Caring for Investors or Preying by Managers? Strategic Use of Dividend Payments by Mutual Funds

Abstract

Dividend payments attenuate agency issues, but they can also be used by managers for management entrenchment. Using open-ended mutual funds, we find that dividend yield (DY) is positively (negatively) related to a fund’s post-dividend net cash flow (performance). In addition, we find that managers of small funds and funds suffering from low net cash flows (NCFs) have stronger incentives to distribute high dividends to increase their NCFs. More importantly, high-DY funds attract disproportionally more individual investors. These results suggest that fund managers take advantage of the individual investors’ irrational behavior of dividend chasing, thereby using dividends strategically to benefit managers at the expense of fund investors.

Keywords: Dividend chasing; Conflict of interest; Agency problems; Flow-performance; Irrational behavior; Individual and Institutional investors; Chinese mutual funds

JEL Classification: G30