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The demise of double liability as an optimal contract for large-bank stockholders

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  • Edward J. Kane
  • Berry Wilson

Abstract

This paper tests the optimal-contracting hypothesis, drawing upon data from a natural experiment that ended during the Great Depression. The subjects of our experiment are bank stockholders. The experimental manipulation concerns the imposition of state or federal restrictions on the contracts they write with bank creditors. We contrast stockholders that were subject to the now-conventional privilege of limited liability with stockholders that faced an additional liability in liquidation tied to the par value of the bank's capital. Our tests show that optimal contracting theory can provide an explanation both for the long survival of extended-liability rules in banking and for why they were abandoned in the 1930s.
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Suggested Citation

  • Edward J. Kane & Berry Wilson, 1997. "The demise of double liability as an optimal contract for large-bank stockholders," Proceedings 556, Federal Reserve Bank of Chicago.
    • Handle: RePEc:fip:fedhpr:556
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    References listed on IDEAS

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    Cited by:

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    2. Esty, Benjamin C., 1998. "The impact of contingent liability on commercial bank risk taking," Journal of Financial Economics, Elsevier, vol. 47(2), pages 189-218, February.
    3. von Furstenberg, George M., 2011. "Contingent capital to strengthen the private safety net for financial institutions: Cocos to the rescue?," Discussion Paper Series 2: Banking and Financial Studies 2011,01, Deutsche Bundesbank.
    4. Bogle, David A. & Campbell, Gareth & Coyle, Christopher & Turner, John D., 2024. "Why did shareholder liability disappear?," Journal of Financial Economics, Elsevier, vol. 152(C).
    5. Grodecka, Anna & Kotidis, Antonis, 2016. "Double Liability in a Branch Banking System: Historical Evidence from Canada," Working Paper Series 316, Sveriges Riksbank (Central Bank of Sweden).
    6. Jenter, Dirk & Aldunate, Felipe & Korteweg, Arthur & Koudijs, Peter, 2021. "Shareholder Liability and Bank Failure," CEPR Discussion Papers 16309, Centre for Economic Policy Research.
    7. repec:ehl:lserod:121956 is not listed on IDEAS
    8. Mitchener, Kris James & Richardson, Gary, 2013. "Does “Skin in the Game” Reduce Risk Taking? Leverage, Liability and the Long-Run Consequences of New Deal Financial Reforms," CAGE Online Working Paper Series 118, Competitive Advantage in the Global Economy (CAGE).
    9. Mitchener, Kris James & Richardson, Gary, 2013. "Does “skin in the game” reduce risk taking? Leverage, liability and the long-run consequences of new deal banking reforms," Explorations in Economic History, Elsevier, vol. 50(4), pages 508-525.
    10. Rafiqul Bhuyan & Yuxing Yan, 2007. "Designing deposit insurance scheme under asymmetric information with double liability option," Applied Financial Economics, Taylor & Francis Journals, vol. 17(11), pages 855-870.
    11. Kane, Edward J & Wilson, Berry K, 1998. "A Contracting-Theory Interpretation of the Origins of Federal Deposit Insurance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(3), pages 573-595, August.
    12. repec:ehl:wpaper:121956 is not listed on IDEAS
    13. Brock, Philip L., 1998. "Financial safety nets and incentive structures in Latin America," Policy Research Working Paper Series 1993, The World Bank.

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    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • N2 - Economic History - - Financial Markets and Institutions

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