Liability Rules and Risk Taking in Commercial Banks
Posted: 24 Sep 1996
Date Written: July 25, 1996
From 1863-1933, commercial shareholders were subject to a broad range of liability rules for the obligation of their bank ranging from limited liability to unlimited liability. By increasing shareholder liability, the regulators hope to minimize incentives for risk shifting in these highly leveraged institutions. I find that risk taking is negatively related to the severity of the liability rule primarily because banks choose to hold less risky assets and greater net worth. These findings indicate that the shape of the equityholders' payoff function has a significant effect on their incentives particularly in regard to risk taking.
JEL Classification: K22, G32, G21, G28
Suggested Citation: Suggested Citation