The role of investor preferences for dividends and the value of a firm are pieces of the dividend puzzle, which is the subject of much academic debate. Assuming dividend relevance, coming up with a dividend policy is challenging for the directors and financial manager of a company because different investors have different views on present cash dividends and future capital gains. Investor preferences are first split between choosing dividend payments now, or future capital gains in lieu of dividends. Further elements of the dividend policy also include:1. High versus low payout, 2. Stable versus irregular dividends, and 3. Frequency of payment. Cash dividends provide liquidity, but the bonus share will bring capital gains to the shareholders. The investor's preference between the current cash dividend and the future capital gain has been viewed in kind.
Many people hold the opinion that the future gains are more risky than the current dividends, as the "Bird-in-the-hand Theory" suggests. This view is supported by both the Walter and Gordon models, which find that investors prefer those firms which pay regular dividends, and such dividends affect the market price of the share. Gordon's dividend discount model states that shareholders discount the future capital gains at a higher rate than the firm's earnings, thereby evaluating a higher value of the share. In short, when the retention rate increases, they require a higher discounting rate.
In contrast, others (see Dividend Irrelevance Theory) argue that the investors are indifferent between dividend payments and the future capital gains. Therefore, the content of a firm's dividend policy has no real effect on the value of the firm.
Investor preferences play an uncertain role in the "dividend puzzle," which refers to the phenomenon of companies that pay dividends being rewarded by investors with higher valuations, even though according to many economists, it should not matter to investors whether or not a firm pays dividends. There are a number of factors, such as psychology, taxes, and information asymmetries tied into this puzzle, which further complicate the matter.
Stock Market
Different kinds of investors are active in stock market.