Manuscript Excerpt on the Corporate Form
[Since corporate entity status, limited liability, and other aspects of the corporate form have been the topic of heated discussion on LeftLibertarian2, I decided to publish this excerpt prematurely, despite all the topic sentences for incomplete passages, placeholder footnotes, other gaps, and--the biggie--the fact that I have so far relied entirely on Van Eeghen's quotes from Hessen, not having read the book myself. Still, I've sorted through a lot of debates on the corporate form, and arranged the material around what I think some of the relevant issues are. The excerpt is from manuscript Chapter Three, on state policies that promote economic centralization and excessive scale. It is a subsection on the corporate legal transformation of the late nineteenth century, in a larger section on the overall corporate revolution.]
Robert Hessen has argued that general incorporation under statute law provides no benefits that could not be achieved by simple private contract. [Robert Hessen. In Defense of the Corporation (Stanford, Calif.: Hoover Institution, 1979).]
Piet-Hein Van Eeghen, however, raises the question of whether the entity status of the corporation, distinct from any or all of the individual stockholders, could be established solely by private contract.
While it is common to list various typical corporate features, such as entity status, limited liability and perpetuity, there is really only one defining feature: entity status. Entity status means that certain legal rights and duties are held by the corporation as a separate, impersonal legal entity. In the case of the private business corporation, entity status implies that title to the firm's assets is held by the corporation in its own right, separate from its shareholders.
Illustrative of the fact that the corporate form of private enterprise deviates from traditional forms of private property, entity status renders the legal position of both corporate shareholders and managers (directors) awkward and ambiguous. As for corporate shareholders, they are commonly regarded as the owners of the corporation, but they are owners only in a limited sense. Shareholders do not have title to the assets of the corporate firm, but merely possess the right to appoint management and to receive dividends as and when these are declared; title to the firm's assets reverts back to shareholders only when its corporate status is terminated. The lack of ownership rights over assets is illustrated by the fact that, in contrast to partners in an unincorporated partnership, corporate shareholders cannot lay claim to their share of the assets of the corporate firm nor do they have the right to force their co-partners to buy them out. Corporate shareholders can liquidate their investment only by selling their shares to third parties. In short, the ambiguity in the legal position of shareholders lies in the fact that, while certain traditional ownership rights rest with them (profit accrual and power to appoint agents to manage the firm for them), other traditional ownership rights are exercised by the corporation as a legal entity separate from them (title to the firm's assets).
As for corporate management, their legal position is equally ambiguous. Managers are appointed by directors who are the representatives of shareholders. Ultimately, management is thus the agent for shareholders, managing the corporation as their representative. This, however, is only part of the picture. While management is the agent for shareholders in the sense of being ultimately appointed by and accountable to them, it is also the agent for the corporation itself. After all, in order to manage the corporation's assets, management must legally represent the corporation as the titleholder to these assets. And because the corporation is an impersonal legal entity, agency for the corporation lends a significant degree of autonomy to the position of management, which is precisely why it has proved so difficult to make shareholder control over management more effective, despite the many legislative measures aimed at enhancing management accountability to shareholders. The significant degree of autonomy inherent in the legal position of corporate management was, of course, the main theme of Berle and Means's (1932) seminal work on the corporation. To sum up, the position of management is ambiguous because management acts as agent for two principals, the shareholders and the corporation.
Other typical features of the corporation like limited liability and perpetuity are not independent, original attributes, but are derived from its entity status.
Shareholders possess limited liability because they do not own the corporation's assets and are, consequently, also not liable for claims against these assets. Responsibility for corporate debt rests with the corporation in its own right rather than with them. Corporate creditors cannot, therefore, lay claim to the personal possessions of corporate shareholders, as they can to the personal possessions of partners in an unincorporated partnership. The most shareholders can lose is their initial investment when buying the shares, which happens only when the corporation goes bankrupt and the shares lose their value. Such is the origin of limited liability for shareholders.
The corporate feature of perpetuity can also be traced back to the corporation's entity status. It is because assets are owned by the corporation in its own right rather than by shareholders that the death or departure of shareholders does not affect its continued existence. While unincorporated partnerships need to be legally reconstituted each time partners leave, die, or are added, corporations continue irrespective of who holds their shares. The corporation's entity status thus gives it a life independent of the life of its shareholders, which is the sense in which it is commonly said to possess perpetuity or immortality. [Piet-Hein van Eeghen. "The Corporation at Issue, Part I: The Clash of Classical Liberal Values and the Negative Consequences for Capitalist Practice" Journal of Libertarian Studies Vol. 19 Num. 3 (Fall 2005), pp. 52-54.]
