We study how parent liability for subsidiary environmental cleanup costs affects industrial pollution and production. Our empirical setting exploits a Supreme Court decision that strengthened parent limited liability protection for some subsidiaries. Us- ing a difference-in-differences framework, we find that increased liability protection for parents leads to a 5–9% increase in toxic emissions by subsidiaries. Evidence suggests the increase in pollution is driven by lower investment in abatement technologies rather than reallocation across plants or increased production. Cross-sectional tests suggest a harm-shifting motivation for these effects. Overall, our results highlight moral hazard problems associated with limited liability.
Associate Professor, National University of Singapore
Visiting Associate Professor of Finance, Kellogg School of Management