The Impact of Tax Law Changes on Bank Dividend Policy,Sell-offs, Organizational Form, and Industry Structure

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The Impact of Tax Law Changes on Bank Dividend Policy, Sell-offs, Organizational Form, and Industry Structure

April 2009 Number 369

JEL classification: A12, K34, H25, G20

Authors: Hamid Mehran and Michael Suher

This paper investigates the effect at the bank and industry level of a 1996 tax law change allowing commercial banks to elect S-corporation status. By the end of 2007, roughly one in three commercial banks had either opted for or converted to the S-corporation form of organization. Our study analyzes the effect of this conversion on bank dividend payouts. It also examines the effect S-corporation status has on a community bank’s likelihood of sell-off and measures a firm’s sensitivity to tax rates based on its choice of organizational form. We document that dividend payouts increase substantially after a bank’s conversion to S status. Moreover, community banks that convert are significantly less likely to be sold than their C-corporation peers. We estimate a tax rate elasticity of conversion in the range of 2 to 3 percent for every 1-percentage-point change in relative tax rates. Overall, our results provide evidence that Subchapter S status has significant effects on bank conduct and industry structure.

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