And this quest for shareholder returns was in turn aided and abetted by creditors who, far from pricing this rising risk, charged a low and falling interest rate to the banks, further fuelling risk-taking incentives. This risk-shifting crystallised as the crisis broke. At that point, yields on bank borrowing shot up and risk-taking was crushed. Creditors bore large losses, which would have been larger still without government support. This experience makes clear that risk-shifting is not a theoretical phenomenon; it is very much real, with large costs for creditors and for the wider economy. Indeed, the welfare implications of risk-shifting are doubly troubling. Not only does it generate excessive risk-taking and credit creation during upswings. As importantly, it also contributes to excessive caution and a credit crunch during the downswing. Risk-shifting results in twosided deadweight costs, for creditors and for the macro-economy. 19 Both have been much in evidence over recent years. (b)  Risk-alignment  A related, but distinct, micro-economic risk friction concerns how rights are allocated to different stakeholders in a company. Standard corporate finance theory sets out, on the face of it, a coherent allocation of control rights and risks. Shareholders have a junior claim on the profits of a company, in that they are paid out after employees, creditors and the taxwoman. Theirs is the riskiest piece of the profits pie. This means “ownership” is really a misnomer when applied to shareholders. What defines shareholders is not that they own most or all of the company.

Experience in the run-up to the crisis suggests, if anything, the opposite. Paying in equity appears to have increased the probability of failure. Among US bank CEOs pre-crisis, the top five equity stakes were held by Dick Fuld (Lehman Brothers), Jimmy Cayne (Bear Stearns), Stan O’Neill (Merrill Lynch), John Mack (Morgan Stanley) and Angelo BIS central bankers’ speeches  7  Mozilo (Countrywide). This is not a random sample. 16 It also suggests the macro-economic costs of this principal/agent problem may have been non-trivial. (b)  Collective action problems: the “ownerless corporation”  A second stakeholder friction arises because a diffuse and dispersed set of shareholders are likely to find it difficult to corral management (Shleifer and Vishny (1986)). There is a coordination problem among shareholders. Moreover, most individual shareholders tend to have modest amounts of skin in the game. This reduces their incentives to exercise corporate control in the first place. This shareholder collective action problem is not new. It lay at the heart of Berle and Mean’s concern about “ownerless corporations” in the 1930s. But there are good reasons for believing this problem may have become more acute since then, as the shareholder base has become more fragmented and diffuse and shareholder co-ordination more difficult (Kay (2012)). One reason is that the role of institutional investors has changed. They have tended historically to play an important stewardship role. But this role has waned. As recently as 1990, pension funds and insurance companies held more than half of UK equities.