How is that both Dividend Preference (high payout ratio) and Tax Aversion (low payout ratio) theories results in increase in firm value and decrease in cost of equity capital ? A bit confused here.
With dividend preference, required return decreases because investors are more certain of having a return from the stock in the form of a dividend. Whether or not they ultimately have a gain on the stock is less certain. Bird in the hand as opposed to two in the bush. Higher preference for certain dividends over uncertain capital gains --> req. return decreases, r-g spread decreases, and stock price goes up. Tax Aversion reasons for req. return decrease aren’t spelled out as clearly, but essentially if all investors are tax averse, they will NOT want to incur taxes on a regular basis through dividends. If they were getting taxed on dividends they didn’t want, they would demand more capital appreciation on the stock to compensate them (i.e. higher req. return). With no dividends, they demand less capital appreciation since there are no taxes to be offset from dividends --> req. return decreases.