Reducing Moral Hazard at the Expense of Market Discipline: The Effectiveness of Double Liability before and During the Great Depression

Anderson, Haelim; Barth, Daniel S.; Choi, Dong Beom

doi:10.2139/ssrn.3266619

Cited by 2 publications

(5 citation statements)

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“…First, depositor discipline, highlighted by many as important for reducing bank risk (e.g., Kahn 1991, Diamond andRajan 2001), might be weakened. Depositors in DL banks receive a payout in case the bank fails, which reduces their optimal monitoring effort Wilson 2004, Anderson, Barth, andChoi 2018). Second, DL shareholders might be adversely selected.…”

Section: B Double Liability and Bank Risk Takingmentioning

confidence: 99%

“…First, with no deposit insurance during our sample period, depositors might not allow single liability banks to lever up as much as those with double liability. Second, depositors in double liability banks might permit more risk taking while expending less effort on monitoring Wilson 2004, Anderson, Barth, andChoi 2018). Finally, adverse selection of double liability shareholders might reduce its effectiveness (Winton 1993, Kane andWilson 1998), although empirical evidence does not support this concern.…”

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confidence: 99%

“…Its effect on several variables examined in prior studies is, as we will argue, ambiguous. Anderson and Watugala (2017) and Anderson, Barth, and Choi (2018) use deposit outflows to measure bank distress. They find that banks with less shareholder liability suffered larger withdrawals during the Panic of 1893 and the Great Depression, respectively.…”

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confidence: 99%

“…Analyzing different datasets and time periods, studies find mixed results. Some papers report a positive effect of limited liability on leverage (Grossman 2001, Mitchener and Richardson 2013, Koudijs, Salisbury, and Sran 2019, while others find no or a negative effect (Evans and Quigley 1995, Bodenhorn 2015, Grodecka and Kotidis 2016, Anderson and Watugala 2017, Anderson, Barth, and Choi 2018.…”

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confidence: 99%

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Shareholder Liability and Bank Failure

et al. 2021

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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.

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Section: B Double Liability and Bank Risk Takingmentioning

confidence: 99%

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confidence: 99%

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Shareholder Liability and Bank Failure

et al. 2021

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“…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.…”

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confidence: 99%

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

Koudijs¹,

Salisbury²,

Sran³

2021

The Journal of Finance

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We study whether banks are riskier if managers have less liability. We focus on New England between 1867 and 1880 and consider the introduction of marital property laws that limited liability for newly wedded bankers. We find that banks with managers who married after a law had higher leverage, delayed loss recognition, made more risky and fraudulent loans, and lost more capital and deposits in the Long Depression of 1873 to 1878. These effects were most pronounced for bankers with the largest reduction in liability. We find no evidence that limiting liability increased firm investment at the county level.TO WHAT EXTENT ARE AGENCY PROBLEMS in banking responsible for financial instability and how can these problems be addressed? These questions have been the subject of renewed interest since the 2008 financial crisis. Some commentators have argued that the asymmetric payoff faced by bank

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Reducing Moral Hazard at the Expense of Market Discipline: The Effectiveness of Double Liability before and During the Great Depression

Abstract: Reducing moral hazard at the expense of market discipline: The effectiveness of double liability before and during the Great Depression Staff Report, No. 869

Cited by 2 publications

References 11 publications

Shareholder Liability and Bank Failure

Shareholder Liability and Bank Failure

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

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