The Limits of Limited Liability: Evidence from Industrial Pollution
87 Pages Posted: 10 Dec 2017 Last revised: 7 Jan 2020
Date Written: September 7, 2018
We study how parent liability for subsidiaries' environmental cleanup costs affects industrial pollution and production. Our empirical setting exploits a Supreme Court decision that strengthened parent limited liability protection for some subsidiaries. Using a difference-in-differences framework, we find that stronger liability protection for parents leads to a 5-9% increase in toxic emissions by subsidiaries. Evidence suggests the increase in pollution is driven by lower investment in abatement technologies rather than increased production. Cross-sectional tests suggest convexities associated with insolvency and executive compensation drive heterogeneous effects. Overall, our findings highlight the moral hazard problem associated with limited liability.
Keywords: Limited Liability, Industrial Pollution, Moral Hazard, Risk-shifting, Investment
JEL Classification: K22, G34, G38, Q58
Suggested Citation: Suggested Citation