[Senate Hearing 108-894]
[From the U.S. Government Publishing Office]
S. Hrg. 108-894
PROMOTING CORPORATE RESPONSIBILITY THROUGH THE REDUCTION OF DIVIDEND
TAXES
=======================================================================
HEARING
before the
SUBCOMMITTEE ON CONSUMER AFFAIRS AND PRODUCT SAFETY
OF THE
COMMITTEE ON COMMERCE,
SCIENCE, AND TRANSPORTATION
UNITED STATES SENATE
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
__________
APRIL 8, 2003
__________
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SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
JOHN McCAIN, Arizona, Chairman
TED STEVENS, Alaska ERNEST F. HOLLINGS, South Carolina
CONRAD BURNS, Montana DANIEL K. INOUYE, Hawaii
TRENT LOTT, Mississippi JOHN D. ROCKEFELLER IV, West
KAY BAILEY HUTCHISON, Texas Virginia
OLYMPIA J. SNOWE, Maine JOHN F. KERRY, Massachusetts
SAM BROWNBACK, Kansas JOHN B. BREAUX, Louisiana
GORDON SMITH, Oregon BYRON L. DORGAN, North Dakota
PETER G. FITZGERALD, Illinois RON WYDEN, Oregon
JOHN ENSIGN, Nevada BARBARA BOXER, California
GEORGE ALLEN, Virginia BILL NELSON, Florida
JOHN E. SUNUNU, New Hampshire MARIA CANTWELL, Washington
FRANK LAUTENBERG, New Jersey
Jeanne Bumpus, Republican Staff Director and General Counsel
Robert W. Chamberlin, Republican Chief Counsel
Kevin D. Kayes, Democratic Staff Director and Chief Counsel
Gregg Elias, Democratic General Counsel
------
Subcommittee on Consumer Affairs and Product Safety
PETER G. FITZGERALD, Illinois, Chairman
CONRAD BURNS, Montana RON WYDEN, Oregon
GORDON SMITH, Oregon BYRON L. DORGAN, North Dakota
C O N T E N T S
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Page
Hearing held on April 8, 2003.................................... 1
Statement of Senator Fitzgerald.................................. 1
Witnesses
Bull, Elizabeth W., Vice President and Treasurer, Texas
Instruments
Incorporated................................................... 14
Prepared statement........................................... 16
Elson, Charles M., Chairman, Center for Corporate Governance,
Lerner
College of Business and Economics, University of Delaware...... 11
Prepared statement........................................... 13
Fisher, Peter R., Under Secretary for Domestic Finance,
Department of the Treasury..................................... 5
Prepared statement........................................... 7
Rowe, John W., Chairman and CEO, Exelon Corporation.............. 17
Prepared statement........................................... 19
Siegel, Jeremy J., Professor of Finance, The Wharton School,
University of Pennsylvania..................................... 21
Prepared statement........................................... 23
PROMOTING CORPORATE RESPONSIBILITY THROUGH THE REDUCTION OF DIVIDEND
TAXES
----------
TUESDAY, APRIL 8, 2003
U.S. Senate,
Subcommittee on Consumer Affairs and Product
Safety,
Committee on Commerce, Science, and Transportation,
Washington, DC.
The Subcommittee met, pursuant to notice, at 10:08 a.m. in
room SR-253, Russell Senate Office Building, Hon. Peter G.
Fitzgerald, Chairman of the Subcommittee, presiding.
OPENING STATEMENT OF HON. PETER G. FITZGERALD,
U.S. SENATOR FROM ILLINOIS
Senator Fitzgerald. I will call this Subcommittee meeting
to order.
I want to thank all the witnesses, Secretary Fisher for
being here and all the others who are here. I understand that
Professor Elson wants to be out of here by 11 o'clock, and we
are going to try to accommodate the professor and keep this
Subcommittee meeting moving. I want to thank all of you for
agreeing to testify today. I appreciate that it takes a lot of
time to prepare congressional testimony and make yourselves
available, and I certainly appreciate it.
I wanted to call this hearing because we have had a great
debate in this country about the propriety of cutting taxes or
providing tax relief at this point in our Nation's history, and
there has been a lot of debate especially about cutting the
level of taxation or eliminating the double taxation of
corporate dividends. It seems to me that the debate has
centered almost entirely around the tax policy involved, and
there has not been enough discussion out there about how
corporate behavior might change or be modified if the double
taxation on dividends were eliminated.
Now, last year at about this time we had several executives
from Enron testifying right at that very same table there, and
we got a real lesson in how earnings reports of corporations
can be very misleading, even earnings reports that may well, in
fact, comply with the strictest interpretations of GAAP
accounting rules.
In fact, I remember when Jeffrey Skilling testified,
sitting right where Peter Fisher is right now, I thought I was
going to trap him and find stuff that was not disclosed in
their financial statements, hidden liabilities that I was
certain were not ever disclosed to investors. And Mr. Skilling
surprised me by pointing to specific pages and footnotes in the
annual reports or annual filings with the SEC where they had
disclosed hidden liabilities that had analysts picked up on,
there would have been a whole different interpretation of that
company Enron in the late 1990s and early 2000 when its stock
price was going up and up.
The bottom line is, it seems to me, that earnings figures
can mislead. Earnings are not easily defined. There is a lot of
play within what earnings are defined, but on the other hand,
as Professor Siegel is going to testify--and I have read ahead
to his testimony--dividends are very well defined and tangible
and a very good way for investors to judge the profitability of
companies.
Now, we have gotten away dramatically from corporations
paying dividends in this country, and I do not know if my staff
has some of the charts that we have prepared.
Back in the old days, investors really looked to the
dividend returns on stocks, and in fact, if you go back to the
twenties and thirties, we had very high yields on corporate
stocks ranging from 4 percent or a little bit under 4 percent
down in 1926 when the stock market was very high. Then when the
stock market collapsed, of course, the dividend yield was up to
10 percent on stocks. People still did not want to own stocks.
But all the way, as late as the fifties and sixties, you could
probably expect a 3 or a 3.5 percent dividend yield on most
stocks. And then even in the late seventies and early eighties
you were seeing 5, almost 6 percent yields as being common.
But then in the early eighties, the SEC made it easier for
companies to buy back their own shares, and that is a way in my
judgment of doing a tax-advantaged dividend to your
shareholders. If you pay a corporate dividend, it is going to
get taxed twice, but if you buy back your shares, make them
more scarce, drive up their value, you can more easily return
capital gains to your shareholders. So the SEC, doing that in
the early eighties--and I think Professor Siegel points that
out in his written testimony--caused some changes.
And then in the late eighties, early nineties and
especially in the late nineties, we had a vast proliferation of
stock option grants in corporate America. Stock options used to
be fairly rare in this country. I know my grandfather had a
stock option in the twenties that he could only exercise after
running the company for 25 years, and he did exercise it in the
fifties. But they were much longer-term in those days, and now
we have stock option grants that grant very rapidly. Companies
can get a tax deduction for stock option compensation paid to
management, but they do not have to expense the compensation on
their earnings report. So it is like manna from heaven for
corporations.
In 1993-1994, FASB was going to require companies to
expense stock options, but at that time Senator Lieberman
introduced a resolution in the Senate which passed with 88
votes condemning FASB for having the audacity to require
corporate America to expense stock option compensation on their
earnings reports. In fact, Senator Lieberman also introduced a
side bill that if FASB did not back down on their Rule 123, he
would have put FASB out of business. In the face of that
congressional pressure, FASB backed down and stock option
grants took off with abandon.
Then by the late 1990s, we had Enrons, Global Crossings,
WorldCom, all sorts of corporations, high-flying at the time,
where the insiders were getting very rich on their stock option
grants. Now, in the case of Enron, the top 29 insiders in the 3
years before the company's demise cashed in $1.1 billion worth
of stock options. Now, with such proliferation in stock
options, that is a further incentive for managers not to pay a
dividend to the shareholders, but to focus all their attention
on trying to lift the share prices because that is how those
with stock options will benefit if they can cash in their
options.
In the case of Enron, it appeared to me, after really
delving into this for many months and many different hearings
and after personally examining the documents, that all of the
top insiders had to know they were running a house of cards,
but they all had an incentive not to blow the whistle because
they were getting very rich very quickly on their options.
Finally, it was someone who did not have options, Sherry
Watkins, who was in the CFO's office for just a few weeks, who
figured the whole thing out in a matter of weeks and she did
blow the whistle. And there are many other companies that have
similar patterns.
Now, it strikes me that President Bush's proposal to
eliminate the double taxation of dividends is the best possible
answer to the corporate governance problems that we have seen
in recent years in this country, and that is why I wanted to
hold this hearing to delve into what the likely effect on
corporate behavior would be. While I think we could continue to
tighten the accounting rules and SEC rules, as we began with
Sarbanes-Oxley, no matter how hard you tighten those rules, I
think the earnings figures can always mislead. There are always
going to be assumptions, and I think Professor Siegel points
out in his testimony there are assumptions as to assumed future
rates of return on your pension assets. You have to choose some
depreciation schedules. There is always some play in GAAP
accounting that always makes earnings numbers at the end of the
day an opinion rather than a fact, whereas a dividend check is
a fact.
Now, corporate executives can always take back a bad
earnings forecast. We saw some examples in the late 1990s and
the early part of this decade where companies were coming out
with strong earnings forecasts. Then a bunch of insiders would
cash out their stock options when the price was high, and then
later the earnings forecast would be taken back.
Well, how do we protect investors in this kind of an
environment? I think a return to dividends is a great way of
starting because that corporate CEO cannot take back a dividend
check. He can take back an earnings forecast and say, oh,
sorry, I was wrong, but they cannot take back that dividend
check.
The other thing I think clearly that we would do is
probably lower the level of corporate debt in America.
Companies have a huge incentive to use debt financing instead
of equity financing because you get a tax deduction on your
interest payments on corporate debt. You do not get that
treatment with equity when you pay a dividend on your equity.
So I would expect that corporate behavior would be modified in
the direction of having less debt, and I think that would be
helpful in corporate America. Look what happens to industries
that are over-leveraged. Certainly, Peter Fisher, you have had
to deal a lot with the airline industry. That is a very good
example of an over-leveraged industry. When there is a
downturn, they are not in a strong position to handle that.
