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

Which statement best describes the 'bird in the hand' argument associated with Gordon and Lintner?

The bird-in-the-hand argument says investors see dividends as more certain than future capital gains, so they accept a lower required return from high-payout firms. A higher dividend payout is therefore claimed to increase share value, contrary to the M&M irrelevance view.

  1. AInvestors are indifferent between dividends and capital gains, so payout does not matter
  2. BInvestors regard dividends as less risky than uncertain future capital gains, so higher payout lowers the required return and raises share valueCorrect
  3. CCompanies should retain all profits because capital gains are taxed more lightly than dividends
  4. DA dividend increase always signals that management expects profits to fall
  5. Shareholders sort themselves into groups according to their preferred payout ratios

Explanation

The bird-in-the-hand view holds that a dividend received now is more certain than a promised future gain. Investors therefore apply a lower discount rate to firms paying higher dividends, which raises value. Option 0 is the M&M view, option 2 is the tax preference argument, and option 4 is the clientele effect.

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