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Equity Finance: Matching Liability to Power

Author

Listed:
  • C A E Goodhart
  • R M Lastra

Abstract

In this article we question the wisdom of limited liability for all equity holders in the case of banks and systemically important financial institutions (SIFIs), though our proposals could be extended to all public limited companies. Limited liability can be a major source of moral hazard and excessive risk taking—a privilege that allows shareholders to enjoy the upside from their commercial activity while limiting their exposure in the event of failure. We propose that there should be two different classes of equity for banks and SIFIs. The division should be between outsiders, with no inside knowledge of the working of the firm and/or ability to control its decisions, and insiders, who have both the information and capacity to influence corporate decision-making. Outsiders would remain with limited liability, while multiple liability (double, triple, and potentially unlimited) would apply to insiders. The purpose of our proposal is to shift the costs of failure back to those who have responsibility for taking these decisions. The idea of financial liability ‘with teeth’—which is rooted in history—provides an innovative solution that improves the incentives for managers to take responsible decisions, and promotes a radical change in the structure of capitalism—addressing the unfairness of the current system which has enhanced inequality and encouraged populism.

Suggested Citation

  • C A E Goodhart & R M Lastra, 0. "Equity Finance: Matching Liability to Power," Journal of Financial Regulation, Oxford University Press, vol. 6(1), pages 1-40.
  • Handle: RePEc:oup:refreg:v:6:y::i:1:p:1-40.
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    File URL: http://hdl.handle.net/10.1093/jfr/fjz010
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    Citations

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    Cited by:

    1. Peter Koudijs & Laura Salisbury & Gurpal Sran, 2021. "For Richer, for Poorer: Bankers' Liability and Bank Risk in New England, 1867 to 1880," Journal of Finance, American Finance Association, vol. 76(3), pages 1541-1599, June.
    2. Marcus Miller, 2021. "Choosing the Narrative: the Shadow Banking Crisis in Light of Covid," Open Economies Review, Springer, vol. 32(2), pages 291-310, April.
    3. Jenter, Dirk & Aldunate, Felipe & Korteweg, Arthur & Koudijs, Peter, 2021. "Shareholder Liability and Bank Failure," CEPR Discussion Papers 16309, C.E.P.R. Discussion Papers.

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