Institutional stock ownership and firms' cash dividend policies: Evidence from China

Agency theory suggests that outside shareholders prefer higher dividend payouts in order to reduce the free cash flows of firms that are under the insiders' control. Our study investigates the effects of mutual funds, typically the most important and influential type of outside shareholder, on firms' dividend payouts in China during the period from 2003 to 2011. We find that mutual funds influence firms to pay higher cash dividends. The results are consistent with the predictions from exit theory. The effects are more pronounced in firms controlled by state and regional governments and in firms with relatively higher free cash flows. We also find evidence that the mutual funds' effects are stronger when their investment horizon is longer and the ownership interest is larger. Other institutional investors, such as banks, insurance companies, and securities companies have a lower exit threat and do not have an influence on firms' cash dividend payments or financial performances.