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Thoughts on Limited Liability
Vinay Gupta, 1 Jun 06

One of the persistent threads running through environmentalism is the notion of "Corporate Responsibility." I've been thinking through some of the issues involving how corporations are formed and how the nature of the corporation affects how the economy assesses and handles risk and I'd like to present an idea for comment and examination.

The seed of the idea is that the limited liability corporation is a government subsidy to risky investments and as such may be partly what drives the reckless attitude of corporations towards the environment. Read on for more details.

So, please follow my chain of thought and see where it leads:

1> The difference between a partnership and a corporation is that shareholders in a corporation are protected from liability for the debts of the corporation in bankruptcy (”limited liability.”)

2> The same protection from liability could be obtained in partnership by the purchase of “liability insurance” which would, if the company you co-owned went down, cover your debts. Because of the open-ended nature of the liability being insured against, this insurance would probably be fairly expensive.

3> The fiat (government-created) limited liability provided by the state is actually a subsidy at the expense of those whom bankrupted corporations owe money to, in favor of the investors, and its financial value can be calculated as the total value of the insurance services provided to investors or perhaps as the total cost to the creditors.

It surprises me that I can't find an analysis of how large this subsidy to investors is!

Possibly, if this question was analyzed, we would discover that limited liability protection is the largest goverment programme there is, perhaps even larger than the military. Plausible? Well, consider the total size of the stock market - the market capitalization of the entire economy. Now imagine insuring that. Limited liability moves a lot of wealth from creditors to investors in any given year, through bankruptcy proceedings - how much wealth is transferred in a given year?

This may explain why limited liability creates wealth so fast: by taking an intangible like “risk” and providing an equally intangible “protection from risk” goverments subsidied real, tangible spending with a vast, intangible subsidy.

The Polluter Pays principle becomes interesting when examined from this perspective. If the real polluter is not the corporation, but the benificiary of the corporation's actions - that is to say, the owners/shareholders - then making the real polluter pay may require a change in corporate law. Providing shareholders with blanket protection from the actions taken on their behalf may no longer be a sensible approach.

Unlimited limited liability may, in fact, be a perverse insentive encouraging the economy to continue high risk activities such as unregulated release of GMOs into the environment by subsidising shareholders who assume these risks in their investment strategies.

What if we phased out limited liability? Suppose, for example, we made shareholders liable for up to 1% of their assets in corporate bankruptcy cases - you can lose up to 1% of your net worth to cover the unpaid debts of corporations in which you own stock. Would that change shareholder behavior to less risky investments? Would it cool the economy - or increase corporate responsibility at no cost to the tax payer?

Could regulating the degree of investor protection become one way of pulling corporations back into line when corruption becomes rife? Would ENRON have happened if shareholders had been even partially liable?

I'm not enough of an economist to really understand the implications of this idea, but I'd like to open the floor up to discussion: is viewing limited liability as a subsidy to the investor a valid way of thinking about it, and is reducing that subsidy to the investor a plausible way of making our economy a little more risk-averse and therefor environmentally responsible?

What do you think? Please comment!

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Comments

Of course it is. Back in the 19th century people already wrote about the strangeness of the legal protection of corporate "persons".

Corporate "persons" -- which are purely abstract entities -- have more rights than the real persons: they're not liable for their actions (in the sense you explained), they are protected by the bank secret (everything is transparent in this world, except the banked wealth of corporations), and they don't pay taxes on speculative currency trading.

Take the mining industry in the U.S. It is well known that these companies do not have to calculate in costs for cleaning up their mess *before* they actually set out to do a project; instead, they are only forced to confront it *after* the damage's been done; that's when they suddenly go bankrupt and start over somewhere else.

Finally, you want to compare this subsidy to the trillion dollar subsidies handed out to the military-industrial complex. One thing you are forgetting is that this complex itself has become entirely privatized. Anglosaxon wars are private capitalist wars. 30% of all foreign troops in Iraq are Private Military Company troops, subsidized twice. Military services (housing, catering, etc) are services offered by Private Limited Liability Companies - subsidized twice.

Over here, we call this "corporate communism".

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And if I may, the thing you are describing -- the absence of a kind of precautionary principle in the formal liability structure of a company -- has been even codified in the new accounting laws that are being forged by capitalist elites.

Allow me to quote a very interesting piece of text that complements the topic nicely:

Le Monde issue mentioned below

This month's Le Monde Diplomatique features a brilliant but ultra-boring essay on the new accounting rules that are being created (US/EU-worldwide). I was shocked at what I read there. It shows how a small clique of technocrats wants to turn the entire world's population into one of shareholders buying into purely virtual companies whose share values don't have to reflect in any way any fundamentals of any kind.

http://www.monde-diplomatique.fr/2005/11/RICHARD/12911

The article sharply shows how accounting standards have changed over time, with norms growing increasingly towards "virtual accounting", with the aim of giving quick dividends to shareholders, based on almost fraudulent and gratuituous assessments of CEOs. The new rules are almost barbaric: they now allow the CEO to present an entirely ficticious book based on entirely ficticious projections about the potential future value of the shares.
All the real fundamentals of a company's health have been eliminated.

So, Donshan, you're describing basic fundamentals of real companies making real business decisions, but we're already waaaayyy beyond this. Today's companies make money in a purely virtual way, on their shares, no matter their fundamentals.

1. In the first phase of capitalism (1800-1860), companies had to include "potential losses" in their books and the cautionary principle of the lowest potential future market value of the shares; this kept shareholders cautious and companies with their feet on the ground.
> This way, it was impossible to issue dividends at the beginning phase of an investment; because all kinds of costs (R&D, etc...) were put in the books, brutally, at the beginning of the investment cycle; these costs had to be valorized, which takes time. So, investors knew that ROIs based on real fundamentals take time to come about.

2. In the second phase of capitalism (ca. 1900-2004), those who supported the shareholders revolted against this cautionary principle and after countless wars, they succeeded, throughout the 20th century, to include this cautionary principle as something that can be "amortized", "written off", put on the long track, eliminated as a post at the beginning of the investment cycle.
>This nasty little trick means that these costs are written off following a fixed procedure, not following the real "lowest potential market value". Amortizing thus creates a fiction, with which one can relegate the real costs which slow down the process by which a company makes profits, to a later date.
>Shareholders could now cash in very quickly on their investments; no need to wait years to get a real share of the real profits of a real company.
>This is what allowed pure speculative investments; because one could cash in at any time, step out at any time, get a dividend real quickly, without you having to take the burden of the real costs the company has made (because they are being magically amortized).

3. Today, in the final phase of capitalism, after Enron, WorldCom and countless other speculative bubbles, an international consortium of accountants was called to revise the rules. Now one would think they would get rid of the potential for such bubbles. But on the contrary, they created more conditions which make bubbles much more likely.
>This final phase of capitalism (2004-...) invents a really brilliant nasty idea: costs are no longer amortized, you don't even have to write them in your books as fundamentals, amortization has been declared dead; instead comes: the freedom of the CEO squad to write "maximum potential future market values" of the shares, and use them as the basis for estimations about potential profits. The world turned upside down!
>No need any longer to have a company that produces real stuff; you can just create a company, tell the world that you "expect" a 200% increase of your share value over the coming year, you don't have to prove anything on paper (which used to be the case in phase I and II); just go out and say something. Wear a tie!
>This is the perfect recipee for more bubbles and crashes; people will invest, expect a fast dividend and cash, tomorrow, and pull out if lucky or lose everything if gambling badly.

So we have moved towards a purely virtual business culture of fantasy expectations and fantasy "facts" taken as fundamentals.

