Costly Bank Recapitalization with Execution Delay
26 Pages Posted: 15 Aug 2018 Last revised: 7 Aug 2019
Date Written: August 1, 2018
How should shareholders make dividend and recapitalization policies for a bank when there exists execution delay and fix costs on recapitalizations? What is the optimal time and magnitude of recapitalization if the magnitude of recapitalization is pre-determined at the time of recapitalization-making, instead of at the delayed time of execution? How much impact will the execution delay have on bank policies? To answer these questions, we develop a continuous time model based on the work of Peura and Keppo [The Journal of Business 79(4), 2163-2201, 2006] (henceforth PK) and reformulate the path-dependent problem to a path-independent problem by introducing an additional state variable to record the recapitalization amount. An iteratively numerical algorithm is provided to solve the problem and can be widely applied to other financial models with execution delay or decision lag. Compared to PK, the information loss due to execution delay induces more conservative and rational policies to keep higher level of capital ratio and thus, lowers the bank value.
Keywords: dividend payment, recapitalization, execution delay, impulse control
JEL Classification: G33, G24, G32, C61
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