Homework SourseThe term clientele effect refers to the tendency of firms to
The term clientele effect refers to the tendency of firms to attract investors who like their dividend policies. Three potential investors are described in the table.
Indicate which type of firms they are most likely to be attracted to.
Defense Dynamics Co. is a typical company that is very concerned with meeting investors’ expectations and keeping investors happy. Its earnings tend to fluctuate from year to year because of the nature of the business the company is in. Which of these statements most likely describes Defense Dynamics Co.’s dividend policy?
Defense Dynamics Co. will be willing to increase its dividend only if it believes that it will be able to maintain the dividend increase in future years.
Defense Dynamics Co. will increase its dividends in years when it has high earnings so that it can distribute excess free cash flows to investors, even if it means that the firm will have to reduce its dividend in subsequent years.
| Potential Investors | Types of Firms |
|---|---|
| Stockholders in their peak earning years | (high dividend payout, low dividend payout) |
| Investors who have a preference for current investment income | (high dividend payout, low dividend payout) |
| Retired individuals, pension funds, and university endowment funds | (high dividend payout, low dividend payout) |
Solution
Clintele Effect:
Dynamics Co:
A dividend is a distribution of a portion of a company\'s earnings. A company can increase its payout if it has high earings in a particular year and can decrease if it has low earnings in any year.It doesn\'t have to maintain growth trend in dividend rates. Hence Option 1 is not correct and option 2 is legitimate.
