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Impact of Dividend Policy on Clientele

Change in a firm's dividend policy may cause loss of old clientele and gain of new clientele, based on their different dividend preferences.

Learning Objective

  • Describe how the clientele effect can influence stock price


Key Points

    • The clientele effect is the idea that the type of investors attracted to a particular kind of security will affect the price of the security when policies or circumstances change.
    • Current clientele might choose to sell their stock if a firm changes their dividend policy and deviates considerably from the investor's preferences. Changes in policy can also lead to new clientele, whose preferences align with the firm's new dividend policy.
    • In equilibrium, the changes in clientele sets will not lead to any change in stock price.
    • The real world implication of the clientele effect lies in the importance of dividend policy stability, rather than the content of the policy itself.

Terms

  • clientele effect

    The theory that changes in a firm's dividend policy will cause loss of some clientele who will choose to sell their stock, and attract new clientele who will buy stock based on dividend preferences.

  • clientele

    The body or class of people who frequent an establishment or purchase a service, especially when considered as forming a more-or-less homogeneous group of clients in terms of values or habits.

  • dividend clientele

    Sets of investors who are attracted to certain types of dividend policy.


Example

    • Suppose Firm A had been in a growth stage and did not offer dividends to its shareholders, but their policy changed to paying low cash dividends. Clientele interested in long term capital gains might be alarmed, interpreting this decision as a sign of slowing growth, which would mean less stock price appreciation in the future. This set of clientele could choose to sell the stock. On the other hand, dividend payments could appeal to investors who are interested in regular additional income from the investment, and they would buy Firm A's stock.

Full Text

The Clientele Effect

The clientele effect is the idea that the type of investors attracted to a particular kind of security will affect the price of the security when policies or circumstances change. These investors are known as dividend clientele. For instance, some clientele would prefer a company that doesn't pay dividends at all, but instead invests their retained earnings toward growing the business. Some would instead prefer the regular income from dividends over capital gains. Of those who prefer dividends over capital gains, there are further subsets of clientele; for example, investors might prefer a stock that pays a high dividend, while another subset might look for a balance between dividend payout and reinvestment in the company.

Clientele Type Example

Retirees are more likely to prefer high dividend payouts over capital gains since this provides them with cash income. Therefore, if a company discontinued paying dividends, the clientele effect may cause retiree shareholders to sell the stock in favor of other income generating investments.

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. These changes in demographics related to a stock's ownership due to a change of dividend policy are examples of the "clientele effect. "

This theory is related to the dividend irrelevance theory presented by Modigliani and Miller, which states that, under particular assumption, an investor's required return and the value of the firm are unrelated to the firm's dividend policy. After all, clientele can just choose to sell off their holdings if they dislike a firm's policy change, and the firm may simultaneously attract a new subset of clientele who like the policy change. Therefore, stock value is unaffected. This is true as long as the "market" for dividend policy is in equilibrium, where demand for such a policy meets the supply.

The clientele effect's real world implication is that what matters is not the content of the dividend policy, but rather the stability of the policy. While investors can always choose to sell shares of firms with undesirable dividend policy, and buy shares of firms with attractive dividend policy, there are brokerage costs and tax considerations associated with this. As a result, an investor may stick with a stock that has a sub-optimal dividend policy because the cost of switching investments outweighs the benefit the investor would receive by investing in a stock with a better dividend policy.

Although commonly used in reference to dividend or coupon (interest) rates, the clientele effect can also be used in the context of leverage (debt levels), changes in line of business, taxes, and other management decisions.

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