Agency theory predicts that managers strongly prefer not to pay dividends because they reduce the amount of cash subject to managerial discretion. Managers with large holdings of stock options also have more incentive to reduce dividend payouts, because they prefer capital gains to income gains. Previous empirical tests of the relations between managerial entrenchment and dividend payouts employ endogenous measures of this agency problem. Using a relatively exogenous measure that incorporates state antitakeover laws, this paper empirically tests the effects of managerial entrenchment on dividend policy for a large number of U.S. industrial firms over the period 1981-1993. Consistent with theoretical predictions, our analysis using the differences-in-differences approach shows that dividend-payout propensities and ratios are lower when managers are insulated from takeovers. Our findings are robust, irrespective of alternative explanations, sample selection methods, and regression specifications.