Managing Risk in Corporate Groups: Limited Liability, Asset Partitioning, and Risk Compartmentalization

Abstract

Limited liability enables parent companies within a corporate group to avoid financial responsibility for their subsidiaries. Under certain circumstances, however, courts can disregard the separate legal personality of a firm, ``pierce the corporate veil'', and impose the debts of a subsidiary on its parent. Legal scholars refer to this exception to the general principle of limited liability as ``enterprise liability''. We argue that, in countries where enterprise liability is weak, groups can better compartmentalize their risks by incorporating a greater fraction of their units as legally independent subsidiaries. Weaker enterprise liability may also encourage headquarters to their grant subsidiaries more decision-making autonomy and may induce groups to take on more risks, invest more, and grow faster. Using data from sixteen countries in the Americas, Asia, and Europe, we provide evidence in support of these predictions. This paper highlights two channels---risk compartmentalization and subsidiary autonomy---through which limited liability laws affect organizational and economic outcomes.