Corporate Architecture and Limited Liability

Abstract

This paper studies the effect of limited liability on corporate architecture. Corporate architecture is to be interpreted as the organizational instruments firms use to organize themselves into a coordinating, hierarchical ordered association of people. In this paper, it specifically refers to the use of four governance instruments within the firm to control the behavior of employees. These four are decision control rights, reward schemes, information systems and conflict resolution rules. Limited liability influences the way in which an incorporated group of firms employs each of these instruments. The most important effects are that limited liability makes it advantageous to allocate decision rights lower in the organization, use higher-powered reward schemes and economize on information systems. The effects lead to a saving of coordination costs within incorporated groups compared to unincorporated groups. Corporate groups thus differ in their governance arrangement from firms that have not organized in corporate groups. Alternatives that restrict limited liability have the effect of centralizing rights, flattening reward schemes and increasing investment in information systems. If corporate groups have attuned their architecture optimally, then restricting, or abolishing, limited liability generates additional coordination costs.