Lintner's Model - Explained
What is Lintner's Model?
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Table of ContentsWhat is Lintner's Model?How is Lintner's Model Used?Lintners Model and Setting Corporate Dividends
What is Lintner's Model?
John Virgil Lintner, Jr., a professor at the Harvard Business School in the 1960s proposed the Lintner's model for corporate dividend policy called the "Lintner's dividend policy model". It proposes that, a company's current year's dividend is dependent on its current years earnings and it's last years dividend. Dividends are thus, defined as the weighted average of a company's past earnings. The model theorizes the process in which a publicly-traded company sets its dividend policy. It logically assumes that every company wants to maintain a constant rate of dividend even if the results in a particular period are not up to the benchmark. It assumes that investors will prefer to receive a particular dividend payout. The Lintner's Formula The Lintner's model can be mathematically expressed as:
Dt = Dy + af x [(Et x tp) Dy]
where: y = t - 1
Dt = the dividend per share at time (t - 1).
Dy = the dividend per share at time (t-1), i.e. last year's dividend per share
af = speed of adjustment rate or the partial adjustment coefficient, with 0 less than or equal to af less than or equal to 1.
Et = is the earnings per share (or free-cash-flow per share) at time t.
tp = the target payout ratio on earnings per share (or on free-cash-flow per share), with 0 less than or equal to tp less than or equal to 1.
Back to:BUSINESS & PERSONAL FINANCE
How is Lintner's Model Used?
Lintner's model made the assumption that a firm will have to change its dividend whenever there is a change in its earnings if the firm is consistent with its target payout. The model suggests that there are two parameters to be considered in dividend policy. These parameters are the target payout ratio and the speed at which current dividends adjust to its target. The model arrived at the following findings:
- Companies set long-run target dividend payout ratios.
- Managers are more interested in change in the dividend rather than in dividend payout.
- There is a tendency for dividends to follow earnings, but they rather follow a smoother path than earnings.
- Dividends are sticky in nature because managers are unwilling to effect dividend changes.
Lintners Model and Setting Corporate Dividends
There are three ways in which corporate dividend policy can be approached:
- No Dividends: is a viable dividends policy. In this scenario, the firm will not distribute any of its earnings as dividends to its shareholders, the firm's management will rather allocate any extra earnings towards expansion and future growth.
- Stable Dividend Policy: the firm shares its dividends at a given rate to its shareholders at set intervals. Quarterly dividend distributions are the most common. This policy can be implemented in various ways.
- Constant payout ratio dividend.
- Constant dollar dividend.
- A combination of the first two policies.
- Irregular Dividends Policy: is mostly used when a company lacks a steady inflow of liquid funds or its earnings fluctuations too much.