Van Eeghen argues that general incorporation under statute law is a source of special privilege, insofar as it confers what were previously considered the incidents of statehood, and is therefore impermissible from a libertarian standpoint:
It has, in fact, always been foreign to common law principles to allow private persons the unrestricted freedom to assign their assets to the ownership of impersonal, and thus state-like, legal entities. As Roy (1997, p. 46) notes: “This feature [entity status] conflicts with a basic tenet of the common law of property: it clouds the distinction between personal rights (in personem) and rights in property (in rem).” In spite of his defense of the corporation, a liberal legal scholar like Richard Epstein (1995, p. 273) agrees that limited liability “deviates from the ordinary common law principles of partnership and agency.” [Piet-Hein van Eeghen. "The Corporation at Issue, Part II: A Critique of Robert Hesson's In Defense of the Corporation and Proposed Conditions for Private Incorporation" Journal of Libertarian Studies Vol. 19 Num. 4 (Fall 2005), p. 39.]
Originally only state institutions (central, regional, and local government) possessed corporate status, which seems entirely natural and appropriate. If we wish to escape Louis XIV's infamous dictum “l'état c'est moi” (“I am the state”)..., the state should indeed be given a legal entity separate from its officials. Only if such a separation exists can state power be vested in the office rather than the person; and only when state power is vested in the office can it be circumscribed by law....
If it is agreed that entity status is indeed a typical attribute of the state, then anarchocapitalists who advocate a stateless society have even more reason to oppose private firms taking on state-like attributes such as happens when they acquire corporate status. [Van Eeghen, "The Corporation at Issue, Part I," pp. 54, 56.]
Further, Van Eeghen argues, corporate entity status and all its incidents have had the practical effect of enabling all the negative features commonly identified in critiques of corporate power:
(a) Increased Speculative Instability
Because incorporation separates ownership from control, shares in a modern corporation can be traded without necessarily affecting the management nor the capital position of the firm. As a result, an active market in such shares develops more easily. By contrast, the shares in an unincorporated partnership are less marketable because they are more strongly linked to the risks and responsibilities of managing the firm, which old owners are more reluctant give up and new owners accept. Moreover, partners normally have the right to consultation in ownership transfers, which also reduces the marketability of ownership stakes in unincorporated businesses.
Unfortunately, marketability and the potential for speculative trading are intimately linked. Since incorporation significantly increases the marketability of ownership stakes, it thereby also enhances the opportunities for speculative activity in share markets. In addition, many of the participants in speculative markets are corporations themselves and thus enjoy a degree of risk protection in the form of limited liability. Because the balance between risk and reward is tampered with, speculative activity is artificially stimulated....
(b) Increased Market Concentration and Concentration of Control
Because the corporate form increases the average firm size, it will also ceteris paribus increase the degree of concentration in any given market. Furthermore, because incorporation enhances the marketability of shares as well as the ease with which capital can be raised, it also creates better opportunities to gain market share by mergers and take-overs.
Generally speaking, corporate capitalist practice has strayed far from the free-enterprise ideal of market decisions being taken at a decentralized level by countless relatively small suppliers and demanders so that market outcomes are broadly impersonal. The very invisibility and beneficence of the invisible hand is thus under threat.
(c) Increased Strength of the Profit Motive
Since corporate shareholders are normally so diversified that they become an amorphous mass, only the lowest common denominator of their wishes can be attended to, which is to maximize return on investment-the wish which the greatest number of shareholders have in common. Put differently, the profit motive is given additional impetus, because it has to perform the additional function of bridging the gap between management and an estranged ownership. The divorce of ownership from control also stimulates the development of a large, impersonal market in corporate control, which makes it even more difficult for management to moderate the pursuit of profit, as they live under the constant threat of losing their position through take-overs-and recall how take-overs are already made easier by the corporate form. That is why corporate behavior tends to be more strongly profit-driven than people tend to be when acting in their private capacity. An exaggerated materialist bias is thus introduced into the liberal capitalist ethos. [Ibid., pp. 60-64.]
Although Hessen argued that entity status could be established solely by contract, van Eeghen takes issue with that claim. Hessen, van Eeghen argues, "confuse[s] the joint-stock principle with corporate status." Entity status does not consist merely, as Hessen seemed to think, of the shareholders acting "as a unified collective in a court of law"; rather, entity status refers to the corporation as "a legal entity separate from shareholders."
First, the fact that shareholders have no legal title to the assets of the corporation, even when they seek to exercise such rights collectively (provided the corporation is not thereby broken up), clearly suggests that the corporation is a legal entity separate from the collective of shareholders and that title to these assets rests with the former. Second, if entity status refers to the collective of shareholders and it is the product of private contracting, there should be private contracts between individual shareholders in existence which stipulate their collective ownership in respect of the firm's assets. But these contracts are simply not there....
