A Theory of Dividends Based on Tax Clienteles


  • Franklin Allen,

  • Antonio E. Bernardo,

  • Ivo Welch

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    • Franklin Allen is from the Wharton School at the University of Pennsylvania. Antonio E. Bernardo is from the Anderson School at UCLA. Ivo Welch is from the School of Management at Yale University. The authors thank Laurie Hodrick, Shlomo Benartzi, Charles Calomiris, Mark Grinblatt, Kathleen Fitzgerald, Avraham Kamara, Jiang Luo, Hamid Mehran, Avanidhar Subrahmanyam, Richard Vines and Chris Hayden (Georgeson Investor Services) and seminar participants at Northwestern, NYU, UC/Davis, Columbia, UC/Riverside, Wharton, Yale, Atlanta, Duke, Chicago, USC, Stanford, Washington, and Wisconsin for helpful comments.


This paper explains why some firms prefer to pay dividends rather than repurchase shares. When institutional investors are relatively less taxed than individual investors, dividends induce “ownership clientele” effects. Firms paying dividends attract relatively more institutions, which have a relative advantage in detecting high firm quality and in ensuring firms are well managed. The theory is consistent with some documented regularities, specifically both the presence and stickiness of dividends, and offers novel empirical implications, e.g., a prediction that it is the tax difference between institutions and retail investors that determines dividend payments, not the absolute tax payments.