Question

Which of the following statements concerning dividend policy is true?

	1.	Unexpected dividend increase announcements are usually perceived as positive signals because they indicate an expected increase in future earnings of the firm.
	2.	A constant payout ratio policy enables stockholders to accurately predict future dividends.
	3.	Since there is no evidence that one investor group is better than another, firms should change dividend policies frequently with no adverse impact stock price.
	4.	Firms with stable earnings, such as utilities, tend to have a low dividend payout ratio.

Answer 1

Answer : Statement 1 is true i.e.Unexpected dividend increase announcements are usually perceived as positive signals because they indicate an expected increase in future earnings of the firm.

Because increased dividend reinforce the belief that company is strong and earnings are consistent and even better than previous years. This implies that company has more growth prospects in the coming year which further soars the investor sentiments.

Statement 2 is incorrect, because constant payout doesn't guarantee constant dividend.If earnings are better than last year, constant payout will render better dividend but if company make a loss then dividend amount will decrease proportionately which means there is always uncertainty around the future dividends.

Statement 3 is incorrect, Frequently Changing dividend policy sends a negative signal regarding Firms's stability and investors tend to lose confidence in consistency of future earnings.

Statement 4 is also incorrect, Utilities pay higher dividends because they carry moderate level of risks and consistent stream of earnings therefore making them favourite for retirees.