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Limited liability and corporate social responsibility

The late Milton Friedman was famous for many viewpoints but one that stands out for me was his admirably blunt statement that the purpose of a business is to make money for the people who own it, not to advance some social, environmental, religious or other agenda. Period. A publicly-quoted firm on the London Stock Exchange or Wall Street should focus on making money for its shareholders. In a competitive market – key proviso – such a purpose will tend to work, as Adam Smith said it would 230 years ago, in the interest of the consumer and worker:

Friedman wrote:

When I hear businessmen speak eloquently about the “social responsibilities of business in a free-enterprise system,” I am reminded of the wonderful line about the Frenchman who discovered at the age of 70 that he had been speaking prose all his life. The businessmen believe that they are defending free en­terprise when they declaim that business is not concerned “merely” with profit but also with promoting desirable “social” ends; that business has a “social conscience” and takes seriously its responsibilities for providing em­ployment, eliminating discrimination, avoid­ing pollution and whatever else may be the catchwords of the contemporary crop of re­formers. In fact they are–or would be if they or anyone else took them seriously–preach­ing pure and unadulterated socialism. Busi­nessmen who talk this way are unwitting pup­pets of the intellectual forces that have been undermining the basis of a free society these past decades.

The doctrine of corporate social responsibility is very much on the march in Britain. Companies are increasingly encouraged to do things to help the environment and help local communities. My own firm encourages its staff to devote some time to voluntary work and sets aside time and resources for that end. Now, I have no trouble whatsoever with a firm that, with the consent of its owners – shareholders – decides to back certain causes so long as the shareholders realise that such activity could affect their shares either positively or negatively. So long as it is made explicit and the owners are allowed to decide yes or no. The problem starts to arise however when this doctrine is forced upon the business owners by state regulation. This is not simply a problem that can face listed companies; it can also potentially affect firms that are not publicly listed but owned, say, by a private equity fund or an individual.

One problem, I think, is limited liability laws. Such laws, one might argue, create a bit of a “moral hazard” problem in that the firm’s owners are less mindful of the harmfulness or riskiness of their decisions than if they were subject to the conditions that used to prevail under the old English Common Law. Might the reason that we have so much focus on the supposed social responsibilities of business stem in part from the idea that limitied liability is a privilege that carries responsibilities? Purist free marketeers might say that the logical step is to remove the privilege, but would the ability of firms to operate on a large scale, with all the advantages that can bring, come to an end without limited liability?

I am not sure about the answers to all these questions, which is why I ask them. I know that some libertarians and classical liberals, such as Sean Gabb, have posed the argument that limited liability is inherently contrary to a consistent free market doctrine, and that the creation of large corporations with certain immunities has actually created businesses that are increasingly indistinguishable from government. On the other hand, one might envisage how constraints on corporate liability might emerge without state legislation, although I confess I am not sure how this would work.

Related thoughts here and here.

23 comments to Limited liability and corporate social responsibility

  • One word: insurance. The owners will then have to price in risky moves, because you can be sure their insurers will.

    I can’t immediately think of any problems with this, but of course I would love someone to point them out.

  • Gabriel

    A sensible, but somewhat misguided, post, a lunatic rant by Sean Gabb and a very sensible conclusion by Mr. North.

  • James of England

    Does anyone have a better example of modern corporatism (ie. the non-violent bits of fascism) than state-initiated CSR?

    It may be that I’m misunderstanding my question. Is there anyone who can explain to me why the current Companies Bill is not fascist? I should note that fascist (or socialist) != wrong, at least not by necessity. There is certainly a fascist strain to the NLRA, for instance, but I find myself in great admiration of the way that private sector unions are handled in America, with much less harm being caused than in the UK, the Continent, or anywhere else that I know of.

  • Paul Marks

    Milton Friedman’s point was that it was the owners of the business (the shareholders) who had the moral duty to help the poor (and so on) – not the hired managers who were simply “being charitable” with other people’s money (i.e. not being charitable at all).

    Of course the left deliberatly misunderstood Dr Friedman as claiming that there was no such thing as moral duty, and that the poor should be left to starve, beautiful parts of the country destroyed (and so on).

  • Paul Marks

    On Dr Gabb and limited liability.

