due_logo
Search
Close this search box.

Table of Contents

Lintner’s Model

Definition

Lintner’s Model is a theory in finance that proposes a company’s dividend payments are related to its current net earnings and the dividends it paid in the previous period. It suggests that firms aim to maintain a consistent dividend payout level, adjusting slowly to changes in earnings over time. Named after the economist John Lintner, it emphasizes the influence of long-term earnings expectations rather than short-term fluctuation in determining dividend policy.

Phonetic

The phonetics for “Lintner’s Model” is: /ˈlɪntnərz ˈmɒdl/.

Key Takeaways

<ol><li>Lintner’s Model proposes that firms have a target dividend payout ratio and both the speed at which they adjust the current dividend to that target and the level of earnings are significant factors when determining dividends.</li><li>The model indicates that changes to dividends are typically done in a gradual, steady manner. Companies are hesitant to make drastic changes to their dividends, thus maintaining a stable policy, as sudden changes could send negative signals to investors.</li><li>Lintner’s Model also posits that dividends are based on the firm’s long-term sustainable earnings rather than the current year’s net income. Therefore, dividends are only increased when there is a belief that the increase in earnings is sustainable.</li></ol>

Importance

Lintner’s Model is crucial in the realm of business and finance as it provides a theoretical framework for corporate dividend policy decision-making. It focuses on the understanding and prediction of how corporations determine dividend payout rates. This model postulates that firms have target payout ratios and they adjust their actual dividend payment gradually towards this target, emphasizing the importance of stable and predictable dividends. The constant adjustment also considers company earnings performance. Hence, it serves as a valuable tool in investment decisions, as it aids investors in forecasting future dividends, which is a key component of the stock valuation process. The model is widely applied in the sphere of portfolio and risk management, strategic planning, and financial analysis.

Explanation

Lintner’s Model is an integral element of financial management, primarily often employed to ascertain the dividend distribution of a firm. The main purpose of Lintner’s Model is to provide a structured framework to predict dividend payouts based on a company’s profitability. The model operates under key presumptions that companies emphasize smooth and regular dividends to avoid stockholder’s anxiety and protect their share price. Therefore, it is widely used as a predictive tool for identifying current and future dividend payout ratios.The primary application of Lintner’s Model lies in its utility for investors, financial managers, and stakeholders to form informed expectations regarding the firm’s dividend policy. With robust prediction of the dividend payout, stakeholders can better align their financial strategies and investment decisions. Financial managers of firms use the model to understand how changes in earnings could impact dividend payout, enabling them to avoid sudden changes in the dividend policies, ensuring stability and investor’s confidence. Hence, Lintner’s Model significantly contributes to making strategic financial decisions.

Examples

Lintner’s model posits that businesses follow a certain structure when deciding dividend payouts, choosing to focus on stable and predictable dividends and reacting slowly to changes in earnings. Here are three real-world examples:1. Tech Company: Apple Inc. is a great example of Lintner’s Model. For many years Apple did not issue dividends, but after accumulating significant surplus profit, they started distributing earnings by way of dividends in 2012. A part of those profits was held back for future investments and some were distributed among shareholders. How much to keep and how much to distribute was exactly what Lintner’s Model suggests.2. Large Retail Chain: Walmart Inc., as a large player in the retail market, adheres to its long-term policy of stable or increasing dividends. Despite economic fluctuations and varying earnings, the company aims to consistently issue dividends to satisfy its shareholders while still retaining a portion for investments, embodying the principles of the Lintner model.3. Pharmaceutical Company: Johnson & Johnson also adheres to Lintner’s model. As a well-established pharmaceutical company, it holds a long-standing policy of increasing dividends each year. Even in times of uncertainty or lower earnings, the company prioritizes maintaining dividend payouts to keep its shareholders happy. This demonstrates Lintner’s suggestion of companies wanting to avoid negative market reactions to decreased dividends.

Frequently Asked Questions(FAQ)

What is Lintner’s Model?

Lintner’s Model is a financial concept that was presented by John Lintner. It characterizes how US companies make decisions about dividends based on their net earnings. The model suggests that businesses tend to smooth out the amount they pay as dividends from year to year.

How does Lintner’s Model work?

The model proposes that firms have a target payout ratio for their earnings — that is, a specific portion of earnings they aim to pay out as dividends. Most of the time, firms adjust their dividends slowly towards this target, paying particular attention to changes in long-term sustainable earnings.

What are the key variables in the Lintner’s model?

The key variables of Lintner’s model are the target payout ratio, the speed of adjustment (how quickly firms close the gap between actual and target dividends), and changes in net earnings.

Is Lintner’s Model empirically tested?

Yes, since its proposition many empirical tests have been conducted worldwide to prove its validity. While it does have some limitations and potential areas of inaccuracy, it’s generally accepted as a good representation of how firms handle dividends.

Is Lintner’s Model used in contemporary finance?

Yes, despite being proposed in the mid-20th century, Lintner’s Model is still widely utilized in contemporary finance. It provides an essential foundation for the understanding of corporate dividend policy and behavior.

What are some limitations of the Lintner’s Model?

The limitations of the Lintner’s Model include its assumption that a firm’s dividends are mainly based on its net earnings. This doesn’t always hold true as dividends can also be influenced by factors like cash flow, financial health of the company, and future investment opportunities. Also, the model does not take into account the potential impact of share repurchases.

Can Lintner’s model be used for firms outside of the US?

While initially based on the dividend behaviors of US firms, Lintner’s model has been applied and tested across various international contexts. Adjustments may need to be made based on the specific financial environment of different countries.

Related Finance Terms

  • Dividend Payout Ratio: The percentage of earnings distributed as dividends to shareholders.
  • Retention Ratio: Part of the company’s earnings that is not paid out as dividends but is retained by the company to reinvest in core operations or pay debt.
  • Desired Dividend Payment: The dividends that a firm plans to pay out to its shareholders in a specific period.
  • Adjustment Speed: It refers to the pace at which actual dividends adjust towards the desired level of dividends.
  • Net Earnings: The profit of a company after all expenses, including taxes and costs, have been paid.

Sources for More Information

About Due

Due makes it easier to retire on your terms. We give you a realistic view on exactly where you’re at financially so when you retire you know how much money you’ll get each month. Get started today.

Due Fact-Checking Standards and Processes

To ensure we’re putting out the highest content standards, we sought out the help of certified financial experts and accredited individuals to verify our advice. We also rely on them for the most up to date information and data to make sure our in-depth research has the facts right, for today… Not yesterday. Our financial expert review board allows our readers to not only trust the information they are reading but to act on it as well. Most of our authors are CFP (Certified Financial Planners) or CRPC (Chartered Retirement Planning Counselor) certified and all have college degrees. Learn more about annuities, retirement advice and take the correct steps towards financial freedom and knowing exactly where you stand today. Learn everything about our top-notch financial expert reviews below… Learn More