Working Paper: CEPR ID: DP16309
Authors: Dirk Jenter; Felipe Aldunate; Arthur Korteweg; Peter Koudijs
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.
Keywords: limited liability; bank risk taking; financial crises; Great Depression
JEL Codes: G21; G28; G32; N22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Enhanced liability (K13) | Reduced bank failure rates (G28) |
| Distress rate of limited liability banks (G33) | Distress rate of banks with enhanced liability (G33) |
| Single liability banks (G21) | Suspension of operations permanently (G33) |
| Single liability banks (G21) | Acquisition of banks (G21) |
| Single liability banks (G21) | Larger capital writedowns (G32) |
| Single liability banks (G21) | Loss of deposits (G33) |
| Higher failure rates of single liability banks (G33) | Ex-ante risk taking (D81) |
| Higher failure rates of single liability banks (G33) | Riskier lending practices prior to 1929 (G21) |
| Higher failure rates of single liability banks (G33) | Increased risk shifting after initial losses (G41) |