If it is agreed that the corporation is a legal entity separate from shareholders, then Hessen's claim that it can be the product of private contracting is obviously severely weakened if not dismissed. It is clear that private contracting can achieve only joint ownership of the contractors' assets (a partnership); it cannot establish a legal entity separate from the natural persons of the contractors themselves to which they assign their assets.
The legal status of nonmanaging partners is obviously similar to that of corporate shareholders, in that they can also obtain limited liability, have given up their control over assets and no longer have the right to consultation in ownership transfers. For Hessen this is evidence to suggest that there is a seamless continuum that starts with the straight, unqualified partnership and ends with the corporation, while the modified partnership is positioned somewhere between the two. But there does seem to be a fundamental difference between partnerships and corporations. Whereas in the case of modified partnerships the rights and responsibilities of ownership are rearranged between nonmanaging and managing partners, these rights and responsibilities are partially cancelled for all corporate shareholders. There are no longer any managing shareholders in a corporation; instead all corporate shareholders are silent partners. From a liberal point of view, such modified partnerships are perfectly in order (e.g., the limited partnership or the Italian commenda), provided that some partners carry the full rights and responsibilities of ownership and that accountability towards third parties is thus not compromised. ["The Corporation at Issue, Part II," pp. ]
I confess the argument that separate entity status could be established by private contract is not entirely implausible. Van Eeghen's argument from the nonexistence of such private contracts is not, in itself, very convincing. One might argue that the general idea of free contract is quite recent, that it has been given even comparatively free rein only in the past few centuries, and that, even so, the form it has taken in that time has reflected the path dependencies created by a far more statist society. A great many contractual arrangements might be conceivable without the state (see, for example, the work of the Tannehills or of David Friedman) that have never yet come into existence simply because the state still casts such a huge shadow. Arguably, the very availability of statutory provisions for general incorporation has had the effect of crowding out private contractual arrangements. There is nothing inherently nonsensical or repugnant in the idea of a number of private individuals contracting to create a permanent corporate entity separate from any or all of themselves as individuals, or of local free juries choosing to recognize the standing of such entities under the body of libertarian law.
Even were we to stipulate such an argument, however, it would not get Hessen and his partisans very far. Whether the corporation, as distinguished by its entity status from an ordinary partnership, could come about through private contracting alone, is in my opinion a question involving so much counterfactual speculation as to be unanswerable. But the fact that the state makes the establishment of entity status and all its accidents so much easier, by providing a ready-made and automatic venue for incorporation, surely results in a considerable distortion of the market. General incorporation legislation creates a standard procedure for setting up a corporation with entity status, with standard forms to file and automatic recognition to anyone following the prescribed procedure. Thus, the state intervenes to make the corporation the standard form of business organization, and essentially removes the transaction costs of organizing it.
Leaving aside the broader question of entity status, both Murray Rothbard and Stephan Kinsella have argued that the narrower principle of limited liability for debt could be established by contract, simply by announcing ahead of time that individual shareholders in a firm would be liable only for the amount of their investment. In that case, it would be entirely the voluntary decision of creditors whether or not to accept such terms, and if most creditors found such terms objectionable, the market would punish firms attempting to limit liability by prior announcement in this way. [Stephan Kinsella "In Defense of the Corporation," Mises Economics Blog, October 27, 2005.] But the very fact that limited liability can be had, not by negotiating it in a private contract, but simply by filing some standard papers under the general terms of the corporate form provided by statute, distorts the market away from the voluntary nature of limited liability as it would exist under a purely contractual regime. If, under the auspices of the state's code of laws, the limited liability corporation becomes the dominant form of organization, how "voluntary" can the choice of alternatives be from the standpoint of a creditor? As Gregory White, a commenter on Kinsella's article, pointed out:
...if you can get a large immunity from debts just by the relatively smaller cost of incorporating, why wouldn't a self-interested investor/owner do so?
So once every firm of any substantial size is incorporated, what real 'agreement' (really choice) is there?....
Rothbard is saying people should be free to incorporate, and I agree. He's also saying government should have nothing to do with it, including an explicit grant of immunity from debts (by "privilege of limited liability" and charter grants), as I originally said and you rejected.
With limited liability to debts granted by government charter, the "right of a free individual" to effectively choose the contract is destroyed by implication. In practice they have little choice but to accept the limited liability condition, since it is a government granted privilege that any business person would quickly seize on.
...The legislation distorts the market by destroying some measure of bargaining power on the part of creditors.