    The idea of limited liability goes back long before the limited liability statutes of the 19th century – and there is nothing anti libertarian about it.

    If I say to you “I will only pay you compensation up to the limit of X number of Dollars if something goes wrong with this business venture” and you agree in advance, then that is that.

    Ditto if a group of people get togther in some undertaking and put a certain of money in the pot – the business is the money in the pot, and as long as they are OPEN about it to the people they do business with these people should have no legal complaint if the business goes bankrupt and the group of people are still wealthy as individuals.

    “But I was not paid and now I am starving in the street watching the former shareholders go past in big cars”.

    Did you not see the sign saying “Limited” or (in the United States) “Incorporated” after the company name?

    Or did you not know that this meant that only the money and assets of the company (not the private ones of the shareholds) could be taken to compesate you for the company’s failure.

    If one does not like this sort of thing one should only do business with nonlimited liability enterprises (such as the old Lloyds of London in insurance) – but the choice is yours.

    As long as no fraud has taken place a person who has made the wrong choice should have no legal complaint.

  • guy herbert

    My approach is similar to Otter’s but I’d really want to keep insurers out of it. Their pusilanimous constraint on the world is already too great.

    It should be recognised that limited liability (and immortality) conferred on corporations is a privilege created by government that should be paid for. Corporations should therefore be taxed more than individuals undertaking the same activities. The reverse is often the case in the real world because corporations have used their privileges to escalate their privileges by lobbying, as so many legislative hackers. And insurance companies (particularly as pension providers) have been among the most effective.

    Because of such entrenchment it is hard to see how the policy could be implemented, though.

  • Richard Garner

    I don’t get it. I understand the evils of socialism and taxation, wherein the government steals my money to aid som “worthy social course.” But if I knowingly invest in a “socially responsible” corporation, then how is that analogous? I may prefer that my money is being used in that way. However, it may not even be that the “social responsibility” agenda is the reason for my investment, but that the corporation simply gives me a better return than others. Whatever the reason, if I consent to it, then why should I not invest in a “socially responsible” corporation, and why not the agents of the corporation pursue a “socially responsible agenda”?

  • Johnathan Pearce

    Richard Garner, your query on my point would be perfectly valid if I had said that shareholders should not invest in “socially responsible firms”. However, I did not say that. I said that I had no problem with firms that act in certain ways so long as their owners consent. The key word is consent.

    This is what I wrote:

    Now, I have no trouble whatsoever with a firm that, with the consent of its owners – shareholders – decides to back certain causes so long as the shareholders realise that such activity could affect their shares either positively or negatively.

    In fact, there are lots of mutual funds and pension funds that now use their economic clout to change how firms run their businesses, to encourage them to protect the environment, etc. Fine. So long as it is clear that is what is going on. My problem is when corporate social responsibility is imposed by government.

  • nic

    -If I say to you “I will only pay you compensation up to the limit of X number of Dollars if something goes wrong with this business venture” and you agree in advance, then that is that.-

    A good point that fits the relationships of client and business partner. But not in the case of bystanders. So, lets say a company is liable for a train crash that hurt people other than their passengers. It is not enough to tell them that the company is limited, because they never entered into a voluntary exchange.

    So limited liability is fine when agreeing who takes on the risk for specific actions with specific people but becomes something much more monstrous as soon as it becomes an essential part of company practice. In fact, it is something that looks much more like a state.

  • Brad

    As I understand it limited liability exists to foster production. People may not put a portion of wealth at risk in the market if they know that potentially all their wealth is at stake. It insulates them from lawsuits and blunts the affect of the use of State force when it is applied to torts (unless the corporate veil is pierced for whatever reason). So it is a counterbalance against invidious lawsuits brought against those who have assets.

    But how does this stack up against those who have an individualist point of view? At least here in the U.S. those who are sole proprietors or in (general)partnerships are not afforded limited liability, yet are doing “good” works via the market. So it becomes a matter of filing the right paperwork and you are magically insulated (again unless actions so foul are perpetrated that it adheres to the individual himself and the veil is pierced). It seems to be sleight of hand at some point and has little to do with the logic of affording some protection for those that are willing to risk wealth.