Now, personally, I don't give a damn, because I'm not that much of a shareholder, but now comes the dirty part: governments themselves are using my tax-money, to invest in such a fantasy world. If they crash, I lose all my money, without having had any say in it and without having any way of recovering it. (Tax money is my money; my productive labor is part income, part tax; I am free to decide what I do with my income, but the State manages its income, which is my money too.)
Banks do the same thing. So I can't even invest my own income into something more stable and durable (I can, but the Bank *itself* which allows me to do so, finds its entire financial base in the fantasy investments; so if my Bank crashes, my cautious non-stock investments are gone too.)

This is what upsets the author of the essay most; if it were up to him, the entire world's elite should be free to gamble, whether on the stock market or in Las Vegas. But when it comes to public goods and public money (which is still my money too), it should be managed more cautiously, preferrably with the 19th century cautionary accounting principle in mind.

So there we have it. A grand history going from companies having to take into account the "potential lowest future market value of the shares" and writing real costs in their books brutally at the beginning of an investment cycle --- all the way to companies hiding all the real costs of their assets, which have been excluded as important accounting parametres, and which have been replaced by the authority of CEO-teams whose only real obligation is to issue statements about "potential maximum future value of the shares", without these statements having to have any factual basis.

Disastrous!


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To me it is obvious that we must revolt against capitalist terrorism.


Posted by: Lorenzo on 1 Jun 06

I don't follow how this is a _government_ subsidy, or even a _subsidy_. The gov. isn't paying anyone anything (that I'm aware of) when a corporation goes bankrupt, at least not in the U.S. And when a corporation goes bankrupt, unable to fully pay back its investors or those to whom it owes liabilities, this is not a subsidy -- it is capitalism. You invest in a risky venture with the hope that it will pay off. You allow someone to purchase from you on credit with the hope that you'll be fully paid and the company will buy more from you this way. That's the market.

Without limited liability, very few people would be willing to own companies. You'd end up with major corporate consolidation, I suspect (1. people would sell out and 2. you'd need a gigantic company with massive, diversified profits to insure that you don't go bankrupt).

Having said that, I do like the idea of forcing companies to deal with environmental risk before hand, particularly through appropriate bonding. I believe there are already industries (i.e. mining) wherein a company must put up a bond to clean up after themselves, but problems still abound with this system. There should be more careful scrutinizing of bond requirements as well as incremental evaluations and clean up (that is, companies should be allowed to make a terrible mess and clean up the whole thing once their operations are done -- they should be required to clean up as they go as well).


Posted by: Stephen A. Fuqua on 1 Jun 06

"Would ENRON have happened if shareholders had been even partially liable?"

What, were Enron shareholders not screwed over ENOUGH?


Posted by: Kenny Boy on 1 Jun 06

My day job is corporate research, and I'm routinely frightened by what I see. Shareholders should have full liability. Contrary to what is said above, this wouldn't lead to massive diversified corporations, it would do the opposite. Small companies would benefit as shareholders could do a better job monitoring their investments in small companies as opposed to the giants. On the other hand, it might not have any affect on shareholders besides a slight increase in costs, as insurers would quickly move into the market. That said, whether its the individual shareholders or their insurers being held accountable, at least someone is. Someone would have an interest in maintaining ethical and legal business practices.

Even worse than shareholder corporations are LLCs. At least corporations on the major markets have audited financials. LLCs can have as few as one shareholder (which can also be an LLC), is not required to have annual meetings or bylaws. There are millions of LLCs in the United States which are audited by a few hundred IRS agents, so they are frequently used for tax evasion and corrupt business practices. String a few dozen of them together, and good luck figuring out who actually owns or controls them and where the money is going.


Posted by: mo on 1 Jun 06

Allowing a human to create a corporate "person" encourages people to create jobs and take risks. If roughly 80% of restaurants go out of business in the first year, who would open one knowing that they may lose their house, retirement savings, and their children's college fund if the business goes bust? The same goes for grocery stores, theaters, and any other small business.

In response to Point 3 of the OP: The people who the bankrupt corporation owes money to are already being paid for the level of risk they are assuming. That is why the interest rate on a loan is proportional to the risk. A first year business is going to get charged more for a line of credit than an established company would since there is more risk. No one is being favored at the expense of another.


Posted by: Robert on 1 Jun 06

Take Agency theory in to account.

Agency theory is directed at the ubiquitous agency relationship, in which one party (the principal) delegates work to another (the agent), who performs that work. Agency theory is concerned with resolving two problems that can occur in agency relationships. The first is the agency problem that arises when (a) the desires or goals of the principal and agent conflict and (b) it is difficult or expensive for the principle to verify what the agent is actually doing. The problem here is that the principal cannot verify that the agent has behaved appropriately. The second is the problem of risk sharing that arises when the principal and agent have different attitudes towards risk. The problem here is that the principle and the agent may prefer different actions because of the different risk preferences.

Source: Eisenhardt, M, K. (1989). Agency theory: An assessment and review. Academy of Management Review, 14(1), 57).


Posted by: digger on 1 Jun 06

Ok, so your solution is for everyone to pay for partnership insurance? Wow, I really don't even know where to start. First of all, there are different levels of corporations in America. There is the LLC, which you keep referring to, which stands for Limited Liability Company, then there are what people commonly refer to S Corporations and C corporations, differing mainly by the way they are taxed and how they are formed, and also the amount of shareholders they can have.

Insurance is very expensive, and thus, not many people would be able to afford building a company and paying for the insurance. See, what you fail to realize is, that Corporations aren't just Enrons and Worldcomms, they are almost every mom and pop store in America. The VAST majority of Corps are small businesses, and its small business that drives the economy. If you took out Limited Liabity, you would literally be crushing the economy.

Also, what shareholders do you want to punish? Shareholders in Enron got completely screwed when they went down. So if I buy stock in Apple, and then they go out of business, and owe money, I have to pay THEIR debtors 1% of my personal income. Are you F'ing mad man!

Im all for a healthy enviroment, but your argument seems trite at best, and hopefully, if anything, it will create a conversation about the enviroment.


Posted by: Eric on 1 Jun 06

Agency theory is directed at the ubiquitous agency relationship, in which one party (the principal) delegates work to another (the agent), who performs that work. Agency theory is concerned with resolving two problems that can occur in agency relationships. The first is the agency problem that arises when (a) the desires or goals of the principal and agent conflict and (b) it is difficult or expensive for the principle to verify what the agent is actually doing. The problem here is that the principal cannot verify that the agent has behaved appropriately. The second is the problem of risk sharing that arises when the principal and agent have different attitudes towards risk. The problem here is that the principle and the agent may prefer different actions because of the different risk preferences.

Source: Eisenhardt, M, K. (1989). Agency theory: An assessment and review. Academy of Management Review, 14(1), 57).


Posted by: simion on 1 Jun 06

Allowing a human to create a corporate "person" encourages people to create jobs and take risks. If roughly 80% of restaurants go out of business in the first year, who would open one knowing that they may lose their house, retirement savings, and their children's college fund if the business goes bust? The same goes for grocery stores, theaters, and any other small business.

In response to Point 3 of the OP: The people who the bankrupt corporation owes money to are already being paid for the level of risk they are assuming. That is why the interest rate on a loan is proportional to the risk. A first year business is going to get charged more for a line of credit than an established company would since there is more risk. No one is being favored at the expense of another.


Posted by: Robert on 1 Jun 06

I think you are mis-parsing the definition of "limited liability".