In response to Kinsella's claim that the government merely duplicates the effect of private contract ("The government only helps hang a bright neon sign recognizing that the shareholders are broadcasting to all third parties: if you deal with us, you can't come after our personal assets"), White responded:
...[The "sign hanging"] guarantees an immunity, destroying possible terms of negotiation. Without government, the corporation can do no more than ask for agreement (sure, they can "announce" their resolute terms as well as I can announce the sky is green). If you were to say that many contracts, and maybe even most, would end up the same way if it were solely private, I would probably agree. But that won't be the limit. The government distorts the market here -- no question about it. And that distortion plays into natural rights. Some will not be able to recover their own property, where without the distortion, they could have otherwise formed a different contract. It will distort bargaining power in some circumstances. No doubt about it. [Ibid.]
Whether or not it could be established by mere contract in a hypothetical scenario, the understanding of the corporate entity status that emerged from the late nineteenth century on was a radical departure from the earlier understanding of the property rights of individual shareholders in a joint-stock corporation. To that extent, the modern corporation with separate entity status really is fundamentally different from the earlier joint-stock corporation. As understood under the earlier doctrine, the property rights of the individual shareholder really were analogous to those of a partner. The understanding is exemplified by the majority opinion in the Dartmouth College case, in which any amendment to a corporate charter, or indeed "any fundamental corporate change," was considered a breach of the shareholder's contract, a "taking" of his property. All such changes had to be consented to unanimously by shareholders, in exactly the same manner as members would consent to the change in terms of a partnership. Under the modern understanding, on the other hand, the corporation is an entity separate entirely from any or all individual shareholders, and governed by a simple majority vote. [ Morton Horwitz, Transformation of American Law (1870-1960), pp. 87-89.]
In addition, many critics of the corporate form argue that the "corporate veil" dilutes legal responsibility.
It is true that officers and shareholders are technically liable for criminal acts, and not legally exempt for criminal behavior under the corporate form, as Kinsella argued. ["In Defense of the Corporation"] And as Joshua Holmes pointed out:
Limited Liability is not at all absolute, as many libertarian detractors seem to imply. In cases of fraud, or where the corporate does not have sufficient independence from its shareholders, courts will "pierce the veil". When courts pierce the veil, plaintiffs against a corporation can indeed hold the shareholders directly liable. This often happens when the corporation is undercapitalised, that is, when the corporation obviously doesn't have enough assets to cover its liabilities. This happens surprisingly frequently, and more often in torts cases than contracts cases. [Comment under Kevin Carson, "Corporate Personhood" April 24, 2006.]
But as van Eeghen said above, the corporate form is a departure from the common law, in its attenuation of ownership and personal responsibility. Sheldon Richman made a similar observation, raising the issue of
whether one is at all responsible for what happens with one's property. It's not a matter of merely giving money to the company. Unlike creditors, shareholders supposedly own the corporation, but if their "property" injures someone, they are out of the liability picture altogether. This is a strange notion of property. The real owner is a fictitious person, while the real persons are not real owners. If one has no liability, one has no incentive to pay attention to how "one's property" is being used. [Ibid.]
With ordinary forms of property under the common law, the burden of monitoring one's property and avoiding the criminal or tortious use of it by one's hired agents is assumed to lie with the owner. With the corporate form, the owner may not be exempt from liability, but the normal presumption is the reverse.
The corporate veil seems deliberately designed to dilute or obscure personal responsibility. The corporate form provides shareholders with all the benefits of ownership, while freeing them from the normal responsibilities associated with property ownership under the common law. An ordinary property owner is expected to take reasonable care in overseeing it, and exercise reasonable supervision over his hired overseers, or risk being charged with negligence if the property is misused to someone else's harm. The corporate form serves not only to absolve the owners of such responsibility, but to make the exercise of responsible control impossible. It functions, in many ways, as a form of "plausible deniability," increasing the difficulty of assigning blame for malfeasance.
Corporate officers, under pressure from "the market for corporate control" to increase profit margins (without overmuch scrupulosity on the investors' part as to what means management uses to achieve the result), are put in a double bind. As "quasibill," an astute commenter on my blog, remarked on my review of van Eeghen's articles:
The reality is that management does get directives from the shareholders, in the form of a demand for greater dividends/share prices. Management does respond to this directive, sometimes at the expense of innocent third parties. And management does present this situation as a defense - "I would've been fired had I paid for a proper truck driver for that route!" and often juries/factfinders will buy that defense - implicitly finding that it was the shareholder's demands that caused the negligence. [Ibid.]
"Who will rid me of this turbulent priest?" If anyone considers the expression "plausible deniability" overblown, consider this bit of legal advice:
First, the corporate veil is always disregarded by courts for criminal acts of the officers, shareholders, or directors of a corporation. Further, federal and state tax laws generally impose personal liability on those individuals responsible for filing sales and income tax returns for the corporation.
