Working Paper: CEPR ID: DP17910
Authors: Guillaume Vuillemey
Abstract: Limited liability is a key feature of corporate law. Using data on asset prices and capital flows in mid-19th century England, I argue that its liberalization was not decided to relax firms' financing constraints, but to satisfy investors' demand for "safe" stores of value. Limited liability eliminated adverse selection about the quality of other shareholders; stocks could be held to store wealth in diversified portfolios, without extended forms of responsibility. Prices of newly issued stocks are consistent with this hypothesis. Thus, the quest for "safe" stores of value explains not only features of debt markets, but also of equity markets.
Keywords: limited liability; safe assets; corporate social responsibility; law and economics
JEL Codes: G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Liberalization of limited liability (K29) | Demand for safe stores of value from investors (E41) |
| Demand for safe stores of value from investors (E41) | Elimination of adverse selection regarding quality of shareholders (G34) |
| Decrease in supply of government bonds (E43) | Increase in demand for limited liability stocks (G19) |
| Increase in demand for limited liability stocks (G19) | Higher stock prices (G19) |
| Scarcity of safe assets (G19) | Willingness to pay more for remaining safe assets (G19) |
| Limited liability stocks (G33) | Perceived as safe assets (G19) |
| Insufficient domestic safe assets (F65) | Investors turn to foreign securities (G15) |
| Newly issued stocks post-liberalization (G24) | Perform worse than those issued prior (L15) |
| Unmet safety demand (J28) | Pool of limited liability firms of significantly lower quality (G33) |