What are Gordon's arguments regarding uncertainty of Capital Gains?

Finance ManagementBanking & FinanceGrowth & Empowerment

According to Myron Gordon, uncertainty increases with futurity. That is, with lapse of time, the certainty of getting a certain dividend gets diminished in value. Gordon argues that as the appropriate discount rate cannot be constant in the longer term, the payouts in the near future would be worth more than the ones in the distant future.

Investors are almost always risk-averse in nature and they would prefer near-term dividends that have a lesser discount rate applicable than the dividends that are discounted more for being distant in nature. In other words, the shareholders would prefer a share that pays them a bit less in the near future than the ones that will pay more in the longer terms. It is an argument that supports the bird in the hands theory.

What is the Bird-in-the-Hands Theory?

The bird-in-the-hands theory argues that a bird in the hand is worth two in the bush. That applies to dividend policy too. In the dividend policy, it is meant to prefer the near term dividends with less premiums than the longer term ones with heavier premiums.

Gordon’s Contribution

According to Gordon, the further one looks into the future, the more will be the uncertainty of a certain payout. Therefore, investors would prefer dividends that are assured than the ones that only state a good payout. For this reason, the firms would need to pay shareholders more of near term dividends to stay competitive in the market.

Investors would actually tend more to investor in shares that pay more current dividends than the ones that will pay dividends later. This is a direct takeout from the fact that risk and uncertainty plays key roles in the valuation of shares. Therefore, investors will follow the bird in the hand arguments more closely to profit from their investments.

Conclusion

The bird-in-the-hand theory was put forward first by Kishman. However, Gordon offered some of the most convincing arguments to prove it. Gordon’s association of time preference of investors is found in almost all share-market situations. Investors prefer shares that pay them the dividends earlier rather than the ones that make it later.

The bird-in-the-hand theory and Gordon’s contribution will remain one of the most influential theories in dividend policies. As one of the most relevant aspects of dividend policy of corporate firms, the bird in the hand theory and Gordon’s contributions will remain attractive for the investors irrespective of the time it is used in the context of share markets and investment projects of firms everywhere.

raja
Updated on 31-Mar-2022 08:26:04

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