Accounting
Textbooks
Boundless Accounting
Reporting of Stockholders' Equity
Dividend Policy
Accounting Textbooks Boundless Accounting Reporting of Stockholders' Equity Dividend Policy
Accounting Textbooks Boundless Accounting Reporting of Stockholders' Equity
Accounting Textbooks Boundless Accounting
Accounting Textbooks
Accounting
Concept Version 8
Created by Boundless

Investor Preferences

The significance of investors' dividend preferences is a contested topic in finance that has serious implications for dividend policy.

Learning Objective

  • Identify the criteria that define a company's dividend policy


Key Points

    • Elements of dividend policy include: paying a dividend vs reinvestment in company, high vs low payout, stable vs irregular dividends, and frequency of payment.
    • Some are of the opinion that the future gains are more risky than the current dividends, so investors prefer dividend payments over capital gains. Others contend that dividend policy is ultimately irrelevant, since investors are indifferent between selling stock and receiving dividends.
    • Assuming dividend relevance, coming up with a dividend policy is challenging for the firms because different investors have different views on present cash dividends and future capital gains.
    • Importance of the content and the stability of a dividend policy are subject to much academic debate.

Terms

  • capital gains

    Profit that results from a disposition of a capital asset, such as stock, bond, or real estate due to arbitrage.

  • dividend

    A pro rata payment of money by a company to its shareholders, usually made periodically (e.g., quarterly or annually).

  • dividend policy

    A firm's decisions on how to distribute (or not distribute) their earnings to their shareholders.


Full Text

The role of investor preferences for dividends and the value of a firm are pieces of the dividend puzzle, which is the subject of much academic debate. Assuming dividend relevance, coming up with a dividend policy is challenging for the directors and financial manager of a company because different investors have different views on present cash dividends and future capital gains. Investor preferences are first split between choosing dividend payments now, or future capital gains in lieu of dividends. Further elements of the dividend policy also include:1. High versus low payout, 2. Stable versus irregular dividends, and 3. Frequency of payment. Cash dividends provide liquidity, but the bonus share will bring capital gains to the shareholders. The investor's preference between the current cash dividend and the future capital gain has been viewed in kind.

Many people hold the opinion that the future gains are more risky than the current dividends, as the "Bird-in-the-hand Theory" suggests. This view is supported by both the Walter and Gordon models, which find that investors prefer those firms which pay regular dividends, and such dividends affect the market price of the share. Gordon's dividend discount model states that shareholders discount the future capital gains at a higher rate than the firm's earnings, thereby evaluating a higher value of the share. In short, when the retention rate increases, they require a higher discounting rate.

In contrast, others (see Dividend Irrelevance Theory) argue that the investors are indifferent between dividend payments and the future capital gains. Therefore, the content of a firm's dividend policy has no real effect on the value of the firm.

Investor preferences play an uncertain role in the "dividend puzzle," which refers to the phenomenon of companies that pay dividends being rewarded by investors with higher valuations, even though according to many economists, it should not matter to investors whether or not a firm pays dividends. There are a number of factors, such as psychology, taxes, and information asymmetries tied into this puzzle, which further complicate the matter.

Stock Market

Different kinds of investors are active in stock market.

[ edit ]
Edit this content
Prev Concept
Stock Dividends vs. Cash Dividends
Accounting Considerations
Next Concept
Subjects
  • Accounting
  • Algebra
  • Art History
  • Biology
  • Business
  • Calculus
  • Chemistry
  • Communications
  • Economics
  • Finance
  • Management
  • Marketing
  • Microbiology
  • Physics
  • Physiology
  • Political Science
  • Psychology
  • Sociology
  • Statistics
  • U.S. History
  • World History
  • Writing

Except where noted, content and user contributions on this site are licensed under CC BY-SA 4.0 with attribution required.