Question

Which one of the following firms is most likely to use retention? A. A closely held firm B. A firm with a high level of financial leverage C. A publicly traded and widely held firm D. A small firm

i choose A

Answer 1

Retention ratio denotes the fraction of earnings in the business which is held back in the form of retained earnings. This portion of earnings is used to grow the business and expand its activity rather than being distributed as dividends among the shareholders.

Since in a closely held company, a small group of individuals (usually a family or a similar closed and small unit) own the majority of shares and only a small fraction of it is available to the outsiders and general public, thus most of the earnings can be used as a retention. This is so because all the decision making and managerial decisions are made only by a few shareholders who actually own and run the firm.

Hence a closely held firm is most likely to use retention as a tool.