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This paper examines the linkage between dividend policy and institutional ownership within the context of the dividend model of Allen, Bernardo and Welch (2000). Specifically, it provides an empirical test of Allen, Bernardo and Welch (2000)’s novel implication that a tax differential between institutions and retail investors effects dividend policies. Using merge data of US industrial firms from 1980-2002, our results indicate that the dividend paying decision is positively related with institutional ownership. That is, firms with higher institutional ownership are more likely to be dividend payers. Further, we find that the deferred tax or tax credits that the institutional investors own significantly contribute to the dividend initiation decision as well as the level of dividend payments.

Institutional ownership and firm’s dividend policy