Corporations have UNlimited liability. It's the shareholders that have limited liability -- in that they can not be sued, nor share in the debts of the operating company. They can, and do, however, lose their entire investment. The liability "insurance" is secured by the capitalization of the company.

While the examples you give of malicious corporations are useful, consider this: would you invest in a pharmaceudical company, or a medical device company, or any other "beneficial" corporation, knowing that through no fault of your own people could come after 1% of your total wealth in the event of a lawsuit? What if the company's drug is flawed, and makes people sicker? Why would you risk your capital to develop that drug? I certainly wouldn't -- and we'd have far fewer drugs for it. I don't think it follows that the drug company will be careless in their drug design, although that can happen. What may happen is that, careful or careless, they will have a hard time getting funding to get started.

It's also clear that even with limited liability, for every company that gets away with murder, there are many others that are crushed. Makers of breast implants were driven out of business on shoddy scientific evidence. No one cared -- hey, it's just breast implants. But asbestos, which was considered to be a great revolution in materials science, is still dogging many corporations and costing the economy tens of millions of dollars a year, DECADES after it was determined to be a hazard and banned.

Now, it is not a REQUIREMENT that corporations shelter themselves under limited liability (although, clearly it's attractive, and has resulted in the spectacular growth we've had for the last 150+ years). Take LLoyds of London for example. "Names" (the investors) have unlimited profit -- and unlimited liability. It was entirely possible to be completely bankrupted if enough of your risk went south. But I wouldn't touch it...

As to your point #3, I am completely lost as to the point you are making. People who are owed money by a corporation are secured creditors. They are in a BETTER position than a shareholder, not a WORSE one. They may not get back 100% of their investment, but they are likely to get something, up to and including ownership of the entire company. As might be expected, their returns are not as good -- look at the yield on a bond versus the performance of a share.

As a side note: I really like the Worldchanging site. But when I see postings that end "I'm not enough of an economist to really understand the implications of this idea...", I tend to think of college dorm-room bull sessions, not well-thought-out analysis. For the former, I'm more than happy to go to Slashdot...


Posted by: Sean Colbath on 1 Jun 06

I have nothing to add. I just wanted to thank you for the article and thank those who responded. I've learned a lot today.


Posted by: Ceci on 1 Jun 06

Lorenzo, thanks for the thoughts. However, I'm definitely not anti-corporate. Corporations *work* and, as Amory Lovins says, "they're the best problem solving entities on the planet."

Need a hard problem solved and can pay? You call a corporation, not a government.

On the other hand, corporate personhood is questionable but it's an quirk of implementation - we had problematic corporations before it was established, and I do not think the end of Corporate Personhood would be the end of corporate problems.

I'm not advocating a future without limited liabiliy. And, yes, calling it a subsidy isn't quite accurate - it's a mandated incentive or something along those lines. One of the reasons I floated the idea of limiting losses in a given year to 1% of an investor's net worth is to control risk: there's no uncertainty about how much liability a given investor has in a given circumstance.


Posted by: Vinay Gupta on 1 Jun 06

Sorry, but your analysis is way off...

Suggesting that the government "provides insurance" as a massive subsidy implies that creditors get paid back by the government in the event of a bankruptcy, which they certainly do not. If anyone is providing insurance, it's the creditors themselves by giving a loan which they know in advance that individuals are not liable for.

What the government does is lay down the default rules under which creditors will get paid back or not. Such protection from liability would still be possible without the existence of corporations. I could construct a somewhat complex contract wherein you make me a loan that will only be paid back if my restaurant is still open three years from now.

Of course there would have to be all kinds of stipulations about how I was allowed to spend the loan, presumably only on the restaurant and not on spa resorts. The existence of corporations as a legal entity saves us from these issues.

If you still don't believe me, spend a couple of hundred dollars to incorporate and see if any bank will give a loan to your "corporation" without asking that you also secure the loan personally.


Posted by: Toby on 1 Jun 06

Ok, I'm not suggesting that people should buy partnership insurance, or that we sacrifice the benefits of limited liability. The advantages are clear... as are the problems.

Consider the example of McDirty's Toxic Waste Disposal, Inc. They take toxic waste and dump it illegally. In the first five years of operations, their stock rises 500%, then they get sued into bankruptcy by the EPA.

The shareholders have benefited by the rise in stock price, and those who have sold their stock before it all goes down get to keep their profits. The company staff, assuming they don't go to jail, get to keep their earnings. In fact, nearly everybody who benefited from the activities of the company gets to keep their loot, and therefore has an incentive to do it again.

Now, if there was partial liability for investors - as I said, say 1% of their net worth in any given year - wouldn't they pay more attention to how McDirty's was making its money?

-----------

On the other hand, how much money would partnership insurance for the companies which make up the stock market cost? Because that is a _service_ that the government provides investors, and it's a huge, huge service. I think it's really a good question and I'd really like to know the answer. A free service to investors isn't exactly a subsidy.

Now, as for creditors and investors: a creditor is guarenteed nothing, only a portion of the liquidated company's assets proportional to the size of the debt, which may be nothing at all or hardly nothing. For a partnership, the creditors can then go after the personal assets of the owners of the company - the partners. That's the point I was trying to make.


Posted by: Vinay Gupta on 1 Jun 06

Unfortunately, you are confusing two different issues of liability.

1) Holding corporations responsible for wrongdoing in the public sector such as pollution and fraud (legal liability).
--This is handled by making management personally responsible for illegal actions. There is a reason that Lay and Skilling were convicted after the collapse of Enron.
--The reason that companies still pollute is that a risk analysis shows that the odds of getting caught and the payment resulting from getting caught will be less than the upfront cost of doing it the correct way. The only way to avoid this is more enforcement and larger penalties to increase the risk.
--The legal protection afforded by the designation of limited liability is that personal assets cannot be attached to repay corporate debts unless you fail to maintain the separation between your personal finances and the corporate finances. As a manager, you can be held personally responsible for your actions and have to pay restitution and/or serve jail time.

2) Compensation to creditors (fiscal liability).
--Shareholders are creditors. The company already owes them a liability and they have to line up with all of the other creditors to get a portion of their money back. Actually, shareholders fall behind other creditors.
--Banks and other direct institutions get paid back first. The institutions that loan money to these companies understand the risk and add a "default risk" percentage to their interest rates to compensate. They expect a certain portion of their investments to fail and adjust their interest rates to offset the risk.

The managment of a corporation has a direct legal responsibility for their actions. The "Limited Liability" designation does not cover criminal activity including fraud and misrepresentation.

Shareholders already bear the fiscal liability of a company. If a company goes bankrupt, they lose the money that they invested. If I have 50% of my assets in a single company that goes belly up, should I have to pay more so that banks can get money even though they had a better understanding of the risk and were able to charge an appropriate interest rate?


Posted by: Keith on 1 Jun 06

The problem is that there are a zillion lawyers out there who want to sue your company for any little thing. If someone trips and breaks their nose in your store, do you want that to personally bankrupt your family? Without protection of personal assets nobody would ever start a risky venture.


Posted by: Jake on 1 Jun 06

Vinay, thanks for the interesting ideas you bring up. I have heard of limited liability discussed as a subsidy with regard to the nuclear energy industry, which is given federal protection in case of a disaster. Those numbers should be available, and may be useful. I also consider tort "reform" to be a related subsidy.
Regarding practically implementing such a policy, it would be fiercely opposed by entrenched financial interests unless an overwhelming argument could be made that the shift was in their own interest. Were this sort of accountability requirement to be instituted, it would have to be phased in to minimize a disastrous crash as speculative investments dried up.
Excellent analysis, Vinay.

