Dividend Policy Theories and their Implications

Hard Dividends And Repurchases Dividend Policy Theories

ABC Corp has been consistently paying dividends to its shareholders and has established a clear dividend policy. Recently, the management is considering altering this policy in response to changes in the market dynamics and investors' needs. According to dividend policy theories, various perspectives exist regarding the impact of dividend policies on the firm's value. Consider the following statements about three dividend policy theories:

1. The Modigliani-Miller theorem suggests that in a perfect market, the value of the firm is unaffected by its dividend policy.

2. The Bird-in-Hand theory posits that investors prefer the certainty of dividends today over the potential capital gains in the future, thereby valuing dividends more highly.

3. The Tax Preference theory indicates that investors may prefer capital gains over dividends because of favorable tax treatment on capital gains.

Given this context, which statement best represents a key insight from dividend policy theories concerning the implications for ABC Corp's proposed changes to its dividend policy?

The Modigliani-Miller theorem indicates that changing the dividend policy will have no impact on firm value.

The Bird-in-Hand theory implies that a reduction in dividends could lead to a decreased stock price due to investors' preference for immediate returns.

The Tax Preference theory suggests that increasing dividends might be beneficial if investors are more focused on capital gains taxation.

Hint

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