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IAI Actuarial Core Principles · Business Finance · Capital structure and dividend policy

A company pays a large special dividend, in addition to its regular dividend, from accumulated surplus cash. Which view is most consistent with the signalling theory of dividends?

A special dividend signals a one-off surplus rather than a permanently higher payout. Management shows confidence in cash generation without committing to a higher regular dividend, so investors should not treat it as a sustained increase.

  1. AInvestors always treat a special dividend as a permanent increase in the regular payout
  2. BA special dividend signals one-off surplus, so the share price should not be expected to rise as if payouts were permanently higherCorrect
  3. CA special dividend proves the company has no profitable investment projects
  4. DDividends are irrelevant, so the special dividend conveys no information at all
  5. A special dividend always signals financial distress

Explanation

Special dividends are labelled one-off, so management avoids committing to a higher regular payout. Signalling theory says dividends convey information, so this mixes confidence about cash with no permanent commitment. Irrelevance theory is the contrasting view, not signalling.

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