    Add together that the State has the power to decide whose lawsuits are valid, be the main driver behind ordering creditors, easy piercing of the corporate veil, all combined with loose interpretations of the commerce clause of the Constitution, it’s not long before one realizes that the State has far too much control over corporations and production even in this (supposed) capitalist society.

    I say a much more rudimentary form of limited liability along with a vigorous use of caveat emptor should be the order of the day. When real risks are blunted away by social engineering, all sorts of misallocations result. Counterbalancing little-guy lawsuits with corporate limited liability merely puts the decision, and control, squarely in the hands of the bureaucrats. Statists creep is merely endless counterbalancing and “compromise”. Again, from a Jeffersonian point of view, social “resets” are needed now and again as no matter how the State is founded, all the power will end up in its hands one way or another.

  • Econ-Scott

    One problem, I think, is limited liability laws. Such laws, one might argue, create a bit of a “moral hazard” problem in that the firm’s owners are less mindful of the harmfulness or riskiness of their decisions than if they were subject to the conditions that used to prevail under the old English Common Law. Might the reason that we have so much focus on the supposed social responsibilities of business stem in part from the idea that limitied liability is a privilege that carries responsibilities?

    It is a curiosity if “Liability” in the U.K. has reached the “out of control” proportions that it has in the U.S. ?

    Liability has reached such a state of near anarchy that “Limited Liability Companies” are being established by “Guys in Pajamas” operating a business with a laptop from their living rooms, just for protection from frivolous lawsuits.

    You harken back to some “Good ‘ol period” under English Common law.

    There never was. What there was, exhisted as a “common understanding” of normative fair and rediculous and the rediculous looked on as “evil” to get rich quick, something for little or nothing by theft or strong arm extortion. That notion of right and wrong is gone now and a whole expensive legal industry has arisen to feed off the vacuum.

    There has always been a hot cold or luke warm war between Capital and labor. In the U.S. a series of anti-trust laws and anti-restraint of trade laws have been erected to level the playing field to prevent the small from being crushed by the very large and very powerful. This has had a very positive effect on economics. To put capitol and time at risk requires some faith in the future outcome.

    We have a whole array of “Professional Liability Insurances” for everything from portfolio manager to municipal dog catcher.

    Not because it is needed but to pay the army, …. that is …. the army of lawyers who must do battle for us against frivolous lawsuits in “get rich quick sce

    “First we kill all the Lawyers” — Dick the Butcher in Henry the VI(Link)

    Tempting, since the anarchy that rule of law is supposed to protect even the common man from, is now being foisted on everyone by lawyers who will “Get you some money” if only you will sue. Right now the cost for protection from legal “trouble” is about .5 to 2% of after tax income depending on insurance limits.

    That cost of doing business hasn’t reached extortion prices… yet …. that threshold is probably between 5% and 10%.

    They don’t worry about this in China and India much.

    How was your year ? “Great, Profits were 3 times legal expenses”

    Freedman believed in a market where you are “Free to Choose”. Out-of-Control concepts of liablity and torts restricts those choices and hence freedom.

    Laws protecting the weak from the avarice of the powerful, are they inherently wrong ?

    Now this seems to go far afield of “legislated morality” of Charitable giving of time and money. But it is related.

    The Tension of the Laws protecting free and “fair” commerce versus legislating morality, an ever enlarging “Nanny State” public and private via mandate laws will go on till the end of the Westfalian states.

    It’s important for commerce and freedoms it gives, to win that contest.

  • Econ-Scott

    The Tension of the Laws protecting free and “fair” commerce versus legislating morality, an ever enlarging “Nanny State” public and private via mandate laws will go on till the end of the Westfalian (Sp) – Westphalian (mybad)states.

    It’s important for commerce and freedoms it gives, to win that contest.

    Wall Street, Main Street, Pennsylvania Avenue. Where economics and politics intersect.

  • Johnathan Pearce

    There has always been a hot cold or luke warm war between Capital and labor. In the U.S. a series of anti-trust laws and anti-restraint of trade laws have been erected to level the playing field to prevent the small from being crushed by the very large and very powerful. This has had a very positive effect on economics. To put capitol and time at risk requires some faith in the future outcome.

