Shareholder Liability and Bank Failure

Abstract

Does enhanced shareholder liability reduce bank failure? We compare the performance of around 4,200 state-regulated banks of similar size in neighboring U.S. states with different liability regimes during the Great Depression. The distress rate of limited liability banks was 29% higher than that of banks with enhanced liability. Results are robust to a diff-in-diff analysis incorporating nationally-regulated banks (which faced the same regulations everywhere) and are not driven by other differences in state regulations, Fed membership, local characteristics, or differential selection into state-regulated banks. Our results suggest that exposing shareholders to more downside risk can successfully reduce bank failure.

The Limits of Limited Liability: Evidence from Industrial Pollution

“…Some empirical work also studies the effects of limited liability for shareholders. For example, several papers study the effects of extended liability (i.e., "double liability") for bank shareholders prior to the 1930s (Esty (1998), Grossman (2001), Aldunate et al (2019)). Other papers examine unlimited liability for individual firms (Weinstein (2008)) and the personal liability of managers (Koudijs, Salisbury, and Sran (2019)).…”

For Richer, for Poorer: Bankers' Liability and Bank Risk in New England, 1867 to 1880

“…A considerable literature studies the role of extended liability in banking and its impact on risk-taking before the Great Depression (Esty (1998), Grossman (2001), Calomiris and Wilson (2004), Mitchener and Richardson (2013), Turner (2014), Anderson and Watugala (2017), Anderson, Barth, and Choi (2018), Goodspeed (2017), and Aldunate et al (2019)). While our paper focuses on the liability of bank managers, this literature focuses on the liability of general shareholders.…”