Dividend Restrictions and Asymmetric Information
58 Pages Posted: 24 May 2021 Last revised: 10 Aug 2021
Date Written: June 25, 2021
We develop a dynamic model of banks whose insiders have superior information about the impact of a pending shock to the bank’s cash holdings and can signal the bank’s type through its dividend policy. Banks that will be adversely affected by the shock have incentives to pool with unaffected banks to increase their market value. To avoid being mimicked, the unaffected banks can credibly signal via a more aggressive payout strategy. Dividend payout restrictions have the potential to prevent a separating equilibrium from forming. This leads to the bad type adopting a more aggressive payout policy with a higher risk of default but mitigates the distortion of the good type's policy. We identify a number of scenarios where this trade-off presents an opportunity for regulatory intervention and some where it does not.
Keywords: Asymmetric Information; Banking; Financial Regulation; Dividend Signaling; Dividend Restrictions
JEL Classification: G14, G21, G28, G35
Suggested Citation: Suggested Citation