DP16309 Shareholder Liability and Bank Failure

Author(s): Felipe Aldunate, Dirk Jenter, Arthur Korteweg, Peter Koudijs
Publication Date: June 2021
Keyword(s): bank risk taking, financial crises, Great Depression, limited liability
JEL(s): G21, G28, G32, N22
Programme Areas: Financial Economics, Economic History
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16309

Does enhanced shareholder liability reduce bank failure? We compare the performance of around 4,200 state-regulated banks of similar size in neighboring U.S. states with different liability regimes during the Great Depression. The distress rate of limited liability banks was 29% higher than that of banks with enhanced liability. Results are robust to a diff-in-diff analysis incorporating nationally-regulated banks (which faced the same regulations everywhere) and are not driven by other differences in state regulations, Fed membership, local characteristics, or differential selection into state-regulated banks. Our results suggest that exposing shareholders to more downside risk can successfully reduce bank failure.