Eli5: why the shareholders in a company are not liable to pay debts owed by the company?
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I take OP’s question to be, *why* do we allow shareholders to keep all the gains when things go well but socialize the losses in situations in which the corporation owes more than it can pay? The answer is to encourage efficient investment and risk-taking, which benefits everyone in the long run by making society more productive.
Imagine a friend of yours invents a new process for extracting flour from wheat. It’s very expensive to get started, but if done right, it can double the output. However, if done wrong, it can not only slash the output but potentially poison people as well. Your friend has no money, so he asks you (and a bunch of other people around town) to invest in his business. You think your friend will do it the right way, but you’re not certain, and it’s possible he could lose control of the business to others who will cut corners. You might be willing to invest if you’re only at risk of losing your investment, but not if you’re at risk for losing everything you own because your friend and/or the townies screw up and you become liable for poisoning a bunch of people. Without a corporate shield, you (and the townies) wouldn’t invest, the new process never gets implemented and perfected, and there’s less flour for everyone than there would be otherwise.
The corporate shield encourages people to invest money in enterprises over which they have no control, in order to empower the people with good ideas but no money to create things. That has to be balanced against the moral hazard that arises when people are shielded from their losses, and there are several ways that the law can do that. For instance, it is sometimes possible to pierce the corporate shield (and hold shareholders personally liable for the corporation’s losses) if the corporation was not adequately capitalized to cover its foreseeable losses to begin with. Also, the law can hold the corporation’s management personally liable for the corporation’s losses (but that has to be balanced against the need to recruit management in the first place, so it’s usually reserved for situations of extreme misconduct by management). In short, a basic theory of corporate law is that there are better ways to achieve good corporate governance than holding shareholders generally liable, which would have very bad effects on investment and productivity.
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