Shareholder Liability Regimes, Principal-Agent Relationships, and Banking Industry Performance

We develop an interpretation of the economics of alternative shareholder liability regimes that challenges the view that limited liability always represents the most efficient form of corporate organization. Unlimited liability will prevail when creditors are willing to compensate shareholders for bearing all of the costs of monitoring management and the risk associated with the activities of the firm. When the information about the financial position of the firm that is required to facilitate increased risk-bearing by creditors can be provided at costs lower than those associated with unlimited liability, firms will incorporate. Scottish banking in the nineteenth century provides unique data on the operation of a market in which firms with limited and unlimited liability competed, on the risk premium associated with unlimited liability shares, and on the innovations in information provision that facilitated the move from unlimited to multiple liability.