    I don’t have the time right now to debate this or the other largely incoherent posts of yours, Econ-Scott, but let’s just say that anyone who believes that anti-trust has much to do with laissez faire and protection of the entrepreneur is naive. The problem with anti-trust is that in most cases, it makes the mistake of assuming that a firm, just because it is big and has a lot of market share, is somehow therefore in possession of a priviledge, a monopoly, that must be removed.

    But that is wrong. Big firms that have competition-denying monopolies nearly always do so with active help from the state, in the form of tariffs, subsidies, or sneaky rules to shaft competion. Take away those state powers, and even the biggest of firms can succumb to nimble competitors. Just look at the rapid changes now affecting the computer or auto industries.

  • Econ-Scott

    but let’s just say that anyone who believes that anti-trust has much to do with laissez faire and protection of the entrepreneur is naive.

    Lest I am to believe you are really completely ignorant re: anti-trust and restraint of trade law in the U.S. perhaps I am misunderstanding your point.

    Related to this topic, “Freedom to Choose” in economics has to have some legal protections for innovationsof the small, e.g. copyright & Patent law, enforcable by the state, as well as “Pricefixing and collusion of competitors” attempting to kill off competition.

    While it doesn’t seem so , You post on an an economics blog so you do understand monopoly and vertically integrated industry .

    Not inherently bad untill it stifles innovation, reinvestment and kills off small innovators or small successful businesses with some competive advantage.

    Is it coincidental that the most productive companies in the world don’t engage in layoffs and are able to prosper and thrive in a roller coaster economy?
    Jason Jennings

    Examples of small competitve companies getting killed off by larger competitors under less than ethical circumstances are too numerous to list here. It’s bad economics bad ethics and throws good innovation out the window or worse allows it to be stolen by thugs.

    Perhaps stealing innovation is the way to go, the Russians have been subsisting off it for 5 decades.

  • Johnathan Pearce

    Examples of small competitve companies getting killed off by larger competitors under less than ethical circumstances are too numerous to list here. It’s bad economics bad ethics and throws good innovation out the window or worse allows it to be stolen by thugs.

    Spell out what you mean by “less than ethical circumstances”. If you mean fraud, theft, or intimidation by force, well we are in agreement. As for the issue about patents, that is a bit of a separate one here, although I am sympathetic for some form of legal IP.

    A large company can, I suppose, “kill off” potential challengers by constantly innovating, cutting its prices, etc. Although quite how this is bad for the consumer I am not sure.

    In any event, there are plenty of cases of where a large company with a supposed arm-lock on a sector has been knocked off its perch. Take an example like Reuters. This firm has been around for more than 150 yeas. About 20 years ago it totally dominated much of the information/price trading market. In the last 20 yrs, Bloomberg has gone from nothing to holding just under 50 pct of the market.

    There are other examples of successful challengers to established firms, but you get my drift.

  • Midwesterner

    Johnathan, excellent topic. But you may need to post follow-ups as there are so many contested sub-topics.

    Paul, there is a fundamental difference between inflicting damage on a consenting ‘victim’ verses inflicting damage on a non-consenting victim.

    To elaborate on nic’s point – for example, the employees of Union Carbide fall under their terms of employment but the victims of Bhopal that were not under any contract with U.C. have just claims to the full extent of their damages. If not U.C.s shareholders, then who is the just recipient of the full cost?

    On Gary North’s essay, in the US there is a tort liability practice called “deep pockets”. It is the absurd case when the parties found liable to varying degrees, and any of them has insufficient funds to cover their legal liability, the amount they fall short is taken from other lesser liability defendents who are determined by the court to have “deep pockets” meaning, enough resources to pay. The easy result of this is one party will be found 95% liable and another will be found 5% liable and the 95% liable party will be without assets so the 5% liable party pays almost the entire 100% of the damages awarded. This removes incentive for responsible behavoir and instead incentivises egregious conduct in legal defense like slandering the personal life of a victim in order to reduce the value of their life and hense the settlement. “Deep pockets” has made a farce of some of the supposed benefits of limited liability for smaller entities that cannot afford to take an offensive approach to their defense.

    Another concern that falls under this general topic is when a government undertakes services similar to private sector services, ie insurance, but absolves itself from liability. Example, government healthcare denies a treatment causing death of ‘insured’ verses private insurance doing the same thing and facing a law-suit. Government is granting itself limited liability in countless ways.

