Risk-Based Equity Requirements: How Equity Rules for the Financial Sector can be Applied to the Real Economy

Abstract

It is undisputed that rules are necessary to cope with the risks of failing financial institutions in the financial sector. These rules link the risk profile of a financial institution to the quantitative and qualitative properties of its capital. In the real economy the discussion proceeds from the opposite direction, questioning the necessity of a minimal amount of capital and its regulation. This essay shows, however, that, even for the real economy, rules are in place which require the board of a company to adjust the risk profile to the level and structure of the company's equity and vice versa. The relationship between risk-bearing ability and equity leads to a set of principles and rules on how to determine the correct amount of equity. The essay describes these rules and their procedural enforcement based on company and accounting law rules.