Corporate Architecture and Limited Liability

Abstract

This paper studies the effect of limited liability on corporate architecture. Corporate architecture refers to the use of governance instruments within the firm to control the behavior of employees. Four general instruments are defined that form the basis of the firm as a governance arrangement. These four are decision control rights, reward schemes, information systems and conflict resolution rules. Limited liability influences the way in which an incorporated group of firms employs each of these instruments. An efficient use of the governance instruments in such a group implies that lower hierarchical levels, incorporated in subsidiaries, will have more discretionary decision rights, higher powered incentives and less information requirements than a group that does not organize its business risks in incorporated subsidiaries. Corporate groups thus differ in their governance arrangement from firms that have not organized in corporate groups. Alternatives that restrict limited liability have the effect of centralizing rights, flattening reward schemes and increasing investment in information systems. If corporate groups have attuned their architecture optimally, then restricting limited liability generates additional coordination costs.

Keywords: Limited liability, Corporate Law, Organizational Form

JEL Classification: K13, K22