Finance

Business

Organic chemistry

Investment (military)

Compensation (psychology)

Hazard

Politics

Epistemology

Psychoanalysis

Subsidiary

Philosophy

Empirical evidence

Political science

Psychology

Multinational corporation

Economics

Microeconomics

Chemistry

Liability

Moral hazard

Production (economics)

Incentive

Insolvency

The Journal of Finance

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‐in‐differences 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.

The Limits of Limited Liability: Evidence from Industrial Pollution