I wonder if there’s a workable tweak to the limited liability of shareholders that would make it less profitable for those who wish to indirectly indicate to their flunkie ceos that they better cut corners on safety and quality or else get fired? I’m guessing this has been extensively discussed by legal thinkers, what are their conclusions/recommendations?

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  • In what country? Maybe I'm not understanding this right, but you are wanting shareholders to require the CEO to cut corners on safety and quality or be fired? Is the CEO also a shareholder (doesn't have to be)? – Ron Beyer Oct 14 '18 at 13:48
  • I'm voting to close this question as off-topic because It is about politics. – TTE Oct 14 '18 at 19:25
  • Ron, no I mean the opposite. Often short term profits can be increased by neglect of safety and quality, leading to short term increases in stock prices. Since shareholders enjoy limited liability, they can enhance the value of their stock by signaling indirectly to corporate manage that they want costcutting even when the costs are necessary to maintain safety. A similar thing can happen with pharmaceutical corporations, but with false marketing of unsafe drugs to increase profits, enhancing stock price.TTE:I’m sure professors at big law schools have studied this, so it’s not politics. – Richard Peterson Oct 15 '18 at 6:54

I wonder if there’s a workable tweak to the limited liability of shareholders that would make it less profitable for those who wish to indirectly indicate to their flunkie ceos that they better cut corners on safety and quality or else get fired? I’m guessing this has been extensively discussed by legal thinkers, what are their conclusions/recommendations?

Director and Officer Liability

There are circumstances in which officers of a company who participate in wrongdoing by the company can be held liable for their personal participation in tortious acts and certain statutory violations (like failure to withhold taxes from payroll, or a false statement in a securities disclosure or on a tax return of a publicly held company that the CEO is required to sign off upon by law), even when a shareholder or other passive investor would not be held liable.

For example, if the CEO personally supervised workers dumping toxic wastes into a stream or directed them to do so, this might justify imposing environmental liability on the CEO as well the limited liability entity for which he was the CEO, but it would not be a basis for "piercing the corporate veil" to impose liability on a passive shareholder who had no involvement in that decision.

Similarly, if a CEO signed a public offering statement in connection with a first sale of stock to the general public, not disclosing threatened product liability suits of which he was aware, or if the CEO signed those public offering statements without doing any due diligence to determine if there were threatened lawsuits or not, the CEO could have securities fraud liability to shareholders who overpaid for their shares as a result of this undisclosed risk in addition to the issuing company.

In a closely held company, this can be a meaningful additional remedy. In a large publicly held company, the officers may have so little personal wealth relative to the assets of the company, that contributions from officers are meaningless.

For example, if the CEO has a net worth of $5,000,000 and the company has a market valuation of $5,000,000,000, any liability on the part of the CEO does almost nothing to better compensate people harmed by a $1,000,000,000 liability like a major oil spill. But, if the same CEO is personally involved in an activity that does $3,000,000 of harm in a company with a $1,000,000 market value that has $1,000,000 policy limits on its insurance policy, like a toxic gas emission that kills several people, the impact of officer liability is much greater.

Other Alternatives

Pro Rata Liability

Intermediate options between joint and several liability (in which one owner's shortfall in making up a deficit situation in the partnership can be satisfied from another owner's assets), which applies to general partnerships, and limited liability, which applies to corporations and limited liability companies (in which there is no passive owner liability), such as pro-rata liability (in which owners are liable for their percentage of any deficit of the venture's assets but not for another owner's shortfall) is used mostly ex ante in Lloyds of London insurance policies.

The problem is that passive dumb money equity investors are generally no more blameworthy than passive dumb money bond investors. Both are victims of either bad luck or bad management, and so imposing liability in excess of their investment on these investors is problematic, and similar in a moral sense to imposing excess liability on an insurance company that immediately tenders its policy limits in settlement or partial settlement of a claim, when it didn't bargain to pay and more than that.

Criminal Liability For Officers, Directors and Employees

Another option is to impose criminal liability or punitive damage liability on officers, directors and employees involved in the decision-making, but this too can be problematic. In the governmental context, judges and juries are loath to impose this kind of liability on employees who were trying to do their government jobs and harmed others in the process due to their improper conduct. And, imposing criminal liability for mere negligence that does not cause death on employees and agents of a company is contrary to long traditions of culpability.

Private attorneys seek compensation for the clients rather than seeking to set incentives to discourage future misconduct, and government attorneys often see cases where substantial corporate assets are available as a lower priority for use of scarce governmental resources.

Mandatory Insurance By An Insurer With Regulatory Authority

Mandatory insurance, accompanied by an ability of an insurer to mandate detailed types of conduct by the insured, the most famous example of which is the Federal Deposit Insurance Corporation (FDIC) can work very well to prevent corporate misconduct by a regulator with skin in the game. Variations on this solution, which makes extra-corporate assets available to people who are harmed are probably underutilized.

The Superfund law (CERCLA) accompanied by other environmental laws regulating toxic waste management (combined) also follow this basic model, but without an explicit mandatory environmental insurance component.

The problem with pinning liability on additional persons beyond a corporation is that this makes proof of liability much harder. Proving that someone affiliated with a company somehow wrongfully harmed an individual is much easier than providing that someone inside a company did something specific wrong that harmed someone.

Incentives Regarding Key Employee Compensation

One of the basic problems of the economics of the firm is the agency problem, which is that management priorities are not necessarily aligned with the interests of the owners of the firm.

This can lead to a "heads I win, tails you lose" situation. If the business is profitable, management will usually be rewarded, but if the business loses value, owners pay the price.

One reform that was designed to align management incentives with those of shareholders, stock option compensation, which is heavily favored in existing U.S. tax law, actually makes this "heads I win, tails you lose" situation even worse, encouraging excessive risk taking by management in firms that adopt highly tax favored stock option compensation. This is because in a stock option, it has value if the firm's value increases, but the only consequence if a firm's value falls is to render the option worthless.

An alternative to stock option compensation would be to insist that key employees own shares in a company that are a significant share of the employee's wealth. Then, the key employees would lose significant personal wealth if actions are taken that harm the company (including violations of the law), while profiting (on a less leveraged and more proportionate basis) if the company's value increases.

The main problems with key employee stock ownership, however, are that many key employees don't have significant resources to buy meaningful numbers of shares in the companies that they manage, that key employees want to diversify risk that is already concentrated by having the company has their main source of income, and that stock ownership by key employees opens the door to insider trading type risks by those key employees in advance of good or bad news that is not yet publicly known about the company. Various securities regulations partially address the last point, and there is some empirical evidence to show that diversification is less of a problem than economic theory might suggest. But, inability to afford significant stock is still a problem for many key employees.

  • 1
    This answer might benefit from a few examples. – agc Oct 15 '18 at 16:49

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