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Entrepreneurs and the Choice of Limited Liability

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  • Michael T. K. Horvath
  • Michael J. Woyode

Abstract

We investigate factors influencing the choice of liability status by the owners of start-up firms. We propose a theoretical model that encompasses risk aversion, as well as differentials across liability states in the cost of capital and tax rates, as reasons why entrepreneurs choose one liability status over another. The likelihood of observing limited liability is predicted to be concave in the project size and the financial wealth of the entrepreneur. We use a recently collected data set on German start-up firms to test the model and find strong support for the model's predictions.

Suggested Citation

  • Michael T. K. Horvath & Michael J. Woyode, 2005. "Entrepreneurs and the Choice of Limited Liability," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 161(4), pages 681-707, December.
    • Handle: RePEc:mhr:jinste:urn:sici:0932-4569(200512)161:4_681:eatcol_2.0.tx_2-2
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    References listed on IDEAS

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    1. Gilson, Ronald J, 1991. "Unlimited Liability and Law Firm Organization: Tax Factors and the Direction of Causation," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 420-425, April.
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    5. Almus, Matthias & Nerlinger, Eric A, 2000. "Testing "Gibrat's Law" for Young Firms--Empirical Results for West Germany," Small Business Economics, Springer, vol. 15(1), pages 1-12, August.
    6. Mayers, David & Smith, Clifford W, Jr, 1982. "On the Corporate Demand for Insurance," The Journal of Business, University of Chicago Press, vol. 55(2), pages 281-296, April.
    7. Douglas Gale & Martin Hellwig, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 52(4), pages 647-663.
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    Cited by:

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    2. Monika Wieczorek-Kosmala & Joanna Błach & Anna Doś, 2021. "COVID-19 Interruptions and SMEs Heterogeneity: Evidence from Poland," Risks, MDPI, vol. 9(9), pages 1-21, September.

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    More about this item

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • K00 - Law and Economics - - General - - - General (including Data Sources and Description)

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