Lintner’s Model, also known as the Lintner Dividend Model, is a theory developed by John Lintner in 1956 that explains how companies decide on the amount of dividends to pay to their shareholders. The model suggests that firms have a target payout ratio (the proportion of earnings they aim to distribute as dividends) and that they adjust their dividends gradually toward this target rather than making abrupt changes.

Key Concepts of Lintner’s Model:

1. Target Payout Ratio:
   • Lintner proposed that companies have a target payout ratio, which is the percentage of earnings they aim to distribute to shareholders as dividends. This ratio is influenced by factors such as the company’s profitability, growth opportunities, and the preferences of its shareholders.
2. Smoothing of Dividends:
   • According to Lintner, companies prefer to “smooth” their dividends, meaning they are reluctant to make large changes to dividend payments from one period to the next. Instead, they adjust dividends gradually toward the target payout ratio over time. This smoothing behavior reflects management’s desire to maintain stable and predictable dividends.
3. Partial Adjustment Mechanism:
   • Lintner’s model incorporates a partial adjustment mechanism, where the change in dividends is only a fraction of the difference between the current dividend and the target dividend based on the target payout ratio. This means that if a company’s earnings increase significantly, it will raise dividends, but typically only by a portion of the increase, reflecting the desire for stability.
4. Formula of Lintner’s Model:
   • The model can be expressed mathematically as: Dt=Dt−1+α×(Et×r−Dt−1)D_t = D_{t-1} + \alpha \times (E_t \times r – D_{t-1})Dt​=Dt−1​+α×(Et​×r−Dt−1​) Where:
     • DtD_tDt​ is the dividend in the current period.
     • Dt−1D_{t-1}Dt−1​ is the dividend in the previous period.
     • $\alpha$ is the speed of adjustment (a number between 0 and 1) indicating how quickly the firm moves toward its target payout ratio.
     • EtE_tEt​ is the earnings in the current period.
     • $r$ is the target payout ratio.
5. Implications of the Model:
   • Stability: The model suggests that companies prioritize dividend stability and are cautious about increasing dividends unless they are confident that higher earnings can be sustained.
   • Signal to Investors: Changes in dividends, according to the model, can signal management’s expectations about future earnings. A dividend increase might indicate confidence in sustained profitability, while a cut could signal concerns about future earnings.
6. Empirical Support:
   • Lintner’s research, based on interviews with corporate managers, found that firms generally follow the behavior described by his model. They aim for stable dividends and gradually adjust payouts in response to changes in earnings.

Example of Lintner’s Model in Action:

• Company Earnings and Dividend Policy: Imagine a company with a target payout ratio of 50% and a current dividend of $2 per share. If the company’s earnings increase, the management might decide to raise the dividend, but rather than doubling the dividend immediately to $4 (which would reflect a 50% payout of the new earnings), they might increase it only to $2.50 or $3, reflecting the partial adjustment mechanism. Over time, if earnings remain stable, the company would continue to increase dividends until they reach the target payout ratio.

Conclusion:

Lintner’s Model provides a framework for understanding how companies decide on dividend payments. It emphasizes the importance of a target payout ratio and the tendency of firms to adjust dividends gradually toward this target rather than making abrupt changes. The model has been influential in explaining why companies tend to maintain stable dividends and how changes in dividends can signal management’s expectations about future earnings.