Why did shareholder liability disappear?
Limited liability is pervasive in modern financial systems. It can encourage investment, but it also has the potential to incentivize risk taking. Asymmetric payoffs between profits and losses can encourage financial firms to pursue more speculative projects, knowing that their shareholders will gain the full benefit of success, but a limited loss from failure. Its […]
John D. Turner is Professor of Finance and Financial History at Queen’s University Belfast and a Director of the Centre for Economics, Policy and History. This post is based on a recent paper forthcoming in the Journal of Financial Economics by David Bogle, Christopher Coyle, Gareth Campbell, and Professor Turner. Related research from the Program on Corporate Governance includes The Case for Increasing Shareholder Power and Letting Shareholders Set the Rules both by Lucian A. Bebchuk.
Limited liability is pervasive in modern financial systems. It can encourage investment, but it also has the potential to incentivize risk taking. Asymmetric payoffs between profits and losses can encourage financial firms to pursue more speculative projects, knowing that their shareholders will gain the full benefit of success, but a limited loss from failure. Its role in exacerbating risk taking may have played a role in the Global Financial Crisis of 2008.
Historically, banks in the United States were required to have double liability, meaning that shareholders faced additional costs beyond their initial investment if the bank became insolvent, and recent scholarship suggests that such banks were less likely to fail.
In the United Kingdom, most banks and insurance firms voluntarily chose to have extended liability, where shareholders could potentially be exposed to payouts which were much greater than the amount that they had invested. However, this is no longer the case. This raises the question: Why did shareholder liability disappear?
