Understanding Bank Payouts during the Crisis of 2007-2009

We provide an extensive analysis of the payout policy of U.S. banks in 2007-2008 to identify the main drivers of their payout decisions. We use established models that relate dividends to fundamentals to provide a benchmark for the normal level of payouts. Based on these models, bank dividends appear excessive in 2007, but not in 2008. We exploit cross-sectional heterogeneity to examine why bank payouts change during the crisis. Banks with low capital ratios have low abnormal payouts during the crisis, and banks with high managerial ownership also have lower payouts. Managers of banks that reduce dividends in 2008 buy more shares than before the crisis. Finally, we examine the correlation between dividends and future performance, as well as announcement returns around dividend changes and repurchases. We find that banks that reduce dividends in 2008 perform worse in 2009, but we do not find that announcements of dividend cuts are associated with a significant negative price reaction in 2007-2008. Our results in general do not support the active wealth transfer hypothesis and provide mixed evidence on banks fearing the adverse effect of dividend cuts.