For most other matters, the corporate veil is most often pierced by courts in situations where the shareholders of a corporation disregard the legal separateness of the corporation and the corporation acts as nothing more than an alter ego for the shareholders' own dealings...
It is essential that minutes be maintained of board and shareholder actions. Corporate minutes are the first line of defense against the IRS, creditors, and other parties making claims against the corporation, particularly if a claim is based on a theory that the corporation should not be taxed as a corporation or afforded limited liability (piercing the corporate veil). Minutes can be the written record of meetings or the unanimous written actions of the directors or shareholders taken without a meeting. Either is acceptable, if properly done. Many closely-held corporations fail to keep even annual minutes, which greatly weakens the position of the corporation and its shareholders, directors, and officers in many circumstances. Regular minutes can also:
Prevent IRS claims of unreasonable compensation of executives who are shareholders
Protect against IRS claims of excess accumulated earnings
Create defenses against lawsuits attempting to establish personal liability of directors or officers, by evidencing board business judgment and specific authorization
Protect against spurious lawsuits of minority shareholders
Establish authority for corporate actions for the benefit of outside parties
Minutes of a meeting should be prepared by the Secretary of the Corporation, signed, and then approved by the Board or shareholders, as the case may be, at the next meeting or in the next action. This will minimize any claim that the written minutes do not accurately reflect the action taken. Minutes should always reflect that proper notice was given or waived, who was present and who was absent, and that a quorum was present. Any abstentions or dissents on a vote should be noted for the protection of the director abstaining or dissenting. In a closely-held corporation, meetings are often held to create minutes rather than to make decisions, but holding formal meetings with parliamentary procedures tends to result in more deliberate and organized decision- making and is recommended if practical.
It is equally important that minutes be limited to material which helps and not hurts the corporation. Resolutions should be set forth. The fact that a report was given or a discussion held on a subject should be noted. Statements made by a director or the actual content of a report or discussion, however, should generally not be included, since these references tend to be damaging more often than not. Claimants of a corporation will many times establish their case on the basis of minutes which were too detailed. It is also important to maintain a climate in which each director feels free to say anything during a board meeting and know that it will be strictly confidential and not later show up in a written record describing the board's deliberations. Generally, only formal resolutions adopted by the Board should be set forth in minutes.
It is advisable to review any other detailed descriptions in minutes with legal counsel before completing them. ["How to Avoid Piercing of Your Corporate Veil." Click&Inc. The Internet's Only Customized Incorporation Service for Home & Small Business Owners.]
In other words, do the minimal amount of documentation to cover your posterior and pay homage to the corporate form, but avoid specific details as much as possible, so that participants can distance themselves from the decision-making process after the fact.
Although shareholders and corporate officers are liable in theory for malfeasance, in practice the standard is applied far differently to the corporation, and the sole proprietorship, respectively. As "quasibill" points out,
agency law is a major source of liability for sole proprietors, but is arbitrarily cut off in the case of shareholders merely by invoking the statutory grant of incorporation. One can argue that the corporate veil can be pierced, but the standards are not the same; in essence, so long as the shareholder is extremely negligent in how the business is run, he's insulated from responsibility. In contrast, agency law places a burden on a sole proprietor to be responsible about his choice of agents.
[The shareholder is protected], so long as [he] can demonstrate that he "respected the corporate identity." So, as long as he didn't mix and mingle assets, or fail to hold corporate meetings, he's protected from liability. In fact, so long as he colludes with his fellow shareholders, he can make it airtight by demonstrating that after all corporate formalities were followed, they all voted for the same result. In this case, they are all enforcing their own claim to having respected the corporate personality, thereby benefitting all of them equally.
In contrast, a sole proprietor who turned the day to day operation of his business over to a hired manager would be bound by the acts of his agent that were taken in the scope of the agency, period. The sole proprietor is responsible for choosing that person and imbuing him with authority. Especially if he didn't supervise the manager very well and the manager uses the business to defraud customers. It doesn't take much to see that a sole proprietor could be held liable for his negligence in such a situation. In contrast, the shareholders are actually encouraged to take LESS care in how the day to day manager is operating the business. The less care he takes, the more he can claim he respected the corporate personality.
It doesn't mean that he will always be held liable when the agent acts negligently in the scope of the agency, but he can be. And that is more than can be said about shareholders, so long as they obey the rituals set forth in business incorporation statutes. [Comment under Stephan Kinsella, "Sean Gabb's Thoughts on Limited Liability," Mises Economics Blog, September 26, 2006]
In countering the argument from the shareholders' moral responsibility, Kinsella is put in the rather akward position of repudiating much of what Mises said about the entrepreneurial corporation, and giving a great deal of ground to Berle and Means on the divorce of ownership from control. As we shall see in the chapter on the calculation problem, Mises repudiated the idea of the managerial corporation, and made a clear distinction between the bureaucratic and entrepreneurial organization. The entrepreneurial corporation, no matter how large, is simply an agent of the owner's will; the owner's will is enforced by the magic of double-entry bookkeeping.
