IAI Actuarial Core Principles · Business Finance · Capital structure and dividend policy
Which of the following best illustrates the clientele effect in dividend policy?
The clientele effect is shown when a change in payout leads income-seeking investors to sell and growth-oriented investors to buy. Shareholders sort themselves according to tax position and income preference, so the investor base changes while overall firm value need not.
- AA company raises its dividend to signal higher expected profits
- BA company pays dividends only after funding all positive-value projects
- CA company that cuts its payout ratio sees some income-seeking investors sell, while growth-oriented investors buy, with no change in overall valueCorrect
- DA company pays dividends to reduce the free cash flow that managers could spend on poor projects
- A company declares a bonus issue in place of a cash dividend to conserve funds
Explanation
The clientele effect says investors choose firms whose payout matches their tax position and income needs, so a change in policy causes a shift in the shareholder base rather than necessarily changing value. Option 0 is signalling, option 1 is residual policy, and option 3 is an agency cost argument.
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