Hair of the Dog That Bit Us: The Insufficiency of New and Improved Capital Requirements

28 Pages Posted: 28 Feb 2013 Last revised: 15 Jul 2014

See all articles by Edward J. Kane

Edward J. Kane

Boston College - Department of Finance; National Bureau of Economic Research (NBER)

Date Written: July 14, 2014

Abstract

Government safety nets give protected institutions an implicit subsidy and intensify incentives for value-maximizing boards and managers to risk the ruin of their firm. Standard accounting statements do not record the value of this subsidy and forcing subsidized institutions to show more accounting capital will do little to curb their enhanced appetite for tail risk. In this paper, I propose new accounting and ethical standards that would reclassify the legal status of the financial support a firm receives from the safety net and record it as an equity investment. The purpose is to recognize statutorily that a safety net is a contract that promises to deliver loss-absorbing equity capital to firms at times when no other investors will. The explicit recognition of the public's stakeholder interest in economically, politically, and administratively difficult-to-unwind firms is a first and necessary step toward assigning to their managers enforceable fiduciary duties of loyalty, competence, and care towards taxpayers. These duties are meant to parallel those that managers owe to shareholders, including the right to share in the firm’s profits and to receive information relevant for assessing their investment. The second step in this process is to change managerial behavior: to implement and enforce a series of requirements and penalties that can lead managers to measure and record on the balance sheet of each subsidized firm – as a special class of equity – the capitalized value of the safety-net subsidies it receives from its “taxpayer put.” Incentives to report and service this value accurately in corporate documents – and in government reports making use of them – should be enhanced by installing civil sanctions such as a call on the personal wealth of managers and officials who can be shown to have engaged in actions intended to corrupt the reporting process and by defining a class of particularly vexing acts of safety-net arbitrage as criminal theft.

Keywords: financial safety net, taxpayer put, capital requirements, Basel III

JEL Classification: G28

Suggested Citation

Kane, Edward J., Hair of the Dog That Bit Us: The Insufficiency of New and Improved Capital Requirements (July 14, 2014). Available at SSRN: https://ssrn.com/abstract=2225432 or http://dx.doi.org/10.2139/ssrn.2225432

Edward J. Kane (Contact Author)

Boston College - Department of Finance ( email )

Fulton Hall
Chestnut Hill, MA 02467
United States
520-299-5066 (Phone)
617-552-0431 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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