One issue I'd like to underline is that the majority of businesses do not enjoy limited liability. Most businesses are single-owner and have full liability. This is your mom-and-pop restaurant, your private contractor, small business. People will still start businesses without limited liability. The real beneficiaries then are big business, which represents the real wealth and power: social, financial, and environmental. Helping these interests to better align their bottom line with long-term social and environmental quality is clearly good. I have qualms about any policy that might threaten limited liability, but that may be simply because I find the concept so new and difficult. It invites a knee-jerk negative reaction. Keep exploring this idea.


Posted by: Lyle Solla-Yates on 1 Jun 06

Umm.

For sake of argument, let's assume that your analysis is correct (it's not, but others have debunked it sufficiently at this point).

What then, happens to the investor who diversifies her risk by spreading the investements around among 100 companies? Is her liability exposure now 100%?

Let's assume that she is conservative, and invests in a mutual fund or two, which has aggregated many stocks into a single vehicle. Is her liability exposure now larger than her actual net-worth?

I have no argument with the fact that the 'corporate person' is a concept long overdue for an overhaul, and that the rights and privileges attached to the concept need carful consideration, but your solution won't do anything but implode the economy.

For another avenue to greater corporate responsibility through negative reinforcement, consider the possibility of revoking corporate charters, ie. the 'corporate death penalty', which is rarely invoked anymore.


Posted by: michael bernstein on 1 Jun 06

I'm not sure that you aren't barking up the wrong tree. Limitation of shareholder liability is an unfair "subsidy" as opposed to what? While I am extremely critical of the power of huge corporations, I don't see the problem as stemming from limited liability.

Corporations are not "immune" from liability. They must pay their debts and judgments to the same extent as real people. (The problem arises when corporations use their considerable resources to avoid liability through legislatures). Shareholders do have risk in the corporation to the extent of their investment. Just ask Enron's shareholders. Shareholders are absolutely last in line, after taxes, creditors and judgment holders, with their claim of a share of the profits and assets of a corporation. Corporations /do/ buy insurance.

The public policy behind the limitation of shareholder liability is to enable businesses to raise capital for new ventures. There is risk inherent to all business activities. In a partnership, that risk is spread among the partners. But few investors are willing to take on partnership risk in a business if they are not personally involved in the management of the business. Eliminating limited liability would make it difficult indeed to start a new business on the funds available to the people who run them.

It is important to realize that most corporations (in the United State, at least) are /small/ businesses, not publicly-traded multinational organizations. I am attorney and all of my clients are small business owners. They include high tech startups, farms and the traditional "Mom & Pop" enterprises.

A limited liability entity is a tool that, along with insurance, business owners use to manage their personal risk in their business. Most small business owners have a lot of "skin in the game" with their businesses, including their entire livelihood and life savings. A limited liability entity gives them some small assurance that their business suffers a disaster or simply goes south, they won't lose their house along with their livelihood. And I /always/ advise my clients to obtain general liability insurance as a first line of defense.

Also, it quite difficult already for a small business venture to raise outside capital. Eliminating limited liability would eliminate that possibility entirely. And since most of the innovation in our economy starts with small ventures, innovation and growth would be stifled.

I have given some thought to the problem of corporate power over the years. I don't believe that limitation of liability is the root of the problem and in fact provides considerable economic benefit to individuals whether they are shareholders or not. Some limitations on other aspects of corporate existence might be worth considering:

- Limit the temporal lifetime of a corporation. Multinationals are immortal, their existence can continue well beyond the natural lifespan of any shareholder or manager. Limiting the existence of a corporation to a term of years and forcing corporations to liquidate when their time is up would restrict their ability to build massive empires and re-inject the underlying capital back into the market periodically. It would make more sense for an established corporation to introduce a new product or technology through a new corporation, which would decentralize both financial capital and innovation.

- Limit the scope activity of corporations. Rather than allowing a corporation to engage in any business whatsoever, require that a corporation "stick to the knitting" of a single line of business. This would also restrict empire building and congolmerates.

- Limit the geography of corporations. Corporations are chartered at the state level in the U.S, but can operate anywhere in the world. Limiting their geographic existence to the state of incorporation would force business to operate at a more local level and decentralize management. While there is certainly some need for multi-state operations for some enterprises, geographic limitations would decentralize the management and capital of such organizations. Ideally this would make corporations more responsive to the communities in which they do business


Posted by: Thomas on 1 Jun 06

Michael S. Rozeff covered this from a libertarian point of view here: "Limited Liability" and "Limited Liability Revisited".


Posted by: Anonymous on 1 Jun 06

Corporations *work* and, as Amory Lovins says, "they're the best problem solving entities on the planet."
Need a hard problem solved and can pay? You call a corporation, not a government.

This is true in many cases, but in many more (important ones), it's not (take global warming, the defense of basic environmental and social standards, democracy, clean water for all, HIV/AIDS, you name it...). Corporations are the worst machines when it comes to solving problems of the public and common good.

They're excellent when it comes to creating artificial needs and solving the problem of fulfilling those needs. (Remember the infamous report published a few weeks ago which shows that pharmacos invent diseases.)


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Vinay, it seems you are using two concepts of liability: one that sticks to mere financial liability, and another one that goes beyond, and that takes into account these broader issues, the issue of being liable for environmental damage, for destroying the social fabric of communties, for destroying lives (in the case of privatized war), for example.

So I would broaden the issue and go beyond mere financial liability. The whole idea of "liability" should be placed in the context of the "commodification" of our life-world and of the "externalisation" of real costs and real risks (such as environmental catastrophes, permanent instability of the world monetary system,...).

Only in such a universe, where something only exists when it is commodified, does liability make sense. The things that cannot be expressed in monetary or commodified terms (the public good, democracy, life, the planet, the atmosphere), do not exist, and hence, you cannot be held accountable or liable when damaging them.


Suggesting that the government "provides insurance" as a massive subsidy implies that creditors get paid back by the government in the event of a bankruptcy, which they certainly do not.

No, but they are not liable when they damage *real* stuff. They merely lose their money, while they should be held liable for destroying stuff.


The case of the mining companies in the U.S. is famous. For years the CEO's and the shareholders cash in, then, when they're supposed to clean up the site, they go bankrupt in a well planned manner, and let the costs to the community. This is how it works on a daily basis.

Check out Diamond's Collapse. He nicely writes about this.

Finally, I would agree that limited liability allows people to take small and well defined risks in a universe where the real important things that drive our lives (water, our ecosystem, democracy, and life itself -- see Iraq), are not taken into account or are seen as irrelevant green hippie dribble.


Posted by: Lorenzo on 1 Jun 06

By the way, there's an interesting chapter about "two kinds of money", in Deleuze's Anti-Oedipe, that vaguely has to do something with the topic at hand:

-a non-incorporated person's money (the ordinary citizen who saves his money and puts it in a bank), is very different from money that's used by manager of a limited liabilty company.

-when the first one goes bust, he, his family and even his dog will be persecuted perpetually, until they pay back the last dime of their debt; the ordinary person has the poor man's choice of either spending his money on consumer goods, or putting it in a saving's bank where he gets a pity back.
But crucially, his money eternally carries virtual unlimited debt. It is non-capitalist money. Money that contains unlimited debt.

-the limited liability guy's money does not carry this inherent or virtual debt; when he defaults, he goes bancarotta, - he shrugs off the debt as if nothing happened.

It's this difference which many people perceive to be problematic.

To put it in Marxist lingo: a limited liability dude's money merely has the function to capture "surplus value", while not being liable for the virtual debt that the non-incorporated person's money carries.