The other thing is we have been dealing with the problem of
corporate inversions, companies going off incorporating
offshore in Bermuda to avoid taxes altogether. Well, I submit
that under President Bush's proposal we would put a stop to a
lot of that behavior because companies would not be able to
deliver a tax-free dividend to their shareholders if the money
had not first been taxed at the corporate level.
So we talk about double taxation of corporate dividends,
for some corporations they are not paying any taxes at all at
the corporate level. They may be reporting tax losses to the
IRS but reporting huge earnings to their shareholders. And a
red flag will be raised under President Bush's proposal, the
Treasury Department's proposal, if you have a company that is
paying dividends on earnings that were never taxed because
people will start to ask questions how that could be. And I
think John Rowe in his testimony is going to talk about that
issue.
Finally, I think there would be, in addition to cutting
down on stock options abuse and cutting down on lowering the
level of corporate debt, discouraging corporate inversions or
bizarre attempts to avoid corporate taxation, I think you just
have less of an incentive for corporations to hoard cash. There
have been a lot of celebrated examples in recent years of
companies just building up enormous cash hoards because it is
foolish under the current tax code to pay that money out a
second time. Better to use it for a stock buy-back, better even
probably to use it for corporate art because you get a tax
deduction on that. But you would see less purchases of
corporate art or lavish yachts or the kind of abuses we saw in
the case of Tyco, buying a lot of perks and benefits for the
CEO to the disadvantage and prejudice of the shareholders with
this proposal from the Administration.
So with that very favorable comment from me on the Treasury
Department and the Administration's proposal, I want to open
this up to Peter Fisher. Peter Fisher is the Under Secretary
for Domestic Finance at the Treasury Department. He was
involved with the Federal Reserve in New York, I believe it
was, and also he has been on the Airline Stabilization Board.
If I could deviate at the very start by asking Secretary
Fisher a question about Hawaiian Airlines. I do not know
whether you picked this up, but I picked it up because I
represent Chicago where Boeing is headquartered. And I noted
that Boeing has a suit in Bankruptcy Court against Hawaiian
Airlines. Apparently this is a small airline that is owned 80
percent, roughly, by inside shareholders, insiders. I think the
Chairman owns about 50 percent. They got $30 million as their
share of the $5 billion cash payout to airlines. According to
the allegations in Boeing's lawsuit, they used roughly $25
million of those proceeds to do a tender offer for their own
shares and bought back about $25 million of their own shares,
of course, to the great benefit of the insiders who run the
company. And then they waited a period of time and filed
bankruptcy. Of course, they are trying to give a hair cut to
their creditors at this point, and Boeing apparently is seeking
to undo that.
I was just wondering if the Under Secretary was aware of
that situation and whether it is possible for the Treasury
Department to look into that or would the legislation Congress
passed last year give the Administration anything that they
could do if the allegations in that complaint were true.
Mr. Fisher. Mr. Chairman, I only know about the allegations
from Boeing from what I have read in the newspapers. So I do
not know anything beyond that.
I think going back to September of 2001 when the original
Air Stabilization Act was passed, the idea of the $5 billion in
grants was no strings attached. That was what came out of the
Administration and it was a rather delicate compromise with the
Administration. So there was no conditionality. There was
simply an allocation of that money by miles flown I believe was
the formula.
So I have not looked into it and I do not know, but if you
would like, I can try. But I do not think we at the Treasury
have any responsibilities here, but I would be happy to check.
Senator Fitzgerald. Well, thank you. I know you were
concerned about protecting the taxpayers in that legislation,
as was I. Just maybe if you can look into that. I think you are
right. Congress had no strings attached. I think it might have
been permissible for an airline to just dividend the money out
to their shareholders and then wait 90 days and file
bankruptcy. I think we should have put more safeguards in
there.
But with that, Mr. Fisher, go ahead. We welcome your
testimony here today. Thank you for being here.
STATEMENT OF PETER R. FISHER, UNDER SECRETARY FOR DOMESTIC
FINANCE, DEPARTMENT OF THE TREASURY
Mr. Fisher. Thank you, Mr. Chairman. I have a written
statement. I ask it be included in the record. I know in the
interest of getting to the full panel, let me try to briefly
summarize my testimony on behalf of the President's proposal to
eliminate the double taxation of dividends.
As we see the proposal, it would strengthen our economy and
create jobs, first, by improving corporate governance, and
second, by retargeting investment to the most productive
ventures.
First, on corporate governance. As you, Mr. Chairman, have
said, I think you and I are having a heated agreement here.
When I look back at the last 2 or 3 years here in Washington, I
think of what has been of concern. Jobs destroyed by bankrupt
firms that took on too much debt. Executives that managed
earnings inflating their company's stock prices and pumping up
the value of their own stock options, and as you have referred
to, corporate inversions where companies move to tax havens
abroad.
Clearly our tax code must share some of the burden for
these events. By taxing dividends twice, our tax code
encourages companies to retain earnings instead of paying them
to shareholders, to raise excessive levels of debt, and
dedicate some of our smartest people in this country to tax
minimization devices rather than job creation.
Now, let us all be clear. There is nothing wrong with
retained earnings or debt or even share buy-backs, but there is
no reason that the tax code should favor them either.
Eliminating the double taxation of dividends would reduce these
biases against investing and creating jobs.
One of the reasons I think that this is such a--well, it is
always a good idea to take a distortion like this out of the
tax code. One reason why this is a particularly good time, as
you have alluded to, Mr. Chairman, is I think that our
corporate leadership and our capital markets are looking for
some way to find some better MO than managed earnings as an MO
of corporate behavior. Today only half of nonfinancial firms
even pay dividends. Without periodic dividends, as you have
said, and the unmistakable facts about cash flow, investors are
basically left, as you said, Mr. Chairman, with earnings
opinions. As Secretary Snow likes to say about this, you can
fudge earnings, but you cannot fudge cash. The President's
proposal would clear the barriers to companies that sought to
mirror in their earnings reports with dividend checks in the
mail.
Now, I feel very strongly that it is through the process of
better corporate governance that the second benefit of the
President's proposal will be realized for all Americans in
boosting investment efficiency and job creation. Let us be
clear about where jobs come from. New jobs come from
investment, from the willingness of investors and entrepreneurs
to put capital at risk in a business venture. And the
President's proposal is focused precisely on that point.
Taxing dividends twice means that we tax investment more
heavily than any other major industrial nation. We all know
that is simply bad policy.
Senator Fitzgerald. More even than Japan?
Mr. Fisher. Yes. Actually after a recent hearing where
Secretary Snow was speaking, I believe a Member of Congress--I
am not recalling precisely--showed an OECD study that said
Japan had the highest tax and we were second. One of my
colleagues at the Treasury, during the hearing, received an e-
mail from someone at the Japanese Embassy pointing out that
there were some things that the OECD had not taken into
account. So we actually have the dubious distinction of being
number one.
I think the problem here is that by sort of slowing down
the investment process, we lock up money inside the balance
sheet of corporations, neither giving it back to shareholders
for them to reinvest if they would like in other ventures, nor
putting a high enough burden of proof on corporate leaders to
have specific reinvestment plans.
Now, if you think about it, each year American firms invest
over $1 trillion in fresh capital, and they generate $700
billion to $800 billion in corporate profits. If we think about
just marginally improving the efficiency with which that sort
of sum of money is invested in capital utilization and job
creation, we are going to accelerate and retarget that entire
investment process. That is really going to pay off for us over
the coming decade which is where our concerns need to lie at
this point. I think it is the nexus between job creation and
capital formation over the coming decade where we should be
concentrating our attention. By taking this distortion out of
our tax code, we know we will be doing the right thing.
So on behalf of the Administration, I thank you for holding
this hearing and I urge that Congress take this opportunity to
improve our tax code.
I would be happy to answer any questions, but I know you
will look forward to talking to the whole panel, so I am at
your service, Mr. Chairman.
[The prepared statement of Mr. Fisher follows:]
Prepared Statement of Peter R. Fisher, Under Secretary for Domestic
Finance, Department of the Treasury
Chairman Fitzgerald, Ranking Member Wyden, and distinguished
Members of the Subcommittee, I am honored to testify before you in
support of the President's proposal to eliminate the double taxation of
dividends.
This proposal would strengthen our economy and create jobs by
improving corporate governance and re-targeting investment to its most
productive ventures. Corporate governance would improve because the
proposal would better align executives' interests with shareholders'
and encourage companies to disclose more clearly their cash earnings
and taxes paid. Investment efficiency would rise because the proposal
would reduce tax distortions to fundamental corporate decisions such as
whether to repay shareholders or how much debt to raise.
The result would be more investment, higher productivity, more new
jobs and faster economic growth. At a time when too many people who
want jobs can't find them, and when economic growth around the world is
slower than we should accept, the President's proposal would be a
welcome shot in the arm.
In the past year, under Chairman Oxley's and Senator Sarbanes'
leadership, Congress took a major step toward improving corporate
governance in America. Investors have matched that with their own call
for improved governance. Corporate executives, directors, auditors, and
lawyers are already hearing and heeding the call for greater
accountability. Better-run corporations make for more efficient capital
markets and a healthier economy.
But there is more to be done in encouraging the best conduct from
corporate executives. Think of the headlines of the past couple years.
Jobs destroyed by bankrupt firms that took on too much debt. Executives
that ``managed'' earnings, inflating their companies' stock prices and
pumping up the value of their own stock options. ``Corporate
inversions'' where companies moved to tax havens abroad.
There are many forces responsible for these problems, but our tax
code shares some of the blame. By taxing dividends twice, our tax code
encourages companies to retain earnings instead of paying them to
shareholders; to raise excessive levels of debt; to repurchase shares,
often on a one-off basis, instead of issuing dividend checks; to
dedicate some of America's leading minds to tax minimization instead of
job creation. There's nothing wrong with debt or retained earnings or
share repurchases. But there's no reason our tax code should favor
them, either.
Eliminating the double taxation of dividends would reduce these
biases against investing and creating jobs. A shareholder would no
longer pay a second layer of taxes on dividends if the corporation had
already paid tax on that income. If the company retained that income
and invested it again, the shareholder would get an equivalent credit.
This is a ripe moment to improve corporate governance by removing
the tax bias toward debt and retained earnings. CEOs and capital
markets are now acutely sensitive to the risks of managed earnings. Yet
today, because of double taxation, only half of non-financial firms pay
dividends. Without periodic dividends--unmistakable facts about cash
flow--investors are basically left with earnings opinions. As Secretary
Snow says, you can fudge earnings, but you can't fudge cash. The
President's proposal would clear the barriers to companies that sought
to mirror their earnings reports with dividend checks.
