Dividends from Unrealized Earnings and Default Risk

63 Pages Posted: 14 Aug 2017 Last revised: 26 Nov 2018

See all articles by Ester Chen

Ester Chen

Peres Academic Center

Ilanit Gavious

Ben-Gurion University of the Negev

Nadav Steinberg

Bank of Israel - Research Department

Date Written: November 25, 2018

Abstract

Using hand-collected data on Israeli firms’ unrealized earnings and debt restructurings following adoption of the International Financial Reporting Standards (IFRS), we investigate whether and how dividend payouts based on unrealized revaluation earnings affect a firm’s default risk. Our results indicate that in the era of fair value accounting, whether the dividend payment originates from unrealized or 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, we find that firms are four 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: cost of debt proxies are generally insignificantly different for these firms following payouts originating from unrealized earnings than for firms that never make such risky payouts.

Keywords: cost of debt, default risk, dividends, fair value accounting

JEL Classification: M21, M41, G35

Suggested Citation

Chen, Ester and Gavious, Ilanit and Steinberg, Nadav, Dividends from Unrealized Earnings and Default Risk (November 25, 2018). Review of Accounting Studies, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3017680 or http://dx.doi.org/10.2139/ssrn.3017680

Ester Chen

Peres Academic Center

P.O.Box 328
Rehovot, 76120
Israel

Ilanit Gavious

Ben-Gurion University of the Negev ( email )

1 Ben-Gurion Blvd
Beer-Sheva 84105, 84105
Israel

Nadav Steinberg (Contact Author)

Bank of Israel - Research Department ( email )

PO Box 780
Jerusalem 91007
Israel

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