Banks thrive on this difference: they give irresponsible money away to companies who are irresponsible (because they're not liable for their debt), and they get this irresponsible money from the hard working ordinary citizen who miserably puts the money that makes no profit and that he got out of his labor, in this bank.

Surplus-value capturing money is not liable when it doesn't realize surplus value (Enron), while non-capitalist money is totally liable for its inherent debt.


All money is equal, but some money is more equal than other kinds.


Posted by: Lorenzo on 1 Jun 06

I think I need to clarify my earlier statements. Like Keith said, the possibility of a company failing to repay loans is already taken into account by lending premiums. No subsidy or problem there.
The problems arise with lawsuits and environmental remediation costs. Corporations have an incentive to ignore these costs. If a corporation does $100 million in environmental damage, but is only worth $50 million, the American people as a whole get stuck with the balance. Sure corporations have liability insurance, but not enough to actually cover their true liability. If a company produces faulty medical devices that kills thousands, someone needs to pick up the tab. As it stands now, the victims might get the company's assets and their insurance, but that doesn't necessarily make up for the loss.
I don't quite understand the concern over small businesses being able to afford insurance. Many already do. Most reputable contractors are licensed and BONDED. They screw up, you get paid damages. States require businesses in some industries to be bonded.
The revoking of limited legal liability will result in risks being accounted for by the persons and companies that can best avoid them. Shareholder insurance is unlikely. More likely, companies would have increased liability insurance costs. This is a good thing!!! Making a new pharmaceutical? You and your insurance company aren't going to be cutting any corners.

"The reason that companies still pollute is that a risk analysis shows that the odds of getting caught and the payment resulting from getting caught will be less than the upfront cost of doing it the correct way. The only way to avoid this is more enforcement and larger penalties to increase the risk."
Uhh, no. More enforcement and larger penalties can only do so much. The largest penalty the government can levy is the total worth of the at fault company. If I invest a dollar that can make 10 dollars polluting, even if the EPA catches me 90% of the time and levies the largest fine possible, I still am making money off pollution. They can fine however much they want, the most I can lose is a dollar. If card game(think mining) had those odds we'd be hanging around that table all day. Even if they catch me all the time, if I can get the money out of the business before they fine me, I'm making money. The house always loses. It's a dumb way to run a casino and a dumb way to run an economy.


Posted by: mo on 1 Jun 06

1% of net assets per year, maximum loss to any particular shareholder was the idea I was floating, because it *controls risk* for the shareholder while still representing rather a large chunk of change for things like institutional investors.

But that was a very casual suggestion to illustrate the idea of limiting shareholder protection as a policy instrument. It's a "for instance."


Posted by: Vinay Gupta on 1 Jun 06

this is an excellent exchange, i really enjoy reading it, thanks a lot for this


Posted by: andreas buechel on 1 Jun 06

> Would ENRON have happened if shareholders had been > even partially liable?

They were - they lost the money they invested in shares.


Posted by: Bob Blob on 1 Jun 06

Regardless of the advantages LLCs give large companies and investment groups, these limited liability corporartions are a god send to small companies and start-ups. Product liability insurance alon is usually set a 1 million dollars as a minimum amount of coverage. The premiums on this kind of coverage can be very expensive for a small shop or family bussines. Without LLC status a small company like my friend who makes fancy handbags in her home would be required to meet the same rigorous standarts of accounting, employee insurance and workplace standards. She would dround in paper work and overhead before she could make a single handbag. In other words the LLC is great tool for the people. Yes it can be abused but so can anything. Besides, an LLC does not protect you from any and all prosecution as a result of your shady practices/crapy products. It allows people or groups that are not mega corporations to compeat on a more level field with these giants.

-H


Posted by: tod on 1 Jun 06

Thank you Mr. Gupta for pointing out the essential flaw in our contemporary system.

There is no free lunch. The grant of limited liability to shareholders is not free- the cost is born by any number of third parties- creditors, pensioners, and communities that have invested in companies through tax abatement schemes.

I believe every shareholder should be responsible for a corporations debts to the extent of their stock ownership. A .05 percent owner would be liable for up to .05 percent of the debts in a case of bankruptcy.

While this is onerous compared to the "free lunch" enjoyed by shareholders today, it would internalize the true risks of corporate behavior and force much greater oversight.

Somebody has to pay for bad corporate behaviour and bad business judgements. It should be those who volunteer by becoming shareholders, not relatively uninvolved third parties who have trusted corporate promises.


Posted by: Tom Kelly on 1 Jun 06

The real problem with paper people (corps, LLCs, etc) is that under the current system, the actual people who make the choice to break the law almost always escape criminal procecution as an individual and so criminal types view it as too good a risk/reward temptation.

If the company is caught doing something wrong and if the company is taken to court and if the company is found guilty, then the guys who made the choice to commit crime pay fines with other people's money (shareholders) and then get on with their next scheme.

The solution is very simple. Actually procecute people for criminal actions that they do when ordered by their company and procecute managers for giving those orders under the RICO act. The laws already exist in the US, they just need to be enforced.

This would simply be an extention of they way we already handle Limited Partnerships. Wherein the General Partners (active managers) are held personally liable and the Limited Partners (investors not involved in actual management) are only liable for what they invested (unless it is proved they knew of criminal activity or were secret managers).

Of course, such a change is unlikly as long as the managers of large corps can make political contributions using other people's money (shareholders).


Posted by: MrX_TLO on 1 Jun 06

It's interesting to see the tension between "make the decision makers pay" and "make the shareholders pay."

Remember that, in theory, the shareholders elect the board who chooses the senior management. Should the shareholders be liable for voting ina board which hires a crook? Should the board be liable for hiring a crook? Should the crook be liable for being a crook?

I think that "polluter pays" is the heart of the issue: the shareholders *own* the entity which causes the problem, but owe nobody anything when the problem is discovered. This creates the possibility of profit without responsiblity, and the rest arises from there. I think I've outlined a plausible "straw man" - a model of shareholder liability which still keeps shareholder risk exposure controlled and knowable, and that answers the primary arguments about "aren't you exposing shareholders to unlimited risk?"

I'm for exposing shareholders to *bounded* risk - they should always know how much they could lose. But bounding the risk at the value they invested is - and thanks for using the phrase! - a Free Lunch for the shareholders. We can trim the size of that free lunch without destroying it entirely, and hopefully could, in theory at least, fix a lot of our problems with corporate govermance into he mix!


Posted by: Vinay Gupta on 1 Jun 06

From my blog:

He's got a good point, but I think he takes it and runs in the wrong direction with it. Taxing 1% of a shareholder's net worth is not going to cut it. I think the problem is that land is parceled out in little squares, which is such a old-school dumb-human way of thinking about it. The earth is not just a bunch of squares of land stuck together. It's an ecosystem where in each overlapping part interacts with and affects all of the other pieces (directly or indirectly). If you dump toxic waste on your land it also affects me over on my land. That waste seeps into the water supply and affects all of us. Pretending we can isolate land via concepts of private land-ownership is insanely stupid. It's clearly a relic of 18th century thinking.


___
Unlimited limited liability may, in fact, be a perverse insentive encouraging the economy to continue high risk activities such as unregulated release of GMOs into the environment by subsidising shareholders who assume these risks in their investment strategies.
___

I can see where the author is coming from here. But the problem is much larger than how he's framed it. And in some ways it's much simpler; corporations can simply bribe (er, "contribute to the re-elections funds of") politicians and make the problem go away...at least for the shareholders and execs. But the rest of us are left to pick up the pieces.

