This study aimed to test a rational expectations hypothesis for firms' dividend behavior by extending Lintner's model of dividends. The researchers specified an econometric model based on Lintner's work but with the addition of lagged earnings as an explanatory variable. Using panel data from US and Japanese firms, they found the rational expectations model yielded somewhat better predictions of dividend payouts in 11 of 12 industry groups based on higher R-squared values. The study concluded the rational expectations hypothesis provides an empirically testable specification of firms' dividend behavior.

1. COURSE TITLE: SEMINAR IN FINANCE COURSE CODE: MPH 622
Presentation on
Rational Expectations and The Firm’s Dividend
Behavior
By
Alice Nakamura and Masao Nakamura
University of Alberta
Published in: The Review of Economics and Statistics, 1985, pp. 606-15.
May 29, 2011

2. Why the study is conducted?
To study a rational expectation hypothesis of
management behavior. (addition of lagged earnings &
expected sign – positive).
The motivation is the econometric specifications of
Lintner’s Model where the change in dividends is
regressed on the current earnings and lagged dividends.
Research gap, specifically between Lintner (1956)
and Fama and Babiak (FB 1968).
What motivates researcher for the study?

3. The research gap in the finance literature specifically
between Lintner (1956) and Fama and Babiak (FB
1968).
Lintner’s Study:
Dividend = f(current earnings and lagged dividends)
FB’s Study:
The forecasting ability of the Lintner’s Model is
increased by adding the lagged earnings as a regressor.
Thus, the study is focus on the dividend behavior of the
firms may be described by an extension of Lintner’s
model.
What is the research gap?

4. The econometric model of the study is designed
based on the variables specified in Lintner’s Model and
FB’s work.
The model is the extension of Linter’s specification,
and
An important empirical difference between the
rational model and FB model is that the expected sign
of the coefficient of the lagged earnings variable is
negative in the rational model while in the FB model it
is positive.
The theoretical framework of the study.

5. The study is based on panel data for U.S. (1964-81=18
years) and Japanese (1961-80=20 years) firms.
The study is the extension of Lintner’s model &
additional explanatory variable is based on the FB’s
study, and the R-squared comparison is made between
Linter’s & Rational model.
What methodology is used for the study?

6. The comparison between in-sample and out-of-
sample time periods are also designed for the study
through simulation technique.
The country-wise data are classified in to two groups
i.e. pooling & endogeneity (r - independent variable
with error term) and split the data under in-sample and
out-of-sample into subgroup 1 (industry-country group
that experienced increases in EPS for 60% or more) &
subgroup 2 (remaining firms) to confirm the results.

7.  The Lintner’s Model: ...(1)
Where,
=changes in dividends
Dt = Dividends paid out in year t
= Target dividend payout
c = Speed of adjustment to the difference between the target dividend payout and last
year’s payout
a0 = Constant
ut = error term
and,
 The its extension: …. (2)
 ……………………………………… . (3)
Where,
= the permanent earnings of the firm as perceived by the management or,
The econometric models specification:
ttt uDDcaD )( 1
*
0
D
*D
ttt uDrycaD )( 10
t
pt ryD*
t
py )( xMVRy m
t
p

8.  ………………………. (4)
Where,
δ is a drift term which represent firm’s expected growth
 ………... (5)
Where,
= Additional earnings in all future periods, Et = Condt. Expectations operator
 Finally, to implement the rational model, the
following econometric model is specified and compare
with Linter’s model
……. (6)
Here, some restrictions applied: the coefficient of y1 is +ve, while yt-1 is –ve, and
11 ttt yy
))1/((1
byyE t
p
t
pt
))1/(( b
tttt cDyyaD 11210
21
b)/( 21

9. Table 1 – Estimated coefficients for the Rational and Lintner
model for U.S. and Japanese firms in selected industries
Rational
Model & t
Rational
Model & t
+ - - - + - - -
Against
the priori
sign

10. Findings:
For both countries, the
coefficients have as
per the priori sign so
that .21
For both models the
constant terms numerically
larger and statistically more
significant for Japanese
firms than for U.S. firms.
Against
the priori
sign
The results support the Lintner’s
arguments that constant term is
non-negative that indicates gradual
growth in dividend payments.
21 αα

11. Table 2- Predictive
comparisons of the
Rational and
Lintner models
The in-sample as
well as the out-of-
sample values for
R2 are higher for
the Rational model
than for the Lintner
model for 11 out of
12 industry groups
for both the U.S.
and Japan.
With this, the study
The major
conclusion is
Rational model
yields somewhat
better predictions
of the dividend
payouts of firms
Exception Exception

12. Table 3 – Predictive power tests of pooling and endogeneity

13. More specifically, under the pooling heading
there is clear evidence that Rational model
outperform whereas under the endogeneity
heading except 4 out of 11 industry groups, a
similar results emerges from the out-of-
sample subgroup.
The finding of the R2 comparison under the
Pooling and Endogeneity heading indicated
that Rational model outperforms the Lintner
model for both subgroups of the firms.

14. The study concluded that under the rational
expectations hypothesis for a firm’s management, an
econometric specification of the firm’s dividend
behavior results the inclusion of a lagged earnings
variable in the Lintner model and,
 The study provided empirically testable sign and
magnitude restrictions on the estimated coefficients of
the resulting model of dividend behavior.
What concludes from the whole analysis?

15. Strength
The detailed description of the methodology and procedures
Discussion of the basic assumptions of the OLS regression
model, and
Specified the additional explanatory variable in Lintner model,
and
Contribution to the literature
Weakness
Conclusions are based only on the R2 comparison criteria.
(By adding one extra variable in the existing Lintner model, it
gives higher R2 because the addition of new explanatory variable
in the regression model always produce the higher coefficient of
determination!)
Critical appreciation of the study

16. Thank you.