The Governance Structure of Shadow Banking: Rethinking Assumptions About Limited Liability

Authors

Steven L. Schwarcz, Duke Law SchoolFollow

Document Type

Article

Publication Date

2014

Keywords

shadow banking, limited liability, corporate governance, systemic risk, shareholders, investors, cost-benefit analysis

Abstract

In an earlier article, I argued that shadow banking — the provision of financial services and products outside of the traditional banking system, and thus without the need for bank intermediation between capital markets and the users of funds — is so radically transforming finance that regulatory scholars need to rethink their basic assumptions. This article attempts to rethink the corporate governance assumption that owners of firms should always have their liability limited to the capital they have invested. In the relatively small and decentralized firms that dominate shadow banking, equity investors tend to be active managers. Limited liability gives these investor-managers strong incentives to take risks that could generate outsized personal profits, even if that greatly increases systemic risk. For shadow banking firms subject to this conflict, limited liability should be redesigned to better align investor and societal interests.

Citation

Steven L. Schwarcz, The Governance Structure of Shadow Banking: Rethinking Assumptions About Limited Liability, 90 Notre Dame Law Review 1-30 (2014)