Answer to Question #6756 in Economics of Enterprise for LaMarcus Streeter

Question

1. Which of the following statements about dividend policies is CORRECT?

a. Modigliani and Miller argue that investors prefer dividends to capital gains because dividends are more certain than capital gains. They call this the ―bird-in-the hand‖ effect.
b. One reason that companies tend to avoid stock repurchases is that dividend payments are taxed at a lower rate than gains on stock repurchases.
c. One advantage of dividend reinvestment plans is that they allow shareholders to avoid paying taxes on the dividends that they choose to reinvest.
d. One key advantage of a residual dividend policy is that it enables a company to follow a stable dividend policy.
e. The clientele effect suggests that companies should follow a stable dividend policy.

Answer 1

Statement E is CORRECT. The clientele effect is the theory that a company's
stock price will move according to the demands and goals of investors in
reaction to a tax, dividend or other policy change affecting the company. The
clientele effect assumes that investors are attracted to different company
policies, and that when a company's policy changes, investors will adjust their
stock holdings accordingly. As a result of this adjustment, the stock price will
move.