Skip to content

IAI Actuarial Core Principles · Business Finance · Capital structure and dividend policy

Which argument is the central claim of the 'bird in the hand' theory of dividends associated with Gordon and Lintner?

The bird-in-the-hand theory holds that investors regard current dividends as more certain than future capital gains, so they accept a lower required return on high-payout shares, meaning a higher payout reduces the cost of equity.

  1. AInvestors value near-term dividends more than uncertain future capital gains, so higher payout lowers the required return on equityCorrect
  2. BInvestors prefer capital gains because they are taxed later, so lower payout lowers the required return
  3. CDividends convey no information to the market about future earnings
  4. DCompanies pay dividends only to reduce agency costs from surplus cash
  5. Shareholders are indifferent between dividends and retentions because they can create homemade dividends

Explanation

The bird-in-the-hand view treats dividends as less risky than future capital gains, so investors discount them at a lower rate and a higher payout reduces the cost of equity. The other options describe tax preference, signalling absence, agency theory or MM irrelevance.

Did you get it right without looking?

One question tells you little. A timed set on Capital structure and dividend policy shows your real accuracy, how long you take and where you lose marks.

Practise Capital structure and dividend policyFree diagnostic mock

More Capital structure and dividend policy questions