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Dividends and Bank Capital in the Financial Crisis of 2007-2009

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  • Viral V. Acharya
  • Irvind Gujral
  • Nirupama Kulkarni
  • Hyun Song Shin

Abstract

The headline numbers appear to show that even as banks and financial intermediaries suffered large credit losses in the financial crisis of 2007-09, they raised substantial amounts of new capital, both from private investors and through government-funded capital injections. However, on closer inspection the composition of bank capital shifted radically from one based on common equity to that based on debt-like hybrid claims such as preferred equity and subordinated debt. The erosion of common equity was exacerbated by large scale payments of dividends, in spite of widely anticipated credit losses. Dividend payments represent a transfer from creditors (and potentially taxpayers) to equity holders in violation of the priority of debt over equity. The dwindling pool of common equity in the banking system may have been one reason for the continued reluctance by banks to lend over this period. We draw conclusions on how capital regulation may be reformed in light of our findings.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16896.

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Date of creation: Mar 2011
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Handle: RePEc:nbr:nberwo:16896

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  1. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
  2. Viral V. Acharya & S. Viswanathan, 2011. "Leverage, Moral Hazard, and Liquidity," Journal of Finance, American Finance Association, vol. 66(1), pages 99-138, 02.
  3. Acharya, Viral V. & Schnabl, Philipp & Suarez, Gustavo, 2013. "Securitization without risk transfer," Journal of Financial Economics, Elsevier, vol. 107(3), pages 515-536.
  4. Acharya, Viral V & Mehran, Hamid & Thakor, Anjan, 2012. "Caught between Scylla and Charybdis? Regulating bank leverage when there is rent-seeking and risk-shifting," CEPR Discussion Papers 8822, C.E.P.R. Discussion Papers.
  5. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
  6. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports 328, Federal Reserve Bank of New York.
  7. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
  8. Eric S. Rosengren, 2010. "Dividend policy and capital retention: a systemic “first response”," Speech 38, Federal Reserve Bank of Boston.
  9. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  10. repec:reg:wpaper:643 is not listed on IDEAS
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Cited by:
  1. Landier, Augustin & Sraer, David & Thesmar, David, 2011. "The risk-Shifting Hypothesis," IDEI Working Papers 699, Institut d'Économie Industrielle (IDEI), Toulouse.
  2. Tommaso Trani, 2012. "Countercyclical Capital Regulation and Bank Ownership Structure," IHEID Working Papers 14-2012, Economics Section, The Graduate Institute of International Studies.
  3. Michal Kowalik, 2011. "Countercyclical capital regulation: should bank regulators use rules or discretion?," Economic Review, Federal Reserve Bank of Kansas City, issue Q II.
  4. Landier, Augustin & Sraer, David & Thesmar, David, 2011. "The risk-Shifting Hypothesis : Evidence from Subprime Originations," TSE Working Papers 11-279, Toulouse School of Economics (TSE).
  5. Anat R. Admati & Peter M. DeMarzo & Martin F. Hellwig & Paul Pfleiderer, 2013. "Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Socially Expensive," Working Paper Series of the Max Planck Institute for Research on Collective Goods 2013_23, Max Planck Institute for Research on Collective Goods.
  6. Haq, Mamiza & Faff, Robert & Seth, Rama & Mohanty, Sunil, 2014. "Disciplinary tools and bank risk exposure," Pacific-Basin Finance Journal, Elsevier, vol. 26(C), pages 37-64.
  7. Riccetti, Luca & Russo, Alberto & Gallegati, Mauro, 2013. "Financialisation and Crisis in an Agent Based Macroeconomomic Model," MPRA Paper 51074, University Library of Munich, Germany.

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