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16. Why are both the agency model and the signalling model consistent with the observation that...

16. Why are both the agency model and the signalling model consistent with the observation that share prices fall for companies that decrease dividends?

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Answer #1

Agency model is a model which lies between shareholders and management executives where the management acts as an agent having a fiduciary duty towards its shareholders, not paying or decreasing the dividends will impact the shareholders mindset as it can be a possibility that the management is not acting responsibly and holding on to cash.

In a Signalling Model the management might give a prior signal of a decrease in dividends which will indicate negative future prospects.

Thus both the models are consistent in the observation that share prices fall for companies that decrease dividend.

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