Limited Liability: Profit Without Responsibility

Yves here. Sundaram provides an informative, high level discussion of the hazards posed by limited liability companies. One might add that they are less dangerous in a system with strong regulation, liability protection, and a legal regime that does not undermine class action litigation. The egregious case of the Sacklers and Purdue Pharma points to the need to be able to penetrate the corporate veil for fraudulent activity in combination with efforts to move assets out of the company to prevent recovery by those harmed. In general, the notion of “fraudulent conveyance” isn’t taken very seriously by courts, which points to the need for much stronger legislation to turn that around.

By Jomo Kwame Sundaram, a former economics professor, who was United Nations Assistant Secretary-General for Economic Development, and received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought. Originally published at his website

Limited liability protection for shareholders in joint stock companies was introduced to encourage investments in them. However, it has encouraged irresponsibility, causing much harm while generating profits without responsibility.

Limited Liability Limits Responsibility

Columbia Law School’s Professor Katarina Pistor has extended her critique of the legal system to emphasize the implications of such limited liability. Limited liability encourages shareholders not to pay attention to the harm corporations they invest in may do.

Instead, as emphasized by Milton Friedman, shareholders should focus on returns to investment, and not be distracted by other considerations, especially the notions of corporate social responsibility and stakeholderism.

Chicago University’s Professor Luigi Zingales has emphasized that companies are not just value-neutral institutional or contractual arrangements. Instead, they have obligations to serve the public good or otherwise benefit society, to reciprocate for privileges provided by the state.

“Historically we know that corporations were born as public institutions with a special privilege granted by the state… Even today, … the privilege of limited liability, especially with respect to tort claims, is an extraordinary privilege granted by the state.”

The limited liability of these companies has allowed them to pursue profits with impunity, and to blatantly violate ethics and moral restraint, with little accountability to other ‘stakeholders’, i.e., with interests in the company’s activities and operations, including their consequences.

Limited liability effectively provides a legal guarantee to prospective shareholders intended to encourage investments in joint stock companies. Legal protection thus exempts shareowners from responsibility for the harm their corporations cause.

Limited Liability Companies

This amounts to a privileged legal exception granted by the state, effectively tantamount to an economic subsidy. Indeed, limited liability has long lay at the heart of the joint stock company. The corporation itself may face liability, but not shareholders who get to keep the profits they get.

Shareholders can, of course, lose money on their shareholdings, but they also profit without liability even if their companies harm others, cause ecological damage — e.g., water or air pollution, or greenhouse gas emission — and deliberately conceal and deny the dangers and costs of corporate practices which may involve corruption or other abuses, whether legal or otherwise.

In effect, shareholders bear virtually ‘no liability’ legally, and have no legal responsibility to other ‘stakeholders’. Unintended beneficial ‘side effects’ or ‘externalities’ for others were acceptable, but corporate governance should not be distracted and undermined by such considerations.

Shareholders are shielded from the consequences of the harm — or ‘negative externalities’ — that corporations inflict on others and on nature with the protection of ‘limited liability’. Under this legal dispensation, company shareholders are absolved of liability, regardless of the human and environmental costs caused by their activities, products or services sold.

Hence, limited liability has long been at the very core of their business models. Those running such limited liability companies have been quite aware of at least some of their ‘negative externalities’, or harm they cause, as such externalities are actually at the core of their profit maximizing strategies.
Thus, cost-saving or efficiency considerations typically involve skirting legal regulations, ‘passing on’ or ‘socializing’ costs, minimizing tax exposure, extracting non-renewable valuable resources, otherwise harming the environment, and other ‘socially irresponsible’ conduct.

Off the Hook

In case after case of corporate crime, shareholders have been let off the hook: from the 1984 gas leak at the Union Carbide plant in Bhopal, India, which killed hundreds of thousands, to the health consequences of the use of tobacco, asbestos and other toxic and carcinogenic substances.

More recently, shareholders of Boeing, responsible for two airplane crashes in Indonesia and Ethiopia that killed 346 people, made US$43 billion from share repurchases during 2013-2019 when the firm ignored safety standards in order to cut costs. Meanwhile, the families of those who died will be compensated from a US$50 million disaster fund, i.e., about under US$150,000 per victim, much less than 0.2 per cent of the share repurchase gains.

