Investors and Dividend Policy
Information Content or Signaling
Signaling hypothesis says that investors regard dividend changes as signals of management's earnings forecasts.
The clientele effect is the tendency of a firm to attract the type of investor who likes its dividend policy.
Free Cash Flow Hypothesis
All else equal, firms that pay dividends from cash flows that cannot be reinvested in positive net present value projects (free cash flows), have higher values than firms that retain free cash flows.
Dividend/Retained Earnings Decision
There are various constraints that may impact on a firm's decision to pay out earnings in the form of dividends.
- Cash flow constraints
- Contractual constraints
- Legal constraints
- Tax considerations
- Return considerations
Types of Dividend Policies
- Constant Dollar Dividend Policy
- Constant Payout Ratio
- Regular with Extras