Limited Liability: One of Man's Greatest Inventions?

Limited liability:

Type of investment in which a partner or investor cannot lose more than the amount invested. Thus, the investor or partner is not personally responsible for the debts and obligations of the company in the event that these are not fulfilled.

Limited liability may not be at the top of your list for one of mankind's greatest inventions, but maybe it should be:

“The economic historian of the future may assign to the nameless inventor of the principle of limited liability, as applied to trading corporations, a place of honour with Watt and Stephenson, and other pioneers of the Industrial Revolution. The genius of these men produced the means by which man’s command of natural resources has multiplied many times over; the limited liability company the means by which huge aggregations of capital required to give effect to their discoveries were collected, organized and efficiently administered.” – The Economist, Dec. 18, 1926

Some of the benefits of limited liability include:

1. Reducing the need to monitor the management of firms,
2. Reducing the need to monitor other shareholders. (You are not liable for more than you invest and therefore aren't on the hook for corporate debts if other shareholders have fewer financial resources than you do.)
3. Because all investors share equal risk, shares of common stock are fungible.
4. Facilitates diversification (without limited liability, investors would likely minimize their financial exposure by only investing in one company.)
5. Enlists creditors to help monitor managers of firms (because creditors bear some of the downside financial risk of a company's performance).
   

Without this innovation in organization of financial capital, modern forms of business organization are unlikely to have ever developed. Without this, industries would be limited in size and scope, technological innovation and economic development would be far behind what it is today, large-scale projects would have been difficult at best to organize in the private sector, and advanced market economies would likely not exist as we know them today.

Timur Kuran argues that the lack of development of laws, which allow the formation of corporations and the accumulation of large sums of capital that outlive the life of one individual, plays a large role in the under-development of much of the Islamic world. Without implementation of ideas such as limited liability, the Western world would likely be in a similar boat today.