A lawsuit against the Sackler family, which owns Purdue Pharma, the company believed to have profited most from the US opioid epidemic, is trying to hold beneficiaries of corporate misconduct accountable. Apparently, Purdue hired McKinsey as consultants to “turbocharge” opioid sales, willfully encouraging addiction, knowing it would lead to many deaths.

Nevertheless, fearing liability, some family members have reportedly moved much of their money to Switzerland. However, they need not fear as US courts have long protected influential shareholders from the victims of such corporate abuses, a norm unlikely to be reversed by senior judicial appointments in recent years.

Internalising Externalities

Limited liability has often been criticised for preventing markets from properly pricing risks posed by corporate activities known to or suspected of causing substantial harm. But this, of course, presumes that assessing and pricing risk and harm by markets is straightforward, unproblematic and uncontroversial.

Property rights, it is claimed, increase efficiency by ensuring that owners bear the costs of the profit-seeking activities their assets are engaged in. Yet, limited liability protects investors from having to bear the full costs of their consequences while retaining profits so generated. Unsurprisingly, shareholders will defend such privileges and resist efforts requiring them to bear such costs.

‘Command and control’ or top-down regulation is dismissed as ineffective, costly and inefficient by the ideology of shareholder market capitalism. Meanwhile, market deterrents, e.g., via taxation, are opposed as governments are dismissed as incapable of setting optimal tax rates.

Shareholders also try to avoid liability by locating assets in safe havens, and by persuading governments to protect them, even threatening sanctions against those seeking to undermine such protection. But laws that allow investors to do harm with impunity also undermine the very legitimacy of the economic and legal system besides the very conditions for humanity’s survival.

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  1. Henry Moon Pie

    “Capitalism is irresponsibility organized into a system.”

    Emil Brunner, 20th century Swiss Reformed theologian

    1. DSB

      Three people go into the government run pie distribution facility. The first person, a socialist, pays their money and steps up to the counter. As they watch the man with the knife cut a thin slice of pie they imagine the best. The man wielding the pie has vast knowledge and understanding. The thin slice is for the socialist’s better health and the well-being of the community. Upon tasting the pie its bad flavor is equated to being more healthy. Later that night as they lay in bed hungry, they are content to know that the man was looking out for them.

      The second person, a communist, pays their money and steps up to the counter. As they watch the man wield the knife, they know the thin slice means there will be that much more for the man to take home to his family. Upon tasting the pie, its bad taste reminds them of the wonderful pies they had as a child. The recipe for which had been handed down for generations. The communist imagines that if there were flour, eggs, butter and fresh fruit in the store, they might one day make a delicious pie from the recipe. Then they could slice the pie.

      The third person, a capitalist, pays their money and steps up to the counter. They are appalled by the thin slice of pie being cut, there is no value for money there. Upon tasting the pie they spit it out given its bad taste. Later that night as they lay in bed hungry, they plan how they can build their own pie making facility, so as to provide the socialist and communist with good tasting pie at a reasonable price.

      Who doesn’t like a fresh out of the oven delicious pie?

      1. Darius

        Except Amazon has captured the market for pies and made the barriers to entry by a new business too high. We stopped enforcing antitrust laws 40 years ago. Thanks Robert Bork!

  2. notabanker

    I have a career in negotiating contracts. Top 2 issues are always, always indemnification and limits of liability. In recent years particularly around cybersecurity. No one wants to have any responsibility for data. Cloud providers go so far as to prohibit you from uploading any data that would cause them to conform with regulatory, legal or industry specific standards. It’s theoretically negotiable, all depends on how much leverage you have. Net result of that is liability tends to flow to the weakest spot in the chain. AIG anyone?

    1. Kurtismayfield

      No one wants to have any responsibility for data.

      But they all want to cash in on it. Strange how they view it as an unlimited resource to be extracted from the people while on the other hand not wanting to be held responsible for farming it.

