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[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

                               __________

    Printed for the use of the Committee on Commerce, Science, and 
                             Transportation

                    U.S. GOVERNMENT PRINTING OFFICE
97-106                      WASHINGTON : 2006
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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

                              ----------                              
                                                                   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.]

                                  
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