Question

Clientele effect, tax differential, agency cost, and information asymmetries affect the dividend value perceived by investors". Express your views on this statement. Justify your answer citing appropriate examples from Saudi Firms

Answer 1

Ans : Clientele effect : Clientele effect is the idea that the set of investors attracted to a particular kind of security will affect the price of the security, when policies and circumstances change. For instance, some investors want a company that doesn't pay dividends but instead invests that money in growing the business, whereas other investors prefer a stock that pays a high dividend and still others want one that balances payout and reinvestment. If a company changes it's dividend policy substantially it is said to be subject to a clientele effect as some of it's investors decide to sell the security due to the change.

Tax differential : The tax differential view of dividend policy is the belief that shareholders prefer equity appreciation to dividends because capital gains are effectively taxed at lower rates than dividends when the investment time horizon and other factors are considered. Corporations that adopt this viewpoint generally have lower targeted payout ratios, or a long term dividend to earning ratio, as dividend payments are set rather than variable.

Agency cost : Agency cost is an internal cost which arises between management and shareholder because of the diverging interest of the two parties. Dividend payments are often employed to mitigate this cost. The dividend mechanism provides an incentive for managers to reduce the costs related to the principal-- agent relationship, one way to reduce agency costs is to increase dividends.

Information Asymmetries : We find that firms that are more subject to information asymmetry are less likely to pay, initiate or increase dividends and disburse smaller amounts. There is a negative relation between asymmetric information and dividend policy.

Saudi firms pay out a lower proportion of their cash flows compared to the proportion of dividends of reported earnings. Firms have more flexible dividend policies since they are willing to cut or skip dividends when profit declines and pay no dividends when losses are reported. Lagged dividend payments, profitability, cash flows and life cycles are determinants of dividend payments. Agency costs are not a critical driver of dividend policy of Saudi firms.