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Limited Liability Is Causing Unlimited Harm

The original purpose of limited-liability protection was to encourage investment in – and risk-taking by – corporations, whose resulting innovations would benefit society. Yet by allowing shareholders to profit from the harms caused by corporations, limited liability has evolved into a source of systemic market failure.

NEW YORK – In a recent tweet, Olivier Blanchard, a former chief economist of the International Monetary Fund, wondered how we can “have so much political and geopolitical uncertainty and so little economic uncertainty.” Markets are supposed to measure and allocate risk, yet shares in companies that pollute, peddle addictive pain killers, and build unsafe airplanes are doing just fine. The same goes for corporations that openly enrich shareholders, directors, and officers at the expense of their employees, many of whom are struggling to make a living and protect their pension plans. Are markets wrong, or are the red flags about climate change, social tensions, and political discontent actually red herrings?

Closer inspection reveals that the problem lies with markets. Under current conditions, markets simply cannot price risk adequately, because market participants are shielded from the harms that corporations inflict on others. This pathology goes by the name of “limited liability,” but when it comes to the risk borne by shareholders, it would be more accurate to call it “no liability.”

Under the prevailing legal dispensation, shareholders are protected from liability when the corporations whose shares they own harm consumers, workers, and the environment. Shareholders can lose money on their holdings, but they also profit when (or even because) companies have caused untold damage by polluting oceans and aquifers, hiding the harms of the products they sell, or pumping greenhouse-gas emissions into the atmosphere. The corporate entity itself might face liability, perhaps even bankruptcy, but the shareholders can walk away from the wreckage, profits in hand.

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