Moral Hazard, Dividends and Risk in Banks

Abstract

This paper is the first investigation of the interplay between dividends and risk taking in banks. I examine the role of dividends as a risk-shifting mechanism that can exacerbate moral hazard, controlling for standard determinants of dividends in nonfinancial firms. My main findings show that banks that are close to depleting their capital pay more dividends to their shareholders, suggesting that dividends are used to shift risk from bank owners to the taxpayer. These findings support recent policy proposals that include restrictions on dividends as part of a set of early regulatory responses to bank distress (Geneva Report, Brunnermeier, 2009).

Keywords: Dividend, Bank Risk, Monitoring, Agency Costs

JEL Classification: G21, G35