Financial markets react when a firm pays or chooses not to pay a dividend. A dividend announcement is a way for management to send a message to shareholders. This is known as the __________________.

Question

Financial markets react when a firm pays or chooses not to pay a dividend. A dividend announcement is a way for management to send a message to shareholders.   This is known as the __________________. ​

Quizplus · Accepted Answer

The signaling effect refers to the notion that a dividend announcement can convey important information about a firm's future prospects and earnings potential. As a result, financial markets tend to react to news of dividend changes. The other options (clientele effect, residual dividend theory, and expectations theory) do not specifically relate to the idea of a dividend announcement as a communication tool.

Financial Markets React When a Firm Pays or Chooses Not