Economic Organization #5

The classic capitalist firm could be either a sole-proprietorship or a corporation with one person having dominant control and owning 100% of the stock. In economic analysis there is little or no difference.

Most business partnerships are sort of in between the classic capitalist firm and the publicly-traded corporation. The partners share both control and ownership. It need not be on an equal basis but it is preset. Call this a general partnership, and the partners general partners, to distinguish it from the following.

Some partnerships have both general partners and limited partners. A limited partnership is similar to a general partnership, except that where a general partnership has two or more general partners, a limited partnership has at least one general partner and at least one limited partner.

The general partners are much like partners in a conventional/general partnership. They have management control, share the right to use partnership property, share the profits of the firm in preset proportions, and have joint and several liability for any debts of the partnership. They have authority, as agents of the firm, to bind the partnership in contracts with third parties in the ordinary course of the partnership's business.

Like shareholders in a corporation, the limited partners have limited liability. They have no management authority, and (unless they obligate themselves by a separate contract such as a guaranty) are not liable for the debts of the partnership. The limited partnership provides the limited partners a return on their investment (similar to a dividend), the nature and extent of which is usually defined in the partnership agreement. General partners thus bear more economic risk than do limited partners, and in cases of financial loss, the general partners may become personally liable.

Although a corporate shareholder's liability for the company's actions is limited, some shareholders may still be liable for their own acts. For example, persons who are directors and major shareholders of small companies are often required to give personal guarantees of the company's debts to those lending to the company. They will become liable for those debts in the event that the company cannot pay, although the other shareholders will not be so liable. This is known as co-signing. The same goes for general partners and sole-proprietors.

The idea of limited liability is widely accepted and generally acknowledged but some people are critical of it on moral grounds. They ask why shouldn’t somebody be able to sue a firm for damages and those with limited liability be subject to pay damages from assets not invested with said firm? In other words, responsibility should not be limited like that. Limited liability is far more criticized than defended. One rare defense of it is in Robert Hessen’s Defense of the Corporation. Hessen argues that unlimited liability should only apply to those shareholders who play an active role in managing an enterprise or in selecting and supervising its employees and agents. The tort liability of inactive shareholders, likewise limited partners, should be limited to the amount invested because they do not participate in management and control. In other words, responsibility is aligned with control.

I believe that without limited liability, the benefits of large-scale economic cooperation would be greatly limited. Also, pursuit of unlimited liability when there are many, many shareholders (changing more frequent than daily for large publicly-traded companies) would likely entail prohibitive discovery costs. The extra discovery cost might easily exceed the additional collections, resulting in a net loss to the litigants compared to limited liability.