Fama And Baudner's Pioneer Model For Dividend Smoothing

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In his pioneer model for dividend smoothing, Lintner (1956) proposed that firms in general have a long-run target payout ratio. The role of the managers is to gradually adjust firm payment of dividends toward the target. However, in this model adjustments are partial because they are not free and the firm has to incur a cost for the adjustment. The Lintner model for partial adjustment is given by:

Dit – Dit-1 = ai + ci (D*it – Dit-1) + εit (1)

where Dt and Dt-1 are dividend payments at times t and t-1, D*it = riEit and r is the target payout ratio, and Et is the current year net profits. Thus, D*it are the current firm’s dividend payout if the firms dividend policy were based only on the target payout ratio ri as a fraction of net profits. The coefficient ci is a percentage representing the difference between the target dividend, D*it, and the dividend payout that occurred in the previous year: the coefficient shows the increase or decrease in dividend payout from the previous year, and Lintner called it the speed-of-adjustment factor. The constant ai has generally a positive value,
…show more content…
In their formulation, for a firm i in period t, they substitute D*it = riEit in …show more content…
As in the general Lintner’s model, the lower the SOA, the higher the level of dividend smoothing in the sample. A high SOA would indicate that firms in the sample under study have a low level of smoothing. Leary and Michaely concluded that the Lintner’s model, as in equation (3), or models directly derived from that one, as those developed by Fama and Babiak (1968), are not accurately reflecting modern firms’ dividend payout policies. As a consequence, the SOA must be redesigned so that it can reflect more precisely firms’ payout

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