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Lintners Model and Radical approach

Lintners Model and Radical approach

The classic study of the actual dividend behavior was  done by John Lintner in 1956. The study was conducted in two stages. First, he conducted a series of interviews with businessmen to form a view of how they went about their dividends decisions. He then formed a model on the basis of those interviews which could be tested on a larger data. His formula is

Lintner’s Model

D1 = D0 + [(EPS X Target Payout) – D0] X AF

Where

D1 = Dividend in year 1

D0 = Dividend in year 0

EPS = Earning Per Share

AF = Adjustment Factor

Lintner model has two parameters:

(1) The target pay-out ratio and

(2) The spread at which current dividends adjust to the target.

From the interviews he conducted, it emerged that investment needs were not a major consideration in the determination of dividend policy, rather the decision to change the dividend was usually a response to a significant change in earnings which had disturbed the existing relationship between earnings and dividends. Lintner concluded that

(1) Companies tend to set long run target dividends-to-earning ratios according to the amount of positive net present value (NPV) project that are available.

(2) Earning increases are not always sustainable. As a result, dividend policy is not changed until managers can see that new earnings level are sustainable.

Radical Approach

This approach takes into consideration the tax aspects on dividend i.e. the corporate tax and the personal tax. Also it considers the fact that tax on dividend and capital gains are taxed as different rate. The approach is based on one premise that if tax on dividend is higher than tax on capital gains, the share of the company will be attractive if the company is offering capital gain. Similarly, if tax on dividend is less than the tax on capital gains, i.e. company offering dividend rather than capital gains, will be priced better.

Lintners Model

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