If we want to end corporate corruption/pollution we're going to have to make massive systemic changes. The author says he's not anti-corporate. Well, I am. I think the current system is out of hand completely. Commenter Lorenzo makes some great points about late-stage capitalism, which basically boils down to this: We took out a loan and used Planet Earth as collateral so we could live like kings. Well now the bill is coming due and we don't have another planet to exploit. What do we do?

Hell if I know, but continuing on the same course is not only insane, it's incredibly dangerous.


Posted by: vemrion on 1 Jun 06

Elimenating LLCs would completely screw over film productions, I know that much. Particularly the little guys.


Posted by: Justin Kuhn on 1 Jun 06

"--The reason that companies still pollute is that a risk analysis shows that the odds of getting caught and the payment resulting from getting caught will be less than the upfront cost of doing it the correct way. The only way to avoid this is more enforcement and larger penalties to increase the risk."

Ecological production has to make money or else it doesn't work. We may be on the cusp of that happening, especially if we use our imaginations. We should be thinking in terms of a zero emissions culture and attach "ownership" to materials down to the parts per billion of toxics excrete to the biosphere and beyond.

Limited liability for shareholders of corporations is only one of our problems. If you look at the trend, you will see that corporations are wining and dining and buying Congress for unlimited liability. Two examples of which are the proposals by the pharmaceutical companies for no civil liability in the case of vaccine production and the gun manufacturers claiming the same for the production of guns. It's not enough that they also get no or low bid contracts and government loan guarantees and trade incentives and... Now they want no financial liability whatsoever while new personal bankruptcy laws begin the slide into indentured servitude and eventual chattel slavery.

That is, if you want to go down tha particular slippery slope.

We are definitely going to have to change the laws, the regulations, and the organizational forms in order to deal with the scale of the changes before us.

Good luck to us all.


Posted by: gmoke on 1 Jun 06

Note that while you may rightly worry about McDirty's Mining Corp abusing limited liability to steal from assets held in common, you also have to worry about making companies too risk-averse to tackle new markets and technologies. The most crucial of those markets is in alternative energy, so that we can react to climate change.

Corporations are the tools of production we have to hand; to use them successfully they need to make a profit from saving the world. Being sued into personal bankruptcy because a person's view was spoilt by your company's windmill does not help that goal.


Posted by: Adam Burke on 1 Jun 06

Well, I'm certainly not talking about a system in which we lose the *benefits* of limited liability. I think that any modification to that system has to keep its big strengths: the ability for risks to be taken.

On the other hand, the "straw man" proposal I outlined was this: in any given year, a shareholder could lose only 1% of their total assets to limited liability companies going down. Liability is *still limited* - it's just limited to 1% of what you own, not $0. Your net worth is a thousand bucks, your liability is $10. At a million dollars, it's $10,000. The point of this approach is that it makes your total exposure completely predictable, so in fact there is very little new *risk* and no *unbounded* risk.

But, as I said, that was a straw man proposal. A real system would be much more nuanced, I think. Consider the 1% of assets idea an existence proof, nothing more!


Posted by: Vinay Gupta on 1 Jun 06

"If I invest a dollar that can make 10 dollars polluting, even if the EPA catches me 90% of the time and levies the largest fine possible, I still am making money off pollution"

While you'd be hard pressed to give a real example of a guaranteed 1000% return on investment I agree that there's a sort of '3 Card Monty' going on with some corporations' attitude toward illegal activity.

I think something should be done with the corporate officers along the lines of what's done with convicted computer hackers and sex offenders. When a person is convicted of computer crimes it is often part of the sentencing that the perpetrator may not take work in the computer industry or access any computers for a number of years. Or a registered sex offender might be told by the judge that they may not ever be alone with children or have romantic relations with anyone who is the custodian of minor children. How about if a person is caught orchestrating or participating in illegal activities from within their position in a corporation, then that person would be forbidden to ever be listed as a corporate officer of any corporation and may not ever hold more than a small percentage of stock in any corporation? This in addition to whatever other fines or jail time would be considered of course.


Posted by: seth on 2 Jun 06

The problems with this idea are many - it takes an overbroad approach to a narrow problem (rewriting the basic laws of corporations to address a much more limited issue of unpaid environmental damages), it confusingly misuses the term government subsidy to address a totally different concept, and it fails completely to take the real world into a ccount.

Let's start with the basic problem. Of the hundreds of thousands of corporations out there, relatively few are engaged in activities of environmental significance (that is, activities beyond those of average citizens such as operating vehicles or creating solid waste). I run and have run in the past internet content companies, for example. We exist only in cyberspace. We have zero environmental impact. All the same, were we to wish to expand, and to seek investor capital, as I raised for prior companies, we would be affected profoundly by a rule of law that would make investors personally liable for unpaid debts such as rent, bank loans, advertising accounts, and so on. Put simply, even though we present zero risk of leaving behind environmental damages, we would be profoundly impacted by these rules. This rule, by rewriting basic corporate law, would apply to every internet start up, every used book store set up as a corporation, every restaurant or bar, and so on, all to address a problem irrelevant to most of them. It is an absurdly overbroad approach.

Then there is the confusing and misappropriate use of the term subsidy. There is no subsidy here. The government is not, directly or indirectly, shifting government funds to corporations. The shifts of wealth, if any, are between the corporations and those who deal with them, voluntarily or not. The term subsidy has a definite meaning, and misusing it here to be provocative just makes the analysis needlessly fuzzy.

Then there are the practical impacts. In the real world, your approach would choke off money to start ups of all kind, and shift investment to debt instruments and to large, multinationals that are unlikely to go bankrupt. As a point of irony, many of the companies that would benefit are exactly the kinds of big multinationals that engage in activities that do cause pollution - so long as they are solvent, it just doesn't matter how much they pollute under your changed rules.

Those most impacted by limitation of shareholder liability are startups. Solvent, ongoing companies can and do pay their bills, making the limitation of shareholder liability irrelevant. Startups, however, are different story, and present a much higher risk profile. In terms of voluntary dealing, most sophisticated players take into account the rules of corporate liability. Any bank dealing with a start up, for example, will seek and usually require a personal guarantee of any loans from the principals before handing over cash. Landlords also take care when dealing with startups, especially those without venture capital backing (it's not just a style statement that places my startups in garages or spare bedrooms). Even employees demand a different deal, seeking more money or stock options to offset the risk of losing their jobs if the company goes tits up.

Do we have a better or cleaner world if we prevent the next Google from getting funding, while passing a rule that won't effect a fully solvent Exxon?

As is true with many facially left wing and progressive proposals, this notion benefits the big multinationals at the expense of the new and creative. Someday, given enough time and coffee, I will come up with my grand unified theory as to why that so often is the case.


Posted by: real world on 2 Jun 06

The reason we have corporations, historically, is so that a bunch of people can all pool their money (and thus power) to accomplish a goal. It used to be that the goal was well-defined, like 'go to the New World and steal gold from Aztecs;' of late, the goal is vague, like 'make money.'

Way back at the dawn of capitalism, the pooling of money and power, especially with limited liability per investor, was rightly seen as a threat to the ruling class in Europe, which is why corporations had to be chartered. The political establishment had to sign off on the venture, or there'd be no venture capital.

Corporations are still charatered, which means there is a political component to their existence that (theoretically) checks the growth of corporate power. Governments already determine the shape and boundaries of all corporations, and rightly so.

