•Foreign shareholding influences dividend decisions and vice versa.•Changes in dividend payments over time positively affect subsequent changes in foreign shareholding, but the opposite is not true.•Foreign institutional investors do not change firms future dividend payments once they have made their investment choices in China.•Chinese listed firms can use dividend payouts to signal good investment opportunities to foreign institutional investors. This study examines whether foreign institutional investment influences firms’ dividend policies. Using data from all domestically listed nonfinancial firms in China during the period of 2003–2013, we find that foreign shareholding influences dividend decisions and vice versa. Furthermore, changes in dividend payments over time positively affect subsequent changes in foreign shareholding, but the opposite is not true. Our study indicates that foreign institutional investors do not change firms’ future dividend payments once they have made their investment choices in China. Moreover, they self-select into Chinese firms that pay high dividends. Our evidence suggests that in an institutional setting where foreign investors have tightly restricted access to local securities markets and a relatively high risk of expropriation by controlling shareholders exists, firms can use dividends to signal good investment opportunities to foreign investors.