The Clientele Effect on Dividend Decisions


A dividend decision refers to a decision made by the chief executive officers and directors of a company about the amount and timing of cash payments that will be made out to the company’s shareholders. The dividends in dividend decisions refer to the distributions made to shareholders after the tax profit made by the organization. Dividend decisions are important for a company as they determine how the directors and managers of these companies will organize the capital structure and the prices of company stock. These decisions are usually related to the financial aspects of an organization where the result of the decision takes account of the various expectations and views of the company’s shareholders (Watson and Head 2007).

Literature Review

As with any other managerial decision within an organization, dividend decisions are influenced by three factors which include free cash flows, information signaling, and the clientele effect. Free cash flow refers to how a company pays out its cash surplus in the form of dividends once it has invested in all of its projects. The free cash flows theory of dividends was developed to explain the concept of free cash flows when making cash flow dividend decisions within organizations.

However, this theory has faced several criticisms where it is unable to explain the observed dividend policies that exist within corporate bodies as most companies pay out their dividends consistently from one year to the next. The free cash flows theory has also been criticized for its lack of relevance in the current stock environment where managers tend to pay out steadily increasing dividends to their shareholders rather than dividends that fluctuate dramatically in an inconsistent way.

The second factor that influences a company’s dividend decision is information signaling which refers to dividend announcements made out to the various shareholders and investors of a company conveying important information on the company’s future. Past research conducted by Miller and Rock during the 1980s has shown that dividend announcements increase or decrease the price of stocks owned by a company before the announcement has been made (Choi and Doukas 1998).

Information signaling allows investors to have important information on the company that will be vital in determining the future of the company as well as provide managers with important information that will be used to make dividend payments to the stockholders of a company. Managers who have access to information that indicates positive prospects for the company will more than likely increase the company’s dividends while managers who lack important information on the direction of a company will more than likely be forced to reduce the number of dividends paid out to shareholders because of their general lack of confidence in the company’s ability to generate adequate cash flows (Keown 2004).

The third factor of dividend decisions that will be the focus of this study is the clientele effect on dividends which refers to the various patterns of dividend payments that suit the various stockholders of a company. The clientele effect mostly arises because of the substantial transaction costs and differential rates that arise in the market forcing the various shareholders of a company to invest in various companies.

For example, a person might choose to invest in a company that has high dividend yields when compared to one that has low dividend yields. Companies can be able to maximize their stock prices if the clientele patterns of investor payouts can be easily identified and determined within an organization. The clientele effect adequately explains the consistent dividend payment policies that are usually followed by various listed companies in the stock market (Brigham and Daves 2010).

According to Kapil (2011), the clientele effect of dividend decisions is based on the premise that shareholders prefer companies that will supply them with their desired dividend payment patterns. Investors are usually attracted to companies that have policy changes in line with dividend decisions which allow them to adjust their stock holdings according to the market changes in share prices. Dividend patterns that can be easily identifiable will allow investors to avoid costs of adjustment in the event stock prices change in the stock market. The clientele effect enables both the stockholders and managers of a company to determine what effect changes to stock price will have on the dividend payments to shareholders (Kapil 2011).

Azzopardi (2004) argues that there is various clientele in firms who invest money in different forms and preferences such as low payout clientele and high payout clientele. Any changes to dividend policies from low to high payouts or vice versa do not affect the market value of the company’s shares but the type of clientele that the company will attract. Azzopardi (2004) argues that if the various clientele of a company is satisfied, their dividend demands for either high or low payouts will have no adverse impact on the price of shares.

With regards to the relevance of clientele effects on shareholder personal tax, the differential rates that exist in dividend payouts create a variation in the personal income tax of an investor or stockholder of a company. The relevance of shareholder personal income tax on a company’s clientele affects the way investors sell or buy stocks as well as the returns they will gain from the company’s dividend payouts (Azzopardi 2004).

This means that the clientele effect impacts the shareholder’s taxes given that the different stockholders of a company who had invested in different stockholder patterns are taxed under different tax regimes. The clientele effect would therefore impact the type of dividend payments that a shareholder would receive based on a similar distribution amount. Shareholder personal tax affects the relevance of dividends where high taxation rates mean that the dividends will be transformed into capital gains.

