Contingent capital and bank risk-taking among British banks before the First World War (original) (raw)
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Contingent Capital and Bank Risk-Taking among British Banks before World War I
2011
The recent financial turmoil highlights the incentive of highly leveraged financial institutions to take excessive risk, given the protection of limited liability. During the nineteenth and early twentieth century, many banks operated under liability rules which obligated shareholders to bear larger costs of bank insolvency in the form of contingent, or even unlimited liability. This paper examines the empirical relationship
Contingent capital and bank risk‐taking among British banks before the First World War1
The recent financial turmoil highlights the incentive of highly leveraged financial institutions to take excessive risk, given the protection of limited liability. During the nineteenth and early twentieth century, many banks operated under liability rules which obligated shareholders to bear larger costs of bank insolvency in the form of contingent, or even unlimited liability. This paper examines the empirical relationship between the size of banks' contingent liability and their risk-taking behavior using data on British banks from 1878-1912. We find that banks with more contingent liability appear to have taken less risk. We also find evidence that the risk-reducing effects of contingent liability were larger for banks with higher leverage, suggesting that contingent capital mitigated moral hazard problem at banks. 1 We are grateful to three anonymous referees, Efraim
The character and denomination of shares in the Victorian equity market
The seminal work of J. B. Jefferys highlighted two unusual features of the Victorian equity market, namely high share denomination and uncalled capital. This article examines the extent to which publicly traded company stocks in the nineteenth century had these features. It also analyses the effect of these features on stock returns using monthly data for the London Stock Market over the period 1825-70. We find that stocks with unpaid capital earned a higher return, which is consistent with investors being rewarded for the risk of a call on their personal assets. We also find that stocks with a high share denomination earned a lower return, which is consistent with the view that this feature was conducive to superior corporate governance.
Does Limited Liability Matter? Evidence From Nineteenth-Century British Banking
Review of Law & Economics, 2000
The widely-held, but empirically unsubstantiated, view is that the main advantage of limited liability over extended shareholder liability is that the enforcement costs of the latter impedes the tradability and liquidity of shares. We use the rich shareholderliability experience of nineteenth-century British banking to test this standard view. As well as exploring the means by which unlimited liability was enforced, we examine the impact of liability regimes on the tradability and liquidity of bank stock. Surprisingly, our evidence suggests that liability rules appear to be irrelevant from a stock-liquidity perspective.
Limited liability is regarded as the sine qua non of the modern company, enabling firms to raise capital from a broad spectrum of investors who have well-diversified portfolios. This paper uses the ownership records of an Irish bank which converted to limited liability in 1883. We explore the impact of introducing limited liability upon the bank's ownership and control. We find that ownership becomes more dispersed amongst individuals from a broader social spectrum. However, there is little impact on geographical dispersion or on portfolio diversification. Furthermore, although limited liability appears to contribute to the rise of the professional director, the evidence suggests that managerial incentives are weakened.
Much ado about nothing: the limitation of liability and the market for 19th century Irish bank stock
Explorations in Economic History, 2005
Limited liability is widely believed to be a prerequisite for the emergence of an active and liquid securities market because the transactions costs associated with trading ownership of unlimited liability firms are viewed as prohibitive. In this article, we examine the trading of shares in an Irish bank, which limited its liability in 1883. Using this bank’s archives, we assemble a time series of trading data, which we test for structural breaks. Our results suggest that the move to limited liability had a negligible impact upon the trading of this bank’s shares.
Predictors of Bank Distress: The 1907 Crisis in Sweden
SVERIGES RIKSBANK WORKING PAPER SERIES 358 , 2018
This paper contributes to literature on bank distress using the Swedish experience of the international crisis of 1907, often paralleled with 2008. By employing previously unanalyzed bank-level data, we use logit regressions and principal component analysis to measure the impact of pre-crisis bank characteristics on the probability of their subsequent distress. The crisis was characterized by “creative destruction,” as those banks with weaker corporate governance structures, wider branching networks, operating with lower cost efficiency were more likely to experience distress. We find that poor credit allocation rather than foreign borrowing, as often stressed, were associated with ultimate demise. Keywords: Bank Distress, Financial Crises, Swedish Banks, Lender of Last Resort JEL-Classification: E58, G21, G28, H12 N23
SSRN Electronic Journal, 2000
Limited liability has been known in Europe since at least the twelfth century, and developed later in England and throughout the developed world. Limited liability can be achieved by private contractual arrangements, by the use of limited liability forms of enterprise, by other statutory limits on liability, and by bankruptcy. The principal advantage of limited liability is in encouraging investment by passive investors in risky enterprises, particularly where these investors are poor monitors of managers. Joint and several liability is a particular deterrent to investment by wealthy investors, who are likely to bear all of the costs of judgment. Pro rata liability shifts collection costs from wealth investors who must seek contribution from other investors to judgment creditors, who must collect from all investors if they are to recover the entire judgment. It is generally agreed that in the context of contractual liability, the costs of limited liability on contract creditors will be fully internalized, as the cost of credit rises to reflect increased risk of firm bankruptcy shifted to these creditors. Determining the efficient rule in the context of tort liability is much more complex. While it is generally true that limited liability allows firms to become judgment proof and frustrate tort creditor recovery, this is only the beginning of the inquiry. First, tort creditors may benefit from efforts of contract creditors to minimize firm risk. Second, it is not clear that unlimited liability would deter risky firm activities if widely dispersed shareholders are poor monitors of risky firm activities, or if many tort liabilities are uncertain in their incidence and extent of harm. Third, it is not clear that shareholders are necessarily the superior risk-bearers where mass torts involve class actions where each claim is relatively small, if some shareholders would bear a large amount of liability. JEL classification: K22
A Contracting-Theory Interpretation of the Origins of Federal Deposit Insurance
Journal of Money, Credit and Banking, 1998
Conventional wisdom holds that the enactment of federal deposit insurance helped small rural banks at the expense of large urban institutions. This paper uses asymmetricinformation, 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.
Predicting the Past: Understanding the Causes of Bank Distress in the Netherlands in the 1920s
2013
Abstract: Why do some banks fail in financial crises while others survive? This paper answers this question by analysing the consequences of the Dutch financial crisis of the 1920s for 143 banks, of which 37 failed. Banks' choices in balance sheet composition, corporate governance practices and shareholder liability regimes were found to have a significant impact on their chances of experiencing distress.