Department of Finance Working Papers

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Unpublished Paper

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Brazilian tax law allows firms to make cash distributions to shareholders in two forms: dividends and interest on equity. Theory suggests that firms should favor interest on equity payments because the net tax burden is lower compared to dividends. We find that taxes are a primary determinant of Brazilian firms’ payout policy decisions, as profitability and payout ratios (nonequity tax shields) are positively (negatively) related to the likelihood that a firm pays interest on equity. However, many firms continue to pay dividends despite the tax advantages of interest on equity payments. Abnormal returns around payout policy announcements suggest that these firms are, at least in part, catering to investor demand.


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