Eli5: why the shareholders in a company are not liable to pay debts owed by the company?
In: 181
Answer: This is only partially the case. Debts get paid as a legally higher priority than shareholders. Companies always pay debt obligations before dividends (to shareholders).
If a corporation’s debts default, go to collection, or otherwise get liquidated, all debts get paid before a single shareholder gets a penny. If the company has a negative net value in default, shareholders get nothing. Not a penny, even after every chair and pencil gets sold.
Hypothetical – let’s say a stock is worth $100 in the market and owes $100 on a bond, but runs out of money and gets liquidated for a total of $101 after everything is sold. In that case, bond holders get $100 (fully paid) and shareholders get $1 (and a 99% loss on their taxes). So to be clear, in a failed company, shareholders get meaningfully more screwed than debtors. If liquidation yielded $99, it all goes to bond holders, but shareholders don’t owe the rest (more on that below).
There is anther legal point that applies to shareholders – they’re passive (not involved in operations of the company). As such, they do not have liability beyond the capital they provide (by legal structures). So their losses cannot exceed their investment. So if you invest money passively in a new car company that fails, you lose every penny of your investment, but not your private house and your car itself. This essentially prevents those operating a company (poorly) from treating their shareholders as ATMs.
That’s not to say that there’s never any funny business, but that’s how it’s supposed to work. The timing of debt payments, bankruptcy, and nested legal structures can complicate the base case. I’m not suggesting that outcomes are reliably fair.
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