  3. cnchal

    More recently, shareholders of Boeing, responsible for two airplane crashes in Indonesia and Ethiopia that killed 346 people, made US$43 billion from share repurchases during 2013-2019 when the firm ignored safety standards in order to cut costs. Meanwhile, the families of those who died will be compensated from a US$50 million disaster fund, i.e., about under US$150,000 per victim, much less than 0.2 per cent of the share repurchase gains.

    Didn’t Boeing do $43 billion in stawk buybacks? And didn’t that money go poof?

    Holding shareholders responsible, when it should be the executives, is going to be difficult to determine when the holding time for stawks is measured in seconds.

    1. Mel

      I doubt the money went poof. I bet the ex-shareholders spent it to their own benefit, if they don’t still have it.

      Purdue Pharmaceuticals is different from many corporations in being privately held. Shares aren’t marketed, Shareholders and management controllers are not hard to identify.

    2. Fraibert

      I think this is the realistic take on the issue (besides the fact that taking away limited liability where it already exists may be unconstitutional in the U.S.–limited liability itself being a key component of the property rights inherent in modern corporate stock).

      Large public corporations have constantly shifting shareholder ownership, and even the companies themselves don’t really know who owns their stock. My understanding is that many shares are held in the name of a third party for the benefit of the true owner (to further facilitate trading). Given that a fixed period or date is necessary to determine which shareholders are “responsible” for a liability, this alone means that logistically piercing the veil of a large public corporation is difficult without completely adjusting how the stock market works.

      In any case, even if one knew for certain all the shareholders in a given period, each shareholder must be sued individually to comply with due process, with the proof being submitted to an independent factfinder of the shareholding in the relevant period of time and a chance for the alleged shareholder to rebut this evidence.

      In light of the above, I suspect that removing corporate limited liability (and limited liability from other business organizations such as LLCs, for that matter), will only harm the owners of small and medium sized businesses, which are much more likely to be held by an individual, a small number of families, or the like. Government readily can pursue the owners of these businesses as the ownership is easy to determine (and with smaller pockets to fund a defense), and it also gives the bureaucrats and politicians a way of appearing to “do something” while pushing around easy targets,

      1. fwe'zy

        In light of the above, I suspect that removing corporate limited liability (and limited liability from other business organizations such as LLCs, for that matter), will only harm the owners of small and medium sized businesses, which are much more likely to be held by an individual, a small number of families, or the like.

        Small businesses are no party for their workers, but as long as we are still here in capitalism, people still want to have these. Ok, beware of people pushing piecemeal bandaids like “no more limited liability!” or “fewer laws” etc … they’re frequently of this ilk:

        ‘Command and control’ or top-down regulation is dismissed as ineffective, costly and inefficient by the ideology of shareholder market capitalism.

        1. jm

          So everything should be owned and run by one monopoly company: The Government!
          Just how is this an improvement?
          Our greatest problem already is too few companies, too little true competition

      2. Dirk77

        The US Constitution says nothing about corporations. So your problem contains its solution: a corporation, being a government created entity, can be whatever the citizens decide. We can remove LL for large companies and retain it from small or medium-sized.

  4. rick shapiro

    Limited liability is crucial to the agglomeration of capital pools which underlie the prosperity of modern life. Responsibility should clearly be the province of decision-makers within the corporation. This means that both civil and criminal liability need to apply to them. Furthermore, that liability should accrue to every link in supervisory authority from the decision-maker up through the chain to the board.

  5. albrt

    In my experience “fraudulent conveyance” is taken very seriously by the courts, but only when it is used against little people.

  6. bruce

    I am sympathetic to the perspective of this post, but I have a question. If limited liability for shareholders was removed, would anybody of sound mind ever buy a single share of stock anymore?

    1. Fraibert

      It’d be a much more difficult sell for large corporations where the individual shareholder has no meaningful control (except in a few cases where shareholdings get very large).

      My guess is absent limited liability the wealthy/sophisticated would simply turn to corporate bonds as the favored investment vehicle in private business. While one can argue that a shareholder “owns” a portion of a corporation (though, as Yves has repeatedly pointed out, shareholders are only entitled to equity–i.e., the leftovers after all the debts are paid), it’s very hard to argue that a lender should pay for the actions of the borrower. IIRC, bonds had higher yields in 19th Century American than stocks.

