The Riddle of the Limited Liability Corporation

Cover The Riddle of the Limited Liability Corporation
The Riddle of the Limited Liability Corporation
John E Parsons
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Because of the limited liability character of the corporation the equity owners cannot be required to make up the difference. The creditors do not share in the upside risk of the firm but do share in a portion of the downside risk Absent the debt obligations the shareholders would bear the full risk of the firm's operations. When, however, the firm has large debt obligations outstanding, a portion of the downside risk assumed by the firm is borne by the creditors. Since the shareholders do not ...fully bear the additional risk that will follow from the choice of a particular investment strategy, they may find it in their interest to choose this riskier strategy although the additional return to the firm as a whole is not sufficient to warrant the additional risk.
The second category of conflicts arises for similar reasons. Any new projects that the firm assumes will necessarily change the risk and return characteristics of the firm's entire portfolio of projects. A new project These cases are presented in most modern corporate finance textbooks: see for example, Brealey and Myers (1988, pp.


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