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28 February, 12:30

Purple Sage Producers Inc. is an oil drilling company. The company paid a dividend of $1.75 last year, and, in the past, its dividend has increased steadily by about 4% a year. Purple Sage just announced that its dividend will increase to $2.50 this year, and its share price rose from $30 per share to $33 per share immediately after the announcement.

Which of the following best explains why Purple Sage's stock price increased as it did?

a. The signaling hypothesis

b. Dividend irrelevance theory

c. The clientele effect

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  1. 28 February, 13:35
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    Option A is the correct one.

    The signaling hypothesis

    Explanation:

    The idea that many actions taken by economic agents are motivated chiefly by the wish to send a positive 'signal' to other agents, rather than by their ostensible purpose. This can be a means of overcoming the problem of asymmetric information between transactors.

    This strategy was implemented by the Purple Sage Producers Inc. and this resulted in increased stock price.
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