Recent discussions about bailouts and regulations have got me thinking.
Corporations enable capitalism. The main feature is limited liability, which limits owner’s losses to their original investment and employee’s to losing their jobs. In other words, if a corporation has obligations it can’t fulfill, the owners (stockholders) and employees aren’t on the hook. This feature lets investors risk capital without worrying about losing their homes.
Moreover, this liability limitation is unbounded — if a corporation racks up $1 or $100 trillion of obligations, a bankruptcy cleans it up and everyone walks away. Unfortunately, as we’re learning, US and world economy does not have an infinite capacity to absorb losses. When corporations amass obligations so large and far-reaching (e.g. AIG, LTCM, etc.), we can’t (collectively) afford to let them fail.
Now, we’re debating regulations to prevent this from happening again. Regulation has a number of problems, including the ability of free markets finding a way to route around, inventing ever complex financial structures, and making money in unregulated ways. Regulation may prevent this crisis from happening again, but won’t prevent the next one.
There is an entirely different way to address this, by targeting the root problem. What if some personal liability phased in for cases of huge, “off the charts” liability? In other words, if your corporation amasses obligations so large that bankruptcy would materially affect the US economy, you might not be able to keep your houses and bonuses.
I guarantee that a threat of the smallest personal liability will cause a whole lot of self-regulation. The art would be to do it in a way that it only applies to the extreme 0.01% of cases, and untended consequences (e.g. the problems with Sarbox) are minimized. It may be possible to make this work.
It’s a slightly crazy idea, but not entirely crazy.
One of the popular stories of the “great depression” is that individuals borrowed lots, invested in the market, and lost it all… then they couldn’t cover their liabilities.
Now, with corporations as a stand-in for individuals, we see the same thing: 35:1 leverage, and so on.
Have you read “Looting” by Akerlof and Romer? I think you are on to something, but something is missing… The problem isn’t risk, it’s guaranteed gains.
Sorry, this is just an asinine suggestion. You think it’s hard to raise capital now? Try telling investors that now their personal assets will be subject to seizure if your company goes under. Same thing in the stock market…if the system you’re describing was implemented, why would anyone invest in the stock market ever again? We’d immediately see every investor pull their money out and never return.
The courts are allowed to pierce the veil of corporatehood in places where the corporate veil is being used to defraud. And in this case it has been used in this way. There is no new rules that need to be passed to do so, there is in fact a lot of case law about this precise point.
However, there would have to be a desire politically to go after the fraudsters, instead of continuing to play the game that the fraudsters have set up.
Who would you hold liable? Stockholders are rarely individuals and more often companies, so that will just move the problem. Do you want to hold all employees liable, then?
@Ryan: I think we need some out of the box thinking. I’m not saying it’s a perfect (or even workable) idea, but it’s a vector worth exploring because it gets to the root of the problem.
If it cuts of investment, maybe we look at other entities — like officers, directors, and highly compensated employees. Officers and directors are already personally liable for items in limited scenarios (e.g. payroll, taxes, etc.)
Also, the cap where liability limitation is limited has to be huge (like $1 trillion, or something tied to GDP). 99.99 of companies would be nowhere close.
Caveat this is a minefield, but I think this is very worthy place for discussion.
Mechanisms for this kind of further liability/responsibility exist. That’s why corporations (or at least ones with brains) always keep in place serious Directors & Officers (D&O), and also Errors and Ommissions (E&O), insurance coverage
Mybe the answer isn’t that key managers and officers and fiduciaries don’t personal liability that extends outside their interaction with the corporation, but DOES pull in (and maybe clawback) all of said interaction, e.g. their ownership and compensation
Imagine if Directors compensation was only payable several years after it was awarded, and its was performance based with metrics looking at the balance sheet and EBITDA — NOT share price. Ditto CEOs and officers etc…
Waggoner: Well-funded companies failed so hard they broke the entire economy; so obviously too few companies getting funded isn’t the problem–too many of the wrong companies getting funded is. If you’re talking about startups, venture capitalists are an entirely different class of investor; and no 37Signals, Twitter, or Facebook is going to pose risk to the US economy like AIG or General Motors.