    Here is another case/question. Should I as a motor vehicle operator be granted limited liability for the consequences of any mistakes I may make and then let ‘society’ pick up the overage? Or should I be required to insure myself against reasonable consequences? Why should a limited liability be granted special privileges? The key point here is that limited liability transfers risk to involuntary recipients (bystanders or society) and insurance transfers risk voluntarily to people who chose to accept it. Limited liability is an insidious form of involuntary wealth redistribution.

    After a quick skim, I find most of Sean’s conclusions good, but probably intuitive. His foundations seem a little shakey. I’ll do some reading when I can to see if there is something stronger to base them on.

  • Midwesterner

    Sean, if you are reading. I mean no disrespect by anything I say. I not only enjoy your writing, lately I’ve take time to listen to some of your spoken words. Refreshing. I feel more optimistic just by hearing them from somewhere outside of my own mind. I think a lot of us here may share that sensation from time to time. Before the net and Samizdata and a very few others, I thought I was alone on the planet. Especially since the few objectivists I sought out were what is now called “Randroids” and didn’t seem capable of rational discourse.

    Your conclusions are sound but actually more cautiously phrased than they need to be. But a few concerns.

    You start by contemplating the question in terms of the existence or non-existence of the state. This is round about backwards. The existence and nature of the state should be conditioned on the needs of the individual. Therefore, the individuals’ need for or harm by an institution should be established first and then determination of whether it needs state enforcement or can be permitted by elective consent.

    Your Boots plc case is exactly the place to start. To exist as an individual, one needs to have life, liberty and property held securely. Anything that can partially or fully strip that from you without your fault or consent, is a violation of individual LLP and must not be permitted. Therefore, Boots plc must not be absolved of its responsibility to those it injures who have not voluntarily waived claim through contract.

    Thus, while a kind of limited liability might arise in contractual arrangements, it would not be recognised in tort.

    Yes. Exactly.

    Your comment about institutional shareholders “flattening” you is a base for another observation. If you as a small stockholder believe their conduct to be placing you at risk, then you must forfeit the benefit of their high return strategies in order to forfeit the risk as well. The owners must make the decisions and face the full reasonably possible consequences of those decisions. If they cannot, they must purchase risk sharing by whatever means are available. Insurance. Surety bonds against risk to the general public. (Those not covered by contracts.)

    The State is legitimate so far � and only so far � as it provides necessaries that will not be otherwise provided.

    Be very careful with this one. The state is never legitimate beyond the bounds of its contract with its constitutients. The state must have no identity beyond the terms of its charter. A state can boundlessly usurp every authority or be too constrained to even survive and in both cases be legitimate. Its sole grounds for legitimacy is honoring its contract with its members. To allow ithose who govern to rewrite the terms by any extra constitutional means can only be some form of totalitarian. Democratic totalitarian is most likely. Unchecked democracy will (and currently is) result in a steady collectivisation of society. Accompanied hand in glove by the ruling class you observe.

    I also challange anything done

    “on the grounds of its convenience”

    . This is inherently subjective and requires governments of men and not of laws. (Or more accurately, principles.)

    Could railways and motorways be built without a large corporation to mobilise the necessary capital, and to provide the necessary term of existence for the capital to provide a return?

    Wrong question. The correct question is “Are railways and motorways essential for individual existence?” You may reach the same action but the grounds are important. In this case it could strongly be argued “not essential for everyone” in which case it is obligatory on those that want them to make among themselves the necessary arrangements to construct them.

    Could these corporations raise capital without being able to sell shares to the public? Again, possibly not. Would anyone buy shares in such corporations if he knew he would have no immediate control over the use of his investment, but might be held personally responsible for its use?

    But in fact, the investor does have immediate control over the use of his investment. He can withdraw it through sale. It is necessary (and current practice) to guarantee share holders knowledge about their company’s business activities. This knowledge must be complete enough to allow the investors to make informed judgements about their own risk. Corporate officers who conceal information (Enron) have commited a crime against their shareholders and should be treated accordingly. I think the executives of Enron should have been sentenced the same as if they had broken into each home serially and stolen the amount they did. White collar crime is just criminals with good lawyers.

    It may then be convenient, if we want large infrastructure projects and large scale manufacturing, to cap the liability of shareholders to the value of their shares.