Kinsella, on the other hand, was obliged to distance the stockholders as much as possible, as theoretical owners, from the workings of the corporation:
It is bizarre that there is this notion that owners of property are automatically liable for crimes done with their property... Moreover, property just means the right to control. This right to control can be divided in varied and complex ways. If you think shareholders are "owners" of corporate property just like they own their homes or cars--well, just buy a share of Exxon stock and try to walk into the boardroom without permission. Clearly, the complex contractual arrangements divide control in various ways: the managers, etc., really have direct control; subject to oversight by the directors... etc. But even here--to get a loan, the company has to agree to various covenants w/ the bank, that condition its right to use property. Even though the law would not call the bank an "owner" praxeologically it of course has a partial right to control the property. If you have a contract allowing rentacops to patrol the building--hey, they are partial owners too. If you are leasing from a landlord--so do they. If you allow the plumber in to fix the building--he has temporary right of control too. So what? [Comment under Carson, "Corporate Personhood."]
In a correspondence with Sean Gabb, Kinsella "raise[d] doubts about the effective control that shareholders have over their companies, and wonders if they should not rather be placed in the same category as employees or lenders or contractors." The answer, Gabb said, is that shareholders are "the natural owners of their companies. They have not lent money to them. They are not providing paid services. They are the owners." [Sean Gabb "Thoughts on Limited Liability" Free Life Commentary, Issue Number 152, 26th September 2006.]
In a subsequent article, Kinsella took up the same question, albeit in somewhat milder terms.
...it seems to me the default libertarian position is that an individual is responsible for torts he commits. If you want to hold others liable for this too, you need to show some kind of causal connection between something done by the third person, and the tort committed by the direct tortfeasor. You seem to assume that this connection is present in the case of a shareholder because he is the "true" or "natural" owner of the company's assets. This I think is what troubles me the most--it seems too much of an assertion to me. [Stephan Kinsella, "Sean Gabb's Thoughts on Limited Liability."]
Now, at least in theory, there is a big difference between the shareholder, on the one hand, and creditors, managers, and associated other parties, on the other. The shareholder is the residual claimant, the owner of the firm, and the principal; the management are his agents. The creditor's position, as opposed to that of the owner or residual claimant, is only to a "contractually defined absolute return." [Quasibill comment under Ibid.] It was of great importance to Mises to demonstrate that the owner's control of the corporation was real, and that the management were entirely his agents. Kinsella, on the other hand, is apparently so dead set on helping the shareholder to evade the responsibilities of ownership, as to identify ownership with "control," and to argue on that basis that since management is in the most direct position of control, the "ownership" of the shareholders is ambiguous at best.
Kinsella ridiculed the common law concept of absolving an employer from respondat superior, on the grounds that his employees were on a "folic." [Ibid.] But that makes perfect sense, given the way property ownership was treated under the common law. The property owner was presumed responsible for how his property was used, under normal circumstances, including the presumption of reasonable care in the supervision of those to whom the management of his property was entrusted. A "frolic," as comical as the term may sound to modern ears, was simply an exception to this strong presumption of responsibility, a case in which the owner was held not to be responsible owing to circumstances beyond his reasonable control.
But consider: the basis for respondeat superior (and I bring this up [because] it seems to me something along the lines of this principle must be employed to hold the shareholder liable for acts of employees) has to do with the employer's practical right or ability to control or direct the actions of the employee (this principle probably underlies the "frolic" exception too). Can we assume that this control is present when we move further back the chain of causation? Say, to the directors, who appoint the managers? Or to the shareholders, who elect the directors? And if practical control is one of the main relevant features that determines whether there is liability, again, why couldn't lenders, employees, suppliers, customers, etc. at least potentially be held liable? In some cases they exert more control and give more "aid and comfort" or "aid and abet" in more visible and substantial ways than a mere shareholder....
