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Thursday, November 26, 2009

Can Limited Liability Incorporation Occur in a Really Free Market?

In a really free market, why would a customer agree to a limited liability clause?

Suppose there are two banks. Suppose Bank A and Bank B are both warehouse receipt banks. Bank A offers a limited liability clause in its deposit contract. Bank B has no such clause. Suppose they otherwise offer identical terms. Which bank would get your deposit?

Suppose Bank A offers lower fees than Bank B. If this is true, then obviously this is because you have a greater risk of losing of your deposit in Bank A.

Similarly, suppose you walk into a restaurant and the waiter made you sign a limited liability agreement before serving you. You'd view this with suspicion, wouldn't you?

Limited liability is a State-granted perk. When you limited liability incorporate, you aren't contracting with your customers, you're contracting with the State. State restriction of the market forces all business owners to incorporate. State restriction of the justice market forces business owners to incorporate to protect their personal assets.

If you incorporate your business, then the State puts its magic pixie dust on you. Now, any liability associated with the business is the responsibility of the corporation, and not you personally.

However, this protection benefits insiders more than individuals. At a large corporation, it's practically impossible to directly sue executives, unless gross misconduct has occurred *AND* the corporation is forced into bankruptcy. Most executives have a clause in their employment contract specifying that the corporation reimburses them if they are sued as a result of job-related misconduct.

As an individual sole-proprietorship, it's very easy to "pierce the corporate veil" and directly sue the owner. Limited liability incorporation provides very little protection to small business owners. Small business owners usually have most of their wealth invested in their business.

In many ways, the outcomes of the legal system are random. If you don't incorporate your business, then you risk losing all your savings due to a random lawsuit. This forces every business owner to incorporate. If there were an agorist banking system, agorists could avoid this problem. The State could seize your on-the-books savings, but the State would have a hard time seizing your agorist savings (if the agorist banking system is well organized)!

The perks of incorporation affect large corporations differently than a small business owner. In a large corporation, it's practically impossible to directly sue executives for misconduct, unless the misconduct is truly egregious. In a small business sole proprietorship, it's much easier to "pierce the corporate veil" and sue the owner directly instead of suing his corporation.

Limited liability incorporation doesn't occur in a free market.

Also in a free market, limited liability incorporation won't protect you when you injure a non-customer. Suppose you own a factory that pollutes. You can't just declare bankruptcy and default on your obligation to clean up your pollution. In the present, the State and limited liability incorporation protect polluters. If you're caught polluting, your corporation can declare bankruptcy and default on your tort obligation. Your personal assets are separate from the corporation's assets. The victims can't sue you personally.

I'm always annoyed at how pro-State (L)libertarians defend corporations as a natural free market occurrence.

In a really free market, you will have businesses. You won't have corporations as currently organized. It's silly/misleading to call a free market business a corporation, because it would get none of the State-granted perks that corporate management gets in the present.

In a really free market, there's a natural limit to the size of a business. Beyond 150-200 people, inefficiencies set in. At that point, someone could profitably form a competing business. Instead of a huge corporations, you'd have several small businesses cooperating.

Suppose someone is a skilled manager who can oversee a factory by himself. Why would this person work as an employee, instead of opening his own factory? State restriction of the capital market and overall market force most skilled managers to work as employees, instead of opening their own business.

Corporations are an artificial creation of the State. Large corporations out-compete small businesses only when there's State restriction of the market.

A pro-State troll said (on mises.org):

Do you want to take my life savings because I have 1000 UPS shares? F*** that!
What kind of idiot buys shares of stock in a corporation? Gold is a better investment.

Yes, in a free market, you can't be partial owner of a business without taking full responsibility for losses. Otherwise, such arrangements allow owners and management to shirk responsibility.

Imagine if AIG/GM/FRE/FNM/BS/LEH shareholders were personally liable for the losses. Do you think that the management would have been allowed to rack up such huge debts?

David Z pointed out:
If you invest your money with a criminal - even if you don't know he's a criminal - aren't you at least partially responsible?
Corporations segregate ownership, control, and responsibility. The shareholders are technically the owners. The CEO controls the corporations, and for all practical purposes acts like the true owner. The CEO milks the corporation for his own personal profit. This is the Principal-Agent Problem. Nobody is responsible for losses in the event of bankruptcy.

Corporations are an artificial creation of a coercive government. Corporations cannot exist in a really free market. In a really free market, there will be businesses and groups of people working together. They won't resemble corporations as they currently exist.

