The Limits of Limited Liability: Evidence from Industrial Pollution
55 Pages Posted: 10 Dec 2017 Last revised: 6 Mar 2018
Date Written: January 17, 2018
We study how parent liability for subsidiary environmental cleanup costs affects industrial pollution and production. Our empirical setting exploits a Supreme Court case that strengthened limited liability protection for parent corporations. Using a difference-in-differences framework, we find that increased liability protection for parents leads to a 10% increase in toxic emissions by subsidiaries. This decision is also associated with abnormal returns of over 1% for parent firms with a relatively high exposure to the change in legal liability. We find evidence that the increase in pollution is driven by lower investment in abatement technologies rather than higher production. Cross-sectional tests suggest a risk-shifting motivation for these effects. Overall, our results highlight moral hazard problems associated with limited liability.
Keywords: Limited Liability, Industrial Pollution, Moral Hazard, Risk-shifting, Investment
JEL Classification: G3, G38, G30, Q52, P14
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