Bird-in-the-hand theory

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Bird-in-the-hand Theory

Bird-in-the-hand Theory is one of the major theories concerning dividend policy in an entreprise. This theory was developed by Myron Gordon and John Lintner as a response to Modigliani and Miller's dividend irrelevance theory.

Gordon and Lintner claimed that MM made a mistake assuming lack of impact of dividend policy on firm's cost of capital. They argued that lower payouts result in higher costs of capital. They suggested that investors prefer dividend as it is more certain than capital gains that might or might not appear if they let the firm retain its earnings. The authors indicated that the higher capital gains/dividend ratio is, the larger total return is required by investors due to increased risk. In other words, Gordon and Lintner claimed that one percent drop in dividend payout has to be offset by more than one percent of additional growth.

Bird-in-the-hand theory was criticised by Modigliani and Miller who claimed that dividend policy does not affect the firm's cost of capital and that investors are totally indifferent if they receive more dividend or capital gains. They called Gordon and Lintner's theory a bird-in-the-hand fallacy indicating that most investors will reinvest the dividend in the similar or even the same company and that company's riskiness is only affected by its cash-flows from operating assets.

Bibliography

  • Eugene F. Brigham, Louis C. Gapenski, Intermediate financial management, The Dryden Press 1990, p. 423
  • Eugene F. Brigham, Fundamentals of financial management, The Dryden Press, 1992,p. 498-499

Author: Michał Pilarczyk

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