July 24, 2024 

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HEDGE: A method of protecting against financial (or other types) of loss by counterbalancing an action. This is commonly seen in the financial markets when investors buy options or futures contracts to protect themselves against price changes. A hedge is essentially a form of insurance. An investor hopes the price of a financial asset doesn't fall, but buying a futures or options contract can reduce the loss if this occurs.

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The extent to which the owners of a business are liable for the debts of the company. The two basic liability alternatives are unlimited liability, which has no restrictions on ownership liability, and limited liability, which does have restrictions. Ownership liability is one characteristic separating legal business organizations. Proprietorships and partnerships have unlimited liability. Corporations have limited liability.
Ownership liability is the extent to which the owners of a business are personally responsible for business debts. With unlimited liability, such as found in proprietorships and partnerships, the owners of the business are personally responsible for company debts. With limited liability, a characteristic of corporations, the owners (shareholders) are only liable for the value of their stock holdings.

The degree to which owners are liable for company debts plays a big role in the size of the business. Unlimited liability tends to keep proprietorships and partnerships relatively small. Limited liability allows corporations to be significantly larger.

Unlimited Liability

Unlimited liability is the condition in which owners can be held personally responsible for any and all debts created by a business. In addition to the assets of the business, the personal assets and wealth of the owners can be used to pay off any debts of the business. Proprietorships and partnerships are the two kinds of businesses in which owners have unlimited liability.

For example, consider a proprietorship such as Phil Gardener's zucchini growing operation. Should Phil come up on the losing end of a law suit filed by a customer who purchased a bad zucchini, then Phil is liable for this business debt. In addition to the "company" bank account, Phil also might need to tap into his personal bank account, sell off most of his personal property, or take out a second mortgage on his house to pay this debt.

Also consider how unlimited liability affects a partnership such as the legal firm of Schrumpmeyer and Schrumpmeyer, owned and operated jointly by Sean and Sally Schrumpmeyer. Should Sean incur several sizeable debts (for luxurious office furniture, business trips, and legal malpractice suits), then Sally also can be held responsible for payment. In addition to the "company" bank account, Sean and Sally might need to tap into their personal bank accounts, sell off some of their personal property, or take out second mortgages on their houses to pay the debts of the business.

Limited Liability

Limited liability is the condition in which owners cannot be held personally responsible for the debts of a business. In most cases, the liability facing the owners of a business is limited by the value of their ownership share. At the very worst, the business goes bankrupt and the ownership shares become worthless. More to the point, creditors cannot force owners to use personal assets and wealth to pay the debts of the business. Corporations are the main form of business in which owners have limited liability.

Consider how unlimited liability works for a hypothetical corporation like InkBlot Print Shop, Inc. InkBlot is a relatively small corporation owned and operated by college friends, Jennifer Blotbug and Kyla Inkster. Out of 100 shares of corporate stock, each owns 50. While Jennifer and Kyla could have established InkBlot as a partnership, they chose instead a corporation. The corporation provides limited liability.

Should an employee incur extravagant hospital bills after losing an appendage in the printing machinery, then the liability faced by Jennifer and Kyla for this debt is limited by the assets of InkBlot Print Shop, Inc. Neither owner can be forced to use their personal wealth or assets to pay the bills.

Pros and Cons

While it might seem as though limited liability is the best way to structure a business, there are advantages and disadvantages to both.
  • Accumulating Resources: Limiting liability to the value of the ownership shares makes it possible for a business to gain control over large quantities of productive resources. Rather than relying ONLY on the resources owned by one person (as with a proprietorship) or that owned by a handful of people (as with a partnership), corporations have almost no limits to the accumulation of productive resources.

    For example, a corporation can accumulate $100 million by selling 1 million shares of limited liability ownership stock to 1 million people each paying $100. Should problems arise, each person is liable ONLY for $100. Accumulating the same $100 million with unlimited liability would be substantially more difficult (and probably impossible). If each of the 1 million owners is held personally responsible for company debts, then they would likely want a great control of the decision making process.

    The ease of accumulating large amounts of resources means corporations can take advantage of large scale production. Larger factories generally mean average production cost declines with increased production.

  • Creating Incentives: The prospects of unlimited liability creates incentives for business owners to weigh every decision carefully. A single bad decision, a single mistake, can decimate the company and destroy the personal wealth of the owners.

    Alternatively, the protection provided by limited liability does not force owners to take personal responsibility for their decisions. A string of bad decisions might force the company into bankruptcy, but the owners can survive with their personal wealth largely intact.


Recommended Citation:

OWNERSHIP LIABILITY, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2024. [Accessed: July 24, 2024].

Check Out These Related Terms...

     | unlimited liability | limited liability | proprietorship | partnership | corporation | enterprise | legal business organizations |

Or For A Little Background...

     | business | firm | company | production | production cost | supply | entrepreneurship | microeconomics | private sector | institution |

And For Further Study...

     | business sector | business objectives | profit maximization | natural selection | plant | factory | industry | business cycle | political views | corporate profits | second estate | free enterprise | ownership and control | short-run production analysis |

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     | Internal Revenue Service |

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