Walters Model: Assumptions, Formula, and Dividend Relevance

Walters model explains the relationship between internal returns or rates of return on investment and the cost of capital. The theory presumes dependence between prices of shares and dividends. Walter Model was a psychologist who created a theory to explain what boosts people. He said people are roused to meet other needs, and there is a clear order of foci. The most basic need is for physical survival. The Walter model of dividend is frequently studied to understand how dividend policy decisions affect shareholder wealth. This means having food, water, shelter, and clothing. Until a person gets enough to meet these physical needs, other needs cannot be their main focus. After the need for physical survival is met, people are driven by the need for safety and security. This has been safe from harm, physical threats, financial flux, and poor health. Security and stability are vital motivators once basic survival is not steady work. With stable survival and security, people evolve, roused by the need for affinities and a sense of belonging. We all want to feel loved, related, and part of a group, whether with family, friends, or coworkers. Making social bonds and having influential affinities with others becomes a priority. Walter’s dividend model explains how a firm’s internal rate of return and cost of capital influence dividend decisions and ultimately affect firm value. Understanding Walters Model helps clarify when a firm should distribute or retain profits.

Walter Model is a vital topic for the UGC-NET Commerce Examination in depth.

In this article, the learners will learn about the following:-

• Walters Model of Dividend – Explanation
• Walters Model of Dividend Key Concepts
• Walters Model Formula
• Assumptions of the Walters Model
• Criticisms of the Walters Model
• Walter vs Gordon vs M&M: Dividend Models Compared

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Read about Maslow's hierarchy of needs theory.

Walter Model of Dividend- Explanation

Walters Model challenges the idea that dividends are always irrelevant by showing their impact on share value. Walter's dividend model told that people's needs develop on a scale, starting with lower physiological needs and moving toward self-actualization. His theory feeds a way to know why people are roused to do what they do.

The basic physiological needs include food, water, shelter, sleep, and health care. Until a person meets these needs, they will likely remain the main basis source. Walter’s Model felt these needs are the most level, saying they override all others until fulfilled to some degree.

Once physiological needs are met, people strive to fulfill safety and security needs. This includes personal and financial security and stability in relationships, employment, and health. With basic survival fairly stable, people seek safety and protection from threats.

With safety and security in place, social needs for belonging, love, and society evolve more vital. People desire social ties, private affinities, and membership in social groups. Forming affinities and earning favor from others feeds pride. The Walter’s model told these social needs to emerge after meeting physiological and safety needs.

Esteem must involve our desire for self-respect, reputation, status, credit, and competence. Gaining life goals and creating skills help fulfill esteem needs. But Walter’s Model thought esteem needs arise only after more basic needs are met.

Finally, self-actualization needs to affect rating one's full mortal prospect. Only a few people achieve self-actualization, as per the Walter’s Model. He viewed self-actualization as the apex of human pride and the climax of meeting all lower-level needs.

Read about Behaviorist Theory.

Fig: walters model

The Walter model of dividend assumes that a firm will fund all investments from retained earnings, avoiding external funding. It seems there might be a confusion in your question. Walter Model and the dividend decision are associated with two different theories in finance. The Walter Model is not a theory related to dividends; rather, it is associated with investment decisions and the valuation of a firm. On the other hand, the dividend decision is often discussed in the context of the dividend policy of a company. One key insight of Walters Model is that the relationship between r and k determines optimal dividend decisions. Let me provide you with a brief overview of both:

Walter Model (Walter's Dividend Irrelevance Model)

While sometimes misinterpreted, Walters dividend model is strictly about dividend relevance in corporate finance, not psychology or motivation. According to Walters Model, firms with high return on investment (r > k) benefit more from retaining earnings

• Earnings Retention and Investment: The Walter Model, developed by James E. Walter in 1956, is related to a firm's investment and financing decisions. The primary focus is on the relationship between a firm's internal rate of return (IRR) and the rate of return required by investors. According to the Walter’s model, if the IRR on retained earnings is greater than the required rate of return, the firm should retain earnings to finance investment projects. Conversely, if the IRR is less than the required rate of return, the firm should distribute dividends.
• Value of the Firm: The Walter Model suggests that the value of the firm is not affected by its dividend policy. The value of the firm is determined by its investment decisions and the internal rate of return on those investments.

