Question

The bird-in-hand hypothesis suggest that firms choicing to pay hiigher current dividends will enjoy higher stock prices because shareholders prefer current dividends to future ones. M&Ms response to the bird-in-hand hypothesis suggested that with perfectly priced capital markets, shareholders can generate an equivalent home-made dividend by selling stock. So, the dividend choice should matter. Is this true or false? Please justify your response as to why.

Answer 1

Answer- yes it is true that dividend option will have an effect at both ends. Before discussing the impact of dividend choice, let us understood the meaning of dividends.

Dividends is a cash flow to an investor for holding a number of shares for a particular point of time. Dividends are paid out of net profits. It is the residual which is available to common shareholders.

The Bird in Hand theory signifies that it is better to have one bird in hand rather two in bushes. It means if an investor receives periodic payout, it is better than the payout he receives only when he sells the shares.

Choice of dividend option depends upon -

1. companies growth opportunities
2. investor risk behaviour

1) If the company has ample opportunities, it can retain more of the cash for future growth. So in this case an investor can earn return only through capital appreciation. In this case an investor bears more risk and with more risk he will demand more return.So in this case an investor can earn more return

On the other hand, if company does not have ample opportunities, it can distribute more of its cash to common shareholders. In this an investor can receive regular cash flow and bears less risk.

2) If an investor is highly conservative(low ability and willingness to take risk) he can opt for dividend payout option rather than choosing reinvestment option to get regular cash flows.On the other hand, if an investor is aggressive in nature (ability and willingness to take high risk)he can opt for dividend reinvestment option for future growth.

Therefore from the above discussion, we can conclude that dividend choice matters a lot.