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Why Did Shareholder Liability Disappear?

Journal: Journal of Financial Economics

Date: 20240201

Author: Bogle, David A.; Campbell, Gareth; Coyle, Christopher; Turner, John D.

Abstract:
Why did shareholder liability disappear? We address this question by looking at its use by British insurance companies until its complete disappearance. We explore three possible explanations for its demise: (1) regulation and government-provided policyholder protection meant that it was no longer required; (2) it had become de facto limited; and (3) shareholders saw an opportunity to expunge something they disliked when insurance companies grew in size. Using hand-collected archival data, our findings suggest investors attached a risk premium to companies with shareholder liability, and it was phased out as insurance companies expanded, which meant that they were better able to pool risks.

Link: Google Scholar

Key Findings

Decline in Shareholder Liability

Shareholder liability in British insurance companies declined dramatically from 97% of companies in 1880 to 0% by 1975, with uncalled capital ratios falling from over 5x to zero.

Size and Risk Management

Larger insurance companies had significantly lower uncalled capital ratios as they were better able to pool risks through diversification and scale.

Higher Cost of Capital

Insurance stocks with shareholder liability earned higher returns (9.6% vs 5.7% annually from 1900-1929), indicating investors demanded a risk premium.

Historical Decline of Shareholder Liability

  • Sharp decline in prevalence of shareholder liability over 85 years
  • Most dramatic drop occurred between 1930-1965
  • By 1965, only 15% of companies maintained shareholder liability

Company Size and Capital Structure

  • Large firms maintained significantly lower uncalled capital ratios
  • Small firms had over 8x higher ratio than large firms
  • Clear inverse relationship between firm size and shareholder liability

Returns Analysis: Liability vs No Liability

  • Shares with liability earned 3.9% higher annual returns
  • Difference indicates significant risk premium for shareholder liability
  • Higher returns compensated investors for additional risk exposure

Contribution and Implications

  • First comprehensive analysis of the disappearance of shareholder liability in the insurance sector
  • Demonstrates how increased firm size and diversification enabled reduction in shareholder liability
  • Provides insights into evolution of corporate liability structures and risk management
  • Highlights importance of scale economies in financial institution development

Data Sources

  • Historical decline chart based on Table 1 showing percentage of companies with uncalled capital 1880-1965
  • Size comparison chart based on Table 5 showing uncalled capital/assets ratios by firm size terciles in 1930
  • Returns analysis chart based on portfolio analysis results reported in text showing average annual returns 1900-1929