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A Contracting-Theory Interpretation of the Origins of Federal Deposit Insurance

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  • Edward J. Kane
  • Berry K. Wilson

Abstract

Conventional wisdom holds that the enactment of federal deposit insurance helped small rural banks at the expense of large urban institutions. This paper uses asymmetric information, agency-cost paradigms from corporate finance theory and data on bank stock prices to show how deposit insurance could and did help stockholders of large banks. The broadening stockholder distribution of large banks during the stock market bubble of the late 1920s undermined the efficiency of double liability provisions in controlling incentive conflict among large bank stakeholders. Federal deposit insurance restored depositor confidence by asking government officials to take over and bond the task of monitoring managerial performance and solvency at U.S. banks.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6451.

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Date of creation: Mar 1998
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Publication status: published as Journal of Money, Credit and Banking, Vol. 30 (August 2000): 51-74.
Handle: RePEc:nbr:nberwo:6451

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  1. Lamoureux, Christopher G & Poon, Percy, 1987. " The Market Reaction to Stock Splits," Journal of Finance, American Finance Association, American Finance Association, vol. 42(5), pages 1347-70, December.
  2. Kane, Edward J., 1995. "Three paradigms for the role of capitalization requirements in insured financial institutions," Journal of Banking & Finance, Elsevier, Elsevier, vol. 19(3-4), pages 431-459, June.
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  4. Black, Fischer & Miller, Merton H & Posner, Richard A, 1978. "An Approach to the Regulation of Bank Holding Companies," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 51(3), pages 379-412, July.
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  6. Berry K. Wilson & Edward J. Kane, 1996. "The Demise of Double Liability as an Optimal Contract for Large-Bank Stockholders," NBER Working Papers 5848, National Bureau of Economic Research, Inc.
  7. Ritter, Jay R, 1991. " The Long-run Performance of Initial Public Offerings," Journal of Finance, American Finance Association, American Finance Association, vol. 46(1), pages 3-27, March.
  8. Gary Gorton, 1986. "Banking panics and business cycles," Working Papers 86-9, Federal Reserve Bank of Philadelphia.
  9. Benjamin C. Esty, 1997. "The impact of contingent liability on commercial bank risk taking," Proceedings, Federal Reserve Bank of Chicago 557, Federal Reserve Bank of Chicago.
  10. Grinblatt, Mark S. & Masulis, Ronald W. & Titman, Sheridan, 1984. "The valuation effects of stock splits and stock dividends," Journal of Financial Economics, Elsevier, Elsevier, vol. 13(4), pages 461-490, December.
  11. Lee, Inmoo, 1997. " Do Firms Knowingly Sell Overvalued Equity?," Journal of Finance, American Finance Association, American Finance Association, vol. 52(4), pages 1439-66, September.
  12. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  13. Charles W. Calomiris & Eugene N. White, 1994. "The Origins of Federal Deposit Insurance," NBER Chapters, in: The Regulated Economy: A Historical Approach to Political Economy, pages 145-188 National Bureau of Economic Research, Inc.
  14. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, Elsevier, vol. 3(4), pages 305-360, October.
  15. Peltzman, Sam, 1970. "Capital Investment in Commercial Banking and Its Relationship to Portfolio Regulation," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 78(1), pages 1-26, Jan.-Feb..
  16. Robert C. Merton & Zvi Bodie, 1992. "On the Management of Financial Guarantees," Financial Management, Financial Management Association, Financial Management Association, vol. 21(4), Winter.
  17. Calomiris, Charles W & Kahn, Charles M, 1991. "The Role of Demandable Debt in Structuring Optimal Banking Arrangements," American Economic Review, American Economic Association, American Economic Association, vol. 81(3), pages 497-513, June.
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Cited by:
  1. DeLong, Gayle & Saunders, Anthony, 2011. "Did the introduction of fixed-rate federal deposit insurance increase long-term bank risk-taking?," Journal of Financial Stability, Elsevier, Elsevier, vol. 7(1), pages 19-25, January.
  2. Luc Laeven, 2004. "The Political Economy of Deposit Insurance," Journal of Financial Services Research, Springer, Springer, vol. 26(3), pages 201-224, December.
  3. Kane, Edward J. & Wilson, Berry, 2002. "Regression evidence of safety-net support in Canada and the U.S., 1893-1992," The Quarterly Review of Economics and Finance, Elsevier, Elsevier, vol. 42(4), pages 649-671.
  4. Beck, Thorsten & Laeven, Luc, 2006. "Resolution of failed banks by deposit insurers : cross-country evidence," Policy Research Working Paper Series 3920, The World Bank.
  5. Asli Demirguc-Kunt & Edward J. Kane & Luc Laeven, 2007. "Determinants of Deposit-Insurance Adoption and Design," NBER Working Papers 12862, National Bureau of Economic Research, Inc.
  6. Malcolm Anderson, 1999. "Accounting History Publications 1998," Accounting History Review, Taylor & Francis Journals, Taylor & Francis Journals, vol. 9(3), pages 375-384.
  7. Charles W. Calomiris & Berry Wilson, 1996. "Bank capital and portfolio management: the 1930s capital crunch and scramble to shed risk," Proceedings, Federal Reserve Bank of Chicago 521, Federal Reserve Bank of Chicago.
  8. Acharya, Viral V. & Cooley, Thomas & Richardson, Matthew & Walter, Ingo, 2011. "Market Failures and Regulatory Failures: Lessons from Past and Present Financial Crises," ADBI Working Papers, Asian Development Bank Institute 264, Asian Development Bank Institute.
  9. Demirguc-Kunt, Asli & Kane, Edward J. & Laeven, Luc, 2006. "Deposit insurance design and implementation : policy lessons from research and practice," Policy Research Working Paper Series 3969, The World Bank.
  10. Ching-Yi Chung & Gary Richardson, 2006. "Deposit Insurance and the Composition of Bank Suspensions in Developing Economies: Lessons from the State Deposit Insurance Experiments of the 1920S," NBER Working Papers 12594, National Bureau of Economic Research, Inc.

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