Does Limited Liability Matter: An Analysis of California Firms, 1920-1940

38 Pages Posted: 17 Jul 2012

See all articles by Kenneth Lehn

Kenneth Lehn

University of Pittsburgh - Finance Group

Leonce Bargeron

University of Kentucky - Gatton College of Business and Economics

Multiple version iconThere are 2 versions of this paper

Date Written: June 29, 2012

Abstract

In 1931, California became the last U.S. state to adopt limited liability. Prior to that, from its inception as a state in 1849, stockholders of California corporations faced pro rata unlimited liability. California's unique liability rule during 1849-1931 provides a natural experiment for testing whether stockholders' liability rules "matter." Using a small sample of publicly traded California firms and a corresponding sample of benchmark companies, we find that California firms realized annual excess returns that were approximately nine percentage points higher than other companies during the 1920s, which is consistent with the view that unlimited liability increases the expected returns on equity. We also find that excess returns for California firms were approximately -12% in October 1929, which suggests that the 1929 stock market crash put the personal assets of stockholders of California firms at risk. We find that share turnover was significantly lower for California firms than other firms during the period California had unlimited liability, but not so after California adopted limited liability. Finally, we find weaker evidence that California firms had more leverage, lower asset risk, and less growth as compared with other firms during the period California had unlimited liability. Overall, the results suggest that rules regarding stockholders' liability matter for the pricing of securities, share turnover, and various corporate policies.

Keywords: limited liability

JEL Classification: G10, K22

Suggested Citation

Lehn, Kenneth and Bargeron, Leonce, Does Limited Liability Matter: An Analysis of California Firms, 1920-1940 (June 29, 2012). Available at SSRN: https://ssrn.com/abstract=2104319 or http://dx.doi.org/10.2139/ssrn.2104319

Kenneth Lehn (Contact Author)

University of Pittsburgh - Finance Group ( email )

372 Mervis Hall
Pittsburgh, PA 15260
United States
412-648-2034 (Phone)

Leonce Bargeron

University of Kentucky - Gatton College of Business and Economics ( email )

550 South Limestone
Lexington, KY 40506
United States
859-257-4397 (Phone)

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