Abstract
The aim of this section is primarily descriptive in order to show that the corporate form is a legal creation of the state to serve the socio-economic goals of government. I shall look at the development of the corporate legal form from the first companies granted Royal Charter in the fifteenth century to the modern corporate legal form of today. The legal and economic development of the corporation reflects the role it has played in society and helps us understand the role the corporation plays in our society today. Interestingly, the evolution of corporate law is paralleled by a legal debate over the nature of the corporation which is reminiscent of the debate over corporate moral agency. The legal debate is primarily between three different positions; those who regard the corporation as a legal fiction, those who regard it as a nexus-of-contracts, and those who regard it as a real entity in a metaphysical sense. The influence of this debate on legislation shows the practical importance of the metaphysical status that we deem the corporation to have. I will be defending the view of the corporation as a legal fiction against both the views of the corporation as a nexus-of-contracts and the corporation conceived as a real entity.
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Notes
- 1.
In 1688 there were only 15 joint stock companies in England.
- 2.
The Acts between 1844 and 1856 are generally referred to as the “Joint Stock Companies Acts” while the 1862 Companies Act and onwards are referred to as the “Companies Acts”. When referring to the Acts collectively, both prior and after 1862, I will simply be using the term “Companies Acts”.
- 3.
The Joint Stock Companies Act of the 5th of September 1844 is formally known as “An Act for the Registration, Incorporation, and Regulation of Joint Stock Companies”. The Act does not explicitly refer to the primacy of the interests of shareholders but it does make certain provisions that together amount to the same: Firstly, section 25, says that the company is only empowered to pursue aims for which it was formed (ultra vires doctrine). Secondly, section 25 also says that the shareholders have unlimited liability; the shareholder shall “be and continue liable as he would have been if the said Company had not been incorporated”. Section 28 says that the company director must “hold in his own Right at least One Share in the Capital of the Company”. Section 29 says that the director must not have any personal interest in company contracts or else “be precluded from voting or otherwise acting as a Director”. These four points in concert amount to prescribing that the efforts of directors and in turn the corporate members are to be primarily directed to satisfying the interests of the shareholders. The fact that the director must be a shareholder implies that the director is in part working in his own interest when he is working for the shareholders. Furthermore, he will be careful not to incur excessive debt in his decision making because all his personal assets, as well as the assets of other shareholders, are accessible in the event of bankruptcy due to unlimited liability. Furthermore, the director may not enter into contracts where he has a personal interest that prevents him from making decisions that are of personal benefit rather than benefit the shareholders as a whole. Finally, the doctrine of ultra vires implies that the director cannot enter the company into legally binding contracts that are not in accord with the purpose for which the incorporators created the company. These restrictions on the company director protect the interests of shareholders and implicitly keep the company focused on satisfying shareholder interests.
- 4.
Conflicts of interest between managers and the corporation have been dubbed “vertical conflicts” and are the main concern of principal-agent conflicts as part of corporate governance.
- 5.
A consequence of the business judgment rule is that directors’ fiduciary duty becomes a negative duty to not act in bad faith. The fiduciary duty of directors seems at first glance to be a positive duty to pursue the interest of shareholders. However, courts do not sanction directors for not pursuing profitable opportunities that are open to the company, but rather for acting in bad faith with regard to the opportunities they do pursue. The courts quite rightly find that it is not their place to make judgments about the merits of directors’ business strategies; that issue is up to the market and the shareholders to decide. (Directors may however be held legally liable for negligence for the losses incurred by the corporation if they are found to breach their duty of care, i.e. a breach of a positive duty to avoid harm to the corporation.)
- 6.
The constitutional document may also be a charter from the Crown or a Special Act of Parliament.
- 7.
This would seem to give rise to an “is-ought” problem for the Real Entity Theory. If the corporation is as a matter of legal fact unable to make any ultra vires acts it is difficult to see how one can also maintain that the corporation is able to pursue any purpose it desires. Is the Real Entity Theory describing the corporation as a social organism with many of the same characteristics of natural persons or is it prescribing that it ought to be attributed with such characteristics?
- 8.
- 9.
Fundamental to the teaching of shareholder value maximization in business schools is the principal-agent model of the corporation, which has its origins in Jensen and Meckling’s (1976) Theory of the Firm. Stout (2012) explains at length how this standard view is ill-founded. First, it assumes shareholders own corporations; whereas, in fact, corporations are independent legal entities that own themselves and shareholders own shares of stock, which amount to a contract between the shareholder and the corporation providing the former with rights under certain limited circumstances. Second, it posits that shareholders are residual claimants, receiving profits left over after the company’s various contractual obligations have been met; whereas, it is up to the board of directors to decide whether (if any) profits are to be distributed as dividends to shareholders (the idea of shareholders as residual claimants has its origins in bankruptcy law and is incorrectly applied to the public corporation that is a going concern). Third, is the assumption that shareholders are principals who hire directors and executives to act as their agents; whereas, as a matter of corporate law, corporations are controlled by boards of directors, not shareholders.
