Agency theory suggests that institutional stockholders are able to influence the dividend policies of listed firms with the underlying objective of reducing a firm’s agency costs. This study explores the causal effects of institutional ownership on dividend policies for the firms listed in China. Using various measures of institutional ownership and dividend policy, I find that mutual fund ownership in a firm causes it to pay out more cash dividends or to initiate cash dividends. These effects are mainly evident in the firms controlled by the state and regional governments and those with relatively high free cash flows. The effects are also shown to be stronger when the mutual fund investment horizon is longer. However, firms with existing high levels of cash dividends do not attract mutual fund investors. The results still hold when I use different methods to mitigate the endogeneity problem. Mutual fund ownership is also shown to reduce agency costs and improve the operating performances of the firms that they invest in. Other institutional investors, such as banks, insurance companies, and securities companies appear to have different influences from those of mutual funds on firms’ cash dividend payments, agency costs and operating performances. My results support the agency costs explanation of institutional ownership and dividend policy.
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