We hypothesize that stock market liquidity affects corporate payout policy primarily through its influence on the decision to repurchase. Our liquidity hypothesis of repurchases is consistent with Barclay and Smith's (1988) theoretical framework as well as with Brav et al.'s (2005) survey and interview results. Managers prefer repurchases over dividends because of tax and flexibility advantages, although their ability to conduct repurchases is subject to various constraints. Prior to the enactment of safe harbor Rule 10b-18, managers were constrained by uncertainty about charges of price manipulation. Repurchase activity increased significantly after this regulatory constraint was lifted by the SEC's ruling in 1982. We argue that stock market liquidity directly impacts the repurchase decision and, through the substitution effect, indirectly impacts the dividend decision.