This paper addresses the question of why firms pay dividends, the so-called "dividend puzzle," from the agency perspective. We outline two agency models of dividends. On what we call "the outcome" model, dividends are the result of effective pressure by minority shareholders to force corporate insiders to disgorge cash. Under this model, stronger minority shareholder rights should be associated with higher dividends. On what we call "the substitute" model, insiders choose to pay dividends to establish a reputation for decent treatment of minority shareholders so that firms can raise equity finance in the future. Under this model. stronger minority shareholder rights reduce the need for establishing a reputation, and so should be associated with lower dividends. We compare these models on a cross-section of 4,000 companies from around the world, which operate in 33 countries with different levels of shareholder protection, and therefore different strength of minority shareholder rights. The findings on payout levels and other results support the outcome agency model of dividends.
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