      1. Charger01

        The 19th century bonds were also pegged to the gold backed (deflationary) dollar, as described in Thomas Franks’ masterpiece “The People, No” . He described that debt based occupations (i.e. farming) were getting poleaxed by the deflationary currency driving down commodity prices, right as farmers needed the income to service their debt. They were keenly aware the bonds (and other debt devices) were valued by the wealthy and despised by the general population.i don’t think were going back to that type of economy as we’ve permanently transitioned to a consumer (debt based) economy.

    2. Yves Smith Post author

      It would likely end ownership by transient owners who knew little about the business or management. Shareholders would have venture capital type relationships, where they were privy to what would be considered insider details….but stocks would be close to illiquid.

      I don’t see any virtue in the current system of transient, no influence shareholders. It produces overpaid and unaccountable executives.

      1. bruce

        CLOSE to illiquid, you say, LOL. It would be totally illiquid. The entire point of why corporations came to exist is so that the risk of the investors would be limited to the amount they paid for their shares. If anybody out there reading this wants to assume potential unlimited liability, you don’t have to revamp the whole system, you can just write naked options. Good luck!

        A change this major would basically level Wall Street. I am curious to hear what you propose to replace it with. Full-on Marxism hasn’t worked the times it’s been tried in my lifetime.

        When I was younger, the limited liability concept sufficiently reassured me to the point where I could buy shares in companies with exposure. When I was younger, GE with Jack Welch at the helm seemed like a starship going ever upward. When I was younger, the potential liabilities of energy companies for climate change was not on the horizon. I have not been in the stock market in a long time. I am not an accountant, I can’t parse a major corp’s balance sheet, it’s all I can do to balance my checkbook. There are sharks in those balance sheets, and I don’t have the chops to recognize them.

        1. Dirk77

          I do not think saving Wall St is a good enough reason by itself to keep capital markets. But no one is advocating communism; however, there does exists a middle ground. While further research is necessary, few would argue against banning both stock buybacks and the linking of executive pay to share price.

  7. Noone from Nowheresville

    So “markets” aka people making policy decisions which effect other people can’t properly assess risk and harm and “market deterrents” again aka people making policy decisions which effect other people are ineffective and inefficient and therefore are also incapable of properly assessing risk & harm.

    So bBasically some people have created legal fictions and systems to screw other people over. More people have learned how to game the system for their own personal advantage. Other people supposedly on the “good” side just can’t stop them.

    Great. Nothing new here.

    Hand wringing ensues. Oh, it’s getting so bad that eventually the entire system may collapse. Maybe.

    Okay, now we’re getting somewhere. Please tell me what happens if it collapses so I know whether or not it’s to my advantage and those of us not privileged by said “markets” and “market deterrents” to let said system collapse. After all austerity and the great buy-ups are coming courtesy of said markets & deterrents so it would be nice to have some real choices.

  8. Rod

    Take the term “efficiency.” In capitalist economics, that’s just regarded as almost a synonym for “good,” but it completely depends on what the efficiency is being aimed at. You know, machine guns are efficient, gas chambers are efficient. So, “efficiency” as such does not mean “good.” It is a measure of the least amount of effort put in for the most amount gotten out.–Kim Stanley Robinson, Author

    a quote from:–in yesterdays WC

    Property rights, it is claimed, increase efficiency by ensuring that owners bear the costs of the profit-seeking activities their assets are engaged in. Yet, limited liability protects investors from having to bear the full costs of their consequences while retaining profits so generated. Unsurprisingly, shareholders will defend such privileges and resist efforts requiring them to bear such costs

    from todays read.
    I see some parallels.

  9. Matthew G. Saroff

    There was a real-world experiment confirming that the corporate liability shield made bankers more reckless in the 1800s.

    Short version: As marital property laws changed state by state, it became possible for bank owners to protect some assets from a failure though spousal assets.

    The ability of a wife to have separate assets changed on a state by state basis throughout the 1800s, and it is clear from bank failure rates that the states where assets could be held by a wife were more reckless:

    What they looked at was the effects of the passage of Married Women’s Property Acts (MWPAs) in the early 1800s on banker risk taking.

    MPWAs changed property law to allow women to hold their own assets, and when women held their own assets, a bank president wife’s assets were not subject to liability from a bank failure, while his assets were subject to recovery from account holders.

