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Can you please help me with the factors involved in deciding on a dividend policy (such as the signalling effect, clientele effect, etc) and the theories relating to it (such as the dividend relevance & irrelevancy theory)?
Thanks in advance 🙂
I do explain all of this in my free lectures working through Chapter 11 of our free lecture notes.
You cannot expect me to type out all my lectures again here 🙂 🙂
I saw your lecture on this and this is what I understood. Please correct me if I am wrong.
Clientele effect:
This theory suggests that a company should be careful when deciding whether to pay the dividend or not or reduce it to a low dividend payout which might upset a few shareholders those who have invested their money in the company. Shareholders have different preferential some people who are retired from the jobs may be invested in the company in expecting huge dividend payouts but many shareholders do prefer no dividend instead they prefer to invest their money in a company for a longer period so that they will get a return from the increase in capital gains.If the company has decided not to pay dividend, for some shareholders this might be good news because since the company has retained money to invest in the expansion of the business which will result in an increase in the shareholder’s wealth in the future.
Therefore, different shareholders or investors have different preference & the company should be careful in deciding the dividend policy because it may attract a group of shareholders to whom the policy is suited but it may upset another group of shareholders those who might have no other means of income except the dividend received from the company.
Signaling Effect:
If a company has a long history of paying dividends to the shareholder but for some reason, they have decided to change their dividend policy for maybe a good reason because they want to buy a new machine which will grow the business expanding (increasing sales).If a company changes its dividend policy by not paying dividends this year (let’s say) for business expansion but shareholders will be upset with the decision and it might result in losing key shareholders which could be harmful to the company’s reputation such as share prices drop sharply.
Therefore, a change in dividend policy should have a negative signaling effect on the shareholders in case a company has decided not to pay dividends or for some other reason.
I could not find dividend relevance theory in the notes. Could you please elaborate that?
What you have written is correct.
There is no such thing as a ‘dividend relevance theory’.
In theory the dividend policy is irrelevant as explained on Page 62 of the lecture notes (and expanded in the free lectures working through the chapter). This is because a lower dividend now should mean higher dividends in the future and shareholders should be indifferent between the two.
In practice, that is not the case because of the clientele effect etc.. Therefore it does matter what dividend policy the company adopts i.e. it is relevant.
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