Bank Dividends and Signaling to Information-Sensitive Depositors (original) (raw)

2012, Social Science Research Network

This study investigates whether banks use dividends to signal asset quality and liquidity to their debtholders. We exploit an exogenous shock to the asset opaqueness and perception of risks of Brazilian banks caused by the global financial turmoil of 2008. Our empirical identification takes advantage of the cross-sectional heterogeneity of types of depositors in Brazilian banks and the existence of several owner-managed banks (for which shareholder-targeted signaling is implausible) to identify that information-sensitive depositors (institutional investors) are targets of dividend signaling by banks. These costly signaling efforts are particularly strong during financial crises when asset opaqueness, informational asymmetry and depositors' concerns regarding bank liquidity are exacerbated. From a policy perspective, our results favor the imposition of limits on bank dividends during financial crises, because the banks' need to signal their financial health through dividends during crises intensifies the pro-cyclical effects of bank capital on lending. Ó 2015 Elsevier B.V. All rights reserved. banks (e.g., Bessler and Nohel, 2000) and show that stock prices react to dividend information. This study investigates whether dividends are used by managers to convey information to debtholders. More specifically, we use the exogenous shock to the opaqueness of assets and perception of risk of Brazilian banks arising from the financial turmoil that followed Lehman Brother's demise to investigate whether banks use dividends as a signal to information-sensitive depositors. Kauko's (2012) model relates bank dividends to funding stability. In this model, dividends are an important source of information for depositors because they signal both profitability and liquidity (i.e., liquid and profitable banks can pay larger dividends than illiquid and unprofitable banks). Depositors are particularly sensitive to bank liquidity during financial crises because of the potential negative effects of bank runs and fire sales. Therefore, banks may decide to increase their dividends to keep depositors calm and to prevent bank runs during periods of financial turmoil. Although Kauko's (2012) model assumes uniform depositors (i.e., all depositors are equally sensitive to information), recent theoretical models and empirical evidence (Huang and Ratnovski, 2011; Oliveira et al., 2015) suggest that wholesale financiers, such as institutional depositors, are both more prone to engaging in runs during periods with high informational asymmetry (asset opaqueness) and more sensitive to information (such as dividend payments) than retail depositors. Ben-David et al. (2012) argue that institutional investors are more reactive to information than other investors because they have internal risk management systems and funding