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Speed of Adjustment and the Safety Factor in Lintner's Dividend Model
John Lintner was a professor at the Harvard Business School who had researched on the factors that guide a company's dividend payout policy. Lintner came up with a formula for determining an optimal corporate dividend policy. His dividend policy model is founded on the principle that all companies tend to grow the dividend payouts to a target level and this process starts slowly in the beginning but takes a certain speed with passing time. This speed is known as the speed of adjustment.
However, it has also been observed that there is a danger in increasing the speed of adjustment abruptly. That is why, the companies follow a certain speed and a factor that limits the speed acquired by the companies in increasing the dividend payout. This factor that keeps the management under control while increasing the dividend payouts is known as the safety factor.
The Speed of Adjustment
It is a fact that shareholders usually desire to get as much income as possible from their investment in a company. So, the companies are compelled to pay the maximum dividends they can afford while satiating the desires of the shareholders. However, companies cannot take dividend decisions without considering slime aspects of payment.
For example, once the payout of dividends is increased, companies cannot bring it down in the near future. If they do so, it will act as a cut in the salary for some investors. Therefore, the companies should increase the dividend payout slowly and gradually. This speed is related to the current and future earnings of a firm and is known as the speed of adjustment of dividend payout in Lintner’s model.
The safety factor is like a valve that keeps a check on the speed of adjustment and it depends on the factors like earnings per share, rate of income and current earnings. This factor is related to the firm’s increase in dividend payout over passing time and it has an influence over the speed of adjustment.
So, what is the use of the safety factor? The safety factor is a very important factor in keeping the speed of adjustment under control. If the safety factor is ignored, the speed of adjustment may go abruptly high or too low, derailing the entire dividend payout model for a long period. Therefore, the safety factor is as important as the speed of adjustment.
By keeping a check on the speed of adjustment and the safety factor, a company can move towards the target payout without any risk and loss of control over the process. Both of these factors are related to dividend payout policy and help the management in devising a perfect dividend payout plan.
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