Limited Liability: Playing It Safe or Going Big?

49 Pages Posted: 13 May 2023 Last revised: 30 Nov 2023

See all articles by Cyndi Xinyu Hou

Cyndi Xinyu Hou

Indiana University - Kelley School of Business - Department of Finance

Date Written: Nov 30, 2023

Abstract

Does limited liability on damages improve social efficiency? I show that optimal liability rules trades off tort damages against benefits to outside stakeholders. Full liability promotes care but raises marginal costs, inducing less-than-efficient scale. Limited liability enhances scale but reduces care, proving more efficient than full liability when outside stakeholder value is high. As market competition grows, liability’s impact on scale diminishes, and internalizing more damages would increase efficiency. We conclude that limited liability is not one-size-fits-all; tailored policies like requiring insurance for contractors and nuclear decommissioning trusts (NDTs) can help adjust for cross-firm differences.

Keywords: limited liability, care, scale, tort law, optimal liability rule

JEL Classification: D21, D41, D42, D62, K13

Suggested Citation

Hou, Cyndi Xinyu, Limited Liability: Playing It Safe or Going Big? (Nov 30, 2023). Available at SSRN: https://ssrn.com/abstract=4445718 or http://dx.doi.org/10.2139/ssrn.4445718

Cyndi Xinyu Hou (Contact Author)

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States
3103104868 (Phone)

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