Dividend Decision

• Dividend Policy: The dividend decision refers to the policy a company adopts regarding the distribution of profits to shareholders. Different theories and models, such as the Modigliani-Miller dividend irrelevance proposition and the residual dividend model, offer perspectives on how a firm should determine its dividend policy.
• Factors Influencing Dividend Policy: Various factors influence a company's dividend policy, including profitability, cash flow, investment opportunities, tax considerations, and the desire to maintain a stable or growing dividend payout. The decision to retain earnings for reinvestment or distribute them as dividends has implications for the firm's shareholders.

In summary, the Walter Model is associated with investment decisions and the valuation of a firm, while the dividend decision involves determining the dividend policy of a company. If you have specific questions or if there's a particular model you'd like to know more about, please provide additional details for a more accurate response. 

Read about Conformity Theory.

Walter Model Formula

Walters Model uses a mathematical formula to connect dividend payouts and firm valuation. The Walter model formula is used to determine a firm's share price based on dividends and retained earnings. To support the Walter model of dividend, a specific formula helps determine the impact of dividend and retention strategies on share price. The share price relies on two facets: dividends and retained earnings. One of the most discussed aspects of Walters dividend model is its quantitative approach to valuing share price using retained earnings. According to the Model's theory, the share price (P) equals the sum of the current dividend per share (D) plus a portion of the contrast among earnings per share (E) and the dividend (E - D). 

The portion of owned wages added to the share price depends on the firm's return on equity (r) and its cost of equity (k). The ratio of r/k defines how much-retained gains are factored into the share price. The larger the ratio of r/k, the more retained earnings will grant to the share price.

In simpler terms, the formula says:

The share price equals the recent dividend per share plus an extra amount based on how much earnings beat that tip. The extra cost is figured by taking the contrast among earnings per share and dividend per share and taking that disparity by the ratio of the firm's return on equity to its cost of equity. The higher that ratio, the more retained profits will impact the share price.

The formula grabs the idea that shares price relies on the current dividend and growth tensions based on how persuasively the firm reinvests its retained yields (as measured by return on equity). This Walter model formula highlights the role of internal profitability (r) versus cost of equity (k) in maximizing firm value.A major feature of Walters Model is its assumption that dividends and retained earnings influence market price.

So, in essence, the formula breaks down share price into two parts: the current dividend portion and the retained earnings portion based on the firm's return on equity.

Read about Functional Theory.

Assumptions of the Walter Model

Walters Model assumes that all financing is done internally, which simplifies the valuation formula. Walter’s Model is built on the idea that a firm’s dividend policy affects its market value. It assumes that internal financing through retained earnings is the only source of funds. The Walter’s model further presumes constant return on investment (r) and cost of capital (k), with no taxes or external financing involved. Beliefs are stated below.

• Physiological needs are the most basic and crucial. They must be fulfilled first before higher needs can boost behaviour.
• Safety and security needs evolve into vital motivators once physiological needs are met to some degree. People desire peace and shelter from harm.
• Social needs for love, friendship, and belongingness only occur after lower needs are well joyful. The desire for social links and affinities boosts people.
• Esteem needs for respect, trust, and action arise after more basic needs are fulfilled. Achieving goals and gaining skills and status help meet esteem needs.
• Self-actualization, or reaching one's full option, is the tallest need but the most hard to achieve. Walter’s Model believed only a minority of people achieve self-actualization.
• Human needs form a scale, with lower needs grazing a floor for higher needs. Each level must be met to some extent for the next level to occur and rouse behaviour.
• People are roused to meet needs on the scale from bottom to top - moving from bodily survival to self-fulfillment and shift. Lower needs take priority over higher needs.
• Cultural and personal contrasts exist in what needs to rouse people and how fully each need must be met before moving on to the next level. But the hierarchical idea applies broadly.
• Walters Model theory depicts human reason by defining an advance of basic needs that drive people's behaviours, goals, and life aspirations.

Read about trait theory.

Criticisms of the Walter Model

Critics of Walters Model argue that its assumptions, such as no taxes or external financing, limit its real-world use. Although the Walter model formula is elegant, it relies on the idealistic assumption of constant r and k, which may not hold in real markets. While Walter’s Model supports dividend relevance, it relies on several unrealistic assumptions. In real markets, taxes exist, external financing is often necessary, and returns fluctuate. These limitations make the model less applicable in dynamic financial environments. The criticisms are stated below.

