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Dividends from Unrealized Earnings and Default Risk

Author

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  • Ester Chen

    (Peres Academic Center)

  • Ilanit Gavious

    (Ben-Gurion University)

  • Nadav Steinberg

    (Bank of Israel)

Abstract

Using hand-collected data on Israeli firms’ unrealized earnings and debt restructurings following adoption of the IFRS, we investigate whether and how dividend payments based on unrealized revaluation earnings affect a firm’s default risk. Our results indicate that in the era of fair value accounting, the origin of the dividend payout—coming from unrealized versus realized earnings—has a significant effect on a firm’s default risk above and beyond the effect of the extent of the payment. Specifically, controlling for various determinants of financial risk, including the amount of the dividends paid (originating from either realized or unrealized earnings), companies are over three times more likely to subsequently require debt restructuring if they distribute dividends based on unrealized earnings. However, this enhanced risk seems to be mispriced by the market; firms that distribute dividends based on unrealized earnings exhibit an insignificantly different cost of debt than firms that never do so.

Suggested Citation

  • Ester Chen & Ilanit Gavious & Nadav Steinberg, 2017. "Dividends from Unrealized Earnings and Default Risk," Bank of Israel Working Papers 2017.05, Bank of Israel.
    • Handle: RePEc:boi:wpaper:2017.05
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    Cited by:

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    2. Nitzan Tzur-Ilan, 2018. "LTV Limits and Borrower Risk," Bank of Israel Working Papers 2018.12, Bank of Israel.

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    More about this item

    Keywords

    cost of debt; default risk; dividends; fair value accounting;
    All these keywords.

    JEL classification:

    • M21 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics - - - Business Economics
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy

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