Lintner’s Model

Lintner’s model explains how firms set and adjust dividend payments over time. Introduced by John Lintner in 1956 after studying large public firms, it captures the observed tendency of companies to “smooth” dividends — moving gradually toward a target payout rather than making abrupt changes.

Core idea

• Firms have a long-run target dividend (or target payout ratio).
• Actual dividends adjust partially and gradually toward that target because managers wait for earnings changes to prove sustainable.
• The pace of adjustment is governed by a partial-adjustment coefficient between 0 and 1.

Common formulations

Two equivalent representations are often used.

1) Change form
ΔD_t = c + λ (D*t − D{t−1}) + ε_t

2) Level form (derived)
D_t = (1 − λ) D_{t−1} + λ D*_t + c + ε_t

Where:
– D_t = dividend at time t
– D_{t−1} = dividend at time t−1
– D*t = target dividend at time t (often target payout ratio × earnings)
– ΔD_t = D_t − D{t−1}
– λ (0 < λ < 1) = partial-adjustment coefficient (speed of adjustment)
– c = constant
– ε_t = error term

Interpretation: λ close to 0 → slow adjustment (strong smoothing). λ close to 1 → fast adjustment (less smoothing).

Lintner’s empirical observations

• Firms set long-run target payout ratios that reflect available positive-net-present-value investment opportunities.
• Managers avoid large dividend increases until higher earnings appear sustainable.
• Dividend policies emphasize stability; firms prefer steady, predictable dividends and adjust payouts gradually around a target.

Practical implications for corporate dividend policy

• Boards use current earnings to inform dividend decisions but adjust cautiously to avoid reversing payouts if earnings prove temporary.
• The model provides a simple framework to evaluate whether a firm is moving efficiently toward its target payout and how conservative its dividend policy is.
• Analysts can use the model to forecast dividends, infer managers’ target payout and adjustment speed, and assess dividend-smoothing behavior.

Approaches to setting dividends (context)

• Residual approach: Pay dividends from leftover equity after funding investment projects; prioritizes maintaining capital structure.
• Stability approach: Maintain steady dividends (e.g., constant quarterly payments as a fraction of annual earnings) to reduce investor uncertainty.
• Hybrid approach: Maintain a modest base dividend and pay supplemental dividends when earnings exceed typical levels.

Key takeaways

• Lintner’s model formalizes dividend smoothing: firms target a payout but adjust only partially each period.
• The partial-adjustment coefficient measures how quickly firms close the gap between actual and target dividends.
• The model remains a foundational tool for understanding and forecasting dividend behavior and for shaping dividend-policy discussions.