Theories of Investors' Preferences for Dividends

C

Different groups, or clientele, of stockholders prefer different dividend payout policies. Stockholders in a low or tax-free tax bracket generally prefer cash income, so a payout would be their preference. On the other hand, stockholders in a high tax bracket might prefer reinvestment of earnings because they have little need for current investment income. To the extent that stockholders can switch firms, a firm can change from one dividend payout policy to another to let stockholder who do not like the new policy sell to other investors who do. Yet this would be costly because of brokerage costs, the capital gains taxes that would have to be paid by the selling stockholders, and the chance that there will be a net loss of investors who like the firm's new dividend policy. Management should therefore, probably not change its policy. Several studies show that there is a clientele effect, which is the tendency of a firm to attract a set of investors who like its dividend policy. The existence of the clientele effect does not necessarily imply that one dividend policy is better than another.