....You conceive of a shareholder as the "natural" owner of the enterprise. I am skeptical of relying on the conceptual classifications imposed by positive law. To me a shareholder's nature or identify depends on what rights it has. What are the basic rights of a shareholder? What is he "buying" when he buys the "share"? Well, he has the right to vote--to elect directors, basically. He has the right to attend shareholder meetings. He has the right to a certain share of the net remaining assets of the company in the event it winds up or dissolves, after it pays off creditors etc. He has the right to receive a certain share of dividends paid if the company decides to pay dividends--that is, he has a right to be treated on some kind of equal footing with other shareholders--he has no absolute right to get a dividend (even if the company has profits), but only a conditional, relative one. He has (usually) the right to sell his shares to someone else. Why assume this bundle of rights is tantamount to "natural ownership"--of what? Of the company's assets? But he has no right to (directly) control the assets. He has no right to use the corporate jet or even enter the company's facilities, without permission of the management. Surely the right to attend meetings is not all that relevant. Nor the right to receive part of the company's assets upon winding up or upon payment of dividends--this could be characterized as the right a type of lender or creditor has. [Ibid.]
This is a long step from Kinsella's initial argument that the corporation was simply a contractual device for property owners to pool their property and appoint managers for it as they saw fit. He winds up, as quasibill comments, "intimat[ing] that there is no real owner of corporate property - that an abstraction... [has] property rights." [Comment under Ibid.]
He does not seem clearly to grasp just how much baby he is throwing out with the bathwater. In legal theory the shareholders are the owner, and corporate managers are the appointed agents of their will, responsible to them in a way that they are not responsible to lenders; so by arguing this Kinsella is in effect conceding much ground to those like Berle and Means and Galbraith who argue that the "private" ownership is a legal fiction, and that the corporation is a quasi-state institution controlled by managers with certain contractually defined obligations--mostly usufructory--to shareholders. Mises' arguments regarding calculation all assume an "entrepreneurial" corporation that is really an extension of the owner's will and judgment; Mises saw the Berle/Means/Galbraith argument as a challenge to be overcome, and his distinction between the bureaucratic and the entrepreneurial large organization is central to his attempt to refute them.
Kinsella's defense of the shareholder based on the lack of control misses the point. He wrote:
You [quasibill] see a sole proprietor as responsible for employees' torts; yet you think there is an artificial exemption for "joint owners". If they just "stand in the shoes" of a sole proprietor, why aren't they collectively liable?
But a sole proprietor is liable because he directs the actions of the negligent employee, and actually runs the company--sets policies, controls is, manages it. In a joint stock company, the shareholders don't do any of this. They elect the board, which appoints managers. In my view, the managers are more analogous to the sole proprietor than the shareholders are.
....Hessen here is making the same basic causation point I have made here: that vicarious liability must be relied on to hold someone liable for the servant's actions--and in the case of a sole proprietorship, it is reasonable to do so because the proprietor/master is hiring, training, supervising the servant/employee. But in the case of a joint stock company, the same idea applies only to those sharehlolders who "play an active role in managing an enterprise or in selecting and supervising its employees and agents."
This makes sense to me. Merely being a shareholder is not sufficient. It's having control. I believe most of the corporation opponents have some view that inherently connects liability to property. I think this is confused and wrong. Liability flows from one's actions--from control--from causing the harm to occur.... [Comment under Ibid.]
But claiming the absence of control is not a defense, because it begs the question of whether they should have exercised more control. The proper question is whether property ownership ought to entail some minimal level of oversight and responsibility, and whether one of the benefits of the corporate form (from the owners' perspective) is that it enables the evasion of that responsibility. Arguably, doesn't the very act of delegating control of property in a way that makes one's own direct oversight less feasible, in itself make one liable for any resulting malfeasance by one's agent? Isn't the absentee owner negligent precisely because he put himself in a position in which he exercised little or no control over how his agents used his property? Isn't one of the virtues of the corporate form, from the owners' perspective, precisely that it entitles them to the profits resulting from management's shady behavior, and enables them to fire managers for failing to produce an adequate level of profit by any means necessary, while absolving them from responsibility for the actual means used by management--in short, that it creates plausible deniability?
And as quasibill repeated, the standard of accountability for the actions of one's agents is qualitatively different under a sole proprietorship and a corporation. The sole proprietor is
the ultimate owner, who has the right to decide that someone else will run the company.... But the manager ultimately derives his authority from the owner, who has non-permanently delegated it to him. This delegation is, in itself, an act that has consequences in the world. For this act, the sole proprietor can be held responsible, including a situation where the sole proprietor hired a dangerous manager because that manager was likely to yield higher profits.
As I've noted, the shareholder's decision to hire a director is, in fact, absolutely immune as long as they follow some statutorily defined rituals. They are the ultimate owner involved, and they are the one(s) that delegate the right to control to the managers. This delegation is an action for which liability can possibly accrue, under a libertarian theory. Under current law, it can't, unless the shareholder disregards a fictitious concept. [Comment under Ibid.]
