Does Dividend Policy Affect Sales Growth in Product Markets?: Evidence from a Quasi-Natural Experiment

Prior literature shows that firms are less likely to pay dividends to preserve financial flexibility when facing greater competitive threats from rival firms in product markets. However, the real effects of dividend policy on product market outcomes are not widely understood. This paper investigates the causal effects of dividend policy on sales growth in product markets. Exploiting the 2003 dividend tax cut as the exogenous shock to dividend policy and the cross-firm variation in the tax status of firms’ largest institutional shareholders, we find that firms’ dividend increases induced by the tax cut reduced their sales growth in product markets in years following the tax cut. Further, those firms exhibited slower growth in investment activities after the tax cut. A battery of robustness checks supports our causal interpretation that dividends reduce firms’ financial flexibility to deploy funds for investing activities, resulting in slower sales growth in product markets.