Information Content, or Signaling, Hypothesis

A theory that holds that investors regard dividend changes as "signals" of management forecasts.  Thus when dividends are raised, this is view by investors as recognition by management of future earnings increases.  Therefore, if a firm's stock price increases with a dividend increase, the reason may not be investor preference for dividends, but expectations of higher future earnings.  Conversely, a dividend reduction may signal that management is forecasting poor earnings in the future.
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