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This Article proposes a legal norm that shifts discretion over dividend policy from managers to the capital markets (i.e., shareholders). State corporate law could effect such a shift by adopting a rule that mandates shareholder control over the dividend decision. The rule would require every firm to adopt an option mechanism that, at predetermined dates, provided each of the firm's shareholders with the right to select either cash or stock dividends in an amount equal to the shareholder's pro rata share of the firm's earnings. For instance, the law might require that, once a year, the firm offer to each shareholder the right to decide what percentage of her share of earnings she will take out of the firm-through a cash dividend-and what percentage she will leave in the firm-through a stock dividend. The option mechanism would be a cost-effective vehicle for assigning control over a firm's accumulated earnings to the capital markets.

Theory and evidence suggest that an unfettered management retains an excessive amount of earnings. Entrusting the capital markets with control over the earnings reinvestment decision would facilitate optimal earnings retention by firms and lessen the need for the indirect and expensive discipline provided by the market for corporate control. Moreover, by giving the capital markets some control over the allocation of approximately seventy-five percent of corporate expenditures, shareholder dividend options would enhance the importance of capital markets in achieving allocative efficiency.


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