Academic journal article Journal of Economic Issues

Bad Losers: An Investigation of the Morality of the Limited Liability of Shareholders in a Joint Stock Company

Academic journal article Journal of Economic Issues

Bad Losers: An Investigation of the Morality of the Limited Liability of Shareholders in a Joint Stock Company

Article excerpt

The corporation, defined as a joint stock company with limited liability, separates the firm's owners, its shareholders, from the firm itself. Problems with the shareholders' ability to control the corporation and of hired managers being entrusted with the shareholders' wealth have been debated intensely for the last two centuries. Less attention has been devoted, however, to the other side of the control issue: the shareholders' limited liability for the actions of the company. There have been many investigations of the economic reasons for limited liability [Alchian 1969; Alchian and Demsetz 1972; Anderson and Tollison 1982; Demsetz 1967; Mill 1848; Scott 1912; Woodward 1985]. Historical descriptions of the rise of the corporation and the establishment of limited liability are less frequent [Campbell 1967; Hadden 1972; Littleton 1933; Shannon 1931; Williston 1888]. Even more rare are analyses of the moral side of limited liability.

The moral problem is that limited liability seems to violate two moral principles commonly held in the Western world. One is the causality principle, expressed as "Thou shalt be liable for the consequences of thy actions." The limited liability rule violates this since it eliminates part of the losses. The other is the symmetry principle, declaring that "Such as enjoy the benefits shalt suffer the losses." Limited liability violates this principle since the liability involved, although encompassing all of the profits, covers only a predetermined amount of the losses. Thus, limited liability creates a moral problem.

Investigation of the morality of limited liability can be conducted with or without the consideration of efficiency. According to Rawls [1971], justice as fairness depends both on the principle of equal rights and on the principle of fair inequality. Limited liability need not violate Rawls's two principles if it is assumed that limited liability as a shareholder is open to everyone and that this leads to an increase in enterprise due to the limitation it imposes on losses. In this paper, however, I focus neither on the fairness of limited liability at the societal level nor on economic efficiency but exclusively on the moral problem.

Initially, I derive determinants of liability on the basis of two simple examples. These determinants are needed in the discussion that follows in the second section, where the limited liability found in the joint stock company is analyzed in terms of the two moral principles.

Determinants of Liability

Let us begin with the assumption that humans have wills that seek realization of goals or ends through deliberate action, with the ability to scan available action alternatives and to estimate their efficiency. The action chosen, which may involve either activity or passivity, creates a situation with consequences that the actor hopes are those sought and predicted. The moral question of liability, as generally understood in Western European traditions, concerns the causality between the action taken and the new situation as well as the propriety of the consequences for the actor. If a person, Juan, leans against the Eiffel tower and the tower collapses for unforeseen reasons, related nevertheless to what he did, it seems obvious that Juan's leaning against the tower was the cause of its collapse. However, he would presumably have no liability, despite the causal connection, since it was impossible to predict the tower's collapse. This implies that predictability is a prerequisite for the determination of liability. However, even if it were within the reach of human faculty to predict the tower's collapse, Juan could still not be blamed for the disaster if predicting it would require an extraordinary expenditure of human resources. The prerequisite of predictability is not absolute, therefore, but is relative to the efforts that prediction would require.

The relativity of the prerequisite of predictability can be illustrated by an example that Ofstad [1980] has constructed. …

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