Enhanced Liability and Bank Failure
Working Paper Author/Authors
Key Finding
Evidence from the Great Depression that that exposing shareholders and managers to more downside risk reduces bank failures
Abstract
Does enhanced liability for shareholders and managers reduce bank failure? We compare the performance of ~4,200 state-regulated banks of similar size in neighboring U.S. states with different liability regimes during the Great Depression. The distress rate for limited liability banks was 29% higher than for banks with enhanced liability. Results are robust to a diff-in-diff analysis incorporating nationally regulated banks (that faced the same regulations everywhere) and are not driven by other differences in regulation, local characteristics, or differential selection into state-regulated banks. Our results suggest that exposing shareholders and managers to more downside risk can substantially reduce bank failure.
© Felipe Aldunate, Haelim Anderson, Daniel Barth, Dong Beom Choi, Dirk Jenter, Arthur G. Korteweg, Peter Koudijs, 2026
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