The new economic rationale for corporate limited liability

Abstract

The legal rule of corporate limited liability is not generally considered to have any fundamental economic significance. This is why the idea of reforming this rule can be raised in discussions concerning corporate accountability and this is why political or administrative difficulties rather than economic considerations are usually cited when this idea is ultimately rejected. This paper puts an economic case for retaining limited liability by arguing that anonymous and unrestricted trading, which is only possible with this rule, has become endogenous to the asset management function of institutional shareholders in the same degree that the asset management industry has become endogenous to the operation of the modern day capitalist economy. A further argument is that while limited liability and unrestricted trading make no direct contribution to the corporate production function they do indirectly help to resolve the problem of corporate accountability by helping to make redundant the use of stock options, instruments which are widely recognised to be today one of the chief sources of corporate irresponsibility.