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Dear,
One of practical dividend policy is to aim for a steady pattern of dividends “e.g to have a policy of increasing dividends by 5% p.a.. This enables investors to choose the
companies whose dividend policy they prefer, and avoids the signalling problem”.What does signalling problem mean?
Shareholders do not like ‘surprises’ and if the dividend suddenly changes from what they are expecting them the danger is that they assume things that may not be the case,
For example, suppose a company has been increasing dividends by 4% a year for many years. But one year they suddenly announce a lower dividend.
Shareholders will immediately assume that the company is doing badly and there is therefore a likelihood that the share price will fall. The company might not be doing badly at all – it could be that they have decided to reduce the dividend so that they can invest a lot of money in expansion.However, there is the danger (and this happens in real life) that shareholder come to the wrong conclusions because a lower dividend had a ‘signalling’ effect – it made the worry that something was wrong.
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