Bank Payouts During the Crisis of 2007-2009

Finance

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Abstract

We provide an extensive analysis of the payout policy of U.S. banks during the crisis to examine potential

risk-shifting and signaling motives of banks. Controlling for fundamentals, bank dividends appear

excessive in 2007, but not in 2008. Announcements of dividend cuts are not associated with a significant

negative price reaction both before the crisis and in 2007-2008. We do not find a significant association

between dividend changes in 2007 and future performance, while banks that perform worse in 2009 did

reduce dividends in 2008. For banks, where insiders are less optimistic as measured by insider net buying

ratio in 2006 and 2007, we find a weakly significant negative association between the 2007 change in

dividend and the 2008 stock return, consistent with risk shifting. While insiders of banks that increase

dividends in 2007 and 2008 have lower insider net buying ratios than insiders of banks that did not

increase dividends, this results is consistent with other explanations than pessimistic insiders increasing

dividends. Overall, we do not find clear evidence of risk shifting or signaling at the beginning of the

crisis. Our results show that both motives, while often difficult to distinguish, are both important in a

crisis. Thus, it is not sufficient to align incentives of bank insiders with those of debt holders or

government. Instead, an explicit constraint on bank payout policy in the crisis is important.