DP9479 Bank Capital and Dividend Externalities

Author(s): Viral V. Acharya, Hanh Le, Hyun Song Shin
Publication Date: May 2013
Keyword(s): externalities, financial crises, franchise value, risk-shifting
JEL(s): G01, G21, G24, G28, G32, G35, G38
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9479

While losses were accumulating during the 2007-09 financial crisis, many banks continued to maintain a relatively smooth dividend policy. We present a model that explains this behavior in a setting where there are financial externalities across banks. In particular, by paying out dividends, a bank transfers value to its shareholders away from its creditors, who in turn are other banks. This way, one bank's dividend payout policy a ects the equity value and risk of default of otther banks. When such negative externalities are strong and bank franchise values are not too low, the private equilibrium can feature excess dividends relative to a coordinated policy that maximizes the combined equity value of banks.