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A Theory of Dividends Based on Tax Clienteles

Author

Listed:
  • Franklin Allen

    (University of Pennsylvania, The Wharton School, Finance Department)

  • Antonio Bernardo

    (Finance Area)

  • Ivo Welch

    (International Center for Finance)

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.

Suggested Citation

  • Franklin Allen & Antonio Bernardo & Ivo Welch, 1998. "A Theory of Dividends Based on Tax Clienteles," Yale School of Management Working Papers ysm92, Yale School of Management.
    • Handle: RePEc:ysm:somwrk:ysm92
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    File URL: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=96608
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    JEL classification:

    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy

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