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Potential corporate misconduct is in the news. Did downed power lines cause the wildfires in Hawaii and California? What more should the power companies have done to avoid wildfires? Did Purdue Pharma and the Sackler family push Oxycontin to increase their profits? Did they knowingly misrepresent how addictive their painkillers can be, potentially causing hundreds of thousands of people to become addicted?
These stories remind us that modern corporations, where shareholders are granted limited liability, reflect a classic legal and economic trade-off. Limiting investors’ liability to the cash they invest in the corporation makes people more willing to invest. In the early 1600s, the East India Co. was created because the expense to fit out ships for trade between England and the East Indies was too great to be easily borne by individual merchants.
On the other hand, mitigating such risk creates a moral-hazard problem. People are less careful when exposed to less liability. Power companies probably would be more cautious about fire risk if shareholders faced greater liability. They might have buried more power lines, installed ground-fault interrupters, and monitored dry vegetation and wind speeds, stopping power to areas with higher fire risk. Avoiding fire risk increases the costs of providing power to rural areas. Would state regulators allow power companies to pass on the higher costs through higher rates? Would power companies segment their companies so smaller, less capitalized companies provide power services to rural areas?
Most states sued Purdue Pharma, saying the company knew the painkiller oxycontin was being diverted and was fueling the opioid epidemic. Would the leaders of Purdue Pharma have been more careful if their shareholders faced greater liability for selling addictive products? Much of the increase in prescriptions was also caused by a group of doctors, with support from the pharma companies, who argued that many physicians were not doing enough to treat many people’s pain and suffering. Some doctors noted that, though some people’s pain probably was being undertreated, this push led to overtreatment and many additional addictions.
We think there will always be a trade-off because limiting liability motivates people to both cooperate more and be less careful. More government regulation might help, or it can make things worse. The English government created the East India Co. to provide public benefits. The company also had monopoly trading rights, one cause of the 1773 Boston Tea Party and the American Revolution.•
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Bohanon and Horowitz are professors of economics at Ball State University. Send comments to ibjedit@ibj.com.
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