    I grant it may not be convenient. I am told that such ventures could by financed by the sale of bonds, in which case the providers of capital would be lenders with a liability naturally limited to the value of their bonds.

    Oh my. Be very careful here. No matter what the method of limiting liability, the risk has to go somewhere. And it must go to someone(s) willing and able to assume it. Mandatory liability insurance is philosophically sound for motorists. It is equally philosophically sound to require it of a company that intends to operate a heap leach metals mine.

    To those who claim that this requirement drives the price of the product above its true cost, I say “nuts!” Let the market decide its true cost. If it is that safe, insurance premiums will reflect that. If it isn’t, then you are in fact expecting non-participants to subsidize the project’s profit margin.

    Your discussion of the societal impact on the moral tenor of the community is interesting and accurate, but in itself is probably a distraction from the actual principles being violated.

    Or, turning to those patterns of immorality, look at the rapacity and corruption of oil companies and other large corporations in poor and barbarous regions of the world.

    This is a major problem. Mega corporations are easily capable of corrupting the governments of small (and many other) nations and then violating the rights of the citizens of those nations. This is one reason that I so strongly advocate against what I call asymmetrical trade. Trade between nations with substantially different regulatory environments. It destroys third world nations in order to underbid companies that do not redistribute their expenses onto the society in which they operate.

    …The British and American peoples …, have been turned by a century of corporatism into nations of sheep. … We are so corrupt as nations that our rulers are still heaping less misgovernment on our heads than most of us would be happy to accept.

    This is largely the effect of a corporatisation of economic activity that would have been impossible without limited liability laws.

    Quite likely true.

    But to summarize, the state is a possible solution to some problems, but never a benchmark to determine the need for something. All decisions regarding the need for something must come from whether they are compatible with the essential nature of individual life, liberty and property.

    Thanks. Also –

    I very much agree with your caution about how to bring things to a more sound practice. The example I use is

    It’s easy to stand on a cliff and point down at the road and say “That’s where we belong.” But only an idiot steps off of the cliff to get there.

  • Paul Marks

    As I (along with others have been pointed out) although there are specific limited liablity statutes, the idea of limited liabilty is not the “creation of government”.

    Whether it is burial clubs or whatever the idea is ancient. And if (say) the club did not have the money to fund all the grave stones it said it would fund, one could not sue the individual members (unless one could prove that they had made claims they knew were not true).

    The same is true of trading corporations (whether secular or religious) – one could sue the whole group (for the common assets), but not an individual (unless it could be shown that he was guilty of making claims he knew to be false).

    For example, the great religious orders were given land by some Kings – but they certainly were not “created by the state” and they had many lay employees (and there were also many organizations that were dominated by lay people – trading groups).

    Certainly the dream of many groups was to have a monopoly or other nasty thing granted by the government – but these groups were not normally CREATED by the government.

    As for corporation tax.

    Firstly this double taxation (as Milton Friedman pointed out so many times) – the income is taxed once as corporate income and then again when it goes to the owners of the corporation (the shareholders).

    Putting up corporation tax simply undermines the companies in a country and drives them to other countries.

    Of course both individual income tax and corporation tax should be as low as possible (at best zero – as they were, at the Federal level, in the United States before 1909) – there at least we can all agree, regardless of whether we think that corporation tax should be bit higher than income tax or not (I do not set out to have disputes with a certain person).

  • Paul Marks

    F.A. Hayek argued that working for a large organization did make people less “market minded”. They might come to think that their income and conditions of work were based upon the goodness or badness of the employer or even of the regulations the employer was subject to – rather than the customers. And this (for example) might effect the way they voted.

    Although, of course, a very large company does not have to be a corporation.

    When Henry Ford found that, although he owned a majority of shares, minority shareholders could still use the government courts to order him about (if Conrad Black had known the results of the Henry Ford court cases he might not have been so confidant of his own chances in court) he bought up every share (so that there was no one who could mess him about with the government courts concerning how he ran his company).

    So, whilst Henry Ford lived, Ford was not really a corporation at all (although this did not stop the government’s prounion laws forceing the U.A.W. on Ford eventually – although he did consider just closing the whole business down rather than giving in to them).

    This did not stop Ford being a very big business indeed (one of the biggest in the world).

