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Why is equity capital expensive for opaque banks?

Author

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  • Kauko, Karlo

Abstract

Bank 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.

Suggested Citation

  • Kauko, Karlo, 2012. "Why is equity capital expensive for opaque banks?," Bank of Finland Research Discussion Papers 4/2012, Bank of Finland.
    • Handle: RePEc:zbw:bofrdp:rdp2012_004
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    File URL: https://www.econstor.eu/bitstream/10419/212207/1/bof-rdp2012-004.pdf
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    Citations

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    Cited by:

    1. Dautović, Ernest & Gambacorta, Leonardo & Reghezza, Alessio, 2023. "Supervisory policy stimulus: evidence from the euro area dividend recommendation," Working Paper Series 2796, European Central Bank.
    2. Salvatore Cardillo & Jacopo Raponi, 2023. "EU banks' dividend policies: main determinants and the role of capital ratios," Temi di discussione (Economic working papers) 1403, Bank of Italy, Economic Research and International Relations Area.

    More about this item

    Keywords

    Bank run; Capital adequacy; Signalling; Dividends; Irrelevance theorem;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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