The problem with corporations is not so much that they have limited liability per investor (greater investor liability means no one invests and nothing gets done), but the combination of this limited liability with the power of a huge pool of capital. Corporate mergers grow the pool of capital and resources, answerable to an ever smaller and more centralized set of decision-makers.

What matters most of all is policy, not liability. Corporate politics have to change. No one should have that much power. We need to bring back the threat of the 'corporate death penalty:' revoking charters. Governments hold the piece of paper that says a given corporation can fundamentally exist, and, at least in the US, we are the government.

Thus: the policy should be that *the government* requires more of a prospective corporation *before* it is chartered, and anti-trust laws need their teeth back. And the oversight for this process is politics.


Posted by: Enoch Root on 2 Jun 06

Gentlemen,

Corporations only represent a subsidy to the extent that certain large entities so organized have captured the workings of federal and state governments. This benefits some corporations at the expense of others and the public at large. To the extent that this is true then, Vinay is functionally correct. In no way is this inherent in the ideal of the corporate form.

An earlier poster mentioned Professor Rozeff's articles regarding corporations on the Mises.org website. Gary North and Stephan Kinsella have also ably defended the corporate form on Mises by pointing out that most of the valuable and legitimate features of corporations would still be available in the absence of a state, through private contracts and insurance.

Pollution is not a necessary result of the corporate form, rather, it is the inevitable result of a process of degradation of property rights through application by legislatures and courts of Coasian utility comparisons, combined with large amounts of unowned commons. In other words, pollution results from inadequate legal protection of property and persons, not from corporations. Murray Rothbard wrote a definitive history of this process, also available at Mises.org.


Posted by: Vince Daliessio on 2 Jun 06

Ok, ok, Vince, you got me fair and square. I was, in fact, on a heavy libertarian bender when I thought of this idea: the original form was "why is the State involved in shifting risk from shareholders to creditors?"

:)

Worked through from that angle, I think it is fairly obvious that the Corporation is a fiat-money type problem: something it is convenient for the State to provide which is, in fact, on closer examination, quite problematic at a theoretical level. Of course, there's no reason that in a Libertopian Society a company could not include something equivalent to limited liability protection in the event of bankruptcy in all contracts it signed... but who would sign such a contract if they were on the losing end of it???

I want to also address the general thread in the comments about interpreting this as an attack on limited liability. It's not quite that simple. As I said, I'm *for* limited liability. But the question is "100% protection" or "99% protection." Why all the fuss over a proposal that protection go from 100% to 99%? Is the limitation of liability a Sacred Cow?

I'm also chatting about this with Matt over here:
http://mspong.com/2006/06/01/limited-liability-corporations/

Anyway, Libertarian bender or not, I'm glad this idea has spawned some serious thought. I'd definitely like to hear why the State belongs in the insurance business :) (joking)

One of the unwritten pieces I have lurking in the back of my mind is "Corporatism vs. Ecostalinism: a 21st Century Dialectic" which basically examines the notion that the Capitalism vs. Socialism battle is pretty much over and is now being replaced with a much more interesting battle about *who runs the world* - multinational corporations which push around governments (see WTO and the failed Multilateral Agreement on Investment (MAI)) or NGOs like the UN which are willing to severely limit individual liberties in favor of environmental or social programs, and which also push around governments!

While it is usually unacceptable to harsh on the United Nation's mellow, a quick read of the "Universal Declaration of Human Rights" makes it clear that it is not Universal by any manner of means and includes massively embedded cultural biases particularly (as I remember, it has been years) in the areas around education and child labor.

I believe that as the century wears on, and multi-state and non-state responses to the environmental problems we face grow in reach and power, we're going to find these tensions becoming increasingly important in how our day-to-day lives run: Multinationals pushing the State around on one hand, and NGOs and the like pushing it around on the other.

Until we figure out some approach to the State protecting the democratic rights of its people against multinational actors of all kinds, I think we are going to have severe problems maintaining the level of liberty and autonomy we have come to expect and enjoy.

But that is a thread for another blog on another day!


Posted by: Vinay Gupta on 2 Jun 06


Go Vinay! for bringing up a very thought provoking "current human condition" where "protected" multi-national corporations have such enormous and pervasive influence on mankind. I am simply overwhelmed by the velocity, quality and the number of responses from worldchanging readers - the likes of Vince, Adam and Enoch to name a few. It does not matter that I do not agree with most of the 40 comments but I feel privilaged to have access to such pure and essential debate on profound matters by folks who care enough to invest their intellect and time for its own sake.

I propose here that it is time that worldchanging.com expand into "walking the walk" from "talking the talk" - i.e. move to "action" level while continuing the dialogue as it stands now. The core of the proposal is that worldchanging.(org?) needs serious money as endowment to begin with and then with the flair and pizzaz that comes from doing good, sprinkle "micro-patronage" (small) grants to peer approved ideas, research, prototypes, proof of concepts, films etc. Each grant can be $10,000 to $30,000 may be? Raising $5 to $10 million with voluntary annual or periodic donations is positively within reach.

I understand that this is a separate topic by itself and that it was brought up before, but I am just throwing the gauntlet out here and the discussion can be picked up later and elsewhere.

Examples of grant usage can be Vinay's own Hexayurt designed for MOP (middle of the pyramid folks) with solar panels; REWA electric car owning 'local' community that has solar and windmill generated charging station (paid for worldchanging) so we can drive for free; an adopted small city in third world wired for free broadband wireless service and then witness the magic unfold and thousands of other ideas available in the woldchanging archives itself.

I am ready for this next step. There will be enough volunteers to work the logistics so it will be interesting to hear why this is not feasible.


Posted by: Subbarao Seethamsetty on 2 Jun 06

I am not paying Subbarao :)

http://www.fundable.org/ would be one way we could do this: write up a project description and a price, and if people want to chip in, go for it. This sort of "swarm philanthropy" (tm) has a lot to recommend it, but I don't know how we would manage the process.

WC has a lot of clout, but we're still figuring out how to turn our reputation and brand into positive change in the world beyond acting as an information hub. Done right, we become a huge positive force, done wrong, we waste the opportunity.

Give us time :)


Posted by: Vinay Gupta on 2 Jun 06

Vinay

While you are correct in stating that limited liability encourages investors to invest. I believe you are missing the point in assigning the cost of the limited liability.

If investors are willing to accept a given level or risk for a given level of return on investment (ROI), as you increase the expected risk, you must increase the expected ROI to generate the same level of investment.

The risk in your example can be quantified by the cost of insuring against liability; a product that by your estimates would be very costly because it covers a large risk.

Using your example of an insured partnership. To encourage a given level of investment (I1) and the purchase of the required liability insurance (LI), the partnership would have to generate ROI on I1 equal to a lower risk investment (I2) where I2 = I1 + LI.

If the partnership operates at the same level of efficiency/effectiveness as the LLC, microeconomic theory tells us that the increased requirement for ROI, i.e. increased cost would be past onto the consumer by higher prices and/or fewer choices.

In other words, the individuals you wish to protect from the damaged caused by imaginary governmental subsidies would suffer real damages caused by increased prices and/or reduced choices.

Additionally, since the insurance paid for by the partnership's customers would maintain the status quo in regard to risk exposure for organizational management, the decision making environment will not have changed, e.g. your system provides no incentive to choose a more environmentally friendly path of action.

In fact, under your system of thought where increases in greed = increases in environmentally-damaging business activity, the added pressure to perform, i.e. to act more greedily to generate higher ROI, provides an incentive for organizations to consider proposals and pursue activities with greater potential for negative environmental impact.