    Because these were state laws, and the laws were passed at different times, we can compare and contrast the behaviors:

    Changing the bankruptcy law to do things like disfavor derivatives should be a first step in financial reform.

    1. rick shapiro

      There was a much more recent experiment in the effects of limited liability. Several decades ago the large investment banks all converted themselves from partnerships into LLCs. The result was that, for example, Goldman-Sachs, which had been a model of probity, became the vampire squid. Similar effects occurred in the others.

      1. Dirk77

        Thank you both for mentioning these experiments. I vaguely recall Yves mentioning, years ago now, about Goldman Sachs. Anyways, perhap we will have more.

  10. Sancho Panza

    In the case of the National Childhood Vaccine Injury Act of 1986, liability of Big Pharma is further limited at the product level. This protects not only shareholders but the corporation itself. Under NCVIA those with tort claims cannot sue the manufacturer though they can make a claim through a federal arbitration process. Seems like eliminating this kind of legislation is lower hanging fruit than tackling something as basic and longstanding as the author describes. The Limited Liability concept goes back to the times of royal shipping companies…and won’t be overturned.

    1. fwe'zy

      Don’t let this be one of those “gosh, if only we could do that one impossible thing, this could be rectified, ho-hum.”

  11. Carolinian

    Some history here.

    By the 15th century, English law had awarded limited liability to monastic communities and trade guilds with commonly held property. In the 17th century, joint stock charters were awarded by the crown to monopolies such as the East India Company.[9] The world’s first modern limited liability law was enacted by the state of New York in 1811.[10] In England it became more straightforward to incorporate a joint stock company following the Joint Stock Companies Act 1844, although investors in such companies carried unlimited liability until the Limited Liability Act 1855.

    There was a degree of public and legislative distaste for a limitation of liability, with fears that it would cause a drop in standards of probity.

    In the robber baron era those tycoons were constantly suing each other and then buying judges to give them a favorable ruling. So simply restoring liability might not solve our problems given that the wealthy have so many other ways of evading responsibility. More of that probity thing might be needed.

  12. Cat Burglar

    The ideas in this article are very useful in persuading people that there is something deeply wrong in the economy, particularly conservatives. It is not hard to get them to see that a government conferred privilege of limited liability places the modern corporation in the criminal class effectively exempt from any legal or moral obligation. One of my friends — who perhaps listens to too much late-night radio from Pahrump — actually tried to incorporate himself for the tax advantages, though it looks like that didn’t work because he is too poor.

    It is interesting that limited liability corporations can be legally considered persons in their rights to free speech, yet have state conferred tax privileges and immunities that no individual as such can have. It is rarely brought up in any public discussion, but it is not hard to get people to see that powerful state protected entities have every incentive to commit any crime unless their powers of expression and action are harshly limited. The idea that the state-created corporation has rights as a simple association of individuals is cut off at the knees by limited liability because full moral and legal liability are attributes of autonomous individuals. If you remove that, then the corporation cannot be a legal person. That one really gets people thinking!

    1. lyle

      All limited liability means is that stockholders have at risk only their investment. The company is itself liable in court for torts etc. Now of course a paper person can’t be put in jail but conversly some crimes amount to capital punishment for the corporation, i.e. this crime is punished by loosing the license to engage in the business they are in. Directors and officers can be forbidden to be an office or director of a corporation in some case.

  13. lyle

    Note that until the middle of the 19th century it took an act of the state legislature to set up a limited liability company. This was a huge way for legislators to get rich. As many have pointed out without limited liability there would be no stock market. For publically held companies the individual stockholders only real influence is nil. Directory and officer liablity is now handled by insurance that if you were a director or office of a large corporation you would have to have purchased for you in particular to be a board member where the comphensation for being a director is less than the risk. (Note that boards often include college professors etc)

  14. kk

    The corporation is a legal person, it can make contracts, incur debts, take risks, own property, be fined and be executed (shut down). The public can have shares in the gains of this legal person and limit losses to our investment in that body ie liability is limited. In return for limiting (not eliminating liability) we traditionally have to share information- in the uk it was originally just a balance sheet, now it’s a lot more in bigger corporations. If you remove limited liability who would invest knowing that only one share in, say Purdue, could beggar you as you would be jointly and severally liable for all debts? The joint stock company and limited liability are deeply flawed concepts as their originators in the 1800’s realised, but they are the rocket fuel of capitalistic growth.

