If you were to argue that the firm's cost of equity increases as the dividend payout decreases, you would be making an argument ________ with MM's dividend irrelevance theory, and ________ with Gordon and Lintner's "bird-in-the-hand" theory.
Click on the arrows to vote for the correct answer
A. B. C. D. E.D
The main conclusion of MM's irrelevance theory is that dividend policy does not affect the required rate of return on equity. Gordon-Lintner disagreed stating that k
(s) decreases as the dividend payout is increased because investors are less certain of receiving the capital gains which should result from retaining earnings than they are of receiving dividends. They said that investors value expected dividends more highly than expected capital gains because the dividend yield is less risky than the growth component in the total expected return equation, k(s) = D1/Po + g. MM disagreed and theorized that k(s) is independent of dividend policy, implying that investors are indifferent between dividends and capital gains. MM called the Gordon-Lintner's study the bird-in-the- hand fallacy, because MM thought the riskiness of the firm's cash flows to investors in the long run is determined by the riskiness of the operating cash flows, not by dividend policy.