New research paper titled: Elective Shareholder Liability for Systemically Important Financial Institution (newly titled as: Solving the Problem of Bailouts: A Theory of Elective Shareholder Liability)
by Peter Conti-Brown
Date: February 16, 2011
Stanford University, Rock Center for Corporate Governance
Rock Center for Corporate Governance at Stanford University Working Paper No. 97
Despite the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) and the initial proposal of Basel III, the debate regarding the regulation of systemically important financial institutions (SIFIs) continues unabated. Prominent among the present proposals is one led by prominent financial economists who argue in favor of 15% capital adequacy requirements for banks. So far, banks and their political supporters have resisted this proposal, claiming that it presents the banks with prohibitive and unnecessary costs. This Article proposes a mechanism, called elective shareholder liability, that provides the shareholders of the largest banks with a way to identify the costs of higher capital adequacy beyond simply the subsidies that come by way of the implicit governmental guarantees that the SIFIs presently enjoy. Elective shareholder liability gives SIFIs the option to subject themselves to the 15% capital adequacy, or, if not, grant a bailout exception to the SIFI’s present limited shareholder liability status. The latter is structured as an obligatory governmental cause of action for the recoupment of all bailout costs against the shareholders, assessed on a pro-rata basis. The cause of action would include an up-front stay on litigation to ensure that there are, in fact, taxpayer losses to be recouped, and to dampen government incentives for over-bailout, political manipulation, and crisis exacerbation. The cause of action would also give the government the authority to declare the shareholders’ use of the corporate form to evade liability null and void. After explaining the structure and benefits of elective shareholder liability, the Article addresses more than a dozen potential objections. Close inspection of these objections, however, reveals that the overall case for elective shareholder liability is strong as a matter of history, law, and economics.