Taxation and Clientele Theory

Taxation and Clientele theory

While it may be true that investors prefer companies paying higher dividends that doesn’t mean you can increase the value of your firm just by increasing its dividend payout. Afterall, lots of smart financial managers would have recognized this fact years ago. They would already have satisfied this clientele for high dividend stocks

Taxation and Clientele theory

You don’t hear business people saying there is a clientele for cars, so we should be manufacturing cars.  They know that clientele was probably satisfied years ago. Likewise, the clientele for high dividend stocks has a wide variety of stocks to choose from.  No one will notice if you add your firm to that already long list!

Taxation

Dividend payments are taxed more heavily than capital gains. So we can expect indv's to prefer income in form of cap. gains. Firms are taxed favorably on dividend income on the shares of other firms that they hold. Some institutions pay no tax at all, so they're indifferent b/w income earned in dividends or cap.gains.

The 3 groups

We might expect, some stocks to pay low dividends (shares held by individuals) some stocks to pay medium level dividends (shares held by tax-exempt Insti's) some stocks to pay high level dividends (shares held by Corporations ) So each type of stock (classified as per the dividend levels) will cater to its own clientele.

MM and Clientele Theory

CT arrives at some conclusion as MM i.e firm values are unaffected by dividend policy/stock prices. However CT also implies that eg: investors in high tax brackets should hold portfolios with low dividend yields - and vice versa. Thus CT is a step forward from MM, assigning more distinctive attributes to study the effects of dividend policy