So there is an irresolvable contradiction in the Hessen-Kinsella understanding of property rights in the corporation. Such defenders of the corporation start out by defending it as a normal outgrowth of private property rights and the right, by free contract, to make arrangements for governing one's property. But before they're done, they wind up minimizing the property relations between individual shareholders and the corporation. The overall effect is one of deliberate ambiguity, n which the corporation is treated as property in the ordinary sense, or as an instrument of the shareholders' exercise of property rights, only when convenient. There is a contradiction in saying the corporation is merely a contractual arrangement for arranging property, like a partnership, and then minimizing the property relationsship or responsibility of an particular property holder. Either the corporation is just another form of partnership, in which case shareholders are the real legal actors, or the corporation is a state-created entity for privatizing profit while attenuating responsibility. It can't be both ways.
Interestingly, some defenders of the corporation have been quite aware of the contradiction.
The main value of a corporate charter arises from the fact that powers and privileges are thereby acquired which individuals do not possess. It is this that makes the difference between a business corporation and a partnership. In the former there is no individual liability.... There is no death.... It is not policy therefore for a corporation to break down its own independent existence by burying its original character in the common place privileges of the individual.... Any mingling of corporate existence with the existence of the shareholders will weaken corporate rights. [Dwight A. Jones, "A Corporation as 'A Distinct Entity,'" 2 Couns. 78, 81 (1892), in Horwitz, The Transformation of American Law !870-1960, p. 91.]
Jones defended the attenuation of shareholder liability under the entity form, in terms quite similar to Kinsella. But he perceived much more acutely than Kinsella that this defense comes at a price: it completely rules out any defense of the corporation in which the latter is an ordinary contractual expression of the property rights of the shareholders, in the same sense as a partnership.
Even those defending entity status, like Hessen and Kinsella, as an outgrowth of ordinary private contracting akin to the partnership, faced difficulties. The most notable proponent of the "natural entity" doctrine (favored also by Hessen and Kinsella) was Ernst Freund, author of The Legal Nature of Corporations (1897). Freund attempted to reconcile the status of the corporation as a representative entity governed by corporate rule, with an individualist understanding of it as the sum of its parts in the same sense as a partnership. Nevertheless, he was somewhat put off by the fact that corporate powers were vested directly in the board of directors. The practical effect, he was forced to admit, was that
corporate capacity [was] thereby shifted from the members at large to the governing body.... Such an organization reduces the personal cohesion between the [shareholders] to a minimum, and allows us to see in a large railroad, banking or insurance corporation rather an aggregation of capital than an association of persons [Quoed in Horwitz, The Transformation of American Law 1870-1960, pp. 102-103.]
Henry Williams argued, in an 1899 American Law Register article, that shareholders "possess[ed] no actual existing legal interest... whatever" in the corporation. They were equivalent in law to "the heirs, or next of kin or residuary legatees of a living person" (and I leave it to the reader to guess who the "living person" is). Their legal rights accrued only at dissolution, and even then their rights were "entirely subsidiary" to those of creditors. [ Ibid. p. 103. ]
In the same regard, almost directly contrary to Mises' perception, the market for corporate control, far from an instrument of the absolute property rights of the entrepreneur, has been associated with the attenuation of shareholder property rights in the corporation. As we saw above, the modern corporate entity status required a shift to majority shareholder control of the corporation, and an end to the earlier understanding (reflected in Dartmouth) of the shareholder as possessing absolute property rights analogous to those in a partnership. The result, by the early twentieth century, was a common legal understanding in which "the modern stockholder is a negligible factor in... management," and in which a sharp distinction was made between the status of "investor" and "proprietor." [ Ibid. p. 93.] The shift was encouraged by the rise of public securities markets. Until the 1890s, public issues of stock were rare and public trading (outside of railroad stock) almost unheard of. In an environment in which the issuance of stock was still largely private and associated with the formation of joint-stock companies, it was more plausible to regard investment in a corporation as equivalent to buying into a partnership. The creation of public equity markets, in which shares were commonly acquired by those with no direct role in the formation or governance of the firm, and bought on an anonymous market rather than issued directly to the shareholder by the firm, made the cultural holdover far less tenable. It became virtually impossible to maintain with a straight face the earlier "trust fund" doctrine of Dartmouth and other decisions, in which the shareholder was a partner with absolute property rights in the governance of the corporation. [Ibid. pp. 96-98.] By the turn of the century, the board of directors was clearly coming to be seen as the agent, not of shareholders, but of the corporation as a separate entity. [Ibid. p. 99.]
Finally, I can't resist pointing out that defending the status of corporate management as agents for an imaginary collective entity, an entity with distinct property rights of its own and capable of making contracts in its own name and otherwise acting as principal, puts Austrian economists in a rather odd position, given their usual professions of "methodological individualism."