Legislative restraints in corporate bailout design

• Published in: Journal of economic behavior & organization 2019-02, Vol.158, p.337-350
• Main Authors: Gradstein, Mark, Kaganovich, Michael
• Format: Article
• Language: English
• Subjects: Corporate bailouts; Political economy
• ISSN: 0167-2681; 1879-1751
• DOI: 10.1016/j.jebo.2018.12.003

•The paper examines the design of ex ante legislative procedures aimed at restraining corporate bailout in the aftermath of a potential crisis.•The restraint is a form of commitment needed to minimize moral hazard-induced excessive risk-taking, which can exacerbate likelihood of a crisis.•We analyze the problems of delegation of executive bailout authority.•We show that selecting bailout executive by legislative process akin to ex post supermajority requirement can ensure effective future restraint. The aftermath of the recent economic crisis saw the largest U.S. government bailout of corporate entities ever. While the bailout was carried out with the explicit goal of restoring stability, it aroused much controversy and public criticism based on moral hazard concerns as well as the exorbitant cost to the taxpayer. This paper examines the bailout design on behalf of an imperfectly informed legislature aimed at shaping the incentives of a policymaker to whom bailout decisions are delegated. We show that important elements of the more moral hazard-proof design entail various legislative procedural hurdles, which effectively make the bailouts dependent on supermajority support.