Ever since the 2007–10 financial crisis, banks in the United States have been asking regulators for the right to resume and increase dividend payments to shareholders. Last March, Wells Fargo and BB&T won approval for such a move—while a subsidiary of Santander Holdings USA, the US unit of Banco Santander, was denied. Research by Rice University’s Eric Floyd, University of Toronto’s Nan Li, and Chicago Booth’s Douglas J. Skinner explains why this issue is so important to banks: their opaque balance sheets make them difficult to analyze, so many investors and other stakeholders use the frequency and amount of dividend payments as a proxy for financial strength.
Dividends play a critical role at banks, the researchers note. “By paying and increasing dividends, bank managers signal to external constituents, including depositors and short-term creditors, that they are confident about bank solvency.” The researchers find that 80 percent of banks have consistently paid dividends over the past 30 years. In 2007, banks’ total payouts peaked at $71 billion, with $47 billion of that in dividends.
The picture is different in the industrial sector, where total payouts also peaked in 2007, but at a far higher $673 billion, including $221 billion in dividends. At industrial companies, most payouts now come in the form of share repurchases (buybacks), which are a more tax-efficient and flexible way for companies to return cash to shareholders. For industrial firms, repurchases now exceed dividends in most years.
However, the researchers note, market participants do not view share-buyback programs as a signal of financial strength, perhaps because of the very flexibility that make buybacks popular with company managers.
“Dividends, at least regular dividends, are a commitment,” says Skinner. “Once a company initiates a regular dividend, it is committed to paying dividends of at least that amount for the indefinite future. There is no such commitment with repurchases—companies can announce a large repurchase in one year and not do any repurchases the next, without raising any concerns with investors.”
The 2007–10 financial crisis tested banks’ commitment to dividends. When the financial system was in turmoil, banks cut repurchases quickly but dividends slowly, suggesting a reluctance to lose the latter. “Some banks maintained dividends while reporting losses,” the researchers write, pointing out that in 2008, aggregate bank dividends exceeded aggregate bank earnings by 30 percent.
Although the crisis significantly reduced bank earnings in 2008, most banks that cut dividends waited until 2009 to do so, even those banks that received bailout money in fall 2008. By spring 2009, regulator-mandated stress tests had revealed which banks were inadequately capitalized, likely putting pressure on their ability to pay out dividends.
In the wake of the crisis, investors’ residual skepticism about financial firms’ health has only served to make dividends more important for banks—to an extent that surprised the researchers. “Dividends are really pervasive for banks in a way that is not true for other types of firms,” says Skinner.
For investors, this means that banks are reliable dividend payers and likely to continue to increase their dividends over time. But bank shareholders aren’t just receiving a direct deposit after every quarter, they’re receiving a message.