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Systemic Risk, Coordination Failures, and Preparedness Externalities: Applications to Tax and Accounting Policy

17 Pages Posted: 22 Aug 2009 Last revised: 2 Sep 2009

Siew Hong Teoh

University of California Irvine, Paul Merage School of Business

David A. Hirshleifer

University of California, Irvine - Paul Merage School of Business; NBER

Date Written: August 17, 2009

Abstract

Sometimes resources are badly employed because of coordination failures. Actions by decisionmakers that affect the likelihood of such failures cause ‘systemic risk.’ We consider here the externality in the choice of ex ante risk management policies by individuals and firms: they are concerned with private risk, not with their contribution to systemic risk. One consequence is that individuals and firms become overleveraged from a social viewpoint. The US tax system taxes equity more heavily than debt, and therefore exacerbates the bias toward overleveraging. A possible solution is to reduce or eliminate taxation of corporate income and capital gains. Preparedness externalities can also cause firms to become too transparent, and thereby subject to financial runs. We consider the implications for debates over fair value accounting.

Keywords: regulation, taxation, systemic risk, risk management, preparedness externalities

JEL Classification: G18, H21, H23, M41

Suggested Citation

Teoh, Siew Hong and Hirshleifer, David A., Systemic Risk, Coordination Failures, and Preparedness Externalities: Applications to Tax and Accounting Policy (August 17, 2009). Available at SSRN: https://ssrn.com/abstract=1458729 or http://dx.doi.org/10.2139/ssrn.1458729

Siew Hong Teoh

University of California Irvine, Paul Merage School of Business ( email )

Irvine, CA California 92697-3125
United States

David A. Hirshleifer (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

Irvine, CA California 92697-3125
United States

HOME PAGE: http://sites.uci.edu/dhirshle/

NBER ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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