    1. Mel

      All that is true. One asymmetry is that a corporation as a legal person can’t be murdered. Willfully bringing about the death (shutting down) of a corporation isn’t considered a capital crime. P.E. would be a lot different if it were.
      Another is that we haven’t found a way to keep a corporation behind bars. :-/

      1. lyle

        Actually for numerous companies there is an equivalent to capital punishment. Consider Tokyo electric power or more recently Purdue Pharma in those cases all the stock holders get wiped out, the government becomes the sole shareholder and in the case of TEP pays the huge expenses due to Fukushima. Or in the case of Purdue all profits now are assigned to addiction treatment.

        One could go back to the 19th century idea of assessible stock where it was sold with a potential liability of up to some amount. (Happened a lot with Mining Stocks)

    2. Noone from Nowheresville

      At this point, do we care who would invest?

      In the US, the statistics are something like the top 10% own 85% of the stocks. Of which I’m guessing that the top 0.01% own the most then the 0.1% then the 1% then 1.1-5% and so on. Leaving about 15% for the bottom of 90% of which most of that will be concentrated in the 10.1-19% zone. At a guess with the policy decisions being made and enacted in 2020, I’d say further concentration is about to happen even if corporations release even more stock blocks.

      What societal purpose does such capitalistic growth serve these days? And hasn’t it really become more a “house” owned casino feeding system?

      Why do people who have reaped excessive rewards of capitalistic growth, because they could either game the system themselves or pay someone else to do so on their behalf, not have any of the responsibility when the debts come due?

      1. Dirk77

        I am starting to think that the upsurge in growth you get from a capitalist system is like burning the furniture to keep the house warm: it works great for awhile.

  15. Dr. E

    Isn’t this a chicken or egg debate at the crux? If we hadn’t developed such a disgustingly litigious culture, wouldn’t the risk of starting a company return to tenable levels? Limited liability would be a ridiculous notion if every company didn’t have to factor in the inevitable loss of profit to those dishonest degenerates among us.

    Also, I may be in an extreme minority, but the public flogging of the Sacklers has felt beyond unethical, if not unconstitutional, to me. They created a medical miracle, despite its demonization, that has aided the lives of countless patients in terminal or post-operative states. Is everyone really feeling comfortable acting like we didn’t all know that potent opiates are addictive if taken for too long or outside of prescriptive orders? Come on. I guess one could argue the same for Boeing, and the more I think of it, the more it rings true. Unless there was overt neglect of danger prior to take-off, we all accept the risks of flying, and thankfully the risk is as small as it is.
    TLDR for (unfortunately) my generation:
    #Buyer always Beware
    #Preach 4 Personal Responsibility

    1. Dirk77

      Yes, but there surely is a middle ground. A libertarian world where we are all evaluating each other’s actions like we are in a knife fight is exhausting.

    2. Futility

      The Sacklers did not create a miracle drug that helped terminally ill patients. They just created a variant of an already existing opiate, whose patent protection (another government created racket) was about to expire, claimed contrary to the facts which they were fully aware of at the time that is was not addictive and pushed it on people knowing full well if would create addiction. They paid doctors and ‘researchers’ to claim that is is not addictive. Terminal patients could just as well be helped with already existing opiates. Nobody needed this ‘miracle’ drug.

  16. Dileep Mehta

    Limited liability is a call option – unlimited upside gain, limited downside losses.
    If the government grants an option in the form of limited liability, what does it receive as a ‘premium’ in return?
    Leaving aside secondary or tertiary benefits such as growth in employment and workers’ spending giving a rise to new businesses, the premium may be the [present value of] future stream of taxes on profits. Thus unlike the conventional premium, its future recept also incorporates uncertainty of non-payment!
    This line of reasoning then effectively demolishes the mythology of “double taxation”, whereby stockholders pay taxes first through the corporation and then pay taxes on dividends declared by the corporation.

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