Limited Liability – Good or Bad for Society? (Part 1)

IB Business & Management.

I.B. Business syllabus links – 1.2 – Types of organisation (plc´s), 1.2 – Limited Liability, 1.4 – Stakeholders, 1.3 – Profit maximization, 1.3 – Business ethics, 1.3 – business strategy, 1.6 – Growth & evolution

On the IB Business course we learn that businesses maximizing their profits is generally a good thing, that the concepts of limited liability and company legal structures such as the public limited company (plc)  are positive, useful things for society, and that a good business manager should consider the long term interests of all the stakeholders in the business. However, is the concept of limited liability really good for society, are plc’s and the way they are run nowadays positive for society, and do business managers really take into consideration the long term interests of all the stakeholders in the business?

Some business analysts think not. Ha-Joon Chang, in his popular book ” 23 Things They Don’t Tell You About Capitalism*”, argues that these things have in many ways been bad for society, that the way plc’s have been run over the last few decades has generated more social harm than good and that, in reality, the interests of just two groups of stakeholders – company shareholders and senior executives – have taken precedence above all others.

When capitalism and business as we know it now was in it’s infancy, owning and running a business was much more risky than it is today. If your business went bankrupt and you ended up owing lots of money to creditors you could have lost all of your personal possessions and have been thrown into a debtors prison. Nowadays we have this concept of limited liability whereby you only lose the original amount of money you invested in the business and your personal possessions are protected.

What a lot of people don’t realize, however, is just how controversial the joint stock company (the limited liability company as we now know it) was when it was first invented. Adam Smith, one of the founding fathers of economics and modern capitalism disapproved saying ” The directors of [joint stock companies] … being the managers rather of other people’s money than their own, it cannot well be expected that they would watch over it with the same anxious vigilance with which the partners in a private copartnery [ i.e. partnership with unlimited liability] frequently watch over their own. “ (P 13, Chang book). His disapproval of limited liability reflected the current wisdom of the time; people felt that managers of limited liability companies would take greater risks because they were managing companies funded in most part by other people’s money rather than their own. Indeed, when the joint stock company was first invented, only very speculative, risky ventures in the national interest took the form of joint stock companies, such as the Dutch East India Company set up by Holland in 1602.

As countries industrialized, however, and there was more and more of a need for investments in large, expensive investment projects such as railways, steel and chemical plants, limited liability companies became more and more popular.  Indeed, this is the main argument for the social usefulness of plc´s as institutional structures – they enable finance to be raised for big, risky investment projects which otherwise would probably not be funded.  Nowadays, they are taken for granted as being essential to the modern business world.

* = This is an excellent book which all IB Business and IB Economics students should read. See image below. I will be using it quite a lot in the next few posts I make. You can buy it on Amazon by clicking the link above.

Ha-Joon Chang´s book cover.
Ha-Joon Chang´s book cover.

Part 2 of this post will follow soon.