Answer (A) is correct. Dividend policy determines the portion of net income distributed to stockholders. Corporations normally try to maintain a stable level of dividends, even though profits may fluctuate considerably, because many stockholders buy stock with the expectation of receiving a certain dividend every year. Thus, management tends not to raise dividends if the payout cannot be sustained. The desire for stability has led theorists to propound the information content or signaling hypothesis: A change in dividend policy is a signal to the market regarding management’s forecast of future
earnings. This stability often results in a stock that sells at a higher market price because stockholders perceive less risk in receiving their dividends.