Limited Liability

Limited Liability

A Legal and Economic Analysis

Stephen M. Bainbridge and M. Todd Henderson

The modern corporation has become central to our society. The key feature of the corporation that makes it such an attractive form of human collaboration is its limited liability. This book explores how, by allowing those who form the corporation to limit their downside risk and personal liability to only the amount they invest, there is the opportunity for more risks taken at a lower cost.

Chapter 3: Why does the law limit corporate shareholders' liability?

Stephen M. Bainbridge and M. Todd Henderson

Subjects: law - academic, corporate law and governance


Limited liability has obvious social costs. Owners of small businesses may deliberately undercapitalize their corporations, while siphoning all profits out of the business, leaving persons injured by corporate acts without recompense. At the other ends of the scale—in an era of mass tort class actions—even the largest corporations may be unable to pay off their creditors in the event of major disaster. Yet, in either case, limited liability prevents the claimants from satisfying their claims out of the personal assets of the company’s shareholders. As a result, a substantial amount of the risk created by corporate activities is externalized onto those who interact with the corporation and society at large. Why? What countervailing benefits does limited liability provide to justify its place in corporate law? In this chapter, we consider five answers that have been offered by both courts and scholars: (1) limited liability is an inevitable consequence of corporate personhood; (2) in complex organizations, responsibility and, thus, liability are too difficult to assign; (3) limited liability serves as an inducement for business to take risks; (4) limited liability is an expression of nineteenth-century populist political theory; and (5) if they could bargain ex ante, shareholders and creditors would agree to a regime of limited liability, making it the so-called majoritarian default. All of these rationales have some validity, yet all also have deficiencies and gaps. On balance, however, we find them collectively persuasive that limited liability produces net benefits for society. While claims based on survival of an organizational form are always somewhat suspect, we also point to the corporation’s survival as evidence of limited liability’s fitness for purpose. In almost every country, limited liability entities dominate the economy.

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