What Is the Clientele Effect

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 which affects the shares. The clientele effect first assumes that specific investors are preliminarily attracted to different company policies and when a company's policy alters, they will adjust their stock holdings accordingly. As a result of this adjustment, stock prices may fluctuate.

Lifespan and Clientele Effect

The most prudent way to explain the clientele effect is by describing how this phenomenon triggers investors' reactions. Public equities are typically categorized either as dividend-paying securities, high-growth stocks, blue-chip stocks or mature stocks. Each of these categories links to a specific age in the lifecycle of a business as it matures. Also, each period in the lifecycle will represent a different type of return to the investor.

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, the dividend-paying stock tends to show smaller movements in capital gains but rewards investors with stable, periodic dividends.

Two Sides of the Clientele Effect

The first side of the clientele effect describes the way in which individual investors seek out stocks from a specific category. Some investors, like the legendary Warren Buffett, seek investment opportunities in high dividend producing stocks. Other investors, 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 high-growth potential stocks. Dividend-seeking income investors may now view the company as an attractive investment. This flow of investors explains the second meaning of the clientele effect, which impacts the company's share price.

Consider a company which 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 re-invest the proceeds in another company paying higher returns. As a result of a sell-off, the company's share price is apt to decline.

Real World Example

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 producing policy negatively. Following their disclosed plans, the company depressed their dividend rate from 5.45% to 5.00%.