Who “Owns” a Corporation?
I have become quite a fan of David Ciepley this summer. He, amongst many I am sure, is blazing a trail through the morass of corporate law and providing new insights into the role and status of the animal we know as the “corporation”.
Anyone with an interest in the role business plays in the economy needs to understand what Ciepley is saying.
In one talk he gave, at MacGill University, the introductory remarks by his host were illumination in themselves. The occasion was a presentation and interdisciplinary discussion about the corporation and its role in shaping the social landscape. The host rattled off the university departments and working groups involved in the discussion in his welcoming remarks. There was no mention of economics. The omission tells us all we need to know. Economics cannot engage, easily with other disciplines in discussions about the organization of business because it cannot recognize the reality associated with said organization. This is not to say that somewhere in the great archipelago known as economics there isn’t some little island of thought about institutions — at one time that island was much more significant — but nowadays the need to crush everything into an anti-social market driven explanation makes the odds of communication with such distant shores very difficult if not impossible.
Which is a shame because I think the key to understanding the contemporary economy requires a solid knowledge of modern business theory, that theory is, after all, simply an expression of neoclassical thought. It is mid-twentieth century economics packaged as organizational technology, and as such, is one of the most powerful innovations and foundations upon which our economy rests. The arc of wages since the 1970s depends upon the incessant and pervasive uptake of that organizational technology. As does the subsequent woeful policy reaction, the supine regulatory response, and the invasion of politics by corporate-financed interests.
This technology has one idea at its core which gives it supreme simplicity and ideological power. That is the idea of shareholder value.
Which gets me back to Ciepley.
Most theories of the firm within economics pick up the narrative with the existence of the corporation as a given. They then bend over backwards to retro-fit this highly centralized pseudo economy into the larger free market narrative preferred in all major textbooks. In so doing they blithely ignore Alfred Chandler’s famous explanation for the rise of modern business organization, which he argued became possible “only when the hand of management proved be more efficient than the invisible hand of market forces”.
Chandler, being a historian rather than an economist, was more interested in reality than in hypotheticals. He understood and tried to explain the actual landscape of large-scale business. I have always wondered what would have happened to economics had it absorbed the true gist of the challenge issued by Coase in 1937. The impudence of that challenge has never been fully understood. Coase asked simply: “why do firms exist?”. After all if market forces are as supreme as the textbooks tell us, there is no room for business organization at all. We ought be able to accomplish all our transacting through a web of contracts in the open marketplace.
Indeed the most common response of economists to the challenge represented by business organization is to argue that a business organization is simply such a web of contracts. In this view we can continue to ignore any oddities of business organization since it is indistinguishable from the market. In this view the firm exists at a “nexus of contracts” and has no special attributes that cannot be negotiated and contracted for in the marketplace.
Except this is not true.
The corporation, as Ciepley and his ilk tell us, is a unique vessel. It has capacities and attributes unavailable in the marketplace. And it precisely these attributes that make it so convenient for the execution of large-scale business.
The concept of the corporation pre-dates the modern economy and industrialization by centuries. It has its roots way back in the Roman era. It was adopted along the way by all sorts of organizations needing the advantages it brings. Those advantages include being able to act as a “legal person” for the purposes of property ownership, being able to enter into contracts in its own name, and having legal standing for the purposes of being sued or suing on its own behalf.
And right there, if we ponder for a while, sits a conundrum for the purveyors of shareholder value.
If we pull on the string hard enough we discover that shareholders do not own corporations. They are simply one group, amongst many, that have varying degrees of financial claims against the corporation. They do not own the corporation’s assets. The corporation does. The myth of shareholder ownership exists only because of subsequent laziness on the part of analysts, and on the ideological preference of neoclassically oriented legal and business scholars: The Chicago School take a bow!
The reality is more complex.
The corporate form as we know it is an adaptation of its medieval precursor. It came down to us via the colonial experience where it proved very useful as a vehicle for assembling capital to take on large-scale trading ventures, exploration, and, eventually, colonization. Those same virtues linger on in its modern business form. Perhaps least recognized is that the corporate form of organization is that of a mini-state. It has the same ability to regulate itself as any modern constitutional state with the exception that its internal statutes must not contradict those of the state where it obtained its original charter. Our separation of the economy into two domains, public and private, needs an addition: the quasi-state of the corporation.
As long as its internal rules are not “repugnant” to the laws of the state the corporation can establish any internal rules it likes. And since no one actually “owns” the corporation, its existence depends only on an originating charter, which is a delegation or power by the state. The corporation truly is a state within a state.
Be logical about the establishment of a new corporation: a charter grants it legal existence; that existence allows the appointment of a Board with fiduciary responsibility to uphold the charter; and then the Board seeks financing to bring the hitherto legal-only corporation into physical reality. So the existence of shareholders, if they are a source of that funding, is secondary to the existence of the corporation. That most corporate charters are sought by people who subsequently provide the funding should not allow us to miss this crucial sequence. Their existence as shareholders is not the same thing as the existence of the corporation. The latter is its own entity, with its own, and prior, legal standing.
Shareholder value thus sits on a false premiss — a rotten one at that.
And the rest, as they say, is history.
Anyway, go read Ciepley. He can explain all this much better than I do.
Addendum:
For those of you carrying the torch for New Institutional Economics, I recognize the effort. The problem, as I see it, is that NIE still tries to force the square peg of organizational reality into the round hole of equilibrium-oriented market-based analysis. Transactions cost minimization is a valuable idea only if we recognize that, ultimately, that it implies the secondary nature of the marketplace in the organization of complex business activities. So textbooks need to be re-written. We ought to start with an explanation of the economy through the prism of business organization. We then could talk about the exceptions, one of which is the marketplace. The other of which is government.
Such a narrative seems to recognize reality. NIE seems still to be bending over backwards to allow the market to retain a supremacy, which if it ever had, has long since disappeared. Markets and hierarchies may be substitutes for one another in theory, but in practice the pragmatic choice is always the hierarchy.