The President's proposal is bad news, too, for the attractiveness
of corporate tax shelters, corporate inversions, and other tax
minimization devices. The rationale for creating these devices would
lessen, because an investor could only claim an exclusion on a dollar
of dividends if the company had paid full tax on that dollar.
The proposal's second benefit would be boosting investment
efficiency and thus job creation. Let's be clear where jobs come from.
New jobs come from investment--the willingness of investors and
entrepreneurs to put capital at risk in a business venture. The
President's proposal is focused precisely on that point: at sharpening
the incentives for investors and entrepreneurs to invest in the most
productive ventures. And higher productivity means higher wages and a
stronger economy for everyone.
Taxing dividends twice means that we tax investment more heavily
than any other major industrial nation. If investment is the blood of
new jobs and growth, this is bad policy.
The double taxation of dividends also distorts companies' decision
to retain funds versus returning capital to shareholders. Even if
shareholders have more promising investment opportunities elsewhere,
the tax code locks those funds up inside the company. That's not good
for shareholders, and it's certainly not good for the economy.
Each year American firms invest over $1 trillion in fresh capital
and generate $700-800 billion in corporate profits. Think of the gains
in capital utilization and job creation for everyone if we accelerate
and re-target this entire investment process. The Council on Economic
Advisors estimates that through 2004 the dividend tax cut alone would
generate more than 400,000 new jobs, nearly a third of the total from
the President's Jobs and Growth Package. The Business Roundtable says
it's even higher, closer to half.
Taxing dividends once and only once would convert directly into
higher share prices. Private sector economists estimate that the
President's proposal could boost stock prices by 5 to 15 percent,
delivering immediate wealth to a confidence-short market.
Last, some ask why the President has not proposed eliminating the
corporate income tax instead. The main reason is that doing so would
violate the President's principle that the government tax dividends
once and only once. If Congress eliminated corporate-level taxation,
many billions in profits, headed to tax-free entities or abroad, would
escape any taxation at all. Much more revenue would be foregone. And
the way would be kept open for the same kind of tax minimization
devices that today's tax code fosters and which the President's
proposal would cut back.
On behalf of the Administration, I urge you to take this
opportunity. Thank you.
Senator Fitzgerald. Well, if I could ask you a few
questions before we bring up the other panel.
Mr. Fisher. Certainly.
Senator Fitzgerald. Some have suggested that the
Administration should have gone about this differently. They
agree that corporate profits should not be taxed twice, but
they recommend that corporations be given a tax deduction for
the dividends they pay to their shareholders, much as they are
given a tax deduction for interest paid on corporate debt. Do
you want to address that issue, why the Administration proposed
providing the relief at the shareholder level rather than at
the corporate level?
Mr. Fisher. Certainly, I would be pleased to. I think the
important thing is to focus on the principle that the President
has put forward, that corporate income be taxed once and only
once. And structuring it the way we have is we think the right
way to get at that. If the elimination of the double taxation
of corporate dividends were done at the corporate level, much
of the income which flows through corporations would not be
taxed at all, given the high level of equity holdings in tax-
preferred vehicles. It would have a much bigger revenue hit to
the Federal Government, and it would create, if you will, a
diversion in which corporate profits paid out as dividends
would not be taxed at all in many cases. That would, if you
think about it to the next step, create a powerful incentive
for dividends as opposed to retained earnings.
And the other important principle that the President felt
strongly about----
Senator Fitzgerald. Retained earnings that had been taxed
at the corporate level would be added to a shareholder's basis.
Is that correct? Because you did not want to give corporations
a tax code incentive to pay out a dividend. If they are better
off, they have better opportunities to retain that.
Mr. Fisher. That is how we have proposed it. So the
President's proposal works hard to be a level playing field
between retained earnings and dividends. It is very important
that we do not want to preference either one of those.
But most of the ways that I am aware of of structuring it
at the corporate level effectively turns it into another tax
management device for corporate leaders, which does not give
you quite as many of the corporate governance benefits that we
see flowing from the way the President has structured this.
Senator Fitzgerald. Now, there are many companies in
America that report tax losses to the IRS, but report earnings
to their shareholders. Is that not correct?
Mr. Fisher. Yes, I am aware that that does happen in common
practice.
Senator Fitzgerald. A congressional study of Enron showed--
I have to give my apologies to John Rowe, but in his statement,
he is going to point out that between 1996 and 1999, Enron
reported $2.3 billion in earnings to its shareholders, but to
the IRS it reported $3 billion in tax losses. And during that
period Enron paid out $1.5 billion in dividends.
Now, if the President's proposal had been in effect then,
Enron would have had to notify its shareholders that its
dividends, its $1.5 billion in dividends, were not excludable
from taxation. Is that correct?
Mr. Fisher. That is my understanding. I have not done my
own calculation of that, but that is my understanding from
others.
Senator Fitzgerald. That itself would raise red flags in
the shareholders' minds that they are getting this dividend,
but for some reason it is not tax deductible because they would
know then that the company is reporting tax losses to the IRS
but earnings to them, and they would be wondering, well, is
this company really profitable. That would kind of raise
questions in investors' minds, would it not? It might have been
a protection for----
Mr. Fisher. I think absolutely. I think there is a very
powerful effect simply of the disclosures which will flow from
the President's proposal that shareholders will routinely have
the opportunity to see the taxes paid and the earnings and the
dividends, all of those pieces put forward by corporate America
for them to see. That alone will be a wonderful bit of
sunshine.
Senator Fitzgerald. Now, we do have S corporations in
America. I imagine we have a lot of S corporations. If I am
correct, the current rule is if you have under 75 shareholders
and meet some other requirements, you are eligible to have your
profits taxed only once. It actually all gets taxed at the
individual shareholder level. Would the President's proposal
essentially make every corporation in America kind of like an S
corporation? Although it would be different from the standpoint
that the money would be taxed at the corporate level as opposed
to the shareholder level in an S corporation.
Mr. Fisher. That is not how I have thought of it, but it is
an effort to make sure that the choice at new business
formation and small businesses, that they make a rational
economic choice as to what form they want of a partnership or
an S corporation or other corporate forms, that they make that
on economic grounds. So I have not quite thought of it in the
way you phrased it, but I see what you are driving at. But I do
think it is very important that we not limit the choice there.
Our current tax code penalizes companies--maybe penalizes is
too strong, but adds a burden if they want to move out of the
partnership structure into a publicly traded vehicle.
Senator Fitzgerald. Now, what about a company that reports
earnings to its shareholders but does not pay taxes to the IRS?
It declares a tax loss to the IRS. But those earnings that it
reports to its shareholders it retains as opposed to paying out
in dividends. That money, I assume, would not get added to the
shareholders' basis in their shares because it was never taxed.
Is that correct?
Mr. Fisher. I believe that is right, although I would want
to check back on that. I think the carry back/carry forward
provisions of losses--I am not in a position to sing you
chapter and verse on that, but we would be happy to clarify
that for staff what our current proposal is.
Senator Fitzgerald. Okay. If you could look into what would
happen in that case.
Also, I would be interested in any statistics the Treasury
Department may have on S corporations in America. My sense is
they are becoming much more common. I know I was in the banking
business, but when I was in the banking business, banks could
not be organized as subchapter S corporations. They now can be
and that has changed a lot of things. I would imagine in
certain areas there has been a big proliferation of S
corporations. I know in Illinois some huge companies that are
privately held and organized as S corporations, multibillion
companies that are run by people in Chicago that are S
corporations. I would be very interested in any statistics you
might have on the growth of S corporations, the number of
companies that are organized that way in America.
Mr. Fisher. We would be happy to look into that for you.
Senator Fitzgerald. Well, thank you very much, Secretary
Fisher, for being here, and thank you for all the good work you
are doing over at the Treasury Department. Keep up the good
work. Thank you very much for being here.
Mr. Fisher. Thank you very much, Mr. Chairman.
Senator Fitzgerald. Now I would like to call the second
panel. As I alluded to earlier, I want to give Professor Elson
the opportunity to testify first. The second panel is Elizabeth
Bull, Vice President and Treasurer of Texas Instruments;
Professor Charles Elson, Chair of the Center for Corporate
Governance, Lerner College of Business and Economics at the
University of Delaware; John Rowe, the President and CEO of
Exelon Corporation in Chicago; and Jeremy Siegel, the Russell
E. Palmer Professor of Finance, at The Wharton School,
University of Pennsylvania.
Mr. Elson, I want to make sure you make your commitment.
You need to catch a plane or otherwise be out of here at 11
o'clock. So I want to thank you for coming here and invite you
to fire away first, and then we will start with Ms. Bull and go
my left to my right. Thank you. Mr. Elson.
STATEMENT OF CHARLES M. ELSON, CHAIRMAN, CENTER FOR CORPORATE
GOVERNANCE, LERNER COLLEGE OF BUSINESS AND ECONOMICS,
UNIVERSITY OF DELAWARE
Mr. Elson. I appreciate your indulgence on the time. I had
a commitment I agreed to in New York a long time ago, and to
work it all out, this is great to let me go a little earlier.
I am going to be talking about strictly the corporate
governance implications of the proposal. I teach corporate
governance at the University of Delaware and have been involved
in corporate governance activities for a long time. When I
first heard of this proposal, I sort of went back to an earlier
life as a law professor. I taught corporate law before I
started teaching corporate governance.
Traditionally the tax on dividends with the resulting
double taxation on profits was universally in the legal
community considered an anomaly in the corporate law arena that
created, it was felt, a distinctive bias against the use of
dividends as a way to distribute earnings to shareholders. I
think obviously this proposal will solve that problem.
But more importantly, from my own standpoint in the
governance area, I think the idea has tremendous positive
implications for corporate governance reform in the country and
may create in the long run greater managerial accountability to
shareholders and, frankly, as you pointed out earlier, lessen
the likelihood of earnings manipulation that led to the
numerous failures that unfortunately I guess a predecessor in
this chair was talking about earlier. By removing I think a
critical, and a lot of folks will say artificial barrier to
dividend usage, you are going to see an increased distribution
of corporate earnings to shareholders in the form of dividends
and collaterally, I think, create five differing but really
important improvements in corporate governance in this country
and, frankly, the protection and expansion of investor capital.
Let me just lay these five out because I think they are
critical.
