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Relevance Theories

1. The bird in hand theory suggests that investors prefer dividends over capital gains due to the greater uncertainty of capital gains in the future. This leads investors to place a higher value on firms that pay dividends. 2. Signaling theory posits that management has more information about a company's current and future prospects than outsiders. Dividends act as a signal to the market about a company's present and expected profits and growth. Higher dividends signal higher future cash flows and value. 3. Agency theory recognizes the potential for conflict between managers and shareholders. Dividends reduce the free cash flow available for managers to pursue personal goals or unprofitable ventures, thereby increasing shareholder value and

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41 views1 page

Relevance Theories

1. The bird in hand theory suggests that investors prefer dividends over capital gains due to the greater uncertainty of capital gains in the future. This leads investors to place a higher value on firms that pay dividends. 2. Signaling theory posits that management has more information about a company's current and future prospects than outsiders. Dividends act as a signal to the market about a company's present and expected profits and growth. Higher dividends signal higher future cash flows and value. 3. Agency theory recognizes the potential for conflict between managers and shareholders. Dividends reduce the free cash flow available for managers to pursue personal goals or unprofitable ventures, thereby increasing shareholder value and

Uploaded by

rawan.omar
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© © All Rights Reserved
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Relevance Theories

Bird in hand theory The logic of this theory is that in light of uncertainty in the business environment,
investors always prefer to have current dividends (a bird in the hand) to capital gains (TWO in the bush)
because capital gains relate to the future which is much riskier than present dividends. Hence, investors
will be willing to pay a higher price for firms with dividend payments and as a result, maximize the value
of the firm (Gordon, 1963; Walter, 1963).

Signaling (asymmetric information) theory The essence of signaling theory is that a firm’s management
is likely to have private knowledge about the current and future situation of their company than
outsiders will have (asymmetric information). Managers use dividends as a device to deliver useful
information to the financial market about present and future profit and growth of their firm (John and
Williams, 1985). Lintner’s (1956), best known research revealed that managers are concerned about a
signal of profit distribution over time. Bhattacharya (1979) suggests that dividend payouts may function
as a signal of a company’s financial health, with an increase in dividends indicating that managers expect
their business to have a higher cash flow in the future. As consequences, a higher value is signaled by
higher dividends

Agency theory One of the assumptions of irrelevance theory is that under perfect market conditions
there is no conflict of interest between corporate insiders (managers) and outside shareholders.
However, in practice this assumption is doubtful. According to agency theory, unless earnings are
distributed to outside shareholders, they might be diverted by managers for personal utility or
committed to unprofitable ventures that provide private benefit for managers. As a result, agency cost
implies that shareholders have a preference for dividends over profit, and firms with generous dividend
payments will improve their value by decreasing the amount of funds available to managers (Rozeff,
1982; La Porta et al., 2000

https://www.researchgate.net/profile/Akram-Budagaga-
2/publication/343350075_DIVIDEND_PAYMENT_AND_ITS_IMPACT_ON_THE_VALUE_OF_FIRMS_LISTED
_ON_ISTANBUL_STOCK_EXCHANGE_A_RESIDUAL_INCOME_APPROACH/links/5f246a84458515b729f8ab
3d/DIVIDEND-PAYMENT-AND-ITS-IMPACT-ON-THE-VALUE-OF-FIRMS-LISTED-ON-ISTANBUL-STOCK-
EXCHANGE-A-RESIDUAL-INCOME-APPROACH.pdf

https://www.futa.edu.ng/journal/papers/paper_6_1509961461.pdf

https://d1wqtxts1xzle7.cloudfront.net/49100170/dividen_policy_1-with-cover-page-
v2.pdf?Expires=1638824563&Signature=XX1ihYBRLMHWB9K3SM3m~VmXtNbidPiJPlCdpi1ToL86HKGpW
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