The limitations of limited liability — how a simple legal concept caused so much success and so much harm

London in the 1855 must have been a stimulating place. A bustling city in the heart of the British Empire, it was going through an unprecedented period of growth, from one million people in 1800 to seven million people a hundred years later. There was a constant and pressing need for new infrastructure; roads, bridges, railroads and public buildings, requiring plenty of capital to fund it. The London Stock Exchange was booming. Although rewards were high for those who got lucky, it must have been nerve-wracking to be an investor in those days. If a project failed you might lose everything, since investors were liable to pay third party losses. This restrained the flow of capital.

The British government thought they had the solution — freedom of capital. At that time, freedom was much in vogue. Britain, keen to exploit its naval power, was promoting free trade. Slavery had been banned in the Empire just 20 years previously. Meanwhile British colonies were agitating for more autonomy. It seemed in keeping (and politically expedient) to extend freedom to the holders of capital.

In July 1855 the government presented the Joint Stock Companies bill in Parliament, proposing that the liability of investors in a company would be limited to the amount of their capital. In other words, once they had paid up the capital they had committed, they would have no further liability for the company’s debts. They would have…