The Role of Banks in Dividend Policy

Abstract

We document a significant inverse relationship between a firm’s dividend payouts and reliance on bank loan financing. Banks limit dividend payouts to shareholders in order to protect the integrity of their senior claims on the firm’s assets. Moreover, dividend payouts decline in the presence of monitoring by relationship banks, which acts as an effective governance mechanism, thereby reducing the gains from pre-committing to costly dividend payouts. Bank monitoring and corporate governance (insider stake and institutional block holdings) are complementary mechanisms to resolve firm agency problems, both reducing the firm’s reliance on dividend policy.