Pennsylvania has been on the front lines of a recent controversy over fracking, a new technique to extract natural gas. Not to be confused with "fraking," fracking involves pumping a bunch of water mixed with all sorts of untoward stuff into underground rock formations. The idea being that the hydraulic pressure will "frack" the rock causing it to release all sorts of trapped natural gas and thus solving the energy crisis all the while earning millions of dollars for the corporations who came up with this fraking plan.
By now you're probably wondering what the frak this has to do with the limited liability problem.
Well, it turns out that fracking, like fraking, carries with it some risk. By pumping all sorts of muck into bedrock formations, fracking stands a good chance of contaminating the drinking water of just about any living organism, humans included, that happens to be downstream. And because once the bedrock is broken we're not going to be able to put it back together, fracking has the potential of creating problems that will be unfixable.
Dirty drinking water is a bad thing. Aside from the whole killing trees thing, it makes people sick. So, if things don't turn out as the oil companies plan and fracking actually does screw up our water supply, someone is going to have to pay for (1) the healthcare bills of all the folks who get sick from drinking dirty water; and (2) the costs of treating all the newly dirtied water.
So fracking carries with it some risk of a fairly nasty outcome.
Risk is important because we use it to calculate value. It's something we do intuitively. We've got all sorts of old-timey sayings that implicitly recognize the effect of risk on value. For instance, a bird in hand is worth two in the bush.
Basically, the idea is that value of any outcome must be discounted by the risk of that outcome's nonoccurence. In other words, the value of the aforementioned birds in the bush must be discounted by the risk that you've had one too many and you miss shooting both.
Corporations do the same when making investment decisions. They've got $1M sitting around burning a hole in their balance sheet so they start looking for various investment opportunities. Some dude comes forward with Investment A that has a potential outcome that would yield $100M. As any good poker player knows, provided the outcome occurs more than 1 out of every 100 outcomes, Investment A is a good bet.
This logic makes sense only in the context of limited liability. Limited liability provides the corporation cost certainty. It makes corporate finance the equivalent of a poker buy-in.
No matter how Investment A turns out, the most the corporation can lose (assuming they've gone out and created a subsidiary that was adequately capitalized by the $1M and ...) is the $1M investment. However, that's not how the real world works.
In the real world, things go horribly wrong. When hunting birds, you not only miss the birds but you also end up shooting your buddy in the face. Sometimes you go out for what appears to be a night of harmless fun, get drunk, frak someone and wake up the next morning with your life irretrievably altered.
In the corporate context, things never get out of hand. A corporation can go out night after night, do a bizillion car bombs, shoot and frak anybody she wants and the worst that can happen is she wakes up with a case of the crotch crickets.
That's limited liability. And that analogy pretty much explains why limited liability creates what dumb asses like to call a "Moral Hazard" problem.
So, long story short, this whole fracking thing. You think if corporations actually had to account for the true cost of this fracking thing may unleash they'd have any interest in doing it? If not shielded by limited liability, Exxon-Mobil would be setting up cash reserves so fraking large, it would cause them to dip into the red for a quarter or two and possibly cause a dent in the annual bonus pool.
In other words, the only reason corporations think fracking is a good idea is that we the taxpayers are going to end up footing the bill for the environmental clean up.
Don't you just love limited liability???
P.S. You know all this hand wringing about the TARP bailouts and "moral hazard"? Frack that. It's implicit in any system of limited liability that the government (aka the taxpayers) act as the insurers of last resort. By allowing banks to take the corporate form and invoke limited liability protections, the taxpayers implicitly wrote the financial industry - Goldman Sachs, AIG, Bear Sterns, Lehman, Citi, BofA... the whole lot of them - a massive policy to insure against the financial destruction its bankers wrought. Greed doesn't cause bankers to take on too much risk, limited liability does. In other words, the next time you come across a dumb ass wringing his hands about "moral hazard," ask him his thoughts on the limited liability problem. Tell that twit he's got the timeline mixed up. Tell him, we were AIG before we were AIG.