The Abuse of The Corporate Form: Why Corporations Are Out of Control

Part I

Since the 1990s headlines have blared about outrageous CEO pay. Politicians, Bill Clinton is one example, had pledged to “putting people first” to end it. All to no avail.

Analysts and economists have criticized the ever-increasing corporate buybacks for a decade or so because of their role in increasing economic inequality. Also to no avail.

At the same time corporations have been given unlimited power to control politicians through political donations.

All these failures at reform occurred because of a general lack of understanding of what a corporation is.

Corporate Personhood

A corporation is a legal form through which a business is carried on.

The purpose of a corporation is to give investors and entrepreneurs the chance to start-up or speculate in a risky business, but not lose their personal assets if the business goes bust. Businesses or banks that give credit to the business, must assess the risk that the business can pay on its own and not consider the personal assets of the shareholder. This is called “limited liability”. To achieve this, government legislation has created the corporate entity as a legal fiction separate from the identity of the shareholders, the humans, who are called natural persons or individuals. In legislation, the term ‘person’ is often defined to include natural persons and artificial persons.

The legislation that permits the creation of a corporation usually sets out its powers so that it can carry on business just like a natural person. A corporation is given the power to do deals (make contracts), sue and be sued, and such as a human, as is necessary to conduct business. For example: New York Consolidated Laws, Business Corporation Law — BSC § 202. General powers

This may seem a picky point, but the corporation is a legal form not a business. And that’s going to become relevant later when we deal with unsupported assertions that the purpose of a corporation is to make money for shareholders.

How Limited Liability Works

There is no better example of limited liability in action than the 1897 British case of Salomon v Salomon

In a highly contentious and seemingly unfair situation, it set the law on point for all common law jurisdictions and remains one of the few common law decisions that has been unchanged for over 120 years.

In that case, Aaron Salomon had a shoe manufacturing business. He incorporated a company, Solomon, Ltd., and sold his business to the company, which had no cash to pay, taking back a mortgage on the assets for their full value. Salomon Ltd. conducted business buying supplies on credit. Eventually, Salomon Ltd. went broke. Salomon seized its assets pursuant to his mortgage. The creditors cried foul, but the court said that the two, Salomon, the human, and Salomon, the legal fiction, were separate entities in law, and the mortgage was good.

So, from that day forward, creditors knew that if they advanced credit to a corporation, they would have only its assets to seize on default — and they may be mortgaged to the hilt, sometimes to the shareholder in a creditor protection scheme just like Aron did.

And so we have those very unfair situations in which to see a business go bankrupt, leaving its creditors unpaid, and yet see its shareholder driving around town in a Maserati — and sometimes even being elected president.

The Corporate Structure — In Theory

Economic historians credit that the rise of the economies in the West, far above those in other areas of our globe, is due to several factors, but one of these is the concept of the corporation.

The brilliance of the corporation is that it splits the aspects of ownership. Ownership is control. So that power is split among three entities: shareholders, Boards of Directors and the CEO.

Shareholders are not owners. In a small one or two person corporation, the shareholders may occupy all roles and not distinguish in which capacity they are acting. However, in a public corporation, the limited ownership powers of a shareholder can be clearly seen. Buy one share of Apple computers, go to Cupertino and try to get past the reception desk.

Giving up power is the trade-off for shareholder limited liability. If Apple goes bust, the creditors cannot seize your personal assets as a shareholder.

Corporate legislation sets out the very limited powers of a shareholder, such as the right to financial statements once a year; to attend the annual general meeting (AGM) and to elect the members of the Board of Directors; and to dividends, but only if the Board of Directors declares dividends. A few other minor rights, but those are the essentials.

The Board of Directors has the power to make policies, but most importantly, to hire and fire the CEO and set their pay. The CEO has the daily management of the corporation.

In theory this resembles the structure of a democratic-republican government with voters, Congress and the executive branch. And perhaps there is some similarity. As a shareholder, you will feel just as impotent as a voter.

However, this explanation is the theory, the practice is much different.

Next article: Part II — The Structure of The Corporation — In Practice

Acknowledgement: Photo by Pixabay: