Question

One argument for high dividend payout is the desire of investors for current income. Explain why this argument does/does not work in a perfect capital market with no transaction costs. Explain how this argument does/does not work in real life. (4 marks)

Answer 1

Answer

Dividend pay out argument

The dividend payout is the amount of dividends paid to investors  relative to the amount of total net income of a company. Investors prefer high dividend payout as a source of income because it is a return for amount invested by them .Investors may prefer dividends over capital gains because they regarded dividends less risky than capital gains ,dividend denote regular income . This argument does not hold true in perfect capital market becuase it is a market in which there is no arbitrage opportunity exit.investors have enough power to change the price of an asset and all of them have access to the same information.

Also there are no taxes, and no transaction cost so we can  say that a perfect capital market doesn't exist and therefore doen not work in real life.Perfect capital market make many assumptions which are impractical in real life .In perfect market stock value adjust to new information ,In Perfect market all earn market earn same income ,they can not complete with each other properly. They dont earn superprofit therefore investor prefer capital gain instead of dividend.