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

Which statement best describes the clientele effect in dividend policy?

The clientele effect means investors sort themselves into companies whose dividend policy matches their tax position and income needs, so a firm that changes its payout may lose its existing shareholders and attract a different group.

  1. ADifferent investor groups, such as high-tax and low-tax investors, are attracted to firms whose payout policy suits their tax and income needs, so frequent policy changes may disrupt the shareholder baseCorrect
  2. BClients of a company's bankers dictate its payout through loan covenants
  3. CDividends are set to equal the amount customers pay in advance
  4. DInvestors always prefer firms that retain all profits
  5. Companies must pay the same dividend to every class of shareholder regardless of preference

Explanation

The clientele effect says shareholders self-select into firms matching their tax position and income needs. A change in policy can cause turnover among investors, which is why firms tend to keep policies stable. The other options are unrelated to this idea.

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