Number one. Dividends, I think, which require tangible cash
outlays by the corporation, create the necessity to generate,
as you pointed out, tangible real returns by companies which
reduce management's ability and incentive to create fictitious
earnings and returns based on the manipulation of accounting
standards or, frankly, outright fraud. A reality check, if you
will, on corporate earnings.
Second, the financial discipline within the organization
itself that regular cash distributions to shareholders requires
is going to aid in the creation, at least in my view, of a
greater culture of managerial accountability to shareholder
interests which in the end spur greater corporate productivity
and real profitability. A very important point, internal point.
Third, regular cash dividend payments, by reducing the now
dominant retention of earnings by most companies, I think will
reduce the temptation presented by large cash positions, or
awards some will say in companies, to management in mature
businesses to, first of all, either misspend capital in poorly
conceived projects or simply expropriate those earnings in the
form of exorbitant salaries or benefits, which you also alluded
to earlier. Additionally, the capital that is going to be
returned to the investors I think will find its way back into
the investment pool and be directed to more meaningful and
productive means. Investors traditionally have shown much
greater wisdom than many managers in the efficient deployment
of capital. And this is a point, frankly, that a lot of public
pension funds have made in private conversations supporting
this proposal, which I think is kind of interesting, that they
do a better job reallocating capital than cash sitting in a
corporation. A very important point.
The fourth point, which is kind of a slightly different
tangent, focuses on executive compensation, which has also been
an issue of a little bit of controversy lately. Use of
dividends to distribute earnings I think will have a big impact
on the way compensation is run in this country. I think it will
change dramatically compensation structure and practice. The
use of option-based compensation I think will decline
significantly as the incentive for its usage by management and
will effectively disappear. Compensation would shift away from
stock options, which many have argued have provided the
incentive for earnings management and other forms of nefarious
activities in some circumstances, towards restricted stock,
which most in the corporate governance community at least
believe to be a better shareholder alignment tool and more
effective incentive for prudent and productive management. In
other words, we will get out of the options culture. We will
not have to have this debate over expensing, not expensing, how
much to expense, how little to expense, but instead focus on--
--
Senator Fitzgerald. Restricted stock is expensed.
Mr. Elson. Exactly, immediately.
Senator Fitzgerald. But options are not.
Mr. Elson. Right. Restricted stock people feel is a better
aligner and a real chunk of the company and frankly a better
aligner both on the upside and on the downside. It would be a
very important collateral benefit that I do not think has
gotten much play, frankly, in the discussion of the tax repeal.
Finally, the fifth point is really kind of a fundamental
point. Through regular cash distribution of corporate earnings,
investors would gain greater liquidity, interestingly enough,
in their investments, and they would not be forced to sell
their holdings quite as regularly, in my view, to access their
capital. And I think longer-term investment would end up
resulting.
Additionally if the sale of stock is the only way to access
the return of your investment, which is true under the current
regime, one is totally dependent on the accuracy of the stock
price to ensure an appropriate return. Unfortunately, as we
know, stock price is sometimes affected by numerous factors,
sometimes completely unrelated to a company's performance,
making the sale of stock sometimes an imperfect way of return
on capital. A greater reliance on the dividend as some way at
least to access one's capital, to access one's return on an
investment, I think would mitigate this problem.
Basically the corporate governance and investor protective
aspects of this tax repeal proposal I think are really powerful
and compelling reasons for its enactment. And you have not
heard a lot about them, and I think you are absolutely right to
hold this hearing on this point. It is one of these side
benefits that people really did not think about until they
started to analyze the proposal. I think its positive impacts
on the investing public far outweigh any kind of short-term
revenue consequences that it is going to provide and, frankly,
in the long run, is only going to lead to greater investment
returns and greater consequent tax revenue in the form of
greater revenues from the companies themselves in the future as
corporate productivity and accountability are strengthened. You
may have a short-term revenue issue, but frankly a much longer-
term revenue productive issue. But more importantly,
structurally you have got tremendous positive impacts that come
out of this thing in my view.
Thank you.
[The prepared statement of Mr. Elson follows:]
Prepared Statement of Charles M. Elson, Chairman, Center for Corporate
Governance, Lerner College of Business and Economics, University of
Delaware
Traditionally, the tax on dividends with its resulting ``double
taxation'' of corporate profits has been virtually universally
considered an anomaly in the corporate law arena that created a
distinctive bias against the use of the dividend as a way to distribute
corporate earnings to shareholders. The present proposal to eliminate
the dividend tax will certainly resolve this anomaly and eliminate the
taxation barrier to dividend declarations. However, more importantly,
the proposal has tremendous positive implications for corporate
governance reform in this country and may act to create greater
managerial accountability to shareholders and lessen the likelihood of
the kinds of earnings manipulation that led to the numerous corporate
failures of the past few years. By removing a critical, and some would
argue artificial, barrier to dividend usage, this proposal will result
in increased distribution of corporate earnings to shareholders in the
form of dividends and collaterally create at least five differing, but
significant improvements to U.S. corporate governance and the
protection and expansion of investor capital.
1. Dividends, which require regular tangible cash outlays by the
corporation, create the necessity to generate tangible returns by a
company, reducing corporate management's ability and incentive to
create fictitious earnings and returns based on the manipulation of
accounting standards or outright fraud.
2. The financial discipline within the organization that regular
cash distributions to shareholders requires will aid in the creation of
a greater culture of managerial accountability to shareholder interests
which will spur greater corporate productivity and real profitability.
3. Regular cash dividend payments, by reducing the now dominant
retention of earnings by most companies, will remove the temptation
presented by large cash positions to management in mature businesses to
misspend capital in poorly conceived projects or simply expropriate
those earnings in the form of exorbitant salaries. The capital that
will be returned to the investors will find its way back into the
investment pool and be directed to more meaningful and productive
means. Investors have traditionally shown greater wisdom than most
managers in the efficient deployment of capital.
4. Use of the dividend to distribute corporate earnings would
dramatically change executive compensation structure and practice in
the United States. The use of option-based compensation would decline
significantly as the incentive for its usage by management would
effectively disappear. Compensation would shift away from stock
options, which have provided the incentive for earnings management and
other forms of nefarious activity, towards restricted stock which most
in the corporate governance community believe to be a better
shareholder alignment tool and more effective incentive for prudent and
productive management.
5. Through the regular cash distribution of corporate earnings,
investors would gain greater liquidity in their investments and not be
forced to sell their holdings as regularly to access their capital.
Longer term investment would result. Additionally, if the sale of stock
is the only way to access the return on one's investment as under the
current regime, one is dependent on the accuracy of the stock price to
ensure an appropriate return. Unfortunately, stock price is affected by
numerous factors, sometimes unrelated to a company's performance,
making the sale of stock a sometimes imperfect way of return on
capital. A greater reliance on the dividend as a way to access return
on investment would mitigate this problem.
In summary, the corporate governance and investor protective
aspects of the dividend tax repeal proposal are powerful and compelling
reasons for its enactment. Its positive impact on the investing public
far outweighs any short-term revenue consequences it may provide and
will lead only to greater investment returns and greater consequent tax
revenue in the future as corporate productivity and accountability are
strengthened.
Senator Fitzgerald. Well, Professor Elson, thank you very
much. You have still got about 15 minutes. We will try to get
through the others. There may be some questions I want to ask
you.
You clearly do not believe in the efficient market
hypothesis of the University of Chicago if you think that a
share price or selling your shares is not necessarily--you are
not necessarily going to get the correct value for them.
Mr. Elson. A softer form of efficiency.
Senator Fitzgerald. Okay.
[Laughter.]
Senator Fitzgerald. Ms. Bull, thank you very much for being
here. I noted that Texas Instruments has been paying a dividend
since 1962. And in the high tech world you stand out as a firm
that actually manufactures something, has a product, and has a
long history of profitability and paying dividends out to the
shareholders. So, Ms. Bull, thank you very much for being here.
We are delighted to have you.
STATEMENT OF ELIZABETH W. BULL, VICE PRESIDENT AND TREASURER,
TEXAS INSTRUMENTS INCORPORATED
Ms. Bull. Thank you, Mr. Chairman. I appreciate you
extending the invitation to Texas Instruments to address the
President's economic growth proposals and soliciting our ideas
on growing the economy.
As you know, the centerpiece of the President's proposal is
the elimination of double taxation on dividends, and we
strongly support that idea. We believe that ending this tax
will promote consumer spending, but more importantly, it will
stimulate business investment by companies, as well as personal
investment by individuals, and ultimately it will serve to
encourage good corporate governance and accountability.
And why better corporate governance? Well, the plan, we
believe, will create more transparency, make corporate earnings
easier to monitor, and place equity financing on more equal
footing with debt financing, as you mentioned earlier. In doing
so, it will reduce the opportunity for poorly managed companies
to mislead their investors.
Although, as you note, the high tech industry in general
has not traditionally paid dividends, TI has issued quarterly
dividends since 1962, and our goal has always been to create
value for our shareholders. We believe that paying a dividend
requires financial discipline and accountability, and we
believe it also sends a message to our shareholders about our
financial health and the credibility, as well as the
sustainability, of our earnings.
The deemed dividend provision of the President's plan means
that the plan does not favor only companies that pay dividends.
In fact, it benefits almost any company that is consistently
profitable and, as you noted, pays taxes. Although it does not
specifically penalize companies that choose not to pay a
dividend, it does force those companies to make a better case
to shareholders that the money is invested wisely within the
company. So this is critical for many startup and high tech
companies where significant capital must be invested in R&D as
well as plant and equipment.
Indeed, dividends help investors keep track of companies in
a way that I think has not always been generally appreciated or
understood. Corporations, as it has been noted, have routinely
been permitted to hold onto their earnings because of the
widely acknowledged inefficiency of dividends due to the double
taxation. However, stockholders who cannot realize value
through dividends must depend on continued stock price
appreciation for their investment to grow, and this increased
pressure on the stock price has, in some cases, apparently led
companies to engage in creative financial engineering and
inappropriate managing of their earnings in order to manipulate
the stock price.
And if this was not bad enough, the double taxation of
dividends creates a bias toward debt on the part of the
companies, as well as their shareholders. So the President's
plan will even the playing field between debt and equity
financing and ultimately result in lower levels of corporate
debt. Companies with lighter debt burdens are better able to
survive economic downturns.
