Question

Define the clientele effects and signaling effects of the dividend policy. Also explain how it affects firm’s dividend policy.

Answer 1

Clientele effects

The clientele effecy states that investor A who is in need of current income will invest in a business that has a high payout ratio, while investor B who is not interested in current income will invest in a low business with low dividend payout, but high capital growth potential.

Signaling effects

It suggests that company announcements of dividend increases are an indication of positive future results. It indicates that companies that pay the highest dividends are, or should be, more profitable those paying smaller dividends.

Impact of Clientele and signaling on firm’s dividend policy.

• Clientele may choose to sell their stock if a firm changes its dividend policy, and deviates considerably from its preferences. On the other hand, the firm may attract a new clientele group if its new dividend policy appeals to the group's dividend preferences.
• It will increase the divindent payout rate. If large dividends are paid , the company retains the lesser part of profits, which means small funds are available for the expansion programmes resulting in lack of growth of firm. But if the divident paid are less means lesser market value of shares and can attain the growth to the firm using large retained profits.