Dividend policies should respond to what factor according to financial theory?

Dividend policies should respond to tax code adjustments according to financial theory. This is because taxes can significantly impact the after-tax return to shareholders, influencing their perception of dividends versus capital gains. When evaluating dividend policies, a firm must consider how different tax treatments of dividends and capital gains affect shareholder wealth.

For instance, if dividends are taxed at a higher rate than capital gains, shareholders may prefer the company to retain earnings and reinvest in growth rather than distributing profits as dividends. Conversely, if dividends are taxed favorably, a company might find it advantageous to increase its dividend payouts.

Selecting the correct dividend policy requires a thorough understanding of the tax implications for shareholders, as it can directly affect the attractiveness of investing in the firm's shares. This understanding helps to align the company's dividend strategy with the interests of its investors, subsequently promoting overall shareholder satisfaction and long-term value creation.