In fact, we can go beyond prediction and actually look at
some data points. A recent Money magazine article reported that
when New Zealand repealed its dividend tax in 1988, debt-to-
equity levels at 92 representative companies fell an average of
15 percent. Likewise, when Australia repealed its dividend tax
in 1987, the use of dividend reinvestment plans grew from 2.5
percent of corporate capital raised to an almost unbelievable
33 percent within 5 years. So if we could achieve that in this
country, I believe it would have a tremendous positive impact.
Under this proposal, companies will need to pay more
attention to cash, how to manage it and how to invest it.
Making companies better and more efficient at managing their
money will have profound, long-term benefits that will
transcend any short-term economic or stock market boost. Ending
double taxation on dividends will ultimately lead to improved
corporate governance and a restoration of confidence in
American companies, and that I believe will lead directly to
economic growth.
Market forces should be allowed to govern a company's
decisions about dividend rather than a law which, at the
moment, clearly discourages them. If I have a key message for
you, it is this: The capitalist system is based on financial
incentives. The Administration's proposal to eliminate
disincentives for dividends and wealth creation and to embrace
incentives which promote those objectives is right on target.
Ultimately I believe this will transform behaviors for both
companies and investors.
Thank you again for this opportunity.
[The prepared statement of Ms. Bull follows:]
Prepared Statement of Elizabeth W. Bull, Vice President and Treasurer,
Texas Instruments Incorporated
Mr. Chairman and Members of the Committee:
Thank you for extending an invitation to Texas Instruments to
address the President's economic growth proposals and soliciting our
ideas on growing the economy.
The centerpiece of the President's proposal is the elimination of
double taxation on dividends and we strongly support that idea. We
believe that ending this tax will promote consumer spending. More
importantly, it will stimulate business investment by companies as well
as personal investment by individuals, and ultimately, it will serve to
encourage good corporate governance and accountability.
Why better corporate governance? The plan will create more
transparency, make corporate earnings easier to monitor, and place
equity financing on more equal footing with debt financing. In doing
so, it will reduce the opportunity for poorly managed companies to
mislead their investors.
Although the high tech industry in general has not traditionally
paid dividends, Texas Instruments has issued quarterly dividends since
1962. Our goal has always been to create value for our shareholders.
Paying a dividend requires financial discipline and accountability. We
believe it sends a message to our shareholders about our financial
health and the credibility and sustainability of our earnings.
The deemed dividend provision of the President's plan means that
the plan does not favor only companies that pay dividends. In fact, it
benefits almost any company that is consistently profitable and pays
taxes. And, although it does not specifically penalize companies that
choose not to pay a dividend, it forces those companies to make a
better case to shareholders that any money not paid in dividends will
be invested wisely within the company. It shines a strong light on
corporate financial management and accountability. This is critical for
many start-up and high tech companies where significant capital must be
invested in R&D and plant and equipment.
Indeed, dividends help investors keep track of companies in a way
that was not generally appreciated or understood during the dot com
boom and collapse. Corporations have routinely been permitted to hold
onto their earnings because of the widely acknowledged inefficiency of
dividends, due to double taxation. However, stockholders who cannot
realize value through dividends must depend on continued stock price
appreciation for their investment to grow. This increased pressure on
the stock price has, in some cases, apparently led companies to engage
in creative financial engineering and inappropriate managing of their
earnings in order to manipulate the stock price.
If this wasn't bad enough, the double taxation of dividends creates
a bias toward debt on the part of companies and their shareholders.
Simply put, the repayment of debt financing is taxed only once (to the
payee) while the repayment of equity financing, the dividend, is
taxable to the corporation as well as the shareholder. The President's
plan will even the playing field between debt and equity financing,
remove the bias, and ultimately result in lower levels of corporate
debt. Companies with lighter debt burdens are better able to survive
economic downturns.
Under this proposal, companies will need to pay more attention to
cash, how to manage it and how to invest it. Making companies better
and more efficient at managing their money will have profound long-term
benefits that will transcend any short-term economic or stock market
boost. Ending double taxation on dividends will ultimately lead to a
restoration of confidence in American companies and that, I believe,
will lead directly to economic growth.
Market forces should be allowed to govern a company's decision
about dividends rather than a law which, at the moment, clearly
discourages them. If I have a key message for you today, this is it:
the capitalist system is based on financial incentives. The
Administration's proposal to eliminate disincentives for dividends and
wealth-creation and to embrace incentives which promote those
objectives is right on target. Ultimately, this will transform
behaviors for both companies and investors.
This plan also would promote better debt-equity ratios. In fact, we
can go beyond predictions and actually have some data points. A recent
Money magazine article reported that when New Zealand repealed its
dividend tax in 1988, debt-to-equity levels at 92 representative
companies fell an average of 15 percent. If we could achieve that in
this country, it would have tremendous positive consequences for equity
markets. Likewise, when Australia repealed its dividend tax in 1987,
the use of dividend-reinvestment plans - or DRIPs - grew from 2.5
percent of corporate capital raised to an almost unbelievable 33
percent within five years. This proposal will powerfully change
investor behavior.
With consumer spending accounting for two-thirds of U.S. Gross
Domestic Product (GDP), it makes good sense to provide consumers with
more purchasing power. Reducing their tax burden achieves this
objective while also providing greater opportunity to make further
investments. Likewise, robust business investment will drive economic
recovery and job creation. Ending the double taxation of retained
earnings and dividends will be a genuine incentive.
I would be happy to take any questions. Thank you very much for
this opportunity.
Senator Fitzgerald. Well, Ms. Bull, thank you very much.
Mr. Rowe? John Rowe is the Chairman and CEO of Exelon
Corporation in Chicago. This is one Illinois company that I am
very proud of. Exelon was last month named the Best Performing
Utility Energy Services Company for the second straight year by
Business Week, and Forbes this year named Exelon Best in Breed
among energy companies. Exelon is the former Unicom, the owner
of Commonwealth Edison in Chicago. Unicom merged a couple of
years ago with PECO based in Pennsylvania. They have done very
well in the last few years. That coincides, not incidentally I
think, with the tenure of Mr. Rowe at the company.
So, Mr. Rowe, I deeply appreciate your traveling all the
way from Chicago to be here, and thank you very much for
coming.
STATEMENT OF JOHN W. ROWE, CHAIRMAN AND CEO, EXELON CORPORATION
Mr. Rowe. Thank you, Mr. Chairman. In turn, we deeply
appreciate your interest in this bill which is of the highest
importance to our shareholders.
We are the largest provider of electricity in the country
in terms of the number of customers we serve. As your remarks
were kind enough to state, we have done well over the past
several years, but we have managed to do well by improving our
service to those customers, and we are very proud of that.
Last year we paid approximately 40 percent of our total
income in dividends, or about half of the income of our
regulated retail subsidiaries. We have an announced plan to
increase those dividends by 4 to 5 percent per year. But if the
bias that now exists against dividends were eliminated, we
would increase those dividends even further which would provide
immediate benefits to our shareholders.
As we look at the proposed legislation, we believe it is
first important to note that it benefits Americans from all
walks of life, not just a few.
Second, as the Chairman has discussed, this is legislation
that would help promote corporate responsibility. It would also
help restore investor confidence in at least part of the stock
market, eliminate the bias in favor of retained earnings, as
other witnesses have testified, and decrease incentives for
companies to engage in transactions which are largely tax
motivated.
As the Chairman knows, shareholding is not confined to a
few who are wealthy. Over 84 million people representing over
half of American households own shares in public companies.
According to IRS data, over 15 million individuals who claimed
under $50,000 in income received $27.2 billion in dividends.
As you might expect, investors in utilities have tended
historically to be that kind of people. It is very difficult to
know exact demographics because many utility shares are held in
mutual funds, and you have to go behind the initial owner. But
studies that have been done by the Edison Electric Institute
and the American Gas Association suggest that 70 percent of
utility shareholders are 65 or older and the typical utility
shareholder lives on a fixed income and has held that stock for
over 9 years.
Now, we in our business are proud of having shareholders
like that, and we look upon some others like hedge funds with
some skepticism. Historically we have been able, by doing a
job, to provide the kind of investment that is good for those
kinds of people. But this is where the corporate responsibility
factor comes in.
I know that the Chairman's earlier career was in banking.
There is an old joke in banking that the worst thing that can
happen to a good bank is to have a stupid bank for a
competitor. Well, in the energy business, the worst thing that
can happen to somebody trying to do an honest job is to have
dishonest competitors.
We have suffered and suffered substantially as an industry
over the past decade or so by some competitors, whose
dishonesty is now widely known, and others who have tried to
grab the brass ring of endless growth and, in doing so, have
forfeited their real responsibilities for public service and
steady cash flow.
The Chairman pointed out in his opening remarks that
earnings sometimes can be manipulated and cash is harder to do.
That is certainly correct, but I fear we are dealing with a
phenomenon that is even more difficult than that. We are
dealing with companies who are competing not on the basis of
cash flow, not even on the basis of earnings, but on earnings
forecasts. And sometimes the person with simply the rosiest
glasses or the boldest willingness to take risks is the one who
commands the highest P/E ratio. This is the kind of thing that
emphasis on paying dividends will help correct. Companies will
have to look for more cash to pay dividends.
It is only 2 years ago that people like me were laughed at
for suggesting dividend increases as something our shareholders
might want. Companies, as the witness from Texas Instruments
suggested, will be forced to pay more attention to their
quality of balance sheet. It is only 2 years ago that people
like me were considered fuddy-duddys in the energy industry
because we still thought having equity was a good thing.
Companies will be forced to look for resilience in their
operations and to explain to shareholders why we are not paying
out more dividends and increasing dividends more.
This goes to one of the most powerful aspects of a market
and economic democracy. This goes to the sense that why should
shareholders not have more chances to decide how to reinvest
because if we pay more dividends and we look at our expansion
plans or our capital plans, we have to go back to those
shareholders and ask for more money. And that is not a bad
thing.
So, respectfully, Mr. Chairman, we ardently support this
bill. The President's proposal is, of course, good for our
company. We believe it is very good for our country and will
help make the corporate community the stewards of capital we
all want them to be.
Thank you very much, Mr. Chairman.
