From the 1980s to the 1990s, there were tremendous changes in the UK tax and regulatory environment. Professors Raghavendra Rau of the Krannert School of Management, Purdue University, and Theo Vermaelen, the Schroders Chaired Professor in International Finance and Asset Management at INSEAD, took advantage of the tumultuous time to test some interesting hypotheses. In their article, forthcoming in the Journal of Business, they examine the effect of the environmental changes on share repurchase activity to see just how important tax and regulatory conditions actually are in determining this type of behavior.
During the period in question, US activity firmly puts the UK experience into the shade, with about 100 companies announcing share repurchases on the open market every month. The UK is of particular interest, however, for two reasons. Firstly, the tax and regulatory environment is different from that in the US, especially because companies are not allowed to buy back shares at times when managers are likely to have privileged information about future earnings.
Secondly, since the regulations changed frequently over the period covered in this article, the authors were able to test the extent to which the regulatory environment affected repurchase activity and the ability of companies to take advantage of undervalued stocks.
This article shows that the regulatory ebb and flow was mirrored by corresponding changes in the way companies distributed their profits. Thus, the hypothesis that the tax treatment of important investors determines payout policy is largely substantiated. And while some believe that large investors guarantee better monitoring and management of companies to the benefit of smaller investors, the authors point out that those benefits would be greater if all investors, large and small, were taxed in the same way.
Journal of Business, April 2002