ABSTRACT
This paper examines the effects of limited liability, one of the most common insurance instruments available to entrepreneurs worldwide, on output, firm size, and technology adoption. Using firm-level data, I show that despite higher financing costs, limited liability firms are larger than their unlimited-liability counterparts, their average productivity is higher, and they face more volatile productivity shocks. I propose a theory where limited liability is endogenously chosen by relatively rich and more productive entrepreneurs to insure themselves against losses, enabling the adoption of more profitable but riskier technologies and sustaining larger firms. I show that limited liability operates as an unusually efficient technology adoption policy: it induces a reallocation toward these technologies at no fiscal cost, since it works purely by shifting downside risk from entrepreneurs to lenders. In general equilibrium, I find that limited liability produces significant output gains driven primarily by the extensive margin of technology choice.
Morales Lema, Raul, Limited Liability and Firm Dynamics. Posted to SSRN 26 June 2026.
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