[The prepared statement of Mr. Rowe follows:]
Prepared Statement of John W. Rowe, Chairman and CEO, Exelon
Corporation
Chairman Fitzgerald, Members of the Subcommittee:
I am John Rowe, Chairman and Chief Executive Officer of Exelon
Corporation, a Chicago-based utility holding company. Our two
utilities, Commonwealth Edison (ComEd) and PECO Energy, serve over 5.1
million customers in Northern Illinois and Southeastern Pennsylvania,
respectively. Exelon also has one of the nation's largest generation
portfolios, owning or controlling the output from over 40,000 megawatts
of electric capacity. Exelon's Power Team affiliate markets the power
from this generation in the 48 Continental United States and Canada.
It is a pleasure to appear before you today to discuss promoting
corporate responsibility through the elimination of dividend taxation
at the shareholder level.
Exelon's Dividend Philosophy
At Exelon, our core mission is ``keeping the lights on'' for our
5.1 million customers. At the same time, our Board of Directors has a
fiduciary responsibility to grow the value of the company for our
shareholders.
In determining how to optimize the investment for our shareholders,
we must balance our desire for long-term growth in the terms of
appreciation of the stock price with the desire of some investors for a
shorter-term return through dividend income.
When Exelon was created in 2000 from the merger of Unicom, ComEd's
parent company, and PECO Energy, the Board of Directors made a decision
to focus on total return to shareholders. Exelon's dividend rate for
2002 represented about a 50 percent payout of the expected 2002
earnings per share from Exelon's regulated electricity delivery
businesses. The Board has stated in regulatory filings that Exelon
intends to grow the dividend to about a 60 percent payout of earnings
from regulated operations based on cash flow and earnings growth
prospects for Energy Delivery. Earlier this year, we stated in
regulatory filings that Exelon intends to grow its dividend over time
at a rate of approximately 4 to 5 percent, commensurate with long-term
earnings growth.
While specific demographic data for Exelon Corporation shareholders
is not available, 70 percent of individual utility shareholders are 65
or older, and that the typical utility shareholder lives on a fixed
income and has held stock for more than 9 years, according to recent
surveys by the American Gas Association and the Edison Electric
Institute.
This shareholder profile is not surprising, since utilities have
been viewed historically an attractive investment for investors
interested in a stock with stable growth and a track record of issuing
predictable dividends. As the industry has undergone deregulation over
the last decade, that image has changed somewhat, with many companies
focusing more on growth and less on issuing high levels of dividends.
This change occurred not only as a result of the changes in our
industry, but also as a result of the changing expectations of
investors and the need for utilities to compete for capital with other
industries which offered high-growth stocks but little return in the
form of dividends.
Utilities have responded to these changing dynamics in a variety of
ways: some utilities--mostly in states that did not fully deregulate
their retail electric markets--have continued to provide relatively
high levels of dividend income; other utilities have cut their dividend
and invested their retained earnings in a variety of businesses;
others--like Exelon--have taken a hybrid approach, pursuing unregulated
business lines as a means of growth, while relying on regulated
business units to provide a steady stream of income for dividends.
Our strategy for achieving the optimum balance for our shareholders
was challenged during the late 1990s by individual investors and the
investment community as a result of the tremendous run-up in the stock
market. A handful of energy companies focused on aggressively pursuing
growth in energy trading and non-core businesses as a means of driving
up the price of their stock. While this strategy resulted in some truly
spectacular results for some companies, the results were short-lived,
and some of those same companies are currently in the midst of
bankruptcy proceedings.
Meanwhile, Exelon's strategy has yielded impressive results that
have been recognized by leading industry observers. Last month,
Business Week named Exelon the best performing utility/energy services
company for the second straight year. Exelon was also among the top 50
S&P Index companies for the second straight year in the Business Week
survey, which rated companies based on growth in sales, profits and
return to shareholders, performance over both one and three years,
profit margins, and return on equity. Exelon was also recognized this
year by Forbes, which named Exelon ``Best in Breed'' among energy
companies.
Promoting Corporate Responsibility Through Elimination of the Dividend
Tax
President Bush's proposal to eliminate the taxation of dividends
would provide significant direct and indirect benefits to the nation's
economy. The Council of Economic Advisors has estimated that
eliminating the taxation of dividends would pump $52 billion into the
economy annually.
The President's dividend proposal will not simply benefit the
wealthy. Elimination of the dividend tax will benefit Americans from
all walks of life. More Americans than ever--84 million people
representing over 50 percent of American households--own shares in
public companies. According to Internal Revenue Service data, over 15
million individuals who claimed under $50,000 in income in 2000
received over $27.2 billion in dividends.
In addition to the financial benefits, elimination of the dividend
tax would have significant long-term economic benefits. Chief among
these is the promotion of corporate responsibility, which will benefit
investors--and all Americans--in a number of ways.
First, eliminating the dividend tax would help restore investor
confidence in the volatile stock market and promote corporate
responsibility by strengthening the degree to which dividends are
viewed as an indicator of a company's financial health. Under the
President's proposal, the dividends would be exempt from taxation only
to the extent that the company's earnings have already been taxed.
Dividend payment has long been an indicator of a company's long-
term stability. According to the Wall Street Journal, the price of
dividend-paying stocks in the Standard & Poors 500 index fell 17
percent during first 9 months of 2002, while the price of non-dividend-
paying stocks fell 39 percent. The President's proposal will make
dividend payment an even stronger indicator of financial health and
will promote corporate responsibility by making companies declare the
extent to which their dividends are paid from taxable earnings.
Second, eliminating the double taxation of dividends will eliminate
the current bias in favor of retained earnings and will require
corporations to be more diligent in evaluating investments made with
retained earnings.
Under current law, many investors prefer growth stocks to dividend-
producing stocks since capital gains are generally taxed at a lower
rate than dividends, which are treated as ordinary income. Most
economists expect corporations to reduce the amount of retained
earnings because this bias will be eliminated. Since companies will
have less excess cash on hand, companies will have to be more selective
when investing that cash in new projects. For projects requiring
financing beyond that available from a company's retained earnings, the
market will impose its own rigorous review of the venture, providing an
added layer of scrutiny.
In effect, the bias is favor of retained earnings is also a bias
against companies that pay dividends, since many investors prefer
companies that retain a higher portion of their earnings. This has
significant implications for electric and gas utilities, which are
facing the prospect of raising hundreds of billions of dollars for
infrastructure investment in the next decade.
It is important to note that the President's proposal also includes
provisions to prevent the current bias against dividends from becoming
a bias in favor of dividend distribution. Specifically, the proposal
allows for the adjustment of a shareholder's stock basis to reflect
retained earnings to the extent they have already been taxed. This
provision ensures that the tax code is neutral in terms of dividends
and retained earnings, allowing investment decisions to be guided by
sound business principles rather than tax policy. It is essential that
this provision be included in any legislation implementing the
President's proposal.
Finally, since corporations must have taxable earnings for
dividends to be tax-free, eliminating the taxation of dividends will
decrease incentives for companies to engage in transactions whose only
purpose is to minimize tax liability. This will shift the focus of both
companies and investors to a corporation's cash earnings, rather than
book earnings. Why is this important? Since dividends can only be paid
on a tax-free basis from cash, the payment of dividends will provide
investors with valuable insights into the financial health of the
company. While companies can engage in various transactions to inflate
book earnings, the ability to artificially inflate cash earnings is
limited. Since dividend payments cannot continue without adequate cash
earnings, investors will be better able to determine the true financial
health of a corporation.
The President's proposal could help avert future tax shelter crises
such as the one that is the subject of the Senate Finance Committee's
hearing on Enron this morning. The Joint Committee on Taxation's
``Investigation of Enron Corporation and Related Entities Regarding
Federal Tax and Compensation Issues'' consists of three volumes
totaling nearly 2,700 pages. Among the findings was the fact that while
Enron reported $2.3 billion in net earning from 1996 to 1999, the
company reported tax losses of $3 billion during those years. During
this same period, Enron paid out over $1.5 billion in dividends. Under
the President's proposal, none of these dividends would have been tax-
free. Clearly, this would have set off alarm bells for investors.
Conclusion
Mr. Chairman, I realize that Congress has a number of competing
budget priorities, and that some members view tax cuts to be
undesirable at this time. Nevertheless, the elimination of dividends
will have significant benefits in both the short-term and the long-
term.
One of the lessons of the last three years is that companies who
put growth ahead of value ended up not getting either. The President's
proposal will encourage companies to be more responsible by focusing on
activities that result in value, not merely growth. I strongly urge
Members of the Subcommittee to support it.
Thank you.
Senator Fitzgerald. Mr. Rowe, thank you.
Finally, we have Professor Siegel, and then we will go back
to questions. Mr. Elson, you can feel free to leave when you
have to.
Professor Siegel, I recalled a few weeks ago, when I was
putting together this hearing, an op-ed by somebody that I
could not remember their name about a year ago in the Wall
Street Journal talking about how does one measure corporate
performance before FASB, before the SEC, before publicly
reported financial statements were out there. Well, you did it
the old-fashioned way. You looked at dividends and what a
company was able to fork over in cash to their shareholders.
Remember, that is how investors did it for a very long time
before the SEC.
I could not remember who wrote that, and I had my staff get
a copy of the op-ed. I thought it was brilliant op-ed at the
time. We tracked you down. I am honored that you would be here.
I think that was a brilliant and prescient piece because that
was long before the Administration proposed ending the double
taxation of corporate dividends, and it was your answer over a
year ago to correcting the corporate malfeasance that we had
seen so much of in 2001 in the United States.
So, Professor Siegel, thank you for coming down from
Wharton to testify before our humble Committee.
STATEMENT OF JEREMY J. SIEGEL, PROFESSOR OF FINANCE, THE
WHARTON SCHOOL, UNIVERSITY OF PENNSYLVANIA
Mr. Siegel. Thank you, Mr. Chairman. Let me say I do feel
somewhat at home. I was born and raised in Chicago, your State.
I now live in Philadelphia and get excellent service from
Exelon from Mr. Rowe on my right here.
[Laughter.]
Mr. Siegel. So even though I am in DC, I feel like I am at
home.
Yes, it was my historical studies, when I went all the way
back to the beginning of the 19th century and began to think we
had 130 years without these regulatory agencies and the markets
worked pretty well. When you look at the big difference, it was
dividends.
Let me give you my prepared comments.
I strongly support legislation leading to the elimination
of the double taxation of dividends. There is no question that
this legislation will have profoundly favorable effects on
corporate governance issues currently plaguing the markets.
Ending this punitive taxation will increase the credibility of
firms' earnings, reduce the amount of debt on the balance
sheet, and lower the number of options granted in lieu of cash
compensation for employees. In short, this legislation will
better align the interests of management with those of the
shareholders.
