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Why did shareholder liability disappear?

Journal: Journal of Financial Economics

Date: 2024

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

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

Background and Context

Historical Setting

Until the 1970s, British insurance companies operated with shareholder liability, where shareholders could be called upon to provide additional capital if the company faced financial difficulties.

Research Focus

The study examines why shareholder liability disappeared in British insurance companies by analyzing hand-collected archival data spanning from 1830 to 1965.

Methodology

The research uses a combination of financial statement analysis, portfolio returns analysis, and examination of merger activities to understand the factors behind the decline of shareholder liability.

Sharp Decline in Uncalled Capital

  • Shows dramatic decline in shareholder liability from 1880 to 1965
  • By 1930, only 4% of assets were covered by uncalled capital, down from 57% in 1880
  • Demonstrates the complete transformation of the industry's liability structure

Growth in Insurance Company Assets as Liability Declined

  • Demonstrates dramatic increase in average company assets over time
  • Shows how companies grew substantially larger through mergers and organic growth
  • Illustrates the increasing ability of companies to self-insure through size

Higher Returns Required for Stocks with Shareholder Liability

  • Shows the difference in annual returns between companies with and without shareholder liability
  • Companies with shareholder liability required 3.8% higher returns to compensate for additional risk
  • Demonstrates the higher cost of capital associated with shareholder liability

Size Difference Between Acquiring and Target Companies

  • Illustrates how larger companies acquired smaller ones
  • Acquiring companies were typically 5 times larger than their targets
  • Shows the consolidation process that led to fewer, larger companies

Decline in Uncalled Capital Ratio by Company Size

  • Shows how larger companies maintained lower levels of uncalled capital
  • Demonstrates the relationship between company size and reduced need for shareholder liability
  • Illustrates how growth enabled companies to reduce shareholder liability

Contribution and Implications

  • Demonstrates that the disappearance of shareholder liability was driven by increased company size and diversification rather than regulation
  • Shows how organic growth and mergers enabled insurance companies to better manage risk without shareholder liability
  • Provides insights into how financial institutions can transition away from extended liability structures as they grow in scale

Data Sources

  • Uncalled Capital as a proportion of Assets: Based on Table 1 showing ratios over time
  • Assets Growth Chart: Constructed using asset values from Table 1
  • Returns Comparison Chart: Based on portfolio analysis results discussed in text showing 9.6% vs 5.7% returns
  • Merger Size Comparison: Created using data from Table 9 showing average assets of targets and bidders
  • Size and Uncalled Capital Chart: Constructed using data from Table 5 showing uncalled capital ratios by company size