"The way in which a firm distributes its earnings to shareholders will have no effect on...

"The way in which a firm distributes its earnings to shareholders will have no effect on shareholder wealth." This statement is known as

a. bird-in-the-hand theory.

b. target dividend payout theory.

c. Modigliani-Miller (MM) dividend policy irrelevancy theory.

d. wealth neutrality theory.

e. MM capital structure irrelevancy theory.

Expert Solution

a. Is wrong. Bird in the hand theory states that investord prefer dividends over returns from capital gains because capital gains are uncertain.

b. Is wrong. Target dividend payout ratio is the payout ratio company wants to achieve in long term. This theory states that changes in dividend policy can have a huge impact on stock prices.

c. Is correct. If dividend paid is less, then according to this theory, shareholders can sell part of their shares to generate required cash flow. If dividend is too high then shareholders can reinvest it again into the firm by buying more shares. According to this theory all dividend policies are same. Therefore, the way firm distributes its earnings will have no impact on shareholder wealth. Investord don't care whether return is from dividend or capital gain.

d is wrong. Wealth neutrality is not related to this.

e. Is wrong. This theory states that valuation of a firm is independent of its capital structure. If debt raised increases, then cost of equity also increases and thus value of firm can't be increased by leverage. Distribution of earnings to shareholders doesn't come under this theory.

Thus, the correct option is C. MM dividend policy irrelevancy theory

jeff jeffy answered 2 years ago

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