The most effective way to encourage dividends in my opinion
would be to make dividends deductible from corporate income.
You spoke a little bit to Mr. Fisher about that just a few
minutes ago, and I am sure we can talk about it more. This
would make the treatment of dividends in computing corporate
taxes no different than that of interest payments to
bondholders. While deductibility at the corporate level in my
opinion more directly incentivizes managers to pay dividends,
President Bush's plan to exempt qualified dividends from
personal taxes should also increase dividends and improve
corporate governance.
In the last 20 years, we have seen a dramatic change in the
composition of the real returns to stocks. From 1871 through
1980, the average dividend yield on stocks was 5 percent,
constituting more than three-quarters of the total real return
from equity. But starting in the 1980s and accelerating in the
1990s, the dividend yield plummeted. Currently, even with
depressed stock market levels, the dividend yield on the S&P
500 Index is under 2 percent, a level that is less than 30
percent of the projected long-term real return on stocks.
The principal reason for the drop in the dividend yield is
the double taxation of dividends. Double taxation encourages
firms to distribute their profits by generating capital gains
which are taxed at a much lower rate than dividends. Although
this tax incentive was always present in the tax code, the
shift away from cash dividends was accelerated by an SEC action
taken in 1982 that made it easier for firms to use profits to
buy back their own shares. This ruling, coupled with the double
taxation of dividends, and the increase in management stock
options, which I will talk about presently, created the perfect
storm that drowned the dividend yield.
Cash dividends are tangible and very well defined, but
earnings are not. Even if the firm applies the strictest GAAP
conventions, there are arbitrary choices and assumptions such
as depreciation schedules and pension return that firms make to
come up with a single earnings number. Suffice it to say, that
judging a firm's value on the basis of earnings alone has been
subject to increasing error. Cash dividends are hard to fake.
Earnings are not. With dividends down, stock investors must put
increasing trust in earnings. Unfortunately, high profile
earnings scandals have broken that trust.
Eliminating the double taxation of dividends is a tangible
action that should restore that trust.
The incentive to use debt instead of equity has led to
increasingly deceptive securities. Enron pioneered the use of
MIPS, or monthly income preferred shares, that could be treated
either as debt or as equity, depending on who was looking. When
Enron reported to the IRS, MIPS were referred to as debt, and
Enron deducted an interest expense. But in its earnings reports
to shareholders, MIPS were referred to as equity. The U.S.
Treasury concluded that this constituted abusive accounting
practices and tried to crack down on the use of MIPS.
Unfortunately, the Treasury was not successful and the use of
these securities has proliferated. If dividends were not tax-
disadvantaged, MIPS would never have been invented, as there
would be no incentive for firms to hide debt as equity or vice
versa.
The unequal treatment of debt and equity also leads to
excessive debt in firms' capital structures. Under these
circumstances, if there is a negative shock to the demand for a
firm's product, such as we see now with the airline industry,
highly leveraged firms will experience financial distress and
perhaps even bankruptcy. Tax deductibility of dividends would
encourage more equity on the firm's balance sheet and lower the
probability of this financial distress.
Finally, the shift from paying dividends to generating
capital gains encouraged the proliferation of option-based
compensation packages that are not accurately reflected in
income statements and distort the decision of management.
Options values are only based on the price of the stock, not on
the dividend. If management holds substantial options, it is
against their interest to pay dividends since the value of
their options will only be enhanced by turning those profits
into a higher price for their shares. Option holders also
desire that the firm take on more risks than shareholders since
the gain in option price from favorable developments outweigh
those from unfavorable developments.
If the payment of dividends were not tax-disadvantaged, I
believe option grants would become a far less popular form of
compensation and would be replaced either by cash compensation
or stock grants. Since the gains and losses realized in stock
grants are identical to those of the shareholders, these grants
better align the interests of management and investors.
In summary, corporate governance would be improved if this
legislation is enacted. Investors would have more trust in
earnings reports. Firms' capital structures would improve, and
there would be better aligned incentives in the compensation
packages for management. While I think that deducting dividend
payments from corporate income best achieves these goals, the
legislation we are discussing here today makes great strides
towards those very same ends.
Thank you.
[The prepared statement of Mr. Siegel follows:]
Prepared Statement of Jeremy J. Siegel, Professor of Finance, The
Wharton School, University of Pennsylvania
I strongly support legislation leading to the elimination of the
double taxation of dividends. There is no question that this
legislation will have profoundly favorable effects on the corporate
governance issues currently plaguing the market. Ending the punitive
taxation of dividends will increase the credibility of firms' earnings,
reduce the amount of debt on balance sheets, and lower the number of
options granted in lieu of cash compensation for employees. In short,
this legislation will better align the interests of management with
those of shareholders.
In order to encourage cash dividend payments, I prefer that
dividends to shareholders be deductible from corporate income, just as
interest payments to bondholders have always been deductible. I believe
that deductibility at the corporate level more directly incentivizes
managers to pay dividends than exemption at the personal level.
However, President Bush's plan to exempt qualified dividends from
personal taxes should also increase dividends and improve corporate
governance.
The fall in dividend yield
In the United States, the after-inflation rate of return on stocks
over all long-term periods has averaged between 6.5 percent and 7
percent. Yet there has been a dramatic change in the composition of
this return over the past twenty years. From 1871 through 1980, the
average dividend yield on stocks was 5 percent. This means that for
over one hundred years, more than three-quarters of the total real
returns on stocks came from cash dividends. But starting in the 1980s,
and accelerating in the 1990s, the dividend yield plummeted. Currently,
even with depressed stock market levels, the dividend yield on the S&P
500 Index is under 2 percent, a level that is less than 30 percent of
the projected long-term real return on stocks.
The principal reason for the drop in dividend yield is the double
taxation of dividends. This encourages firms to distribute their
profits by generating capital gains, which are taxed at a much lower
rate rather than dividends that are taxed at investors' highest
marginal tax rate. Although this incentive to substitute capital gains
for dividends was always present in the tax code, the shift away from
cash dividends was accelerated by an SEC action in 1982 (Ruling 10b-18,
amendment to the Securities Act of 1934) that made it easier for firms
to use profits to buy back their own shares. This ruling, coupled with
the double taxation of dividends and the increase in management stock
options, described below, created the perfect storm that drowned the
dividend yield.
The ambiguity of earnings
The shift to capital gains and away from dividends has led to a
number of developments that hurts corporate governance and
shareholders. Cash dividends are tangible and very well defined, but
earnings are not. Although there are rules outlined in GAAP for
computing ``reported earnings,'' management often chooses a more
generous accounting convention, called ``operating earnings,'' that has
no widely accepted definition. As a result, judging a firm's value on
the basis of earnings alone has been subject to increased error.
Moreover, there are a tremendous amount of assumptions that go into
calculating earnings. Even if the firm applies the strictest GAAP
conventions, there are still arbitrary choices firms must make such as
which schedules should be used to depreciate assets, what future return
should be used to calculate pension plan assets, how fast and in what
period revenue should be recognized, and what capital expenditures
should be capitalized.
It is much harder, however for management to deceive shareholders
about the true state of profitability of the firm when most of the
profits are paid out as cash dividends. This is because accounting
profits that are not backed by positive cash flows are much harder to
turn into dividends. It is unlikely that Enron or Tyco could have
deceived investors and analysts as long as they did if they were
distributing a large share of their purported profits to stockholders.
It is well known that earnings numbers can be manipulated to show a
brighter picture by tweaking a few assumptions. In the past, this was
not such a problem since most of the real return was derived from cash
dividend payments. But today, with returns relying on future earnings
growth, trust in earnings is paramount. Unfortunately, the high profile
earnings scandals have broken that trust. Eliminating the double
taxation of dividends is one tangible action that could restore trust
quickly.
Deceptive Securities and Excessive Debt
Since interest on debt is deductible, while dividends are not, it
is in the interest of management to substitute debt for equity. Yet
higher debt may harm a firm's credit rating. This had led to the
issuance of deceptive securities that qualify as debt for the purpose
of tax deductibility yet are viewed as equity by the rating agencies.
Enron's incentive to manipulate its balance sheet was brought to
light by the Wall Street Journal on February 4, 2002 in an article
titled ``How the Treasury Department Lost a Battle against a Dubious
Security.'' This expose showed how Enron employed a security devised by
Goldman Sachs that, depending on who is looking, can be treated as
either debt or equity. Goldman's securities, or MIPS (Monthly Income
Preferred Shares), incorporate the best of both debt and equity. When
Enron reported to the IRS, MIPS would be referred to as debt and Enron
could deduct an interest expense. But for rating agencies and
shareholders, MIPS were referred to as equity.
Is it surprising that Enron pioneered the use of these securities?
Hardly. We now know that Enron took great strides to hide its debt from
shareholders. Yet the use of MIPS was and still is perfectly legal. The
U.S. Treasury disagreed with Enron's use of these securities, and in
late 1995 tried to crack down on what it considered to be abusive
accounting practices. Unfortunately, an army of lobbyists successfully
forced the Treasury to admit defeat in 1998 after a 3-year battle in
the courts. And despite the U.S. Treasury's persistent attempt to shut
this security down, almost $200 billion of these MIPS, whose existence
is solely to circumvent the unequal deductibility of interest and
dividends, are currently outstanding. If dividends were not tax-
disadvantaged, MIPS would never have been invented as there would be no
incentive for firms to hide debt as equity or vice versa.
Maintaining the tax deductibility of interest payments while
denying it for dividends has also induced management to use excessive
debt in their capital structure. This means that if there is a negative
shock to demand for a firm's product (such as what is happening now to
airlines), a highly leveraged firm will experience financial distress
and possible bankruptcy. Tax deductibility of dividends would encourage
more equity on the firm's balance sheet and lower the probability of
financial distress.
Option Grants
Finally, the shift from paying dividends to generating capital
gains encouraged the proliferation of option-based compensation
packages that are not accurately reflected in income statements and
distort the decisions of management. Option values are only based on
the price of the stock, not on the dividend. If management holds
substantial options, it is against their interest to pay dividends,
since the value of their options will only be enhanced by turning those
profits into a higher price for the shares. Option holders also desire
that the firm take on more risks than shareholders, since the gains in
option price of an upside surprise are far greater than the losses
caused by a downside surprise.
