Lintner’S Model: The Concept, Key Features, And Calculation

Concept of Lintner’s Model

The concept of Lintner’s Model is a financial model that was developed by John Lintner in 1956. It is used to analyze and predict the dividend policy of a company based on its historical dividend behavior and the company’s future earnings prospects.

The model is based on the assumption that companies aim to maintain a stable dividend payout ratio over time. The dividend payout ratio is the percentage of earnings that a company distributes to its shareholders as dividends. According to Lintner’s Model, companies adjust their dividend payments based on their target payout ratio and their expectations of future earnings.

Key Features of Lintner’s Model

Lintner’s Model has several key features that make it a useful tool for analyzing dividend policy:

  1. Stable Dividend Policy: The model assumes that companies aim to maintain a stable dividend payout ratio over time. This means that companies are unlikely to make drastic changes to their dividend payments unless there are significant changes in their earnings.
  2. Adjustment of Dividend Payments: According to the model, companies adjust their dividend payments based on their target payout ratio and their expectations of future earnings. If a company’s earnings are expected to increase, it may increase its dividend payments. Conversely, if a company’s earnings are expected to decrease, it may decrease its dividend payments.
  3. Dividend Smoothing: Lintner’s Model suggests that companies engage in dividend smoothing, which means that they try to avoid making large changes to their dividend payments. Instead, they make small adjustments to their dividend payments over time to maintain a stable payout ratio.
  4. Information Asymmetry: The model recognizes that there may be information asymmetry between the company and its shareholders. Companies may have more information about their future earnings prospects than their shareholders. Therefore, companies may adjust their dividend payments based on their private information.

Key Features of Lintner’s Model

1. Stable Dividend Policy

One of the key features of Lintner’s Model is that it assumes a stable dividend policy. This means that companies aim to maintain a consistent dividend payout over time. According to Lintner, companies are reluctant to change their dividend payments frequently as it may signal instability and negatively impact their stock prices.

2. Adjustment to Target Payout Ratio

2. Adjustment to Target Payout Ratio

Another important feature of Lintner’s Model is that companies adjust their dividend payments to reach their target payout ratio. If a company’s earnings increase, it is likely to increase its dividend payments to maintain the target payout ratio. Conversely, if earnings decrease, the company may reduce its dividend payments to align with the target ratio.

This adjustment mechanism ensures that companies maintain a balance between retaining earnings for future growth and distributing profits to shareholders.

3. Dividend Smoothing

Lintner’s Model also incorporates the concept of dividend smoothing. This means that companies prefer to avoid making large changes in dividend payments, even if their earnings fluctuate significantly. Instead, they prefer to smooth out dividend payments over time, gradually adjusting them towards the target payout ratio.

This feature helps to reduce the volatility of dividend payments and provides a more stable income stream for shareholders.

4. Influence of Past Dividends

Therefore, companies tend to increase dividends gradually over time, maintaining a consistent growth rate, even if their earnings grow at a faster pace.

Calculation of Lintner’s Model

  1. Estimating the target payout ratio: The first step in the calculation is to determine the target payout ratio, which represents the proportion of earnings that a company aims to distribute as dividends. This ratio is influenced by various factors such as industry norms, company policy, and future growth prospects.
  2. Calculating the dividend change: The next step involves calculating the change in dividends by multiplying the adjustment factor with the difference between the target payout ratio and the current payout ratio. This calculation helps in determining the amount by which dividends will change in a given period.
  3. Updating the payout ratio: After calculating the dividend change, the payout ratio is updated by adding the dividend change to the current payout ratio. This step reflects the adjustment made by the company to align its dividends with the target payout ratio.
  4. Repeating the process: The calculation process is repeated for each subsequent period, taking into account the updated payout ratio and the target payout ratio. This iterative approach allows for a dynamic analysis of dividend behavior over time.

By following these steps, analysts and investors can gain insights into how a company’s dividend policy evolves and understand the factors influencing dividend decisions. Lintner’s Model provides a framework for predicting and analyzing dividend behavior, which can be valuable for making informed investment decisions.