Which of the following statements about dividend is NOT true? _____ Bird-in-the-

Question

Which of the following statements about dividend is NOT true? _____ Bird-in-the-hand theory says that investors think dividends are less risky than potential future capital gains, so they like dividends. Tax preference theory indicates that low dividend payments mean higher capital gains. Capital gains taxes are lower than dividend taxes, and they can be deferred. So investors prefer low-dividend-payments or non-dividend-payments firms. Based on the Bird-in-the-hand theory, a firm should set high dividend payout ratio to increase firm value. Based on the Tax preference theory, a firm should pay more dividends to increase firm value.

Explanation / Answer

Bird-in-the-hand theory   believes that dividend is less risky to the investor than uncertain future capital gain and investors prefer higher dividend paying firms than lower dividend paying firms. Th theory also postulates that higher dividend payout together with dividend growth rate increases value of the firm. So first and third statements are true.

Tax preference theory believes that invstors prefer capital gains over dividends as capital gains attract less tax than dividends. So investors prefer lower or no dividend paying firms. The theory also postualtes that lower dividend payout reduces the tax and cost of capital and therfore lower dividend payout lowers the cost of capital and increases the valuation of firm. Therefore second statement is true but the fourth statement that 'Based on the Tax preference theory, a firm should pay more dividends to increase firm value ' is not TRUE.

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