DP9865 Bank Capital and Dividend Externalities

Author(s):	Viral V. Acharya, Hanh Le, Hyun Song Shin
Publication Date:	March 2014
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=9865

In spite of mounting losses banks continued to pay dividends during the crisis. We present a model that addresses this behavior. By paying out dividends, a bank transfers value to its shareholders away from creditors, among whom are other banks. This way, one bank's dividend payout policy affects the equity value and risk of default of other 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.