Bank Dividends and Signaling to Information-Sensitive Depositors

Abstract

This study investigates whether the composition of debt affects the payout policy of banks. We identify that information-sensitive depositors (institutional investors) are targets of dividend signaling by banks. We use a unique database of Brazilian banks, for which we are able to identify several types of debtholders, namely institutional investors, nonfinancial firms and individuals, which are potential targets of dividend signaling. We also exploit the features of the Brazilian banking system, such as the existence of several closely held banks, owned and managed by a small group of shareholders, for which shareholder-targeted signaling is implausible, and find that banks that rely more on information-sensitive (institutional) depositors for funding pay larger dividends, controlling for other features. During the financial crisis, this behavior was even more pronounced. This relationship reinforces the role of dividends as a costly and credible signal of the quality of bank assets. We also find that payout is negatively related to the banks’ cost of funding (interest rates paid on certificates of deposits), that dividends have a positive relationship with size and past profitability and that closely held banks pay more dividends than publicly traded banks, a finding that is also in line with the idea that depositors are targets of dividend-signaling. Finally, we find a negative relationship between dividends and the capital adequacy ratio, which indicates that regulatory pressure may induce banks to pay less dividends and that payouts are negatively related to the growth of the loan portfolio, consistent with the idea of banks retaining earnings to increase equity and thus their lending capacity.