We develop a theory in which the decision to pay dividends is driven by investor demand. Managers cater to investors by paying dividends when investors put a stock price premium on payers and not paying when investors prefer nonpayers. To test this prediction, we construct four time series measures of the investor demand for dividend payers. By each measure, nonpayers initiate dividends when demand for payers is high. By some measures, payers omit dividends when demand is low. Further analysis confirms that the results are better explained by the catering theory than other theories of dividends.

We investigate the empirical implications of using various measures of payout yield rather than dividend yield for asset pricing models. We find statistically and economically significant predictability in the time series when payout (dividends plus repurchases) and net payout (dividends plus repurchases minus issuances) yields are used instead of the dividend yield. Similarly, we find that payout (net payout) yields contains information about the cross section of expected stock returns exceeding that of dividend yields, and that the high minus low payout yield portfolio is a priced factor. WHILE THE IRRELEVANCE THEOREM of Miller and Modigliani (1961) implies that there is no reason to suspect that dividends play a role in determining equity price levels or equity returns, the theorem is silent on the usefulness of dividends in explaining these variables. It is then, perhaps, not surprising that there is a considerable literature exploiting the properties of dividends and dividend yields to better understand the fundamentals of asset pricing both in the time series and in the cross section. Motivation for the former comes from variations of the Gordon growth model in which dividend yields can be written as the return minus the dividend’s growth rate (see, e.g., Fama and French (1988)), from consumption-based asset pricing models in which the firm’s dividends covary with aggregate consumption (e.g., Lucas (1978) and Shiller (1981)), and so forth. Additional motivation comes from cross-sectional heterogeneity in tax, agency, and asymmetric information considerations (e.g.,

We examine how shareholder investment horizons influence firms ’ payout decisions. We find that U.S. firms held by short-term institutional investors have a higher propensity to buybacks shares instead of using dividends. Firm managers seem to respond to the preferred payout policy of investors in their shareholder base. Share buybacks are used by if managers want to appease short-term oriented shareholders, while firms pay dividends if their stock is mostly held by long-term investors who have less need to liquidate their investment and may have a better tax treatment with dividends. We document two effects of investor pressure: for firms initiating payouts through a share buyback we find that the market reaction is lower the more short-term investors are holding the firm’s stock, because such payout decisions are less well monitored; for firms that have already a payout policy at present, the market reacts more positively (and only temporarily) to a buyback in line with investor catering effects. Our findings help explain some of the puzzling recent findings relating the rise in institutional investment to a higher use of share buybacks. JEL Classification: G35; G32 Keywords: payout policy; repurchases; institutional investors; investment horizon; short-termism; shareholder heterogeneity; investor catering.

We survey 384 financial executives and conduct in depth interviews with an additional 23 to determine the factors that drive dividend and share repurchase decisions. Avoiding dividend cuts is a primary corporate objective, on par with investment decisions. While dividends are still smoothed as in Lintner (1956), fifty years later we find that the link between dividends and earnings has weakened. Most managers now favor repurchases and we document the key attributes that lead to this preference over dividends. In particular, many firms use repurchases in an attempt to increase earnings, to time the equity market, and/or because repurchases are more flexible than dividends. Though institutional investors can influence payout choices, executives believe that institutions as a class do not have a strong preference between dividends and repurchases. In contrast, executives believe that retail investors have a strong preference for dividends, even if dividends are tax disadvantaged. In general, management views provide little support for agency, signaling, and clientele hypotheses of payout policy. Tax considerations play a secondary role.

