Does issuing dividends: President Bush's plan to eliminate the individual tax on dividends has spurred real strategy debates within companies--with CFOs often differing with their CEOs.

• Author: Millman, Gregory J.
• Position: Dividends

President Bush's proposed tax break on dividends paid to shareholders obviously puzzled the press. Pundits proclaimed that eliminating double taxation of dividends would make corporations cut down on excessive debt. That was the good news. The bad news, as Sen. John Corzine (D-N.J.) told a press conference, was that the proposal "takes cash off the balance sheets of America's corporations that they need to hire and pay employees and to make capital investments." The press can be excused for the confusion: The devil is in the details.

If the tax break were enacted, interest would still be tax-deductible at the corporate level; dividends still wouldn't be. So when it comes to capital structure decisions, corporations will still look at the debt-equity choice the way they always have -- with a bias toward debt. Chuck Bowman, director of corporate finance for SPX Corp., a Fortune 500 multi-industry corporation based in North Carolina, says, "Part of our philosophy is to maintain as low a cost of capital as is prudent for our company, based on its volatility of cash flow. Having debt in the mix is good for shareholders."

The CFO of a $3 billion-in-sales consumer goods company, the product of a recent merger, is even more blunt. "Whether or not dividends are taxed is irrelevant to the capital structure. In my mind, the dividend decision is a completely different decision from the borrowing decision."

While any Bush tax relief for dividends may not sway corporate thinking about capital structure, it might push corporations to disburse more cash to shareholders. Michael Jensen, professor emeritus at the Harvard Business School and managing director with the Monitor Consulting group, certainly hopes so. "This might make the demands of equity holders like those of debt holders," he says, "If that were to happen, it would change corporate America in dramatic ways." Jensen likens the possible effect to that of the leveraged buyout boom of the 1980s, which forced corporations to become more efficient in order to meet debt service requirements. "If you have a corporation with large amounts of cash sloshing around, it's almost impossible for that corporation to behave. The cash burns a hole in their pocket," Jensen says. A study publicized by the Business Roundtable in January indicated that Jensen might have good cause for his optimism. "There's a consensus that this will give added incentive for corporations to pay out a higher portion of their earnings...