The problem of LLC’s

World Changing has some Thoughts on Limited Liability (via BoingBoing):

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.

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?

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?

One of the common phrases you see in discussions of Enron or any other example of corporate corruption is “bad apples”. As in,”Why are you blaming the organization for the actions of a few bad apples?”. Enron wasn’t bad, Ken Lay was just a bad apple. The problem isn’t systemic, it was just a rogue manager or executive. (The excellent documentary The Corporation starts off with a bad apple montage).

Of course, bad apples happen so frequently in corporate America that on examination you quickly realize the absurdity of it. The problem of corporate crime is systemic: it’s a direct result of the corporate form, as the link alludes to and the documentary examines more fully. The sole purpose of a corporation is to shield shareholders from liability for what this legal person does, and the result is about what you’d expect given that starting condition. There’s a complete absence of any precautionary principle in the structure of a corporation.

The author’s suggestion, to make shareholders liable for up to 1% of their net worth, is a good one, IMHO – it would provide the marginal incentive necessary for shareholders to police the corporations they own, whereas today they hardly do this at all.

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