Dirty Surplus Accounting and Dividend Payout in the Banking Industry

This paper investigates whether the fair value accounting for available-for-sale (AfS) securities and the capital regulation permit to shift risk from shareholders to creditors. Using a sample of 5,510 firm-year observations generated from 754 unique U.S. banks from 1998 to 2013, we find that banks realize gains on available-for-sale securities to distribute resources to shareholders in the form of dividends, while keeping loss-making assets in the balance sheet. Banks experiencing a decline in earnings or regulatory capital appear to rely on realized gains to pay dividends to a larger extent than banks that do not show a decline in earnings or regulatory capital. Our findings indicate that to counterbalance the increased risk banks change their lending behavior