Bird in Hand

The essence of the bird-in-the-hand theory of dividend policy (advanced by John Litner in 1962 and Myron Gordon in 1963) is that shareholders are risk-averse and prefer to receive dividend payments rather than future capital gains. Shareholders consider dividend payments to be more certain that future capital gains – thus a “bird in the hand is worth more than two in the bush”. Gorden contended that the payment of current dividends “resolves investor uncertainty”. Investors have a preference for a certain level of income now rather that the prospect of a higher, but less certain, income at some time in the future.The key implication, as argued by Litner and Gordon, is that because of the less risky nature dividends, shareholders and investors will discount the firm’s dividend stream at a lower rate of return, “r”, thus increasing the value of the firm’s shares. According to the constant growth dividend valuation (or Gordon’s growth) model, the value of an ordinary share, SV0 is given by: SV0 = D1/(r-g) Where the constant dividend growth rate is denoted by g, r is the investor’s required rate of return, and D1, represents the next dividend payments.
Thus the lower r is in relation to the value of the dividend payment D1, the greater the share’s value. In the investor’s view, according to Linter and Gordon, r, the return from the dividend, is less risky than the future growth rate g. M&M argued against this and referred to it as the bird-in-the-hand fallacy. In their irrelevancy model, M&M assume that the required rate of return or cost or capital, r, is independent of dividend policy. They maintain that a firm’s risk (which influences the investor’s required rate of return, r) is a function of its investment and financing decisions, not its dividend policy.M&M contend that investors are indifferent between dividends and capital gains – that is, they are indifferent between r and g is the dividend valuation model. The reason for this indifference, according to M&M, is that shareholders simply reinvest their dividends in share of the same or similar risk companies.
Dividend Signaling Theory In practice, change in a firm’s dividend policy can be observed to have an effect on its share price – an increase in dividend producing an increasing in share price and a reduction in dividends producing a decrease in share price.This pattern led many observers to conclude, contrary to M&M’s model, that shareholders do indeed prefer dividends to future capital gains. Needless to say M&M disagreed. The change in dividend payment is to be interpreted as a signal to shareholders and investors about the future earnings prospects of the firm. Generally a rise in dividend payment is viewed as a positive signal, conveying positive information about a firm’s future earning prospects resulting in an increase in share price.Conversely a reduction in dividend payment is viewed as negative signal about future earnings prospects, resulting in a decrease in share price. DIVIDEND AS A RESIDUAL There is school of thought which regards dividends as a residual payment.

They believe that the dividend pay-out is a function of its financing decision. The investment opportunities should be financed by retained earnings. Thus internal accrual forms the first line of financing growth and investment. If any surplus balance is left after meeting the financing needs, such amount may be distributed to the shareholders in the form of dividends.Thus, dividend policy is in the nature of passive residual. In case the firm has no investment opportunities during a particular time period, the dividend pay-out should be 100%. A firm may smooth out the fluctuations in the payment of dividends over a period of time.
The firm can establish dividend payments at a level at which the cumulative distribution over a period of time corresponds to cumulative residual funds over the same period. This policy smoothens out the fluctuations of dividend pay-out due to fluctuations in investment opportunities.

myhomeworkgeeks (28431)
New York University

Click Here to Hire an Expert

Hire Verified Expert

Calculate the price of your order

550 words
We'll send you the first draft for approval by September 11, 2018 at 10:52 AM
Total price:
The price is based on these factors:
Academic level
Number of pages
Basic features
  • Free title page and bibliography
  • Unlimited revisions
  • Plagiarism-free guarantee
  • Money-back guarantee
  • 24/7 support
On-demand options
  • Writer’s samples
  • Part-by-part delivery
  • Overnight delivery
  • Copies of used sources
  • Expert Proofreading
Paper format
  • 275 words per page
  • 12 pt Arial/Times New Roman
  • Double line spacing
  • Any citation style (APA, MLA, Chicago/Turabian, Harvard)

Our guarantees

Delivering a high-quality product at a reasonable price is not enough anymore.
That’s why we have developed 5 beneficial guarantees that will make your experience with our service enjoyable, easy, and safe.

Money-back guarantee

You have to be 100% sure of the quality of your product to give a money-back guarantee. This describes us perfectly. Make sure that this guarantee is totally transparent.

Read more

Zero-plagiarism guarantee

Each paper is composed from scratch, according to your instructions. It is then checked by our plagiarism-detection software. There is no gap where plagiarism could squeeze in.

Read more

Free-revision policy

Thanks to our free revisions, there is no way for you to be unsatisfied. We will work on your paper until you are completely happy with the result.

Read more

Privacy policy

Your email is safe, as we store it according to international data protection rules. Your bank details are secure, as we use only reliable payment systems.

Read more

Fair-cooperation guarantee

By sending us your money, you buy the service we provide. Check out our terms and conditions if you prefer business talks to be laid out in official language.

Read more
Have a homework question? Get help from verified tutors now!
error: Content is protected !!

Are You Looking For Assignment Help? We Can Certainly Assist You