What it means
John Lintner interviewed corporate managers in the 1950s and found that they cared far more about the stability of dividends than about their exact level. Cutting a dividend sends a bad signal to investors, so managers avoid raising it unless they are confident the higher level can be maintained.
The model captures this with two ideas. First, each company has a target payout ratio, which is the share of profit it would like to pay out in the long run.
Second, there is a speed of adjustment: each year the company closes only part of the gap between its current dividend and its target dividend. The practical result is smoothing.
When profits jump, the dividend rises by a modest step, and when profits dip, the dividend is usually held rather than cut. Investors learn to read an increase as a signal of confidence about future earnings and a cut as a warning of serious trouble.
For finance teams the model is useful in forecasting and in setting policy. It helps predict what next year's dividend is likely to be, and it explains why dividends look so much steadier than earnings in most large companies.
It also warns that a higher dividend is a commitment, since once it is raised the board will be reluctant to lower it. The model is a description of behaviour, not a law.
Some firms pay variable dividends or rely on share buybacks instead, and the speed of adjustment differs between companies and countries. Later research has found that the pattern still holds broadly, but that buybacks have taken over part of the role dividends once played.
In practice
Real-world examples.
Example
A utility company earns more each year but raises its dividend by only a few cents at a time. The finance director explains to investors that the board will move gradually toward a 60% payout of profits. Analysts use this stated pattern to forecast the next two years of dividends with confidence.
Example
A manufacturer has a poor year, with earnings falling by 30%, yet it keeps its dividend unchanged. The board believes the downturn is temporary and wants to avoid signalling weakness. The payout ratio rises for the year, but the board accepts that because the cut would be seen as more damaging.
Example
A software firm with unpredictable profits chooses a low target payout and supplements it with occasional special dividends. This lets the board avoid committing to a high regular dividend that it might later have to cut. Investors understand that the special payments are a bonus rather than a promise.
Formula
Calculation
New dividend = old dividend + adjustment speed x (target payout ratio x earnings per share - old dividend).
Suppose last year's dividend was $1.20 per share, earnings per share are $4.00, the target payout ratio is 50% and the adjustment speed is 0.25. The target dividend = 50% x 4.00 = $2.00. The gap = 2.00 - 1.20 = $0.80. The increase = 0.25 x 0.80 = $0.20. The new dividend = 1.20 + 0.20 = $1.40 per share, so the company moves a quarter of the way to its target in one year.Case study
Seen in the real world.
Stonebridge Utilities is an illustrative, fictional company whose earnings per share jumped from $3.00 to $5.00 in one year after a new contract. The board had a target payout of 60% and last year's dividend was $1.50 per share.
Paying the full target would have meant a dividend of $3.00, double the previous year. Instead the board followed a Lintner-style rule with an adjustment speed of 0.3, raising the dividend by 0.3 x (3.00 - 1.50) = $0.45 to $1.95.
Over the next three years, in this illustrative case, the dividend approached the target step by step while earnings held steady. Investors treated each increase as a sign of confidence, and the share price reacted positively to the predictable pattern. The board also noted that if earnings had fallen back, it could have held the dividend at $1.95 rather than being forced into a cut.
Watch out
Common mistakes.
- Assuming dividends track earnings closely, when most mature companies change dividends far less than profits.
- Reading a single dividend rise as a signal of a permanent profit jump, when the model says increases are deliberately slow.
- Treating the adjustment speed as a fixed number, when it varies by company, industry and period.
Questions
People also ask.
Who was John Lintner?
He was an American economist who published a landmark study of dividend policy in 1956 based on interviews with corporate managers, and the model that bears his name came out of that research.
Why do managers avoid cutting dividends?
A cut is read by the market as bad news about the future, which can push the share price down by more than the value of the cash saved, so managers prefer to hold dividends steady through short downturns.
Does the model still apply today?
Broadly yes, though share buybacks now offer a more flexible way to return cash and have reduced the role of dividends.
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