Question #36
Reading: Reading 15 Analysis of Dividends and Share Repurchases
PDF File: Reading 15 Analysis of Dividends and Share Repurchases.pdf
Page: 14
Status: Unattempted
Question
At a recent conference, "Dividends − Are They Increasing?", several lecturers were discussing the signaling effect and their opinions on how changes in a company's dividend policy are often viewed by investors. Linda Travis, an equity analyst at Girthmore Capital Management and one of the guest lecturers at the conference, made the following observations: Observation 1: A dividend initiation is always viewed as a positive signal by investors. It is an indication that the company has so much cash at its disposal that it can afford to pay it out to shareholders. Observation 2: A dividend decrease is typically a positive signal by a company's management to its shareholders. It indicates that management has a variety of positive NPV projects in its capital budget and would like to finance as many of them as possible with retained earnings. With respect to Travis' observations:
Answer Choices:
A. both are correct
B. only one is correct
C. both are incorrect
Explanation
A dividend initiation is often viewed differently by different investors. On one hand, a
dividend initiation could mean that a company is sharing its wealth with shareholders – a
positive signal. On the other hand, initiating a dividend could mean that a company has a
lack of profitable reinvestment opportunities – a negative signal. Dividend decreases or
omissions are typically negative signals that current and future earnings prospects are not
good and that management does not think the current dividend payment can be
maintained.