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12 J. Bus. Entrepreneurship & L. 361 (2019)
The Social Costs of Dividends and Share Repurchases

handle is hein.journals/jbelw12 and id is 358 raw text is: THE SOCIAL COSTS OF DIVIDENDS AND SHARE REPURCHASES J.B. Heaton* A B STR A C T ................................................................................. 3 6 1 IN T R O D U CTIO N .......................................................................... 363 I. L E G AL R U LE S ..................................................................... 367 A . C ontract Law .................................................... 367 B. Corporate Law .................................................. 368 C. Voidable Transfer Law ...................................... 369 II. SHAREHOLDER INCENTIVES: A SIMPLE MODEL .................... 370 III. DIVIDENDS AND SHARE REPURCHASES: SOME DATA ........... 373 IV . SO CIAL C O ST S .................................................................... 375 A . B enefits ............................................................. 3 75 B. Costs: Riskier D ebt ........................................... 376 C. Costs: A Large Bankruptcy System .................... 377 D. Costs: More Fragile Firms ................................ 378 E. Costs: Harm to Unsophisticated and Involuntary C reditors ........................................................... 3 79 F. Costs: Distortions to the Supply of Securities .... 379 C O N C L U SIO N ............................................................................. 3 8 0 ABSTRACT A long-held view in the academy is that shareholders are residual claimants in the sense that shareholders are paid in full only after the corporation pays its creditors. The reality on the ground is far different. Corporations give assets away to their shareholders long before they have satisfied creditors, both voluntary contract creditors and involuntary tort creditors. In particular, existing US. corporate and voidable transfer laws allow corporations to pay dividends and make share repurchases up to the point where the corporation is insolvent or nearly so. Voluntary creditors can limit dividends and share repurchases by contract, but involuntary creditors like tort claimants cannot, and unsophisticated voluntary creditors rarely do so. I use a simple Black- Scholes model of a debtor firm to illustrate the incentive that shareholders have to take dividends and share repurchases before debts are repaid. I

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