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

61 Pages Posted: 27 Dec 2017 Last revised: 18 Oct 2018

See all articles by Haelim Anderson

Haelim Anderson

Government of the United States of America – Federal Deposit Insurance Corporation

Daniel Barth

Government of the United States of America – Office of Financial Research

Dong Beom Choi

Federal Reserve Bank of New York

Multiple version iconThere are 4 versions of this paper

Date Written: August 28, 2018

Abstract

Scholars and regulators have long maintained that extended shareholder liability reduces bank risk-taking. A novel identification strategy is used on a unique dataset to re-examine the effect of double liability on bank risk-taking from 1926 to 1932. During this period, double liability did not reduce bank risk-taking. Depositors lacked sufficient incentives to withdraw deposits and thus failed to discipline banks for excessive risk-taking. The effect of double liability on bank risk-taking remains ambiguous as it failed to resolve agency conflicts between stakeholders. The depositor protection feature of double liability weakened market discipline and reduced shareholders’ incentives to limit bank risk.

Keywords: Double Liability, Moral Hazard, Market Discipline, Bank Runs, Great Depression

JEL Classification: G21, G28, N22

Suggested Citation

Anderson, Haelim and Barth, Daniel and Choi, Dong Beom, Reducing Moral Hazard at the Expense of Market Discipline: The Effectiveness of Double Liability before and during the Great Depression (August 28, 2018). Available at SSRN: https://ssrn.com/abstract=3091914 or http://dx.doi.org/10.2139/ssrn.3091914

Haelim Anderson

Government of the United States of America – Federal Deposit Insurance Corporation ( email )

550 17th Street NW
Washington, DC 20429
United States

Daniel Barth

Government of the United States of America – Office of Financial Research ( email )

717 14th Street, NW
Washington DC, DC 20005
United States
(202) 927-8235 (Phone)

Dong Beom Choi (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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