The term clientele effect refers to the tendency of firms to attract investors w

Question

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. Potential Investors Types of Firms Stockholders in their peak earning years Investors who have a preference for current investment income Retired individuals, pension funds, and university endowment funds 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? Despite the fact that Defense Dynamics Co.'s earnings tend to fluctuate from year to year, the company most likely pays a predictable, stable dividend each year. Defense Dynamics Co. most likely pays very large dividends in years with high earnings and small dividends in the years with low earnings.

Explanation / Answer

1. A stockholder in their peak earning years would prefer capital appreciation in the value of his holdings over a long period instead of small sums as dividends. Thus, he/she would prefer a company having a high earning retention and low dividend payout.

2. Investors with a preference for current investment income would prefer a company that pays regular stable dividends.

3. Retired individuals, pension funds and University endowment funds typically invest in safe/less-risk instruments such as treasury bonds, investment grade bonds and in some cases high quality bluechip stocks with stable dividend payouts.

> A company very concerned with keeping investors happy and meeting their expectations would pay a predictable stable dividend each year

3.

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