Academic journal article Review of European Studies

Dividend Policy and Investment Decisions of Korean Banks

Academic journal article Review of European Studies

Dividend Policy and Investment Decisions of Korean Banks

Article excerpt

Abstract

The objective of this study is to investigate the inter-relationship between banks' dividend policy and investment decisions in terms of risk management and profit maximization. From the panel regression analysis, this study finds that the bank's dividend policy appears to be closely related to both incentives of profit maximization and risk management. In this study our empirical methodology is based on the general notion that the bank's expectation on future economic condition is best captured by various measures of the components of ex-ante risky asset portfolios as well as the widely used risk measures such as capital ratio, nonperforming loans and return on asset which simply reflect the bank's historical performance. We find that when the banks have positive expectation on future economic condition, they tend to increase the proportion of risky asset portfolios to maximize expected profits rather than putting highest priority on risk management of the bank, and tend to pay more dividends based on higher expected profits. On the other hand, when the expectation on future economic condition is negative, the banks tend to put highest priority on the bank's risk management by increasing the proportion of safe asset portfolios and decreasing dividends based on lower expected profits.

Keywords: dividend policy, investment decision, banking industry, risk management, profit maximization

1. Introduction

Dividend policy is one of very important corporate decisions for the management of the firm. Dividend payment is not just the source of cash compensation to shareholders but also it is an effective means of signaling information on firm's current and future earnings to capital market. Through this signaling effect, dividend policy affects firm value, hence, firm's managers need to determine optimal amount of dividend payment to maximize firm value. In this manner, dividend payment plays the role of disciplining and monitoring firm's managers and contributes to reducing agency problem.

Although theoretical debate regarding the effectiveness of dividend policy is highly controversial, many previous studies attempted to identify the factors determining dividend payout. Jensen and Meckling (1976) argue that large firms increase dividends to deter agency costs. Holder, Langrehr and Hexter (1998) find that larger firms prefer paying dividends than smaller firms because larger firms can get an easier access to capital market at a lower cost. Rozeff (1982) and Jensen (1986) find that firms with higher debt financing avoid paying more dividends to reserve earnings. Aivazian et al. (2003) find that firms with higher investment opportunities tend to pay higher dividends. Kania and Bacon (2005) find that firms with higher profits distribute higher dividend payment. Kim and Gu (2009) also find that large and profitable firms tend to pay more dividends. Al-Shubiri (2011) finds a positive relationship between investment opportunities and dividend. There are very few studies on dividend policy of banks. Bessler and Nohel (1996) find that profit growth and number of shareholders have significant impact on bank dividend policy of north American banks. Matthias and Akpomi (2008) identify current profits, financial leverage, capital structure, past dividends and legal restrictions as the determinants of Nigerian banks' dividend policy. Baker et al. (2001) find that profit stability, past dividends, current and projected profits affect dividend policy decisions of American banks.

This study is on the same line with previous researches in the literature of dividend policy. More specifically, this study is focusing on analyzing how the Korean banks' dividend policy is related to the banks' investment decisions which would be made based on the expectation of future market condition. For this analysis, we believe that the expectation on future market condition would be efficiently reflected by the banks' composition of asset portfolios. …

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