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On the Marginal Source of Investment Funds

Since 2008, CalSTRS Global Equity investments have included a sustainable manager portfolio. With assets under management in excess of USD 600 million, this portfolio has a double bottom line goal of financial and sustainable outperformance and is one of CalSTRS best performing equity portfolios. CalSTRS Private Equity Clean Technology and Energy Program has commitments in excess of USD 600 million and is a diversified portfolio of venture and buyout investments across the clean technology and clean energy universe. The program is global in nature and encompasses both fund investments and co-investments. The CalSTRS Real Estate unit has established. | On the Marginal Source of Investment Funds Alan J. Auerbach University of California Berkeley and NBER Kevin A. Hassett American Enterprise Institute July 2000 This paper was presented at the Trans-Atlantic Public Economics Seminar Gerzensee Switzerland May 2000. We are grateful to many attending that conference particularly our discussants Bill Gentry and Soren Bo Nielsen and to participants in seminars at Freiburg Harvard Michigan Warwick and the NBER Summer Institute for comments on earlier drafts. We also thank Kevin Cole and Nancy Nicosia for research assistance I B E S International Inc. for the provision of data as part of their academic research program and the Burch Center for Tax Policy and Public Finance at Berkeley for research support. Abstract Under the new view of dividend taxation developed in Auerbach 1979 Bradford 1981 and King 1977 the marginal source of finance for new investment projects is retained earnings. In this case the tax advantage of retentions precisely offsets the double taxation of subsequent dividends taxes on dividends have no impact on the investment incentives of firms using retentions as a marginal source of funds and paying dividends with residual cash flows. We find evidence that dividends do respond to investment and cash flow for the nonfinancial corporate sector as a whole in a manner consistent with the new view. We also find that this dividend pattern is weaker for firms with better access to capital markets as measured by bond rating and the number of analysts following them. Finally we find that although new share issues and repurchases respond to the same firm characteristics as dividends do the pattern of these responses is consistent with a broader interpretation of the new view that preserves the main result of dividend-tax irrelevance with respect to the cost of capital. Alan J. Auerbach Department of Economics University of California Berkeley CA 94720-3880 auerbach@econ.berkeley.edu Kevin A. Hassett AEI 1150 .