Catering to behavioral demand for dividends and its potential agency issue

Using a unique sample of open-ended mutual funds, which are not subject to “pass through” requirements, we test whether paying dividend creates a potential agency issue. We find that dividend yield (DY) is positively (negatively) related to a fund's post-dividend net cash flow (performance). In addition, small funds and funds suffering from low inflows have stronger incentives to distribute high dividends after controlling for dividend paying capacity. More importantly, the prevalent behavioral demand for dividend is mainly due to individual investors' dividend chasing. Thus, catering to a behavioral demand for dividends creates a potential agency issue rather than mitigating one.