- 10.
It has been suggested by some that the right to vote should be revoked from shareholders to enable managers to dispose of corporate funds with less focus on the bottom line. However, this suggestion ignores the genesis of corporations. If incorporation implies that shareholders lose control of the company then few if any entrepreneurs or investors would choose to make use of the corporate legal form. Moreover, if directors and managers no longer need to answer to shareholders then there is no primary stakeholder to hold them accountable to goals of financial performance. With less incentive to pursue profits, corporations will be less profitable which further diminishes the incentive for shareholders to incorporate. Although corporate managers might make more use of corporate funds for philanthropic ventures, removing shareholder voting rights may have negative consequences for the corporation’s role as an efficient producer of goods and services.
- 11.
Long ago, Berle and Means (1932) argued that shareholders of corporations with dispersed shareholdings had lost their de facto control to corporate managers because of diluted voting power. In this context it should be acknowledged the threat of dismissal / non-reelection of board members is real but rarely happens in practice in large public corporations (Benz and Frey 2007). However, in these large organizations there are usually other incentive structures in place that aim to align shareholder interests with those of top management; for example, the issuing of shares or stock options and payment of bonuses tied to corporate financial performance. Voting rights matter even in this context because it is common practice for shareholders to approve top management’s remuneration by voting. The legal power of shareholders to vote for the board of directors and their remuneration helps perpetuate the SPN as a social norm, not as a principle of law likely to be upheld in court.
- 12.
Recall that the Nexus-of-Contracts Theory does not regard legal incorporation as necessary for creating a corporation; the legal act of incorporation is merely a shorthand way of obtaining a contractual situation that can be obtained through the private contracting of individuals.
- 13.
This can help explain why people often refer to the corporation in the singular in their responsibility attributions. It is not that the corporation is a moral agent, but rather that they have adopted the legal singular usage referring to the separate legal entity. This may mean that they are not making a moral responsibility attribution at all, but a legal responsibility attribution, or it may mean that they are making a category mistake by attributing moral responsibility to a legal agent.
- 14.
It is generally accepted that an incentive problem occurs when a corporation is near insolvency. This is because the closer the corporation is to being insolvent, the less the corporation is worth, and therefore due to limited liability the corporation has “nothing to lose” in making very risky decisions.
- 15.
An externality is a cost or benefit of a decision that falls onto a third party that plays no part in the decision made.
- 16.
The following points are inspired by Easterbrook and Fischel (1985).
- 17.
A market portfolio of shares is a portfolio that mirrors the proportions of all the shares in the market.
- 18.
The net present value of an investment is the discounted sum of all expected future revenues and costs of the investment.
- 19.
Arguably a risk neutral rational investor would not pass up on a positive net present value investment irrespective of the risk and possibility of having claims made against his personal assets. However, it seems reasonable to assume that real investors are not risk neutral about their personal assets in a way that they might be about their shareholdings. People tend to regard their shareholdings as assets disposable for speculation while personal wealth is needed for living.
- 20.
Although the Nexus-of-Contracts Theory probably was the motivating force for the Santa Clara ruling it was not well thought through. By the time of Santa Clara, limited liability had already been conferred upon incorporation for several decades and the corporation was clearly established as a separate legal entity from the shareholders. The Nexus-of Contacts Theory as the primary justification for regarding the corporation as a “person” under the 14th amendment is problematic because it is inconsistent with the corporation’s limited liability and legal status as a separate entity. If “corporations cannot be separated from the natural persons who compose them”, then one should also bite the bullet and hold that the debts of the corporation ought to also be the debts of the shareholders.
- 21.
For example, in the 2004 presidential election billionaire George Soros contributed vast amounts of his personal wealth to counter the re-election of George W. Bush.
- 22.
Austin says that corporations may not use their resources to contribute directly to an election campaign, but it does not restrict them from establishing a segregated fund to achieve the same goal. This seems a bit strange because it does not in effect hinder corporations in practice from influencing the electoral process.
- 23.
A consequence of this is that the theoretical ideal of a perfect market (characterised by an absence of transaction costs) would not have any companies.
- 24.
Interestingly Adam Smith thought that corporations were inefficient in comparison with sole traders and disliked that companies like the East India Company were granted monopoly status in their Royal Charters. He acknowledged that corporations could be useful for banking, insurance, and public utilities that required vast amounts of financial capital and management skill, but otherwise he considers them to be inefficient for ordinary competitive enterprise. This conviction was probably a reflection of his over-reliance on the market mechanism and a disregard for transaction costs.
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Rönnegard, D. (2015). The Role of the Corporation in Society: The Descriptive View. In: The Fallacy of Corporate Moral Agency. Issues in Business Ethics, vol 44. Springer, Dordrecht. https://doi.org/10.1007/978-94-017-9756-6_10
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