Veronesi. We are particularly grateful for the many helpful comments and suggestions of the editor William Schwert and of an anonymous referee. All errors are our Corporate cash flows are highly volatile and strongly procyclical. We examine the asset-pricing implications of the sensitivity of corporate cash flows to economic shocks within a continuous-time model in which dividends are a stochastic fraction of aggregate consumption. We provide closed-form solutions for stock values and show that the equity premium canberepresentedasthesumofthreecomponentswhichwecallthe consumption-risk, event-risk, and corporate-risk premia. Calibrating to historical data, we show that the model implies a total equity premium many times larger than in the standard model. The model also generates levels of equity volatility consistent with those experienced in the stock market

two anonymous reviewers. We also appreciate the helpful comments by workshop participants

New theoretical papers and empirical developments have changed the framework required for understanding the nature of payout policies. The institutional developments are the rise of private equity firms, hedge funds, and venture capital firms. Central bank policies and actions are now followed by households as well as firms as closely as wins and losses of major sports terms. The growth of the economies of China and India have changed the competitive structure and dynamics of the global economy, with strong impacts on commodity prices such as gold, steel and nonferrous metals such as aluminum, copper, zinc, etc. The formation of regional economic blocs in Western Europe and its Eurocurrency are having effects similar to those in the United States of North America when the completion of the transcontinental railroad systems in the 1980s resulted in the first common market, resulting in the national scope of business activity. The increased pace of technological change from computers, Internet and the information highway, biological and chemical industry developments have shortened product cycles and intensified competitive pressures. Product market opportunities for the formation of new business firms have also expanded. Continuing reassessment of a firm’s external economic, political, cultural, and competitive environments has become imperative, leading to continuing strategic planning processes. Specific policy areas such as human resource management, research and development policies, investment choices as well as payout policies must be made within this broader framework. This central proposition is the organizing framework of this paper.

We present a model in which partial smoothing of dividends is an equilibrium outcome. An informed manager who cares about the intrinsic value of the firm but also about the current period’s stock price, has to decide how to allocated earnings between investment and dividends. The stock price is determined by uninformed investors. Asymmetric information provides an incentive to inflate dividends and lower investment relative to the first best. We show that a continuum of equilibria exist in which for a given range of earnings the dividend is constant. Hence the variation in dividends does not reflect the full extent of variation in earnings. Compared to the standard separating equilibrium, this partial revelation of earnings induces an investment level that is closer to the first best. Thus, dividend smoothing implies higher firm value, lower average dividends, and lower deviation from first-best investment. We conclude that dividend smoothing provides a partial remedy to underinvestment resulting from information asymmetries. We suggest that last year’s dividend can serve as a “focal point, ” allowing managers and investors to coordinate on just one

The statistical analysis of firm-level data on U.S. multinational companies was conducted at the International Investment Division, Bureau of Economic Analysis, U.S. Department of Commerce under arrangements that maintain legal confidentiality requirements. The views expressed are those of the authors and do not reflect official positions of the U.S. Department of Commerce. We thank Ned Howenstine, Ray Mataloni, and Bill

Please do not cite without author’s permission. In this paper, I test the dividend clientele hypothesis (DCH) by examining the impact of the Jobs and Growth Tax Relief Reconciliation Act of 2003 (the 2003 tax act) on household portfolio dividend yields. The DCH predicts that the 2003 tax act, which reduced the tax-disadvantage of dividends differentially across the income distribution, would cause high income households to shift their portfolios towards dividend paying stocks relatively more than lower income households. Using the 2001 and 2004 Surveys of Consumer Finances (SCF), I examine how changes in tax rates affect changes in household portfolio dividend yields. I find that the 2003 tax act caused households in the highest (35%) tax bracket to increase their portfolio dividend yields by 1.1 percentage points more than those in the next (33%) tax bracket, and by 2.6 percentage points more than those two tax brackets (28%) below. Compared to a 2.1 percent average dividend yield in 2001, these responses are large and economically significant. Using the 2007 SCF, I find that the reduced variation in dividend tax rates across households caused portfolio dividend yields to become homogeneous within three years of the tax act. Using a battery of sensitivity checks, I verify that these findings are not driven by other explanations for changes in dividend preferences, such as changes in optimism or risk-aversion. ∗I am grateful to my dissertation committee members, Amy Dittmar, Matthew Shapiro, Joel Slemrod and Jeff Smith for invaluable guidance, to Kevin Moore for assistance with using the Survey of Consumer