Shareholder Illiquidity and Firm Behavior: Financial and Real Effects of the Personal Wealth Tax in Private Firms

The interaction between household finance and corporate finance may be particularly strong in private firms. First, private firms often face higher costs of external finance than public firms do, making the private firm unusually dependent on internal funds to finance growth. Second, private firms have less diversified owners and less liquid shares, making their shareholders’ personal finance unusually dependent on the firm’s payout. Consequently, the firm may have to pay out more and abandon profitable investments when their shareholders need additional liquidity for personal reasons. If this happens, shareholder illiquidity has financial and real effects on the firm.

We explore whether such a channel exists between household finance and corporate finance using proprietary tax returns data from Norway for the population of private family-controlled firms and their shareholders from 2000 to 2010. The sample holds about 33,000 firms per year. We find that when the controlling shareholder experiences a negative liquidity shock that is unrelated to the firm’s situation, the firm’s subsequent dividend and salary payments to the shareholder increase, while the firm’s cash holdings, growth, and performance decrease. This novel finding suggests that shocks to household finance propagate to corporate finance.

To be more specific, our overall finding has two components. First, we find that the increased tax value of the controlling shareholder’s personal home, which is unrelated to the firm and leads to higher personal wealth tax payments, is associated with higher dividend and salary payments from the firm to the shareholder and with lower cash holdings in the firm. On average, when the controlling shareholder’s wealth-tax-to-liquid-assets ratio (wealth tax payment per unit of liquid assets) increases by 1 percentage point, the firm’s payout ratio (dividends plus salary paid to the controlling shareholder per unit of firm earnings before salary) increases by 0.49 percentage points, and the firm’s cash ratio (cash holding per unit of assets) decreases by 1.09 percentage points. Also, the firm more often pays dividends even in loss-making years after a wealth tax shock. Thus, the personal liquidity shock propagates to the firm’s liquidity because the shareholder withdraws cash to cover larger personal tax payments. These are the financial effects on the firm.

Second, the larger payout to shareholders has real effects on the firm through lower growth and performance in the firm. A 1 percentage-point increase in the shareholder’s wealth-tax-to-liquid-assets ratio is on average associated with a 0.45 percentage-points decrease in next year’s sales growth. The effect on employment is also negative, but not statistically significant, perhaps because employment tends to be more stable in family-controlled firms than elsewhere. We also find a negative and significant effect on firm performance, as a 1 percentage point increase in the wealth-tax-to-liquid-assets ratio is followed by a 0.49 percentage-points decrease in returns on assets.

These findings suggest that even strictly personal taxes can affect firm behavior by draining liquidity away from the firm’s owners, who in turn partially fill the gap with higher payout from the firm, which in turn reduces its growth and performance. This evidence also suggests that the effect of personal liquidity concerns for the shareholders and financial concerns for the firm should be analyzed jointly. This perspective is particularly important in private firms with concentrated ownership and moderate size, where both the owners’ liquidity constraints and the firm’s financial constraints are likely to be strong. From a policy point of view, our results suggest that taxes strictly related to the personal sphere may have important spillover effects on the corporate sphere through the ownership channel.