    I forget if Ford ever actually got rid of limited liability – but I know that Henry Ford offered to make himself liable for everything (if, in return, he could get out from under all the regulations).

    Still (on the other hand) it was Henry Ford that had argued for government roads (when people like President Warren Harding were opposed to such Federal schemes) and Henry Ford was one of the people who argued for a government credit money bubble (and it was this that led to the bust of 1929 – which in turn helped lead to the Great Depression that brought the F.D.R. regime to power).

    So “he who lives by the sword, dies by the sword”. Henry Ford had called for some interventions – so he left himself open to others (such as the prounion laws that so undermine the Ford Motor Company today).

  • Midwesterner

    Some more comments, this time on some of Stephen Kinsella’s concerns.

    He expresses dissatisfaction with the legal case of “respondeat superior“, the practice that employers are held responsible for actions carried out by employees in the name of and/or using the resources of the employer.

    He states –

    I have always loved the idea that if the employee goes off on a “frolic” then there is no respondeat superior liability


    But consider: the basis for respondeat superior (and I bring this up b/c it seems to me something along the lines of this principle must be employed to hold the shareholder liable for acts of employees) has to do with the employer’s practical right or ability to control or direct the actions of the employee (this principle probably underlies the “frolic” exception too). Can we assume that this control is present when we move further back the chain of causation? Say, to the directors, who appoint the managers? Or to the shareholders, who elect the directors? And if practical control is one of the main relevant features that determines whether there is liability, again, why couldn’t lenders, employees, suppliers, customers, etc. at least potentially be held liable? In some cases they exert more control and give more “aid and comfort” or “aid and abet” in more visible and substantial ways than a mere shareholder.

    Well, not quite. Let’s go back and look at the chain of causation a little more closely. Yes, the employee must be held accountable for his actions. The question is, to whom? There is a (contractual) relationship between the employer and the customer and between the employer and the employee, but not between the employee and the customer. The employer is always responsible for the actions of the company, regardless of which particular employee acted on the company’s behalf. The employee is responsible to the employer to meet the terms of their employment. (And to obeying the law in his personal actions.)

    It is not possible in many or most cases for the employee of a large organization to understand the full consequences of their actions. Most employees of large organizations are specialists whose knowledge of the full effects of their actions is quite limited. Therefore, the company must be accountable for the consequences of employees acting in good faith and believing themselves to be within the law. If a scaffolding manufactorer ships product with a particular part missing, and some scaffolding fails, it is a matter between the employer and employee whether that employee acted according to their terms of employment when leaving out that obscure part. But the company is responsible for the product they ship. They are the one with a contract with the customer by delivering a product labeled for use as “scaffolding”.

    The deciding factor here is that actions taken by one party that are consequential to another must be consentual. It may be a drawn out chain of consent, but it still must be consentual. The employee is accountable to the customer through the intermediary of the employer/company, not directly (for actions taken in the name of and with the company’s direct support.) If the employee acts in knowing violation of his contract with the company/employer, then he is responsible to the company under the terms of his contract with them, and directly to the victim for actions taken outside of his contract with the company. But the company is still responsible to honor its contract with the customer. So it is not absolved. If the company has no contract with the ‘victim’ then the employee’s action amounts to impersonation of the company and anything outside of his employment contract is no different than a stranger impersonating the company re the ’employee’/company action. The company may have negligently facilitated the crime, that is a separate factor re the company/customer action.

    Lenders verses owners.

    This highlights that you still seem to draw some kind of bright line between the position of a lender and a shareholder. Something about this troubles me–it seems too artificial; too reliant on the state’s own positive legal distinctions. In my view, the general question is one of causation.


    I cannot say from my armchair that lenders necessarily are radically less responsible for the actions of company employees than are shareholders. It seems to me one needs to say this, however, in order to draw the bright line distinctions you do.

    Ownership has one distinct characteristic. Control. The fact that it is shared does not make it anyless fundamental. No decisions can be imposed on a company by any lender, employee, supplier or customer. These persons can only seek to impose their decision on the owner(s), who have the sole power to impose decisions on a company. The owners can always decline. On the other hand owners can compel the company for no other reason than they are the owners. Owners may deligate their decisions, but they are always made on the owners authority.

