Limited Liability of Professional Firms after Enron
24 Pages Posted: 23 Apr 2003
Date Written: April 4, 2003
Some commentators suggest that mandatory personal liability of professionals for liabilities of their firms is appropriate in light of professionals' role in Enron and other recent frauds. This liability can, indeed, help ensure that professional firms deliver on their obligations to monitor their members and clients. However, such liability is ineffective and costly. Holding professionals vicariously liable for their colleagues' defaults is unlikely significantly to increase firm monitoring. At the same time, imposing this risk on professional firm members is likely perversely to affect both professionals' incentives and the structure of their firms. Professional firms accordingly are better constrained by the market for professional services, which demands that professional firms develop significant reputations to, in effect, bond their promises to monitor. Moreover, professional services firms someday may be able to rely more on conventional financial capital to bond its monitoring promises. These alternatives to vicarious liability are constrained by legal restrictions on the size and shape of professional firms, particularly including restrictions on non-competition agreements and on ownership by non-professionals. Although these restrictions strengthen the case for vicarious liability of professional firm owners, the better approach is to deregulate professional firm structure.
Keywords: professional regulation, limited liability, Enron, law firms, accounting firms
JEL Classification: G3, K2
Suggested Citation: Suggested Citation