Risk-taking Under Limited Liability
Risk-taking Under Limited Liability

Author: Ciril Bosch-Rosa

Publisher:

Published: 2019

Total Pages:

ISBN-13:

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This paper investigates whether limited liability affects risk-taking through motivated beliefs. To do so, we run a within-subject experiment in which subjects invest in a risky asset under full or limited liability. In both cases, before the investment is made, subjects observe a noisy signal that indicates whether the investment will succeed or fail. They then state the likelihood of the investment's success and decide how much to invest. Our results show a strong effect of limited liability on both the investment decision and the formation of motivated beliefs. Compared to subjects under full liability, subjects under limited liability not only invest larger amounts but are also significantly more optimistic about the success of their investments. Finally, we show that more than one-third of the increase in investment under limited liability can be explained through motivated beliefs.

Risk-Taking Behavior with Limited Liability and Risk Aversion
Risk-Taking Behavior with Limited Liability and Risk Aversion

Author: Christian Gollier

Publisher:

Published: 2008

Total Pages:

ISBN-13:

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We consider in this paper the problem of a risk-averse firm with limited liability. The firm has to select the size of its investment in a risky project. We show that the optimal exposure to risk of the limited liability firm is always larger than under full liability. Moreover, there exists a positive lower bound on the value of the firm below which the firm will quot;bet for resurrection,quot; i.e. it will invest the largest positive amount in the risky project. We also consider the standard portfolio problem with more than one risky asset. We show that limited liability may induce the firm to specialize in no Mean-Variance efficient assets.

Heads We Both Win, Tails Only You Lose
Heads We Both Win, Tails Only You Lose

Author: Steffen Ahrens

Publisher:

Published: 2019

Total Pages:

ISBN-13:

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One of the reasons for the recent crisis is that financial institutions took "too much risk" (Brunnermeier, 2009; Taylor et al., 2010). Why were these institutions taking so much risk is an open question. A recent strand in the literature points towards the "cognitive dissonance" of investors who, because of the limited liability of their investments, had a distorted view of riskiness (e.g., Barberis (2013); Benabou (2015)). In a series of laboratory experiments we show how limited liability does not affect the beliefs of investors, but does increase their willing exposure to risk. This results points to a simple explanation for the over-investment of banks and hedge-funds: When incentives are not aligned, investors take advantage of the moral hazard opportunities.

Risk Taking, Limited Liability and the Competition of Bank Regulators
Risk Taking, Limited Liability and the Competition of Bank Regulators

Author: Hans-Werner Sinn

Publisher:

Published: 2010

Total Pages: 38

ISBN-13:

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Limited liability and asymmetric information between an investment bank and its lenders provide an incentive for a bank to undercapitalise and finance overly risky business projects. To counter this market failure, national governments have imposed solvency constraints on banks. However, these constraints may not survive in systems competition, as systems competition is likely to suffer from the same type of information asymmetry which induced the private market failure and which brought in the government in the first place (Selection Principle). As national solvency regulation creates a positive international policy externality on foreign lenders of domestic banks, there will be an undersupply of such regulation. This may explain why Asian banks were undercapitalised and took excessive risks before the banking crisis emerged.

Limited Liability, Moral Hazard, and Risk Taking
Limited Liability, Moral Hazard, and Risk Taking

Author: Sascha Füllbrunn

Publisher:

Published: 2013

Total Pages: 0

ISBN-13:

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We model the safety net problem as a social dilemma game involving moral hazard, risk taking, and limited liability. The safety net game is compared to both an individual decision task involving full liability and the deterministic public goods game. We report experimental data to show that limited liability leads to higher risk taking in comparison to full liability; nevertheless, the difference is much smaller than predicted by theory. In the safety net game, subjects behave as if socially responsible for the losses they impose on the group. With repetition, nevertheless, a gradual emergence of the moral hazard problem arises.

Risk-taking, Limited Liability, and the Banking Crisis
Risk-taking, Limited Liability, and the Banking Crisis

Author: Hans-Werner Sinn

Publisher:

Published: 2009

Total Pages: 208

ISBN-13:

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"The volume includes theoretical articles on banks' liability restrictions, on the possible causes of the banking crisis and economic-policy recommendations on banking regulation by Hans-Werner Sinn in the past three decades."--Publisher's website.

Liability Rules and Risk Taking in Commercial Banks
Liability Rules and Risk Taking in Commercial Banks

Author: Benjamin Esty

Publisher:

Published: 2009

Total Pages:

ISBN-13:

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From 1863-1933, commercial shareholders were subject to a broad range of liability rules for the obligation of their bank ranging from limited liability to unlimited liability. By increasing shareholder liability, the regulators hope to minimize incentives for risk shifting in these highly leveraged institutions. I find that risk taking is negatively related to the severity of the liability rule primarily because banks choose to hold less risky assets and greater net worth. These findings indicate that the shape of the equityholders' payoff function has a significant effect on their incentives particularly in regard to risk taking.