If the payment of dividends were not tax-disadvantaged, I believe
option grants would become a less popular form of compensation and
would be replaced by either cash compensation or stock grants. The
gains and losses realized in stock grants are identical to those of
shareholders and help align the interests of management and investors.
Summary
In summary, corporate governance would be improved if this
legislation is enacted. Investors would be better equipped to make
investment decisions based on true profitability if firms were paying
out more of their earnings as cash dividends. Firms' capital structure
would improve, and there would be better aligned incentives in
compensation packages for management. While I think deducting dividend
payments from corporate income best achieves these goals, the
legislation we are discussing here today makes great strides towards
the same ends.
Senator Fitzgerald. Professor Siegel, thank you very much.
I would like to start off with you right away to talk about
your historical studies. Let us go back to the late 1800s
before the Federal income tax and also before the SEC. Let us
say the late 1890s when Standard Oil was going around. John D.
Rockefeller used to offer his stock to small oil producers that
he would be buying up. But he had no publicly available
financial statements, in fact, did he at that time?
Mr. Siegel. No. Although there were accounting firms, there
was no legislation on the New York Stock Exchange that really
mandated more than a very cursory examination of what financial
statements were----
Senator Fitzgerald. So the New York Stock Exchange may have
required something?
Mr. Siegel. They may have required some of the firms on a
yearly basis to report. I have not checked on the exact
requirements of the firms. But clearly it was nowhere near what
we have today and certainly what we have had since the
establishment of the SEC in the 1930s.
Senator Fitzgerald. And it was only I believe, was it not,
around the turn of the century that the New York Stock Exchange
started recommending some reporting to shareholders? Of course,
there was no Federal law. Prior to that, the stock exchange
would not have even had a rule, would it?
Mr. Siegel. No. Prior to that, there was not even a rule
from the stock exchange. In other words, the firms themselves
had to present credibility to the shareholders.
Senator Fitzgerald. And how did they do that?
Mr. Siegel. And they presented that credibility through
saying these are the cash disbursements, the dividends, that we
have been paying for years and that we hope to continue to pay
and increase in our role as a firm listed on the New York Stock
Exchange.
Senator Fitzgerald. That is interesting. Do you think the
investors back then were less protected than they are today,
now that we have the SEC?
Mr. Siegel. I would say we are more protected today because
the shareholder population has increased so dramatically. We
have more people that are not as sophisticated with
understanding all of the ins and outs of holding shares. But
there were advisors back then, there were brokers back then,
and to my knowledge they pitched the shares on the basis of the
dividend.
By the way, dividend yields back in the 19th century were
not uncommon to be 7, 8, 9 percent. They were 2 to 3 percentage
points above the bonds. They were saying these are riskier
securities. You cannot count on capital gains. You are going to
count on these dividends and these dividend yields, and that
was it. If they could pay those dividends and had a good record
at paying those dividends, then they were recommended and they
were bought by investors.
Senator Fitzgerald. Back before the SEC, we of course had
notable stock market collapses such as 1929 that led to the
SEC, and prior to the crash in the late twenties we had many
other crashes where investors were totally wiped out. But in
the recent collapses in the stock market where several trillion
dollars in market capitalization have evaporated, many
companies, particularly high tech firms, that were once worth
billions and billions of dollars, became worthless. Enron,
which was I forget what its market cap was at the height, maybe
$60 billion or something like that?
Mr. Rowe. $70 billion.
Mr. Siegel. $70 billion.
Senator Fitzgerald. $70 billion at the height. Worthless.
The collapse we have had in the last couple of years with
the dot-coms and so forth, that has to rank as one of the most
spectacular in our history, is that not correct, even though we
have the SEC?
Mr. Siegel. Oh, yes, absolutely. The NASDAQ, going down by
nearly 80 percent, just about rivals the great crash of 1929 to
1932 in the size. The S&P down 50 percent from the high. That
just about equals 1972, but it does rank as one of the very few
worst. SEC and all these regulatory agencies are really never
going to be able to prevent bubbles. Bubbles are a result of
psychology and similar phenomenon, and they will always exist
as long as we have free markets.
Senator Fitzgerald. The greater fool theory, right? There
is always going to be somebody coming along who----
Mr. Siegel. Psychology is often more persistent than some
of the direct economic forces or, let me say, the lessons of
history.
Senator Fitzgerald. Now, Ms. Bull, you discussed that it is
harder to manipulate or manage cash flow than it is earnings.
But did we not see in the case of Enron that they actually even
managed to manipulate their cash flow reports? I mean, they
knew. Skilling knew that, boy, you want to show good cash flow
because the really sophisticated investors are not going to
look at the earnings report. They are going to look at the cash
flow to see what we are really earning. They managed, as I
recall, to manipulate their cash flow statements. It was very
involved. I do not recall the details. I did at one time know.
The New York Times wrote some good pieces on how they
manipulated their cash flow. But it is in fact possible, even
complying with GAAP and SEC rules, to manipulate the appearance
of your cash flow statement.
Ms. Bull. While it might be possible, I would say it is
much more difficult now. Enron did take that to a new height or
depth, I guess. But it is much more difficult to manipulate
cash flow in my opinion.
Senator Fitzgerald. Mr. Rowe, it is good to see you have
your day in the sun. I do remember a couple of years ago when
firms that were perceived to be stodgy, particularly in the
energy business that were not involved in trading, trading was
going to be the way of the future, and so many of your
competitors got all caught up in that. I think that you guys
really look good at this point.
You mentioned that your payout now is about 40 percent and
you have plans to increase that even more, possibly did you say
as high as 60 percent?
Thank you, Professor Elson. Thank you for being here.
Mr. Rowe. Our current plans are to increase the dividend 4
to 5 percent a year, but if legislation like this proposal
passed, I am certain we would increase the dividend more
substantially.
Senator Fitzgerald. So that is a good barometer. There have
to be a lot of other companies out there like that. You are in
a mature industry where you feel it would make sense. Unless
you feel you could deploy the cash somewhere and make a better
return on it, you feel that you are better off returning it to
the shareholders.
Mr. Rowe. Well, we keep hunting for ways to have more value
added. But our shareholders send us pretty clear messages that
they would prefer to have the choices about capital allocation
themselves.
Senator Fitzgerald. Now, you believe, based on the Edison
Electric Institute's studies, while it is very hard to
determine, that most utility shareholders are senior citizens.
Did you say an average age of 70 who would hold the----
Mr. Rowe. Those are the studies that EEI and the American
Gas Association made several years ago, yes, Mr. Chairman.
Senator Fitzgerald. Do you know the percentage of
institutional and individual shareholders that Exelon has?
Mr. Rowe. In our case it is about two-thirds institutional,
one-third individual. But this is what makes giving you a
really precise answer difficult. A great many of the people who
hold the shares in the mutual funds are themselves senior
citizens or other fixed-income people. There is, even in our
institutional shareholdings, a strong tendency for utility
shares to appeal to ordinary Americans as opposed to a more
narrow class. As I indicated in my statement, we always have
hedge funds moving in and out and they may be in one day and
out the next. But excepting that, our kinds of securities
appeal to ordinary people and the President's proposal would
make them even more appealing in that regard. I do think,
however, given the confusions of the market, mutual funds are a
very appealing way for regular folks to invest even in
utilities.
Senator Fitzgerald. Now, what do you think about--Professor
Siegel recommends he likes ending the double taxation of
dividends, but thinks it should be done at the corporate level,
giving a deduction to the corporation to make it on the same
basis as debt.
Mr. Rowe. Well, I think that is literally more even-handed,
but I am so delighted by this proposal to end double taxation
basically that I find no fault with the one we have. I would
rather bet on a very good proposal that has the kind of backing
this does than look for something that may have one more notch
theoretical elegance but has not generated this sort of
support.
The way the President has done it has made it very clear
that his concern is for the investors and the citizens rather
than for the corporate management, and I think that is a good
thing.
Senator Fitzgerald. And he would make sure the money is
taxed at least once. It is possible to run a corporation so
that you are reporting, as you pointed out, as Enron did. They
reported $2.3 billion in earnings to shareholders between 1996
and 1999, but they reported a $3 billion tax loss, all the
while paying $1.5 billion in dividends. My understanding is,
under the President's proposal, you would not get a tax-
advantaged dividend to your shareholders if you had not paid
taxes on that in the first instance. Is that not correct?
Mr. Rowe. That is my understanding also. I suspect, as the
Under Secretary suggested, you have to look at that over a
period of 2 or 3 years, and that the tax provision does not
work literally year to year. But I think it works over a period
of 2 to 3 years to yield the result the Chairman suggests.
Senator Fitzgerald. Now, Professor Siegel, what do you
think about that? I mean, one of the advantages, it seems to me
the way the Administration has proposed this, is that we would
cut down on the incentive for the corporate inversions or
finding elaborate ways to avoid tax liability at the corporate
level altogether. Enron could not get away with what it got
away with in 1996 to 1999 the way the Administration has come
up with their proposal. What do you think about that?
Mr. Siegel. I think what you say is certainly true. I also
paid close attention to your comments about the S corporations
which flow through to the individuals. That is what I think is
really ideal, S corporations or REITs, as we all know, which
are flow through as long as a certain percentage--they are not
taxed as entities. That is what I think would be closest
achieved by having the deductibility at the corporate level
because you would probably then--the only tax would be on the
retained earnings of the firm. And as you mentioned, a lot of
times, when firms retain earnings and build up these cash
hoards, it is not in the interest of shareholders. They spend
it on acquisitions that do not always make sense.
Senator Fitzgerald. Then that would be a bias against
retained earnings, would it not?
Mr. Siegel. It would be a bias against retained earnings,
yes. And I think there is too much bias in favor of it. I want
to redress that, and I think that if you paid it all out and
then get it back, for instance, with dividend reinvestment
plans, which are getting more popular, the firm would have to
basically get it back from the shareholders on their plans or
convince the lenders that this is a good project for them to
do. I think it is too easy often when they have a big cash
hoard and they do not always pursue those projects that are in
the best interest of the shareholders. So, yes, it is a bias
against retained earnings and I do not mind a little bias
against retained earnings.
Senator Fitzgerald. Well, with that, I want to conclude
this hearing. I thank all of you for coming here. Your
testimony has been wonderful, and we really appreciate your
making yourselves available and taking the time to prepare your
testimony. So thank you all very much for coming.
This meeting is adjourned.
[Whereupon, at 11:22 a.m., the hearing was adjourned.]