Limited Liability, Asymmetric Taxation, and Risk Taking - Why Partial Tax Neutralities Can Be Harmful

AbstractThe effects of capital requirements on risk-taking and welfare are studied in an overlapping generations model of endogenous growth with banking, limited liability, and government guarantees. Capital producers face a choice between a safe technology and a risky, more productive but socially inefficient, technology. Bank risk-taking is endogenous. As a result of a skin in the game effect—motivated either as an aggregate externality, or as the outcome of the optimal choice of monitoring effort by individual banks—default risk is inversely related to the capital adequacy ratio. Numerical simulations show that in an equilibrium where banks extend both safe and risky loans, the skin in the game effect must be sufficiently strong for a welfare-maximizing regulatory policy to exist. These results remain qualitatively similar with endogenous monitoring costs and a strong effect of monitoring on entrepreneurial moral hazard. However, numerical experiments also suggest that the optimal capital adequacy ratio may be too high in practice and may require concomitantly a broadening of the perimeter of regulation and a strengthening of financial supervision to prevent disintermediation and distortions in financial markets.

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Risk Taking, Limited Liability and the Competition of Bank Regulators

10.3386/w8669 ◽

2001 ◽

Cited By ~ 8

Author(s):

Hans-Werner Sinn

Keyword(s):

Risk Taking ◽

Limited Liability

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Convergence in Corporations Law - Towards a Facilitative Model

Victoria University of Wellington Law Review ◽

10.26686/vuwlr.v26i2.6171 ◽

1996 ◽

Vol 26 (2) ◽

pp. 191 ◽

Cited By ~ 1

Author(s):

David Goddard

Keyword(s):

Risk Taking ◽

Buenos Aires ◽

International Association ◽

Limited Liability ◽

Significant Degree ◽

Ius Commune ◽

Modern Economy ◽

Convergence And Divergence ◽

Degree Of Convergence ◽

Insight Into

The following is the Report of the General Reporter on the Law of Corporations presented to the Annual Colloquium of the International Association of Legal Science (the 1995 IALS Colloquium) which was held in Buenos Aires in September 1995. The theme of the conference was "Towards a modern ius commune: converging trends in a changing world". This article argues that there has been a significant degree of convergence internationally in the general approach of states to corporations law. The article begins by setting out the purpose and justifications of corporations in a modern economy: the division of ownership interest into shares, the limited liability of the shareholders, and the nature of risk-taking and risk-bearing. The article then provides the evidence of both convergence and divergence in corporations law, ultimately arguing for there being a convergence. The author also provides some insight into the likely directions for convergence. The author concludes that the overall movement towards a facilitative model of corporations law is a self-reinforcing process which can be expected to become even more widespread and rapid in the future.

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Optimal contracts with a risk‐taking agent

Theoretical Economics ◽

10.3982/te3660 ◽

2020 ◽

Vol 15 (2) ◽

pp. 715-761 ◽

Cited By ~ 2

Author(s):

Daniel Barron ◽

George Georgiadis ◽

Jeroen Swinkels

Keyword(s):

Risk Taking ◽

Limited Liability ◽

Risk Averse ◽

Trade Off ◽

Optimal Contracts ◽

Risk Neutral ◽

Profit Maximizing ◽

Over Time

Consider an agent who can costlessly add mean‐preserving noise to his output. To deter such risk‐taking, the principal optimally offers a contract that makes the agent's utility concave in output. If the agent is risk‐neutral and protected by limited liability, this concavity constraint binds and so linear contracts maximize profit. If the agent is risk averse, the concavity constraint might bind for some outputs but not others. We characterize the unique profit‐maximizing contract and show how deterring risk‐taking affects the insurance‐incentive trade‐off. Our logic extends to costly risk‐taking and to dynamic settings where the agent can shift output over time.

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Optimal Monetary and Prudential Policies

American Economic Journal Macroeconomics ◽

10.1257/mac.20140139 ◽

2017 ◽

Vol 9 (1) ◽

pp. 40-87 ◽

Cited By ~ 23

Author(s):

Fabrice Collard ◽

Harris Dellas ◽

Behzad Diba ◽

Olivier Loisel

Keyword(s):

Risk Taking ◽

Financial Stability ◽

Deposit Insurance ◽

Limited Liability ◽

Capital Requirements ◽

Bank Capital ◽

The Business Cycle ◽

Recent Financial Crisis ◽

The Interest Rate ◽

Excessive Risk Taking

The recent financial crisis has highlighted the interconnectedness between macroeconomic and financial stability, raising questions about how to combine monetary and prudential policies. This paper characterizes the jointly optimal monetary and prudential policies, setting the interest rate and bank-capital requirements. The source of financial fragility is the socially excessive risk taking by banks due to limited liability and deposit insurance. We provide conditions under which locally (Ramsey) optimal policy dedicates the prudential instrument to preventing inefficient risk taking by banks, and the monetary instrument to dealing with the business cycle, with the two instruments covarying either negatively, or positively and countercyclically. (JEL E32, E43, E44, E52, G01, G21, G28)

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