Stock Liquidity and Dividend Policy: Dividend Policy Changes Following an Exogenous Liquidity Shock

Investors’ liquidity needs may be an important reason why firms pay dividends. While intuitive, identification issues limit researchers’ ability to examine this hypothesis empirically. We overcome the identification concerns by using an exogenous shock to stock liquidity. We find that firms reduce dividend payments when stock liquidity increases. The reduction is greater for firms that experience a greater stock liquidity increase and/or firms whose shareholders have greater cash needs or rebalancing demands. Shareholders who exhibit large liquidity demands in the pre-event period are also more likely to sell shares after the stock liquidity increases.