Taxation on capital gains is usually beneficial for a company as taxes can be deferred until the stock of a company has been completely sold whereas for dividends the taxes have to be paid immediately. This is however disadvantageous to companies that make huge one-off distributions to their shareholders as they are liable to be heavily taxed on their dividend distributions (Azzopardi 2004).

The clientele effect of dividend decisions has come under some criticism from various quarters especially in the case where investors do not have to rely on a company to provide a pattern of cash flows that will determine their investment decisions. The argument that an investor who wants to receive some cash by selling off a portion of their investment in the current economic context does not hold water especially with the current saturation in the stock market of low-cost discount stockbrokers. Investors who wanted to gain a return from their investment usually sold a portion of their stock holdings so that they could be able to gain a return on investment (Bhalla 2006).

Analysis and Discussion

Anand (2002) conducted a comprehensive study on the different dimensions that influence the dividend policy decisions by focusing on the corporate world in India. The basis for Anand’s study was to identify the factors that directors of organizations considered when formulating dividend policies that would be used in corporate India. In his analysis of clientele effect on dividend payments, Anand (2002) noted that there were two variables related to investors’ preference for dividends and these variables were the relative risk perceptions of dividend payments and retained earnings of clientele payment.

The results of his studies showed that managers in many of the corporations in India acted in the best interests of their shareholders where a meaningful loading of 0.75 and 0.54 was allocated to the two clientele effect variables (Anand, 2002).

Azzopardi (2004) in his analysis of the clientele effect on dividend decisions noted that imperfections in the capital market hurt the transaction costs of dividends as well as the differential interest rates on stock prices. He noted that shareholders chose companies that were able to supply the desired dividend pattern which would be able to create a demand for company stocks. Companies that were able to have diverse investment policies allowed investors some flexibility when adjusting their stock holdings.

This however created a problem where the company and the investor incurred adjustment costs because of the unpredictable nature of the stock prices. To explain this aspect, Azzopardi (2004) used an example of a profitable utility company, Florida Power and Light (FPL) which announced a large dividend cut of 33% in 1994. As a result of this move, the stock price of the company fell by 15% despite this result being predicted by many financial analysts.

However, within two weeks, the company’s stock began to increase given that FPL’s stock prices were outperforming those of other public utility companies in the same industry. These increases continued for the next two years which eventually forced the managers of the company to issue a dividend announcement on the status of dividend payments. The directors of FPL noted that they could not be able to retain the high dividend payout of 90% regardless of the company’s performance in the financial market. The directors instead opted to review the existing policy on dividends while at the same time repurchasing 10 million of the company’s shares that had been placed in the stock market. Many financial analysts viewed the dividend decision of FPL as being a strategic one as it was directed towards strengthening the company’s growth in the future (Azzopardi 2004).


The purpose of this research has been to discuss the clientele effect on dividend decisions by reviewing various aspects of literature available on the subject. While academic material on the subject is limited and far between, the results of the study have been able to reveal that clientele effects affect the dividend decisions of companies where the management of a corporate body has to consider the various investor patterns before they make any dividend payments to their shareholders.


Anand, M., (2002) Corporate finance practices in India: a survey, Journal for Decision Makers, Vol. 27, No.4, pp 29-56.

Azzopardi, F., (2004) Dividend irrelevance and the clientele effect. Leicester, UK: University of Leicester.

Bhalla, V.K., (2006) Financial management and policy. New Delhi, India: Anmol Publications Limited.

Brigham, E.F. and Daves, P.R., (2010) Intermediate financial management. Mason, Ohio: South-Western Cengage Learning.

Choi, J.J., and Doukas, J., (1998) Emerging capital markets: financial and investment issue. Westport, Cincinnati: Greenwood Publishing Group.

Kapil, S., (2011) Financial management. New Delhi, India: Pearson Education.

Keown, A.J., (2004) Foundations of finance: the logic and practice of financial management. New Jersey: Pearson Education.

Watson, D., and Head, A., (2007) Corporate finance: principles and practice, 4th Edition. New York: Pearson Education.

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