The Limits of Limited Liability: Evidence from Industrial Pollution

86 Pages Posted: 10 Dec 2017 Last revised: 7 Jan 2021

See all articles by Pat Akey

Pat Akey

University of Toronto - Rotman School of Management

Ian Appel

Boston College - Carroll School of Management

Date Written: September 7, 2018

Abstract

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

Akey, Pat and Appel, Ian, The Limits of Limited Liability: Evidence from Industrial Pollution (September 7, 2018). Journal of Finance, 2021, 76(1), pp 5-55, European Corporate Governance Institute - Finance Working Paper No. 611/2019, 13th Annual Mid-Atlantic Research Conference in Finance (MARC) Paper, Available at SSRN: https://ssrn.com/abstract=3083013 or http://dx.doi.org/10.2139/ssrn.3083013

Pat Akey (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Ian Appel

Boston College - Carroll School of Management ( email )

Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467-3808
United States

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