Does dividend policy affect sales growth in product markets? Evidence from the 2003 dividend tax cut

We examine the effect of firms’ dividend policy on product market outcomes. Exploiting the 2003 dividend tax cut as the exogenous increase in demand for dividends from tax-sensitive shareholders, we show that firms that raised dividends in response to the tax cut recorded lower sales growth in product markets after the tax cut. These firms experienced a reduction in financial flexibility, which led to a decrease in investment activities. Despite the negative effects of dividends on sales growth, firm value increased on average, indicating that the firms raised dividends when the shareholder benefits outweighed the costs.