Law and Economics Classics - Unlimited Liability for Torts
At Grove City College, I teach Law and Economics--a course that explicitly examines how "people expand their options by cooperating." It therefore lies at the heart of "mere economics." In this sermon series, I'll be posting a summary of classic L&E papers over the coming weeks.
Hansmann, Henry, and Reinier Kraakman. "Toward unlimited shareholder liability for corporate torts." Yale Law Journal 100 (1990): 1879-1934.
The authors argue normatively in this piece. Limited liability for torts creates incentives to excessive risk-taking since a corporation does not bear the full costs of its actions. The existing literature provides no comparison of limited and unlimited liability for torts. The case for unlimited liability for torts is increasingly especially relevant in a world where firms are imposing larger and larger risks (like carcinogens and environmental disasters).
At the same time, Hansmann and Kraakman do acknowledge several arguments for limited liability in torts. First, shareholders might attempt to hide assets in order to evade liability. Second, it would it not be easy to implement unlimited liability in one jurisdiction when limited liability governed a neighboring jurisdiction. Third, limited liability might serve as a necessary check on the expansionist tendencies of the courts in deploying liability rules. But they conclude that these deficiencies in limited liability for torts are not a reason to oppose it.
The article systematically explores the case for retaining a rule of limited shareholder liability by comparing it with pro rata shareholder liability for torts. They argue that there’s no reason unlimited liability would discourage investment except for in those firms that impose a net loss in society—which is where we’d want to discourage investment. They believe that unlimited liability would, in fact, depress share prices, but that this price would better reflect the full cost of corporate activities.
The great Ludwig von Mises made a similar argument in his magisterial Human Action:
- The laws concerning liability and indemnification for damages caused were and still are in some respects deficient. By and large the principle is accepted that everybody is liable to damages which his actions have inflicted upon other people. But there were loopholes left which the legislators were slow to fill. In some cases this tardiness was intentional because the imperfections agreed with the plans of the authorities. When in the past in many countries the owners of factories and railroads were not held liable for the damages which the conduct of their enterprises inflicted on the property and health of neighbors, patrons, employees, and other people through smoke, soot, noise, water pollution, and accidents caused by defective or inappropriate equipment, the idea was that one should not undermine the progress of industrialization and the development of transportation facilities. The same doctrines which prompted and srilI are prompting many governments to encourage investment in factories and railroads through subsidies, tax exemption, tariffs, and cheap credit were at work in the emergence of a legal state of affairs in which the liability of such enterprises was either formally or practically abated.