Question

yron Gordon and John Lintner argued that the cost of equity, rs, as the dividend payout is increased because investors are less certain of receiving that should result from retaining earnings than they are of receiving . MM named this theory the bird-in-the-hand fallacy. MM believed that the cost of equity was independent of dividend policy, which implies that investors are indifferent between dividends and capital gains.?

Answer 1

Modigliani and Miller, the principle proponents of the dividend irrelevance theory, called the Gordon-Lintner theory the bird in hand fallacy. The argued that Gordon-Lintner believed investors would view dividends as safer and less riskier than stocks because they had the bird in the hand and not in the bush.

While Modigliani and Miller argued that investors (specially corporate investors) almost always reinvest dividends in stock which have similar risks. So dividends are in no way safer investment than stocks. They proposed that a firm's value depends only on the income its assets can produce.

MM's theory has only been proven under very specific circumstances and cannot be applied to the general stock market.