The Birdinthe Hand Fallacy

One reason given for the view that investors prefer dividends to capital gains is that dividends are certain, whereas capital gains are uncertain. Proponents of this view of dividend policy feel that risk averse investors will therefore prefer the former. This argument is flawed. The simplest counter-response is to point out that the choice is not between certain dividends today and uncertain capital gains at some unspecified point in the future, but between dividends today and an almost equivalent amount in price appreciation today. This comparison follows from our earlier discussion, where we noted that the stock price dropped by slightly less than the dividend on the ex-dividend day. By paying the dividend, the firm causes its stock price to drop today.

Another response to this argument is that a firm's value is determined by the cash flows from its projects. If a firm increases its dividends but its investment policy remains unchanged, it will have to replace the dividends with new stock issues. The investor who receives the higher dividend will therefore find himself or herself losing, in present value terms, an equivalent amount in price appreciation.

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