Clientele Effect: Definition, Theory, Examples

What Is the Clientele Effect?

The clientele effect explains the movement in a company's stock price according to the demands and goals of its investors. These investor demands come in reaction to a tax, dividend, or other policy change or corporate action which affects a company's shares.

The clientele effect assumes that specific investors are preliminarily attracted to different company policies, and that when a company alters one or more such policies they will adjust their stock holdings accordingly. As a result of this adjustment, stock prices can fluctuate.

How the Clientele Effect Works

The clientele effect is a change in share price due to corporate decision-making that triggers investors' reactions. A change in policy that is viewed by shareholders as unfavorable may cause them to sell some or all of their holdings, depressing the share price.

Large policy shifts can be disruptive for both the company’s long-term interests, as well as shareholders’ portfolios. Once a company establishes a policy pattern and attracts a given clientele, it is generally best not to tinker with it too much.

There is a good deal of controversy about whether the clientele effect is a real phenomenon in the markets. Some believe that it takes more factors than just the wishes of a company’s clientele to move a stock’s price greatly. Moreover, even though investors could switch to companies that offered the profile they desired, such changes could entail transaction fees, taxable events, and other costs.

Dividend Clientele

Public equities are typically categorized either as dividend-paying securities or not. Each of these categories links to a specific age in the lifecycle of a business as it matures.

For example, high-growth stocks traditionally do not pay dividends. However, they are more likely to exhibit substantial price appreciation as the company grows. On the other hand, dividend-paying stocks tend to show smaller movements in capital gains but reward investors with stable, periodic dividends.

Shareholders in a dividend clientele generally base their preferences for a particular dividend payout ratio on comparable income level, personal income tax considerations, or their age.

Special Considerations

Some investors, like the legendary Warren Buffett, seek investment opportunities in high-dividend stocks. Others, such as technology investors, often seek out high-growth companies with the potential for extravagant capital gains. Thus, the effect first outlines the way in which the company's maturity and business operations initially attract a specific investor type.

The second facet of the clientele effect describes how current investors react to substantial changes in a company's policies. For example, if a public technology stock pays no dividends and reinvests all of its profits back into its operations, it initially attracts growth investors. However, if the company stops reinvesting in its growth and instead begins channeling money to dividend payouts, high-growth investors may be inclined to exit their positions and seek other opportunities that better match their needs. Dividend-seeking income investors may now view the company as an attractive investment.

Consider a company that already pays dividends and has consequently attracted clientele seeking high dividend-paying stocks. If the company should experience a downturn or elects to decrease its dividend offerings, the dividend investors may sell their stock and reinvest the proceeds in another company paying higher returns. As a result of a sell-off, the company's share price is apt to decline.

Example of the Clientele Effect

In 2016, the CEO of Northwestern Mutual publicly announced in a press release a 45-basis-point drop in the dividend scale interest rate. This decision proved to impact the company’s dividend policy negatively. Following the disclosed plans, the company depressed its dividend rate from 5.45% to 5.00%.

Meanwhile, in 2001, Winn-Dixie slashed its dividend and altered its payment structure, opting to distribute income quarterly in arrears instead of monthly in advance. Its shareholders, many of which valued the regular current income, were not happy, and the stock tanked. Some experts see this as the clientele effect in action.