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ISSN : 2288-4637(Print)
ISSN : 2288-4645(Online)
The Journal of Asian Finance, Economics and Business Vol.7 No.2 pp.53-64
DOI : https://doi.org/10.13106/jafeb.2020.vol7.no2.53

Bank Dividend Policy and Degree of Total Leverage

Dung Viet TRAN*
*First Author and Corresponding Author. Lecturer in Finance, International School of Business, Banking University Ho Chi Minh City, Vietnam. [Postal Address: 36 Ton That Dam Street, District 1, Ho Chi Minh City, 700000, Vietnam] Tel: +84 989 808 777 Email: dungtv@buh.edu.vn

© Copyright: The Author(s)
This is an Open Access article distributed under the terms of the Creative Commons Attribution Non- Commercial License (https://creativecommons.org/licenses/by-nc/4.0/) which permits unrestricted noncommercial use, distribution, and reproduction in any medium, provided the original work is properly cited.
December 6, 2019 December 18, 2019 December 28, 2019

Abstract

We provide one of the first investigation on the impact of the degree of total leverage to the dividend policy of bank. We use a large sample of US bank holding companies from 2000:Q1 to 2017:Q4 to shed light our research question. Our empirical analysis provides consistent evidence that banks with high degree of total leverage (i.e. banks with a relatively high fixed-to-variables costs) are less likely to pay dividends, and they spend a lower fraction of incomes to pay back shareholders, suggesting a higher conservatism in dividend policy of banks subject to high degree of total leverage. The evidence remains unchanged with alternative econometric approaches, alternative measures of dividend policy and degree of total leverage. We further document that this higher conservatism is strengthened for a sample of banks with low franchise value during the financial crises. Our result suggests that the conservatism in dividend policy of banks with high degree of total leverage seems to be related to the precautionary motives aimed at preserving corporate resources under financial distress. Our study contributes to the literature of cost structure and dividend policy by pointing out that the impacts of the degree of fixed-to-variable expenses to dividend policy are extended to the case of banks.

JEL Classification Codes: G21, G28

1. Introduction

Dividend policy is one of key topics of financial economic literature. Since the seminal works of Miller and Modigliani (1961) on the irrelevance of dividends for firm’s value in a context of perfect capital markets with rational investors, there is an extensive literature related to dividends puzzle. Major theories of dividends are signaling, agency, tax preference and clientele effects, catering and firms’ life cycle theories. See e.g. Allen and Michaely (2003), Farre-Mensa, Michaely, and Schmalz (2014) for extensive review of seminal contributions in the dividend policy literature. In the aftermath of the financial crisis, dividends attract greater attention of scholars, investors, and especially banking regulators. Regulators impose more restrictions on dividends since dividend payments increase leverage, reduce capital which is considered as a loss-absorbing cushion (Committee Basel, 2010; FRB, 2016). This study aims to provide an additional factor related to the dividend policy – the degree of total leverage within banking context.

A bank with a relatively high fixed-to-variables costs is considered as one with a high degree of total leverage (DTL), and banks with high DTL have cash-flow highly sensitive to revenues changes (DeYoung & Roland, 2001). A small reduce in revenues could lead to a large reduce in earnings in high DTL banks since such banks have to spend a relatively large fraction of each decreased revenue dollar. In such situation, high DTL banks are more likely to encounter financial distress. Hence, one may suggest banks with high DTL are less likely to pay dividends, and spend lower fraction of income to pay dividends. This conservatism in dividend policy is due to the precautionary motives aimed at preserving corporate resources during distress times.

We examine the effects of DTL on bank dividend policy for a large sample of US bank holding companies (BHC) during 2000:Q1 and 2017:Q4. Our empirical analysis provides consistent evidence on a higher conservatism in dividend policy of banks subject to high DTL. To ensure the robustness of our finding, we provide a battery of sensitivity tests. The evidence remains unchanged when we use the propensity score matching (PSM), alternative measures of dividends and DTL.

