Optimal dividend decisions with capital infusion in a dynamic nonterminal bankruptcy model

Abstract

We develop a stochastic dynamic model of dividend optimization under the conditions of a positive recovery, in which shareholders can recover a portion of their capital, and nonterminal bankruptcy due to private capital infusion or government bailout. In the presence of a recovery, the optimization problem becomes a mixed classical impulse stochastic control problem. We provide a closed-form solution for optimal dividend payout and timing under nonterminal bankruptcy. We take the model to the real data and show that this model explains the dividend puzzle during the financial crisis when the US government bailed out insurance companies and banks.