Shareholder Liability and Bank Failure

Abstract

Does additional shareholder liability reduce bank failure? We compare the performance of around 4,400 state-regulated banks of similar size in neighboring U.S. states with different liability regimes during the Great Depression. We find that additional shareholder liability reduced bank failure by 30%. Results are robust to a diff-in-diff analysis incorporating National banks (which faced the same regulations in every state), and are not driven by other differences in state regulation, FED membership, or differential selection into state and nationally regulated banks. Our results suggest that exposing shareholders to more downside risk reduces bank risk taking.

Keywords: Bank Risk Taking, Limited Liability, Double Liability, Financial Crises, Great Depression

JEL Classification: G30, G32, G34, G38, G20, G21, G28