Why Manager Liability Fails at Controlling Systemic Risk

Abstract

Should bank managers be liable for taking excessive risks? The paper cautions that manager liability has very little promise as a safeguard for financial stability. In support of this claim, a twofold argument is made: First, neither prudential regulation nor the general duty of care provide specific and predictable limits of permissible risk taking. As a consequence, managers face considerable uncertainty on the applicable standard of care and hence on how they can avoid liability. Second, exposing managers to uncertain liability is inconsistent with their role as agents (corporate organs). Banks will respond by adjusting performance pay and other incentives to offset the risk-dampening effect of liability. The resulting incentive scheme for managers will be more costly and less effective in controlling systemic risk.

Keywords: Manager liability, directors liability, officers liability, financial crisis, systemic risk, systemic stability, standard of care, legal uncertainty

JEL Classification: G21, G28, K22