Economic Analysis of Limited Liability of Shareholders under Ethiopian Company Law (original) (raw)

2021, Social Science Research Network

Without exaggeration, a company with limited liability protection is the greatest invention ever to make an unlimited profit with limited liability or without risk to personal assets of shareholders. As per this doctrine of limited liability, the shareholders are liable for the company's debts only to the limit of their investment in the company. This triggers the issue of its economic efficiency. In this article, the researcher has theoretically examined the economic efficiency of companies with limited liability from different stakeholders' perspectives. The analysis of productivity, bargaining theory, transaction costs, agency costs, social costs, and enforcement costs revealed that in the case of Share Company, generally, the benefits of limited liability outweigh its costs. Hence, limited liability is an efficient rule that needs to be maintained. However, to reduce costs and thereby ensure its overall efficiency mandatory insurance, the unlimited liability of a director, veil piercing doctrine, minimum capital requirement, and legal reserve should be made functional based on economically sound principles. Concerning tort creditors, unlimited liability is an economically efficient rule. Hence, unlimited liability should be introduced concerning the claim of tort creditor. Alternately, the author argues for the introduction of mandatory insurance coverage to reduce uncompensated risk transfer to tort creditors. With respect to a private limited company, the difference between limited and unlimited liability on its productivity and transaction cost is minimal. Thus, the unlimited liability rule is recommended for private or closely held companies to minimize the social cost of limited liability.