Abstract
Contrary to the conventional wisdom that dividends are the primary means of transferring cash from the firm to its shareholders, nondividend cash payments surpassed dividends in the two most recent years for which data are available, 1984 and 1985 (Shoven 1986). This development challenges the "trapped-equity" cost of capital models 'which equate the cost of retained earnings to the after-tax yield of the alternative considered, namely, dividends. If dividends are the only alternative to retaining earnings, the high taxation of dividends lowers the shadow cost of retained earnings and hence lowers the cost of capital. On the other hand, if cash can be and is paid out in nondividend form, with lower taxes, the economics profession needs to change the way it computes the cost of equity capital.
In this paper we review the theoretical rationale for nondividend cash payments. These payments can take the form of either share repurchase programs or cash mergers. The primary new material of this paper is an econometric investigation in to what types of firms engage in these two forms of share acquisition programs: repurchasing own shares or acquiring the shares of other firms. We examine whether the same characteristics of the firm determine both mergers (or acquisitions) and share repurchases. Because these activities are so much more prominent now, than in the past, we also examine whether the type of firm involved in these activities has changed since a decade ago.