Given the protections that LLCs provide for everyone, not just investors, I would think that that any clear minded individual: liberal or conservative, industrialist or environmentalist would be supportive of this type of governmental protection.

At least these are some of the things I would consider when I was analyzing the situation.

Take care...

John


Posted by: John on 2 Jun 06

Libertarians like me are always saying that corporations give capitalism a bad name. Limited liability means limited responsibility.


Posted by: Steve smith on 3 Jun 06

Great post. It's very provocative and useful to question the fundamental assumptions of capitalist enterprise. I share your concerns about the outputs of the system under the current rules, but I think that even partial abolition of limited liability won't actually address the fundmental incentives you seek to change.

It seems that the purpose of your proposal is to get investors (presumably major and powerful investors with the resources and time to oversee the corporate management's behavior) to pay closer attention to the corporations they are the owners of. It seems more productive to give them incentives and legal tools to accomplish that desired goal, rather than to strip away limited liability.

Everyone wants to control risk in their economic lives. Investors are no different. Limited liability simply provides a default rule that the only assets available to satisfy the claims of investors and creditors upon failure (bankruptcy) are the assets investors have consciously pledged to the enterprise. This does act as an incentive in the macroeconomic scale to take greater risks than would otherwise be taken. It makes the economy more dynamic and more open to speculative entry into unproven markets. Eliminating this default rule would have a deletrious effect on economic growth, and would perversely not produce the greater investor vigilance you seek. Investors may not be risking their entire (or even a slice) of their net worth, but they are risking 100% of what they have chosen to invest. That's a pretty powerful incentive to be vigilant already.

Limited liability isn't what leads to the massive externalities and outright frauds that are the major source of real collective harms that corporation commit and the costs they impose on society. Instead it is poor accounting standards, lax regulation, and sheer ignorance on the part of government about the existence and cost of these externalities. Making the entire assets of investors available to satisfy these claims may feel more just, but those assets are far from large enough to satisfy the actual costs of these systemic failures. Far better to work at preventing such externalities that manifest in abuse of labor, environmental damage, and social dislocation. It is hard and very expensive to remedy such harms; far better to invest heavily in avoiding them.

Some economists have called corporations 'externality machines'. The ability to shift hidden, and not so hidden, costs on to the public purse and consumers is the root of most corporate 'evil'. Limited liability doesn't cause corporations to seek externalities, nor would it's abolition significantly reduce that perverse incentive, nor ameliorate the harms thereby created. The responsibility to for governing corporations must lie in many hands to be effective. Both the private sector (direct investors, institutional investors, and market makeres) and government on multiple levels from the local to the national must be effectively engaged in governance to prevent the very great harms corporation can do by dint of their conomic power. Limited liability may provide some modest increment of increased private investor vigilance, but that is not nearly enough to move the massive indifference and conflicts of interest that prevent effective oversight of corporate management by both private and government actors. In short, eliminating or curtailing limited liability is actually too weak a response to the problems we face.

It is good to question the fundamental assumptions about the capitalist system, because it has become abundantly clear that this system requires fundamental reforms if our society is to survive and thrive. This particular plank of the capitalist platform, limited liability, is a sound and neccessary rule, however, not an eggregious government subsidy (in most cases) nor is it an effective lever to change systemic behavior. The real solutions lies elsewhere; in the rules of corporate governance and the regulation of cost externalization by corporations.


Posted by: Michael D. Bryan on 3 Jun 06

Wow. John, Michael, thank you for your posts. Yes, I do think that stripping away a *little* protection would change how shareholders govern. I think that the shareholder - as the democratic ruler of the corporation - is the logical intervention point if we want to change how corporations do business.

If you want to change the character of America, do you go after the Generals and the CEOs? Or do you try and educate the voters?

I do take the point about accounting standards and other aspects of corporate governance. Of course, the other side of that is: if the shareholders had some skin in the game, would they have allowed those standards to be chosen? Or would institutional investors have made sure that things were done properly?

In a whole systems thinking approach, one of the key questions is "where in the system do you make an intervention?"

I'm not convinced by my own case: if I was sure this would be a Good Thing I'd be insane - a very great deal of anaysis and low-risk experimentation would need to be done before meddling with the LLC.


Posted by: Vinay Gupta on 3 Jun 06

I have a proposal for handling the problem you're trying to fix, that of liability of corporations for the environmental consequences of their actions. But first I want to say a few things about money, because that angle always proves productive in these conversations.

Without limited liability, our currency system would go to the dogs. Money is created by debt: everything from credit cards to the Federal government is calling money into existence by fiat. In order for inflation to proceed at a relatively slow boil, some of that money has to disappear. Also, because the debts are all at interest, only some of them can be paid back from the available supply of money.

This is where corporations flaming out is VERY useful to the ruling elite, as is "currency adjustment" on the international market, and the derivative market, which exists entirely to manage risk.

So, here's my proposal to band-aid the corporate behavior you seek to limit. Every endeavor of a corporation in certain categories (mining, factories, construction, agribusiness, others?) needs to fill out paperwork of the environmental impact statement variety. They must then purchase liability insurance for the probable impact as approved by the environmental inspector, or they aren't approved for the action: this payment up front is used to clean up the mine site whether the company goes bankrupt or not. Corporate officers who try to dodge the permit process are criminally liable.

Will it go that way? maybe maybe not. It's just a few more hedges on investment, really. From where i'm sitting the danger arises from authoritarian money. That is what props up the ruling elite: it is the invisible force which works against cooperative ownership.

The idea that someone can invest *something* in another person's business and thereby derive some advantage in life as profit is laudable, and in 'newtonian economics' (the scale of economic transaction we are familiar with, stores and purchases and whatnot) it works pretty well. The emergent effects of authoritarian currency are felt on an entirely different scale of operation, and it is that scale which could destroy the Earth for long-term human use within a few decades. Money ITSELF, by its divorce from ANY of the activities it passes through, is the ultimate permissor of risky behavior. What if you could refuse any money that has touched guns, or strip mining, or pig farming, or whatever else you don't like?

Until the network effects of the digital age smooth out the problems we're currently having with large-scale decision making and assigning value to property and services, the contradictions are only going to grow more obvious. Yes, Vinay, that's probably the most Marxist thing you've ever heard me say; and yes, this visitation is most certainly boingboing's doing.


Posted by: @man on 4 Jun 06

Some seven men form an association,
If possible all peers and baronets.
They start out with a public declaration
To what extent they mean to pay their debts.
That's called their capital; if they are wary
They will not quote it as a sum immense.
The figure's immaterial; it may vary
From eighteen million down to eighteen pence.
I should put it rather low;
The good sense of doing so
Will be evident at once to any debtor.
When it's left for you to say
What amount you mean to pay,
Why, the lower you can put it at the better.

From "Utopia Limited" by Gilbert and Sullivan. The song goes on for several more verses, and ends with:

Though a Rothchilds you may be
In your own capacity,
As a company you've come to utter sorrow.
But the liquidators say,
"Never mind, you needn't pay,"
So you start another company tomorrow.

Leave it to W.S. Gilbert to make sense of things.


Posted by: Jana C.H. on 6 Jun 06

Well, I have to completly disagree with you on this matter, LLC is a tool that has completly transformed business in this country it allows your average joe to set up shop and experiment with business ventures. If there were not LLC there would not be small business in this country as simple as that. It protects the little guy so he can start his own company without risking his entire life savings/childs college funds. The insurance you speak of is already factored in by the bank loaning the money to start the venture. That insurance is covered by the intrest rate. The amount of small business would be cut 10 fold and what would we be left... large corporations.


Posted by: Alex on 18 Jun 06



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