    If at any time, creditors assume command of a company, they are no longer acting as lenders, but have now assumed the power of ownership. They have, whether termporarily or permanently, converted their loan into ownership. It is a fore known risk of lending.

    On stockholder’s supposed impotence in the face of other larger blocks of stockholders –

    It is illusional to state that he “has no right to (directly) control the [company’s] assets“. Direct and fractional are not antithetical. He has fractional direct control. If he is on the losing side of a vote, he has the power to sell his stock. He is not, in fact, compelled to use his assets to carry out a choice he opposes. Since he profits if the act he dissapproves of succeeds, and he has the power to sell his share if he choses, he has retained all of the powers and benefits of ownership. He has total control over his assets (by selling the stock and spending the value elsewhere) or by retaining the value in place in the company

    If there are encumbrances on how he may get rid of the stock, then he consented to these voluntarily at the time he accepted ownership of the stock. That liability was part of an exchange for a perceived higher value.

    Stephen ends (or almost ends) his article with a key observation. Insurance.

    Insurance is the proper solution to the dilemma because it places risk on a willing recipient. It places a market value on the risk, for that is all insurance really is, is a risk market.

    In conclusion – the only winners of limited liability are those whose liability is displaced onto other involuntary recipients. The only losers of ending limited liability are those who have been profiting from not being fully accountable for the risks they take. Everybody else benefits from eliminating them because it returns to a natural state where risky and risk adverse behavior acts with direct consequences on the person making the choice. Can anybody say that S&Ls (in the US) would have behaved the same if they were not sheltered from the consequences of their choices?

    The correct name should be “Redistributed Liability Corporations”.

  • Midwesterner

    Gary North spends his entire article on consentual limited liability contracts (which I have absolutely no problem with), and then closes with this paragraph –

    There is an argument that rejects the corporation because third parties who have not entered into a contract with a corporation may be harmed in some way, such as by pollution. They assume that harmed individuals cannot sue the senior managers of a corportation beyond the corporation’s assets. But courts need not prohibut tort law compensation for the decision-makers. The economic issue is the protection of investors who were not decision-makers, as I have already written.

    I addressed the idea of impotent investors above. Their risk and reward options are of their own choosing. If they don’t like the risk and won’t buy insurance, then they should sell the stock. Those decision-makers are acting solely on the authority granted them by the owners. They are accountable to the owners. The owners are accountable to third parties.

  • Johnathan Pearce

    Johnathan, excellent topic. But you may need to post follow-ups as there are so many contested sub-topics.

    Midwesterner, thanks for your appreciation but I am not too sure where I stand on this, although I think Paul Marks pretty much has nailed where my views are leaning. I may return to the topic if I can clarify my views further.

  • Midwesterner


    Paul said –

    If one does not like this sort of thing one should only do business with nonlimited liability enterprises.

    From that and many other of his remarks in this thread, I don’t think he addressed when a company hides behind limited liability for its shareholders to get away with something that would be illegal for an indvidual without limited liability to do. Example: inflict injury on someone with which one has no contract.

    I think its clear that when someone’s rewards are diconnected from their risks (ie S&Ls) they alter their conduct in ways that create a lot more risk. After all, someone else pays the price. Risk is controlled when contracts are involved because if you take risks that your potential contractees will not accept, you have no contracts. The reward/punishment is still on the risk taker.

    Stockholders would never have permitted such a high consequence pattern of negligence by UC in India if they thought they could lose more than their stock and its profits.

    A textbook case is the Bhopal disaster. Interesting to note that UC claimed an employee did it deliberately, but yet never brought action of their own against the unnamed employee. The settlement UC reached with the government (acting collectively for the victims) was 470 million. While the Biased Broadcasting Company gives the death toll as ~3000 outright and 15,000 from related illnesses, it is clear that many thousands who were not under any assumption of risk contract with UC died and where severely injured.

    To my understanding, UC was able to avoid declaring bankruptcy and actually defaulting on damages. But it is also likely that those damages could have been substantially more in open litigation.

    I would like to know Paul’s thought specifically on limiting the liability of a company’s stockholders from damage to uncontracted parties through negligence. I’m pretty sure he has strong opinions on how people behave when the full consequences for their choices are transfered to others. I’m equally sure that he sees additional factors that I don’t. Paul?