Corporate Governance

Local Dividend Clienteles

By Harvard Law School Program on Corporate Governance

In our paper Local Dividend Clienteles, which is forthcoming in the Journal of Finance, we examine the role of investor demand in shaping corporate payout policy. Miller and Modigliani (1961) raise the question of whether firms set policies and investors sort accordingly, or companies respond to the preferences of their current shareholders. In this paper, we provide evidence consistent with the latter.

Specifically, we test for the effect of dividend demand on payout policy. The tendency of older investors to hold dividend-paying stocks in combination with individual investors? inclination to hold local stocks results in stronger dividend demand for companies located in areas with many seniors. Demographics thus provide an empirical proxy for dividend demand, which we exploit in this paper to examine the broader question of whether the preferences of current owners influence corporate actions.

As predicted, we find a significant positive effect of Local Seniors, the fraction of seniors in the county in which a firm is located, on the firm?s propensity to pay dividends, its propensity to initiate dividends, and on its dividend yield. The effect of Local Seniors on the corporate decision to start paying dividends is particularly strong and of the same economic magnitude as other key determinants such as company size and age.

Because demographics are only a rough proxy for demand, our results, in some sense, place a lower bound on the effect of investor preferences on payout policy. If there are other components of demand, the total effect of investor preferences on corporate policies may be larger. Our results are robust to various methodologies and identification strategies, and are not supportive of alternative explanations (for example, that firms located in the areas with many seniors have low growth opportunities and, therefore, are more likely to pay out cash to shareholders).

The main implication of our findings is that, at least in part, corporations respond to the preferences of their owners when setting payout policy. We further show that there are dividend clienteles that vary geographically, creating differences in demand for dividends across firms that help explain some of the substantial cross-sectional heterogeneity as to why some companies pay dividends while other do not. Our findings thus suggest that there is important geographical variation in the financial conditions facing firms.

The full paper is available for download here.

Full post as published by The Harvard Law School Corporate Governance Blog on February 12, 2010 (boomark / email).