The Limits of Limited Liability: Evidence from Industrial Pollution

55 Pages Posted: 10 Dec 2017 Last revised: 6 Mar 2018

Pat Akey

University of Toronto - Rotman School of Management

Ian Appel

Boston College - Carroll School of Management

Date Written: January 17, 2018

Abstract

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

Suggested Citation

Akey, Pat and Appel, Ian, The Limits of Limited Liability: Evidence from Industrial Pollution (January 17, 2018). 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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