The Limits of Limited Liability: Evidence from Industrial Pollution

Abstract

We study how parent liability for subsidiaries' environmental cleanup costs affects industrial pollution and production. Our empirical setting exploits a Supreme Court decision that strengthened parent limited liability protection for some subsidiaries. Using a difference-indifferences framework, we find that stronger liability protection for parents leads to a 5% to 9% increase in toxic emissions by subsidiaries. Evidence suggests the increase in pollution is driven by lower investment in abatement technologies rather than increased production. Cross-sectional tests suggest convexities associated with insolvency and executive compensation drive heterogeneous effects. Overall, our findings highlight the moral hazard problem associated with limited liability. * Pat Akey is at University of Toronto. Ian Appel is at Boston College. We thank Amit Seru (the Editor), an anonymous Associate Editor, and two anonymous referees for valuable comments that improved the paper. We also thank Vineet Bhagwat; Thomas Bourveau; Naveen Daniel; Slava Fos; Erik Gilje; Denis Gromb;

Real effects of climate policy: Financial constraints and spillovers

“…Kim and Xu (2020) show that financial constraints exacerbate toxic pollution by firms due to the costs of waste management, and that this effect is stronger when regulatory monitoring is weak. In a similar vein, Akey and Appel (2021) find that firm subsidiaries are more likely to increase toxic emissions when parent companies have better liability protection for their subsidiaries' environmental clean-up costs, consistent with the binding effects of higher financial burdens associated with abatement. Complementing these studies, our paper highlights the reallocative effects of financial constraints that induce firms to internally shift their pollutive resources across plants under heightened regulatory costs, which in turn distort the outcome of regional environmental policies.…”

“…Specifically, we employ a difference- 1 The economic consequences of climate change have recently garnered much interest among financial economists. See, among others, Addoum, Ng, and Ortiz-Bobea (2020), Akey and Appel (2021), Bernstein, Gustafson, and Lewis (2019), Engle, Giglio, Kelly, Lee, and Stroebel (2020), Forster and Shive (2020), Krueger, Sautner, and Starks (2020), and Painter (2020).…”

Finance and Carbon Emissions

“…A substantial body of empirical evidence has by now established that growing …nancial systems contribute to economic growth in a causal sense. 4 While earlier …ndings suggest that the structure of the …nancial system-bank-based or market-based-matters little for economic growth (Beck and Levine, 2002), more recent research quali…es this …nding by showing that the impact of banking on growth declines (and the impact of securities markets on growth increases) as national income rises (Demirgüç-Kunt, Feyen and Levine, 2013; Gambacorta, Yang and Tsatsaronis, 2014). Our contribution is to show that the structure of the …nancial system also matters for the degree of environmental degradation that accompanies the process of economic development.…”

Regulating Sustainable Finance in the Dark

“…Cf. on limited liability in the context of environmental laws,Akey and Appel (2021). But the argument against quack legislation aired herein is all the truer for tampering with basic governance features.…”