Abstract
This paper examines the effects of increasing directors’ personal liability on board composition and outcomes of private financial institutions. We utilize a 2015 regulatory reform in Sweden that imposed a financial penalty of up to five million euro on directors of financial institutions for regulatory violations, thus effectively increasing their personal liability. Our findings show that board composition changes following the reform. The incoming directors are older at the time of their appointment, less experienced, and hold fewer directorships than the outgoing directors, suggesting that personal liability deters expert individuals from serving as directors of financial firms. Consistent with the expectation that directors require additional compensation for greater liability, we document that director compensation is higher after the reform. We also find evidence of lower earnings volatility and higher distance to default, suggesting that more director liability equates to less risk-taking in financial firms. Overall, our findings indicate that director liability provisions have a significant effect on board composition, compensation, and risk-taking in financial institutions.