- Comments and Discussion
This paper by Malcolm Baker, Stefan Nagel, and Jeffrey Wurgler asks whether the division of corporate earnings between retentions and payouts affects consumer spending. The authors bring novel insight and a creative empirical strategy to bear on a question that has a long pedigree in empirical macroeconomics. Early attempts to model aggregate consumption related consumer spending to disposable income and household wealth. Estimates of the marginal propensity to consume out of income were typically an order of magnitude greater than estimates of the marginal propensity to consume out of wealth. Taken at face value, such estimates implied that if a firm reduced its retained earnings by a dollar, thereby reducing its share price, and paid a dollar of dividends, consumer spending would rise by the difference between the marginal propensity to consume out of disposable income and the marginal propensity to consume out of wealth. Some researchers argued that, to avoid this stark result, consumption should depend on corporate retained earnings as well as disposable income. This suggestion led to an empirical debate about whether consumers "pierce the corporate veil" and recognize the firm's underlying earnings, or fail to do this and instead consume at different rates out of different components of corporate earnings.
In contemporary textbook models of consumer behavior, current household spending depends on the present discounted value of current and future labor earnings and on current financial assets. In the absence of taxes and other institutional rigidities, a dividend payment, as opposed to a capital gain, should not change a household's net financial assets and therefore should not affect consumer spending. Yet the possibility remains that different ways of transmitting earnings to shareholders have different effects on consumption. Various models in behavioral economics can [End Page 277] justify such an outcome. This paper offers intriguing evidence in support of these models.
In linking this paper and its findings to the debate concerning the corporate veil, it is important to recognize that even if one does not reject the null hypothesis that consumers have equal propensities to consume from dividends and other components of equity returns, the corporate payout decision may still affect consumption. To illustrate this possibility, assume that a project generates a dollar of after-tax corporate profits for an equity-financed firm. The firm could distribute the dollar as a dividend payment, or it could retain the dollar. In the latter case the firm's share price would be higher, by dV, than if the earnings were distributed to the shareholders. The change in consumption spending from the dividend payout would be MPCdiv, and the change in the retained earnings case would be MPCcgdV. Even if MPCdiv = MPCcg, which is the proposition that the authors study, it is still possible that distributing earnings could affect consumption if dV is not equal to unity. Tax considerations could break this equality, for example if retained earnings may be distributed in the future by repurchasing shares and therefore face a lower tax burden than dividend payments. Corporate governance factors may also come into play. If a dollar of retained earnings may be reinvested by the management team at a rate of return below that demanded by the marketplace, but not low enough to warrant shareholders incurring the costs of removing the managers, then dV may be less than 1.
Previous researchers have found it difficult to distinguish the consumption impact of dividends from that of accruing capital gains, because there are few exogenous shocks to corporate distribution policy that cannot be plausibly linked in other ways to consumer spending. This paper presents two ingenious tests of whether households consume at different rates from dividend income and from accruing capital gains. By presenting empirical findings suggesting that dividends increase consumption more than do accrued capital gains of equal value, this paper suggests that policies that encourage firms to distribute earnings may increase aggregate consumer spending.
The identification problem confronting earlier studies is easily summarized. In time-series data, most of the variation in the mix between dividends and retained earnings is due to shocks to corporate earnings. Such shocks may affect consumer...