How Can a Firm Declare a Dividend When It Is Experiencing a Liquidity Crisis?

I have not studied much accounting in the past 72 years, but my understanding of a liquidity crisis is that you're having one when you are short on funds although you expect to receive some in the future. As a result of this shortage, you borrow some to tide you over until your receivables come in or until your other assets become more liquid. You have enough wealth/assets to cover your outstanding liabilities, but only if you don't have to convert those assets into cash at distress-sale prices.



Isn't that what happened with Northern Rock?



If so, and if Northern Rock really is short on liquidity, what on earth is it doing declaring a dividend payable next month? Dividend payments are cash outflows, so where is Northern Rock expecting to get the cash for these dividend payments? Is it expecting to receive buckets of cash in the meantime? Is it now expecting that the Brit gubmnt will bail them out no matter what they do? Or is management looting the firm (and funds from the Bank of England) on behalf of current stockholders? Or is the firm maybe not just illiquid but also insolvent, and perhaps management is trying to hide this possibility?



From The Scotsman, courtesy of Brian Ferguson:

Crisis-hit Northern Rock sparked controversy yesterday by pledging to pay shareholders a 30 per cent higher dividend, following its bail-out by the Bank of England.



It said it would honour its 14.2p dividend announced in July - up from last year's 10.9p a share - that will cost the group nearly £60 million, or 7 per cent of the value of shares in the bank. ...



Moneysupermarket.com, said: "There will be a lot of people bemused by the whole process - how Northern Rock found themselves in the position they are in at the least.



"Now that they are effectively being backed by a government guarantee, most people will be astonished by the fact that shareholders are still receiving a significant dividend.



"It does seem inappropriate that shareholders should be getting a dividend at the same time the organisation is being underwritten by the Bank of England."

Is it possible that the current management is trying to reduce the firm's attractiveness as a takeover target even more than the recent liquidity crisis has already? What other plausible explanation is there for why rational maximizers might do this?



If I had much money in Northern Rock, this latest development would really encourage me to move it if I hadn't already done so.



Update: From the WSJ ($)[h/t to Brian Ferguson], it looks as if Northern Rock has decided not to pay the dividend after all. This makes sense. If it is looking for a buyer, it will be more attractive if it has some cash and hasn't had it's assets looted to pay off current stockholders.

The Newcastle bank said in a statement late yesterday that it was in preliminary discussions with potential buyers but any deal was far from certain.



Meantime, the lender, needing to stockpile cash and buy time to hash out a deal, said it has suspended its per-share dividend of 14.2 pence (29 cents) that was due Oct. 26, just days after insisting it would pay the dividend.

Remind me again. Why are they looking for a buyer if they are solvent but are merely facing a short-term liquidity crunch? These recent developments look like lots more than just a cash-flow problem to me.