The Dividend Substitution Hypothesis: Australian Evidence

Abstract

In a perfect capital market firms are indifferent to either dividends or repurchases as payout mechanisms, suggesting that the two payout methods should be perfect substitutes. Empirical research at the single country level, as well as cross country studies, provide evidence that dividends and repurchases act as substitutes (the dividend substitution hypothesis), and that the tax treatment of dividends versus capital gains affects this relation. Australia, which operates under a full dividend imputation system, has two types of repurchases: on- and off-market. On-market repurchases are taxed as capital gains while off-market repurchases comprise a large dividend component carrying valuable t..