Unveil the veil of limited liability: Evidence from firm investment

Abstract

We investigate the effect of limited liability on firm investment. We find firms that intend to borrow but have higher risk have a greater probability of changing to limited liability. With propensity score matching, difference-in-differences analysis, and switching regressions with an endogenous switching model, we find that, after the liability regime change, firm investment aggressiveness decreases but on a lesser level than the over-time change for firms using unlimited liability. We also find there is improvement in investment efficiency and return on invested capital. These results suggest that limited liability encourages firm investment and leads to more effective investment policies.