Recent studies point out that during the financial crises, the conflicts between creditors and shareholders become more serious. Since bank’s franchise value is smaller, banks have higher vocation to pay out to shareholders rather than to transfer cash to creditors in case of defaults (Acharya, Le, & Shin, 2016; Tran & Ashraf, 2018). Hence, one could expect high DTL banks which face further difficulties during crisis have higher incentives to pay dividends. However, one may suggest that high DTL banks could become more conservative in their dividend policy to deal better to the crisis.  Our results do not support these both expectations. We do find there is no difference in the impacts of DTL on the dividend policy during the crisis versus normal times. When we focus on banks with low franchise value as defined by the level of Tier-1 capital ratio, the negative relation between DTL and dividend policy is more pronounced with these banks during the financial crises. This finding suggests that the agency problems between creditors and shareholders do not affect the relation between DTL and dividend policy. Rather, it shows that the conservatism in dividend policy of high DTL banks seems to be related to the precautionary motives aimed at preserving corporate resources under financial distress.

However, one could suggest that the conservatism of dividend policy in high DTL banks may be derived from the self-interested managers who do not act in the interests of the shareholders and seek for private benefits of control. Hence, the conservative dividend policy observed in high DTL banks could be not in the purpose of maximizing the shareholder value, but is dedicated to the private benefits of managers. To address this concern, we adopt the established methodology pioneered by Fama and French (1998) which aims to examine the marginal value of dividends. If the lower amount of dividends observed in banks with high DTL reflect the private benefits of controls of managers, dividend payback should be related to a higher value than those from low DTL banks, since paying back to shareholders reduces the available funds for managers.

On the contrary, if it is not derived from the managerial discretion, but for precautionary reason, dividend payback in high DTL banks should be related to a lower value than those from low DTL banks, since paying dividends may involve banks to higher probabilities of financial distress. We do find that an additional dollar of current dividend (DIV) is associated with a higher increase of additional value in low DTL banks than in high DTL banks, suggesting that our evidence so far is not concerned by the managerial self-interest.

Recently, Kulchania (2016) documents that cost structure is an important determinant in the decision of payout policy in non-financial firms. Our study contributes to the literature of cost structure and dividend policy by pointing out that the impacts of the degree of fixed-to-variable expenses to dividend policy are extended to the case of banks.

We develop our hypotheses in the next section. Section III describes the data. Section IV reports the results from our main framework. We examine the effects of the crisis in Section V, and provide robustness checks in Section VI. Section VII discusses the finding, and identifies the foundation of the relation between total leverage and bank dividend policy. Section VIII concludes the study.

2. Hypothesis Development

A bank with a relatively high fixed-to-variables costs is considered as one with a high degree of total leverage (DTL) (DeYoung & Roland, 2001). Fixed costs could be the fixed or quasi-fixed operating costs (e.g. labor, offices …) or fixed financing expenses. Banks with high DTL have cash-flow highly sensitive to revenues. When revenues increase, high DTL banks can enjoy higher earnings as the increases in revenues are higher than the increases in costs. In contrast, a small reduce in revenues could lead to a large reduce in earnings in high DTL banks since such banks have to spend a relatively large fraction of each decreased revenue dollar. In such situation, high DTL banks could face funds shortfall, and have difficulties to raise external funds since additional raising funds are firstly served to fixed operating and financial expenses. Furthermore, these banks are more likely to encounter financial distress. Hence, one may suggest banks with high DTL are more conservative in dividend policy due to the precautionary motives aimed at preserving corporate resources.

Recent studies point out that during the financial crises, the conflicts between creditors and shareholders become more serious. The crisis has negative effects on bank’s earnings, especially for high DTL banks which cannot adjust quickly their costs due to high fraction of fixed costs. One may expect that since the franchise value of high DTL banks become smaller than low DTL banks, they are more likely to pay out to shareholders rather than to transfer cash to creditors in case of defaults (e.g. Acharya, Le, & Shin, 2016). However, one may suggest that high DTL banks could become more conservative in their dividend policy to deal better to the crisis. Since most banks in our sample curtail their dividends, our hypothesis is based on the greater conservatism of dividend policy during the crisis.

8. Conclusions

Our study aims to investigate the impacts of the cost structure to the bank dividend policy. We focus on banks with a relatively high fixed-to-variables costs, which are considered as banks with high degree of total leverage. The empirical evidence suggests that banks with high degree of total leverage are less likely to pay dividends to compared with other banks, and those banks spend a lower fraction of income to pay back to shareholders. We provide a battery of sensitivity tests, and find similar results. We further demonstrate that the conservatism in dividend policy in high DTL banks is not due to the managerial self-interest.

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