The Heritage Foundation

WebMemo #265 on Taxes

April 18, 2003

April 18, 2003 | WebMemo on Taxes

Most Stocks are Held by Private Investors

When the President proposed ending the double tax on dividends, many critics charged that such a policy would not increase corporate investment.[1] These critics argued that since large institutional investors, such as tax-exempt pension and mutual fund companies, hold large percentages of corporate stock, dividend tax relief would be unlikely to increase corporate investment.[2] However, these arguments ignore the fact that even institutional investors pass on corporate profits to individual investors. Furthermore, a close examination of the data strongly suggests that most corporate equity is not held by large tax-exempt investors, leaving the critics to search for another reason to oppose the President's plan. Institutional investors do own about 66 percent of the outstanding shares of the S&P 500 companies.[3] This high percentage of institutional ownership, however, obscures several important facts. To begin, all shares held by institutions are held with the purpose of earning a profit for the institutions' individual investors, individuals who are likely to pay taxes. Additionally, focusing only on the S&P 500, rather than all publicly traded companies, makes the overall percentage of institutional ownership seem much higher than it really is.

As of January 2003, institutional investors held only about thirty percent of the outstanding shares of stock in a sample of7,158 publicly traded firms. Looked at differently, private investors held approximately seventy percent of these shares. In fact, sixty percent of these firms had less than one-third of their stocks owned by tax-exempt investors (see Table 1 - Percentage of Shares Held By Institutional Investors).[4] Furthermore, when this sample is classified by common equity, number of common shares outstanding and book value of assets (measures of size), the data suggest that institutional investors are most likely to buy only the largest companies:

For instance, Table 2 shows that the median percentage of shares held institutionally for firms with less than $1 million in equity is only 1.58 percent. In fact, the median percentage for companies with between $50 and $75 million in equity is just above 21 percent. Similarly, Table 4 shows that the median percentage of shares held by institutions for firms with less than $10 million in assets is less than one percent. Moreover, the median percentage for corporations with between $150 and $300 million in assets is slightly less than 26 percent. These figures suggest that the President's plan would directly lower the cost of capital for smaller businesses.[5] Also, when classified by industry, the data show that individuals hold a larger percentage of outstanding stock than looking at just the S&P 500 companies would suggest (see Table 5 - Percentage of Shares Held By Institutional Investors, Classified by Industry). For example, individuals own almost three-fourths of the outstanding stock in oil and gas industry firms. Similarly, individuals hold approximately 65 and 88 percent of the outstanding shares in the Machinery and Telecommunications Services industries, respectively.[6] Overall, the data strongly suggest that most shares of corporate equity are held by private investors. These figures, combined with the fact that all returns eventually have to be passed through to individuals, demonstrate that corporate managers cannot ignore tax consequences when estimating their firms' cost of capital. Whether corporate managers assume their shareholders are in the 10 or 39 percent tax bracket, eliminating the double tax on corporate income will lower their hurdle rates, thus leading to increased investment and job growth.[7]

[1] To be precise, the President's plan actually eliminates the double tax on both types of corporate earnings, not just dividends. In addition to the personal dividend exclusion, the plan would also provide a basis adjustment for the portion of corporate earnings that are retained, thus lowering individuals' effective capital gains taxes. For more information on the plan, see U.S. Treasury Fact Sheet, January 14, 2003 at

[2] Mutual fund companies, for example, are classified as Regulated Investment Companies (RIC), entities which pass income through to individual shareholders who are then subject to income taxes. The RIC itself, however, is not subject to income taxes.

[3] These figures, as well as all subsequent references to samples of publicly traded companies, are taken from Standard and Poor's Compustat database and reflect the percentage of shares held institutionally as of the latest available quarter, January 2003.

[4]The median percentage of shares held institutionally is 18.92, with a standard deviation of 30.64. Together, these figures suggest that most firms are not majority owned by institutions. This sample consists of all publicly traded firms in the S&P Compustat database for which the measures IOTSHR0 (percentage of shares held by institutions), CSHO (common shares outstanding), and CEQ (common equity) are reported.

[5] Since the President's plan eliminates the double tax on both distributed and retained corporate income, both dividend paying and non-dividend paying firms would see a reduction in their cost of capital.

[6] Industry classification is according to 6 digit GICS code.

[7] For more on corporate hurdle rates, see Norbert J. Michel, "Everyone Profits From Hurdling Dividends," WebMemo #248, April 3, 2003, at

About the Author

Norbert J. Michel, Ph.D. Research Fellow in Financial Regulations
Thomas A. Roe Institute for Economic Policy Studies