The valuable instrument of limited liability

Trouw

In the 1940s, the Married Women's Property Acts came into effect. These laws ensured that if the husband could not repay his debts, the family would not also lose the wife's property. With the introduction of those laws, a form of limited liability was introduced. Peter Koudijs, Professor of Finance and History at Erasmus School of Economics, studies the phenomenon of limited liability and its effects.

The greatest invention of mankind

'Limited liability has been called the greatest invention of mankind,' says Koudijs in an interview with Trouw. 'It is a foundation. We have built our economy on it. An entrepreneur who borrows money to invest does not always have to pay it back if things go wrong. A shareholder can lose the value of his shares, but doesn't have to pay for the company's debts.'

You come across limited liability everywhere, but its effects are still difficult to research, Koudijs explains. This is because the phenomenon is now so widespread. An academic economist may then choose to set up an experiment. In this case, that would be a kind of investment game with entrepreneurs and bankers in their different roles. 'But that wouldn't work,' says Koudijs. ‘It requires a lot of knowledge from the players. With a club of students you will not be able to approach reality in such a game. Not even with economics students.'

A wonderful experiment 

According to Koudijs, the Married Women's Property Acts was actually a wonderful experiment for investigating the effects of limited liability. At the time, business meant investing in a cotton plantation and buying slaves. This was not without risk and you needed credit to start a cotton plantation. 'The introduction of limited liability made that easier,' says Koudijs. The reality, however, turned out to be more complicated. 'The positive side: if things go wrong with the business, the family has the wife's property to fall back on. This allows the entrepreneur to take more risks, because the creditor cannot claim his wife's property. The lender knows this too. He will become more cautious, because he bears part of the risk. That's the negative side.’

The results of the study also reflected this: 'In marriages between a rich man and a woman who contributed practically nothing, the introduction of the new legislation had no effect at all on investment behavior. Nor in marriages in which both partners contributed an equal amount of property. But if a poor man had married a rich woman, there was an effect. Those couples could get less credit now that most of the property was protected. In marriages where the man brought in about 70% of the property and the woman about 30, there was an opposite effect: those couples could invest more in cotton plantations and slaves, because part of their entrepreneurial risk had been shifted to the lender.'

Private liability 

So what is the significance of this research nowadays? In the US, limited liability applies not only to entrepreneurs but also to individuals. In the Netherlands, however, we do not have this type of limited liability for individuals. You could ask yourself whether it wouldn't be better for the Dutch economy if private liability were also limited here,' Koudijs says. ‘That would stimulate the economy because it makes investing and doing business less risky.’

Professor
More information

The full article from Trouw, 6 February 2021, can be downloaded above (in Dutch).