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Matching liability to power: A proposal for a two-tier equity structure for banks and SIFIs

Professor Rosa Lastra discusses her upcoming paper with Professor Charles Goodhart for the Centre for the Study of Financial Innovation.

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Panelists at the Matching liability to power event

On Tuesday 26 November 2019, Professor Rosa María Lastra (CCLS, Queen Mary) and Professor Charles Goodhart (LSE) presented and discussed their forthcoming paper in the Journal of Financial Regulation. The event was hosted by the Centre for the Study of Financial Innovation (CSFI).

Professor Goodhart and Professor Lastra have been working for some time on what they see as one of the major shortcomings in the current model of capitalism: the fact that, as presently structured, limited liability allows shareholders (and managements) to enjoy the upside while restricting their exposure to the downside. This, the two of them fear, is particularly dangerous in the case of banks – though their criticism is more general.

The paper, titled Matching liability to power: A proposal for a two-tier equity structure for banks and SIFIs, suggests that “equity holders with limited liability are insured against the risk of really bad outcomes” – and that this is “the biggest source of moral hazard and risk shifting in a capitalist economy”. It also “naturally leads shareholders to push management to adopt riskier strategies than would be socially optimal”.

The paper has already stirred up some controversy, as has the solution they propose.

Just as there are already several classes of debt, with different characteristics, Charles and Rosa are proposing that there should be two classes of equity:

  • One for “outsiders”, with no knowledge of a firm’s inner workings and no ability to control its decision-making; and
  • One for “insiders”, who have both the information and capacity to influence decision-making.

This event, held at Furniture Makers’ Hall in London, also welcomed Charles Dumas, Chief Economist at TS Lombard, and Guy Morton, Solicitor and former Partner at Freshfields Bruckhaus Deringer LLP, as Respondents.

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