Clientele Effect Essay

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The paper of {Miller, 1961 #41} suggested that the pre-existing clientele effect might explain firms’ dividend decisions under certain circumstances. A clientele effect means that a group or some group of investors (clienteles) might prefer to invest in some firms because firms’ dividend policy fits investors’ preferences. For example, a firm in high growth industries that pay little or no dividends might attract a clientele who is in favor of share price appreciation. Such a clientele could be a group of younger investors, who usually have a long time investment horizon and therefore prefer owning the share of a firm which reinvests its earnings for further capital growth. Alternatively, a firm that has high dividend payout level might attract …show more content…

Generally, two of the most commonly discussed clienteles are tax-minimization induced clientele and transaction costs -minimization induced clientele. As investors are interested in their after-tax returns, the different tax rates of dividends income and capital gains strongly affect investors’ preference for dividends versus capital gains. If the marginal tax rate on capital gains is lower (higher) than that on dividend income, an investor might consider capital gain (dividend income) is more beneficial. All else being equal, however, a tax-exempt investor should be indifferent of capital gains or dividends from a taxation perspective Elton and (Gruber, 1970). On the other hand, transaction costs may also affect investors’ investment preference and therefore influence firms’ dividend decisions. Note that no matter whether investors prefer high dividend or high capital gains, transaction costs on financial assets are always incurred. For example, investors who heavily rely on dividend income for liquidity needs might prefer investing in a firm that pays high and stable dividend, since such an investment can help them to avoid significant transaction costs with selling stocks for capital gains. While investors who have less consumption needs at the moment might be interested in firms’ future capital growth, and thus prefer low dividend payouts to avoid transaction costs related to reinvesting the proceeds of dividends (Bishop et al.,

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