9 comments:

Anonymous said...

You could just avoid doing any business with corporations.

The problem is when they force their business on you. They can burn your house down and you can't sue the owners of the company, even though you never agreed to "limited liability".

Anonymous said...

Stocks are for idiots and crooks. Unless you have enough to take over a company, the crooks are gonna use their 51% to vote themselves all of your money (golden parachutes, etc.).

Anonymous said...

If a market is free, then there isn't going to be:

a) confiscation by taxation
b) confiscation by inflation
c) confiscation by coercion (em.dom., courts, i.e. abusive legal system)
d) confiscation by war
e) confiscation by majority vote

In such conditions, the risk of shouldering the responsibility in hopes of turning a profit is reasonable. There is no need to spend time and money to acquire additional perks from government, because while doing so, one will miss out on the opportunities of the day.

Without a free market, businessmen need to petition the government for the additional advantages against individuals and small firms, because as inefficiency of a corporation rises with it's size, so does the risk of error.

Keep in mind, though, that without those perks, there is no point in being in the game at all. (Unless you're a slave and used to working for food).

A free market system is a fair system that treats everyone equally. It does not give the bounties to the stronger on account of those less capable of causing harm. Just read the constitution and it's goals.

A coercive system, on the opposite acts as a tyrant, i.e. it has to punish the weak in order to squeeze the strong ones with less toll, as in it's whole, the tyrannical, coercive system is a parasite. This is why, current system takes the whole nine yards on an individual (good example of criminal connection there, FSK), and throws a book at him, while it steps back for businessmen who control large corporations, and gives them extraordinary perks.


One thing in your article is incorrect. A smart manager of a factory, ready to manage his own, should not be able to start his own factory, if he has no capital. It is unfair to start receiving capital gain without first denying oneself some immediate gratifications in order to accumulate the capital. Once accumulated, you then also need to be smart enough to deploy it profitably. If you're not smart, then it is unfair for you to receive an active capital income.

This is so, because the money is only an accounting for what we have done for others. Capital, then is an accumulation of the above in form of cash and or tools. One can spend it, that's fine, but in order to receive active profit comparable to those who benefit the society (i.e. above and beyond savings interest where one does not make deployment decisions), one needs to correctly identify the need and correctly solve the problem of satisfying that need at a minimal expense possible.

Anonymous said...

LLC has a valid purpose given our corrupt legal system where you can bankrupt someone for frivolous reasons in a court of "law", but you're right that it wouldn't exist otherwise.

Michael Haislip said...

In a truly free market, with no state coercion, what's to stop me and another person or group from agreeing to a contract of limited liability? If one of the requirements to gain that group's services is an agreement for limited liability, then it is my choice as a free man to sign that contract. Neither side would be coerced into this agreement.

Should either party break the agreement, then our mutually agreed-upon moderator will step in to settle the dispute. This type of arrangement has long been discussed in anarcho-capitalist circles.

Anyone who wishes to respond privately may do so at:

michael@michaelhaislip.com

Anonymous said...

Again, the problem is when you force your business on someone else. Your company can hurt someone by "accident" but they can't sue you even if they never agreed to your "limited liability".

Anonymous said...

How easy is it to "pierce the corrupt veil" of a LLC?

If it were that easy it would defeat the point of forming LLCs.

In practice, how often do they get pierced?

Chrono said...

Excellent post. This one should become part of the best of FSK. It would be useful for you to consider the posts that include the 'hidden principles' of a free society, as this is one
-LLC is generally unfeasible
-large organizations are inefficient
-person vs. person justice instead of State vs. person justice (from a more recent post)
etc...
You could assemble them as you have done in a way here, and in the more recent post and work your way toward a short primer on a free society and why it is superior to a violent society.

Michael, it is perfectly fine if you want to do business with someone and agree to their limited liability clause in your agreement. People already do this when signing waivers and also in software agreements. The problem is not that LLC is impractical, it's just another way to do business. The problem is that it's forced on us. FSK's posts on this topic show you the problems LLCs cause in society, via state violence. You should focus on those problems, as they are solid examples for why state violence is impractical, not to mention, immoral and illegitimate.

Anonymous said...

I agree with the comment by Anonymous (4th one!).

>LLC has a valid purpose given our
>corrupt legal system where you can
>bankrupt someone for frivolous
>reasons in a

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