A Theory of Dividends Based on Tax Clienteles

Rodney L. White Center Working Paper No. 15-98

Posted: 25 Jun 1998

See all articles by Franklin Allen

Franklin Allen

Imperial College London

Antonio E. Bernardo

University of California, Los Angeles (UCLA) - Finance Area

Ivo Welch

University of California, Los Angeles (UCLA); National Bureau of Economic Research (NBER)

Abstract

This paper offers a novel explanation for why some firms prefer to pay dividends rather than repurchase shares. It is well-known that institutional investors are relatively less taxed than individual investors, and that this induces "dividend clientele" effects. We argue that these clientele effects are the very reason for the presence of dividends, because institutions have a relative advantage in monitoring firms or in detecting firm quality. Firms paying dividends attract relatively more institutions and perform better. The theory is consistent with some documented regularities, such as a reluctance of firms to cut dividends, and offers novel empirical implications, such as a prediction that is the tax difference between institutions and retail investors that determines dividend payments, not the absolute tax payments.

JEL Classification: G35

Suggested Citation

Allen, Franklin and Bernardo, Antonio E. and Welch, Ivo, A Theory of Dividends Based on Tax Clienteles. Rodney L. White Center Working Paper No. 15-98. Available at SSRN: https://ssrn.com/abstract=96608

Franklin Allen (Contact Author)

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Antonio E. Bernardo

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-2198 (Phone)
310-206-5455 (Fax)

Ivo Welch

University of California, Los Angeles (UCLA) ( email )

110 Westwood Plaza
C519
Los Angeles, CA 90095-1481
United States
310-825-2508 (Phone)

HOME PAGE: http://www.ivo-welch.info

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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