Limited Liability

Abstract

Limited liability has been known in Europe since at least the twelfth century, and appeared later in England and throughout the remainder of the developed world. Limited liability can be achieved by private contractual arrangements, by the use of limited liability forms of enterprise, by other statutory limits on liability, and by bankruptcy. The principal advantage of limited liability is in encouraging investment by passive investors in risky enterprises, particularly where these investors are poor monitors of managers. Joint and several liability is a particular deterrent to investment by wealthy investors, who are likely to bear all of the costs of judgment. Pro rata liability shifts collection costs from wealthy investors who must seek contribution from other investors to judgment creditors, who must collect from all investors if they are to recover the entire judgment.

JEL Classification: G38, K13, K22