What Is the Lintner Model?
Let me explain the Lintner model to you—it's an economic formula designed to figure out the best dividend policy for a corporation. John Lintner, a former professor at Harvard Business School, came up with this in 1956. The model zeros in on two main ideas: the target payout ratio for dividends and how quickly current dividends move toward that target.
It started out as a way to describe how companies actually handle their dividends based on observations, but now people use it as a guide for what companies should do with their dividend policies.
Key Takeaways
Here's what you need to know: the Lintner model gives you a formula to determine the right dividend policy for a firm. It emphasizes the target ratio of dividends to earnings and the time it takes for dividends to stabilize after an increase. If a company's board follows this, they can assess how well their dividend policy is working.
Understanding the Lintner Model
The formula for a mature company's dividend payout looks like this: Dt = k + PAC (TDt - Dt-1) + et, where D is the dividend, Dt is the dividend at time t (changed from the previous period t-1), PAC is the partial adjustment coefficient less than 1, TD is the target dividend, k is a constant, and et is the error term.
John Lintner created this model in 1956 after studying 28 large public manufacturing companies inductively. Even though Lintner is no longer with us, his model is still the go-to reference for how dividends evolve in companies over time.
From his observations, companies set long-term targets for dividends relative to earnings, based on positive NPV projects they have. Earnings boosts aren't always permanent, so managers hold off on changing dividend policies until they're sure the new levels will stick.
Every company wants to keep dividends steady to build shareholder wealth, but business ups and downs mean they have to plan dividends long-term around their target ratio. Using Lintner's formula, the board decides on dividends based on current net income, but they tweak for shocks and slowly adapt to income changes.
The Lintner Model and Setting Corporate Dividends
The board of directors handles setting the dividend policy, including payout rates and distribution dates. Shareholders don't get a vote on this, unlike mergers, acquisitions, or executive pay.
There are three primary ways companies approach dividend policies. First, the residual approach: dividends come from whatever equity is left after funding projects, and companies try to keep their debt-to-equity ratios balanced before paying out.
Second, the stability approach: boards set quarterly dividends as a portion of annual earnings to cut down on investor uncertainty and provide reliable income.
Third, a hybrid of residual and stability: the board treats the debt-to-equity ratio as a long-term target, setting a small, maintainable base dividend from yearly income, plus extra payouts only when earnings are unusually high.
