Monitoring for latent liabilities: When is it necessary and who should do it?

Abstract

The problem of intentional environmental harms is discussed as the combined consequence of limited liability laws and specific capital structures. When the conditions are “right”, then the option of planned liquidation is optimal for certain types of firms. These firms are typified by capital structures that make it easy for them to engage in “hit and run” strategies on their industries, i.e. they operate with the intention of early exit. When this is the case it can be demonstrated that mandatory insurance forms of institutions are inadequate to the regulation of this particular problem. It is necessary to engage some manner of continuous monitoring institution, capable of observing and identifying when the capital structure of the firm begins to resemble those that would choose to engage in strategic liquidation. The paper concludes by stating that it might be possible to introduce private sector (bonding) institutions that perform this function, but it is more likely that a combination of public and private sector institutions will be able to best undertake the combined monitoring/insurance role that this requires. In short, the paper recommends that the public sector should have the obligation to monitor/audit all limited liability institutions for the existence of the pre-conditions for “looting” behaviour, and then to charge these firms for limited liability in order to cover the costs of the monitoring. In this way the costs of incorporation would be raised sufficiently to render the worst forms of looting unlikely from the outset.

Citation

Swanson, T. and Mason, R. (2002), "Monitoring for latent liabilities: When is it necessary and who should do it?", Swanson, T. (Ed.) An Introduction to the Law and Economics of Environmental Policy: Issues in Institutional Design (Research in Law and Economics, Vol. 20), Emerald Group Publishing Limited, Leeds, pp. 387-411. https://doi.org/10.1016/S0193-5895(02)20019-6