Elective Shareholder Liability
University of Pennsylvania - The Wharton School
September 28, 2011
Stanford Law Review, Forthcoming
Rock Center for Corporate Governance at Stanford University Working Paper No. 97
Stanford Law and Economics Olin Working Paper No. 408
Government bailouts undermine the core principles of capitalism. They are also expensive, unjust, unpopular, and usually represent dramatic deviations from the rule of law. However, they are also, in some cases, necessary. The “problem of bailouts,” then, is that they are almost always inimical to the interests of society, except when they are not. This complexity is ignored under the recent Dodd-Frank Act, which improbably guarantees an end of taxpayer bailouts. Indeed, much of the Act makes bailouts more likely, not less, making the wrong kind of bailouts available far too often.
This Article proposes to solve the problem of bailouts by retaining governmental ability to make the right kinds of bailouts possible by forcing the bailed out firms to internalize the costs of such bailouts. The proposal - called elective shareholder liability - allows bank shareholders, according to their own internal risk analyses, the option of either changing their capital structure to include dramatically less debt, consistent with a consensus recommendation of leading economists; or, alternatively, adding a bailout exception to the banks’ limited shareholder liability status to require shareholders - not taxpayers - to cover the ultimate costs of their failure. This liability would be structured as a governmental collection, similar to a tax assessment, for the recoupment of all bailout costs against the shareholders, on a pro-rata basis. It would also include an up-front stay on collections to ensure that there are, in fact, taxpayer losses to be recouped, and to mitigate government incentives for over-bailout, political manipulation, and crisis exacerbation. The proposed structure would also give the government the authority to declare the shareholders’ use of the corporate form to evade liability null and void, and require that shareholders who litigate against collection and subsequently lose to pay the government’s litigation expenses. Among the many benefits of elective shareholder liability, the proposal anticipates the development of a derivatives market that would insure shareholders against liability, the price of which will contain more relevant market information than any other asset price presently available. After explaining the structure and other benefits of elective shareholder liability, the Article addresses several potential objections. Close inspection of these objections, however, reveals that the overall case for elective shareholder liability is strong as a matter of history, law, and economics, though, perhaps, not politics.
Number of Pages in PDF File: 60
Keywords: limited shareholder liability, Dodd-Frank, systemic risk, Too-Big-To-Fail, bailouts, bankruptcy, capital adequacy requirements, financial crisis
JEL Classification: D21, E44, E50, E60, G10, G20, G30, G31, G32, G33, K22, K4
Date posted: February 17, 2011 ; Last revised: September 27, 2014