• The hierarchy is too rigid and linear. It does not account for the fact that some needs like belongingness and esteem can arise simultaneously in people's lives.
• Not everyone moves through the needs in the same way. Cultural and unique facets affect which needs grown foci at various sets of life.
• Some needs, like esteem and self-actualization, are never fully earned by most people. Yet people are still roused by them.
• Higher needs can sometimes uplift people more firmly than lower needs. For example, the desire for esteem can override bodily needs in sure cases.
• The borders among mixed levels of needs are often blurred. The needs cannot ever be neatly split into, unlike sorts, as the Model offered.
• The walters model assumes people are roused to meet lower needs before pursuing higher ones, but a study shows this is not always true. Some people prioritize esteem or self-actualization over more basic needs.
• The concept of "self-actualization" is vague and hard to define objectively. Diverse people have erratic riffs of what it means to reach one's full option.
• The theory lacks scientific proof to support the hierarchical form of needs that the walters Model offered. It remains largely an abstract framework rather than an empirically validated walters model.
• The theory does not account for more tough causes that arise from cognitive plans, cultural forces, and nature traits. It focuses only on basic physiological and psychological needs.

Read about situational theory.

Walter vs Gordon vs M&M: Dividend Models Compared

Understanding the differences between Walters Model, Gordon’s Growth Model, and the Modigliani-Miller (M&M) Theory is essential for analyzing how dividend decisions impact the value of a firm. While all three theories address dividend relevance, they differ in their assumptions, implications, and treatment of earnings retention. This comparison helps students grasp each model's core logic—particularly useful for UGC NET, MBA finance, and competitive commerce exams.

Comparison Table: Dividend Models

Walters Model plays a foundational role in dividend relevance theories, especially before Gordon and M&M came into focus. In academic exams like UGC NET, understanding Walters dividend model along with Gordon’s and M&M is essential for evaluating dividend relevance. Unlike M&M’s irrelevance theory, Walters Model aligns with the belief that dividends can signal strong financial health

Conclusion

Walter Model's hierarchy of needs theory feeds a vital but oversimplified view of human reason. The idea of basic needs set in a hierarchy from physical to psychological gave senses into what drives people's behaviours. However, critics argue the theory is too rigid and does not account for the plight and unique contrasts in reason. Still, the theory feeds a useful framework for feeling how unmet needs at various levels shape cause and action. Model's theory has limits, but it still feeds a useful framework for thinking how unmet needs at various levels - from physical survival to self-fulfillment - shape human basis and action across contexts. Running needs across the hierarchy in age-appropriate ways can foster growth and well-being.Although Walter’s Model has limitations, it remains a key milestone in the evolution of dividend theories

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Read about Integrated Psychological Theory.

Major Takeaways for UGC NET Aspirants:-  Walter Model of Dividend: Definition: According to Walter’s Model, a firm’s internal rate of return (r) or cost of capital (k) decides the relevance of dividends to valuation. It suggests that they can affect shareholder value depending on how well the firm reinvests its earnings.  Walter Model of Dividend Related Basic Concepts: According to the model, a firm should either retain or distribute its earnings depending upon the relative position of r and k. It considers retained earnings as the only source of finance and assumes perfect conditions of capital markets.  Walter Model Formula: The formula of the Walter Model determines the market price of a share in terms of dividends, earnings, return on investment, and cost of capital. It divides the value of the firm between current dividend income and growth from retained earnings reinvested at the internal rate of return. The Walter Model Assumptions: The model assumes no external financing, constant r and k, and no taxes, rendering it simply theoretical. While these assumptions simplify the analysis, they severely limit any applicability in the real world.  Observations Against the Walter Model: The critics think that the model is idealistic in the sense that it neglects taxes, market imperfections, and external funding. These assumptions about constant return and cost of capital limit any practical application in modern financial settings. Comparison of Dividend Models-Walter vs. Gordon vs. M&M: Comparison of Dividend Models-Walter vs. Gordon vs. M&M. The comparison reveals that while Walter and Gordon assert dividend relevance, M&M considers dividend policy irrelevant in perfect markets. The contrasts help students evaluate which model stands up better in regard to real-world corporate finance.

Walters Model Previous Year Questions

1. Which of the following is true according to Walters Model of dividend relevance?
   a) Dividends have no impact on the value of the firm
   b) Retaining earnings always increases firm value
   c) If return on investment (r) > cost of capital (k), firm should retain earnings
   d) If r < k, firm should retain all profits

 Answer: c) If return on investment (r) > cost of capital (k), firm should retain earnings