# Lintner's Model

Lintner's Model focuses on how firms actually set dividends in practice — they adjust dividends gradually toward a target rather than changing them sharply each year.

## Two Key Parameters

1. The target payout ratio — the proportion of earnings the firm ideally wants to pay.

2. The speed/spread of adjustment — how quickly current dividends move toward that target.

## How It Works

Under this model, D₁ (the dividend to be paid) is computed.
The **current year's dividend depends on the current year's earnings and last year's dividend**.
A fall in dividend signals a wrong (negative) signal to the market, so firms smooth dividends and avoid cuts.

## Formula

$$D_1 = D_0 + \big[(EPS \times \text{Target payout}) - D_0\big] \times A_f$$

Where:

D₁ = Dividend in year 1
D₀ = Dividend in year 0 (last year's dividend)
EPS = Earnings per share
Af = Adjustment factor or speed of adjustment

Reading the formula: Start from last year's dividend (D₀). Compute the target dividend (EPS × target payout). The gap between target and last year's dividend is closed only partially — by the fraction Af. A higher Af means faster movement to target.

## Key Takeaway

Lintner's model captures dividend smoothing: firms are reluctant to cut dividends, so they raise them slowly and only when they believe higher earnings are sustainable.

Worked example

### Example 1

Computing next year's dividend: D₀ = ₹3, EPS = ₹10, target payout = 50%, adjustment factor Af = 0.6.\n\nTarget dividend = EPS × payout = 10 × 0.50 = ₹5.\nD₁ = D₀ + [(EPS × Target payout) − D₀] × Af\n= 3 + [(5) − 3] × 0.6\n= 3 + (2 × 0.6)\n= 3 + 1.2 = ₹4.20.\n\nThe firm moves only 60% of the way from ₹3 toward the ₹5 target — illustrating dividend smoothing.

⚠️ Common exam mistakes

Forgetting to multiply only the gap (target − D₀) by the adjustment factor — the formula adjusts the shortfall, not the whole target.
Computing the target dividend as EPS alone instead of EPS × target payout ratio.
Ignoring the role of last year's dividend (D₀) — Lintner's model is explicitly path-dependent on the prior dividend.
Assuming firms jump straight to the target payout — the adjustment factor (Af < 1) means the move is gradual.

Reference:

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