Journal of the European Economic Association
The Lock-In Effect and the Corporate Payout Puzzle,
2026-07-24
Taxes on capital gains are deferred until realization whereas dividends are taxed upon accrual. This often makes dividends tax disadvantaged relative to share repurchases, which leads to the payout puzzle: why do firms pay dividends? This paper demonstrates that tax deferment can also provide a solution to this puzzle: if shareholders with an accrued capital gain and a non-zero investment horizon demand a premium to sell equity—as compensation for accelerated realizations (and taxation)—then dividends can become tax efficient. This mechanism is appealing because it can explain dividend payments without appealing to asymmetric information, incomplete contracting, repurchase constraints, and/or irrationality.