CIMA F3 Dumps Questions Answers

Signalling effect (information content of dividends)In CIMA F3, dividend policy is closely linked to information asymmetry between a company’s management and its shareholders. Managers typically have better information about the firm’s future prospects than external investors. As a result, investors often interpret changes in dividends as signals about management’s expectations of future earnings and cash flows.The concern that cutting dividends will cause the share price to fall illustrates the signalling effect (also known as dividend signalling theory). According to this theory, a dividend cut is interpreted by the market as a negative signal, suggesting that management expects lower future profits or cash flow difficulties. Investors react by revising their expectations downward, leading to a fall in the share price.CIMA F3 study guidance contrasts this with Modigliani and Miller’s dividend irrelevance theory, which assumes perfect markets and no information asymmetry. In reality, markets are imperfect, and dividends convey information. Therefore, companies are often reluctant to reduce dividends even when it may be financially prudent, due to fear of adverse market reactions.This behaviour is also linked to dividend stability, another key concept in F3, where firms prefer stable or gradually increasing dividends to avoid sending negative signals to investors.