Assume that a firm has a steady record of paying stable dividends for years.Market analysts had expected management to increase the dividend by 7.5% in the latest quarter.However,management announced a 15% increase in the current year's dividend.The market value of the stock rose 20% on the day of the announcement.Which of the following would best explain the stock market's reaction to the announcement?
A) expectations theory
B) dividend irrelevance theory
C) residual dividend theory
D) agency theory

Question

Quizplus · Accepted Answer

The market's reaction is best explained by the expectations theory, which suggests that the stock price reflects investors' expectations of the company's future earnings and dividends. The larger-than-expected dividend increase implies that the company's management is more optimistic about its future earnings growth, which led to a positive market reaction and an increase in the stock price. The other theories (dividend irrelevance theory, residual dividend theory, and agency theory) do not fully address the impact of the unexpected dividend increase on the stock price.

Assume That a Firm Has a Steady Record of Paying