Institutional Investors, Payout Policy, and Agency Costs

Abstract

This paper seeks to determine if institutional investors influence corporate payout policies. Specifically, this study tests whether institutional investors encourage higher payouts in firms with higher free cash flow and poor growth opportunities. Firm and year fixed effect regressions examining the effect of changes in institutional investor levels to subsequent changes in payout levels are used. For robustness, difference-GMM regressions and regressions for different time periods are performed on the same relationship. Increased institutional ownership leads to increases in total payouts, especially in firms with high free cash flow and poor investment opportunities (low q). According to agency-based free cash flow theory, stockholders should prefer that the management of firms with higher free cash flow and poor investment opportunities increase payouts to shareholders. The results indicate that institutional shareholders reduce agency costs by encouraging management to raise payouts, thus benefiting institutional investors and non-institutional shareholders.