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 5.9% 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.
We contribute to the debate about the future of capital markets and corporate finance, which has ensued against the background of a significant boom in...