Why is equity capital expensive for opaque banks?
AbstractBank managers often claim that equity is expensive relative to debt, which contradicts the Modigliani-Miller irrelevance theorem. This paper combines dividend signalling theories and the Diamond-Dybvig bank run model. An opaque bank must signal its solvency by paying high and stable dividends in order to keep depositors tranquil. This signalling may require costly liquidations if the return on assets has been poor, but not paying the dividend might cause panic and trigger a run on the bank. The more equity has been issued, the more liquidations are needed during bad times to pay the expected dividend to each share.
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Bibliographic InfoPaper provided by Bank of Finland in its series Research Discussion Papers with number 4/2012.
Length: 26 pages
Date of creation: 26 Jan 2012
Date of revision:
bank run; capital adequacy; signalling; dividends; irrelevance theorem;
Find related papers by JEL classification:
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy
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