"Now that the countries of the west have agreed to a three-trillion dollar bailout programme to rescue their banking systems, it is time to look forward and to draw lessons from the crisis. To do this we must understand the causes of the crisis. ... The core of the crisis lies in the legal provisions of limited liability. Creditors of corporations have no claims against the personal assets of the owners (shareholders) of these corporations. ... In times of great economic insecurity, however, limiting liability can become a problem because it induces entrepreneurs to become gamblers. ... The risks created incentives to minimise the stock of equity kept inside these firms, and the small amount of equity capital in turn created incentives to pursue overly risky operations. The interplay of these incentives is the actual cause of the crisis--and this is where reform must begin. The privilege of limited liabilty is not a creation of the market. ... Politicians must finally face the task of defining legal liability limitations for corporations by establishing strict minimum standards for equity capital requirement for the various business models of the banks, both in America and in Europe", my emphasis, Hans-Werner Sinn, 17 December 2008 at http://www.voxeu.org/index.php?q=node/2701.
I agree with Sinn, a University of Munich professor, but think his remedy unworkable as the system will be gamed and publicly-traded companies shares would in effect, be traded with "coupons attached". How do you attribute liability to a shareholder who owned his 100 shares for three days of the company with nine billion shares outstanding? Assume you make a three-year "fraudulent transfer" search. Should the 100 share shareholder be liable for 300 / 9,855 billion of the company's liabilities (9 billion x 365 x 3)? Should you bring hundreds of thousands of shareholders into the bankruptcy? I proposed making officers of companies liable up to three times each's last three years' compensation. In effect, making publicly-traded companies limited partnerships.
9 comments:
IA >>> is this related only to publicly traded bank holding companies or all types of public companies?
I'm with you on resting more liability on the officers of the corp... especially in financial institutions... the idea that officers are remote from the consequences of the risks that they put the company into is not healthy... I don't know how to do it on the legal front but more connection between profits, actions and risks need to be embedded in the system...
Anonymous:
I would apply this to all publicly-held companies.
Uhmmm...
Wouldn't this be a relatively substantial change to the structure of our hybrid form of capitalism?
I'm trying to imagine what would flow from this change... it would likely run off the knowing frauds from corps... but how much a disincentive for others?
And wouldn't it push more firms to remain private (not neccessarily a bad outcome)?
Anonymous:
Yes, this is a big change. So? I prefer corporate officers paying to the public. What will flow? It will become riskier to be a corporate officer. So? Look at a guy like Richard Fuld at Lehman. Why should he not be financially ruined? Or Goldman's Lloyd Blankfein? Or Citigroup's $800 million man, Vikram Pandit? Now corporate officers will evaluate risk differently. Hans-Werner and I see the same problem: individuals can use the corporate form to "pay a heads I win, tails you lose game". This is a big problem with leveraged buyouts. So big a problem, I don't think banks should be permitted to make LBO loans at all!
I recently saw an interview with a Lehman alumnus who said Lehman would never have played the gambling games it has in the last few years if it was still privately held.
No doubt Lehman wouldn't have taken on the leverage and risk that it had as a private corp...
I think your idea is sound... imagine the howling in C-Suites... "it will destroy risk-taking"...no... it will just right-size it...
suuuweeeee....
Anonymous:
"Destroy risk taking" is an emotive term. It will shift the incidence of risk to managers from stockholders of a firm and its creditors. Let them howl. The more they howl the better. As a policy preference, I would rather see 10,000 useless millionaires on Wall Street ruined as opposed to the American public. Anyone running an investment bank with a 30 to 1 leverage ratio should have had his head examined. Or else chopped off. Sharpen up that guillotine blade.
No need to fear 30 times levered when you are the market and make the prices... dos guys did rule...no more...
Yes please... sharpen up the blade... the system will get along fine without those guys!
I believe that idea that limited liability
caused the current problems is false,
but ignoring that there is another problem.
You can't *effectively* remove the limited liability. All you will do by changing the rules is cause ownership to be held
by frontmen who have little to lose.
Where is the liability of the sub-prime mortgage borrowers? They had nothing to start with so giving them liability over
the value of the real estate doesn't add anything.
Also where is the liability of congress for the debt they've run up (and continue to run up)? Or the California legislators?
Anonymous:
Are you a bankruptcy lawyer? Front men? In that case that's a job for criminal law. 18 USC 152, 1341, 1343, 1344, and 15 USC 78. We have crimes like RICO, 18 USC 1961-69 and continuing financial crimes enterprise, 18 USC 225, that should put the "front men" away for a very long time. Just increase the risk enough and very few will be willing to be a "front man". Trust me, 30 years in the federal pen with no possibility of parole for 25, will discourage most would be "front men".
We disagree. To me this is a simple expected value calculation. I'll give you this much, our current DOJ fails to enforce the criminal law against the politically favored. As for the front men, those who used them would have "aider-abettor" liabilility, 18 USC 2. Check it out.
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