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Dividend Policy: how to signal effects for changes in dividends

1.) Should a firm be concerned about signaling effects if it plans to alter its dividend policy? If so, how should signaling be taken into account?

2.) In general, what impact should "clientele effects" have on its dividend policy?

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1.) Should a firm be concerned about signaling effects if it plans to alter its dividend policy? If so, how should signaling be taken into account?

Signaling hypothesis: A change in the dividend policy by the managers sends signals to the market about the future performance of the company. Thus, this will leads to change in the stock of the company. The market looks at changes in dividend payout ratio as a signal to the market about the future earning potential of the company. Markets interpret decreased dividends as signals that the firm is not expecting to do well, which of course sends the stock price lower. Increased dividends on the other hand generally send stock prices higher. Hence firms are less reticent about increasing dividends provided they can ...

Solution Summary

In a 490 word solution, the response presents a comprehensive answer to each of the questions about the impact of changes in dividends to shareholders and investors.

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