and 1993 respectively) and analyze the possible reasons behind the observed changes. 2. Study the relationship between financial leverage and dividend payout policy. We have developed nine hypotheses based on the following two paradigms: (1) benefit-cost tradeoff framework and (2) tax induced clientele effects of financial leverage as well as dividend. The main findings of the study can be summarized as follows: 1. The partial-adjustment effect posited by Lintner (1956) dominates the dividend decisions of listed firms in Singapore. However, the propensity to pay dividend out of earnings increases significantly after the cut in corporate tax rate in 1993. 2. The decisions on capital structure are affected by both the tax effect and agency cost considerations. Firms with different average debt ratios are found to have reacted differently to the cuts in the corporate tax rates. 3. No significant relationship between the debt ratios and dividend payout ratios is observed for listed firms in Singapore during the period from 1983 to 1996. Neither are tax-induced clientele effects detected. These results may be due to ( 1) high personal income tax rate of the marginal investor and (2) agency cost considerations.