Whose Taxes Matter?: The Effects of Institutional Ownership on Dividend Payout Policy Around Tax Rate Changes

Abstract

Prior research finds that firms accelerate dividends into the period before tax rate increases, especially when insider ownership is high, thus reducing insiders’ taxes (Hanlon and Hoopes 2014). However, this research does not consider the preferences of other investors, many of which are tax-insensitive. First, ignoring insider ownership, we find that the likelihood and magnitude of dividend acceleration is lower for firms with high tax-insensitive institutional ownership, providing new evidence on the broad relation between shareholder taxes and dividend payout. Second, accounting for insider ownership, we find that dividend acceleration increases with insider ownership even when tax-insensitive institutional ownership is high, indicating managers’ preferences outweigh institutions’ preferences. Third, accounting for both insider ownership and institutions’ monitoring ability, we find that tax-insensitive dedicated institutions constrain insiders’ ability to accelerate dividends, particularly when acceleration costs are high. This suggests dedicated institutions play a part in monitoring potentially excessive and costly tax-motivated dividend payments made in managers’, not shareholders’, best interest. Overall, our results differ from several recent studies and provide important new insight into the relation between shareholder-level taxes and dividends.