The Corporate Form, Limited Liability, and the State
A common complaint of anticorporate libertarians and self-described anarchists is that corporations are creatures of the state. The limited-liability feature of the corporate form, they claim, and the ability of corporations to raise large amounts of capital are state-granted privileges.
Two important replies to such claims must make their way into cultural awareness: (1) we need corporations if we want any decent standard of living; and (2) these corporate powers would exist without the state. FULL ARTICLE
Comments (57)
There are two problems with this blog. The first is that it doesn't support the either point. In fact closer examination reveals that exactly the opposite of these points is true.
If 'corporate entities' were so important to maintaining our standard of living I have all the faith in the world that a good entrepenuer would find a way, through the free market, to raise these funds. It is true that the idea for a corporation did not come from the government but like other things the government hijacked the idea and turned it into the limited liability structure that it is today.
The thing that promotes ethical business practices in a free market is the knowledge that you have a lot to lose. Every decision is based around the idea that if it is a wrong one there are consequences. Unfortunately the current corporate structure is so skewed by the government that a corporation no longer has to worry about the true consequences of their action. There are abitrary consequenses set into place by the government.
Beside the very lenient consequences put onto corporations by the government the only other motivator for ethical business practices is profit. Investors no have to worry about anything but the profitability of a company before sending their money.
I guess the point I am trying to make is that in a free market there is multiple motivating factors. Profit is just one of them but by no means the only one. Without the true cnsequences of negative action every other action is skewed. The problem is not the corporate sructure the problem is what government has done to the structure.
Published: December 24, 2007 11:20 AM
That less risk comes from government regulation which means that corporations have a large amount of malinvestment.
I'm still not convinced that the current corporate structure, with it's lack of responsibility, could exist without the state.
I'm not sure that innovations are promoted by the corpoate structure. Hear me out. As a company expands so does it's bueracracy. Thats what allows new companies to enter the market when a corporation has a hold over most of the market of a particular product. It is these new companies that drive innovation. With a lack of consequence it becomes much harder for these new companies to drive out the less innovative old companies.
Published: December 24, 2007 11:51 AM
Use of ad hominen language such as "self-described anarchists" and "economically ignorant claims" is hardly constructive in this ongoing debate.
Please keep the punches above the waist. ;-)
Published: December 24, 2007 12:24 PM
This post misses the point regarding incorporation and government provided immunity.
The argument against incorporation as a merchantilist legal device reduces to the following:
When corporations are penalized by large fines, this allows "pooling" of resources to cover (pay for) ostensible crimes committed possibly by only a few individuals. In this sense, wrongful actions are encouraged in any instance where the penalty for the crime is spread over a large number of share holders, rather than paid expressly by the perpetrator of the crime(s).
This pooling of penalty costs allows specific individuals to take actions they would or may not, were they not protected by laws of incorporation, and would they have to pay the entire legal penalty of their crime.
The law of incorporation distorts legal penalty in the same way artificial lowering of the interest rate distorts price signals. It allows for a lowering of the "price" for specific wrongful actions, specifically those actions covered by incorporation.
But this incorporation "contract" is one made between the monopolistic government that claims jurisdiction over the entire geographic region (entirely through force), and those who subscribe to the incorporation "program" offered by this government. Left out of this sweetheart deal is the victim of any wrongful action committed by those protected by incorporation immunity; those who choose not to sign up for incorporation immunity themselves.
This of course leaves individuals not wanting to support the monopolistic state through utilization of its "services" at a legal disadvantage. They must choose between utilizing these programs, and themselves becoming part of the monopolistic system, or, not utilizing these programs and thus constantly being subject to the actions of those who are "covered" by the incorporation immunity scheme.
Any theory that tries to justify laws of incorporation as they now exist, must treat this specific aspect of incorporation. Otherwise it offers an irrelevant analysis.
If Jones can incorporate and receive pool insurance from all his shareholders for wrongful action against Smith, then Jones has been incentivised in his action by the very same government which is supposed to be protecting Smith.
(it won't do to say that Smith will be compensated by all of Jones' shareholders. This would be to say it is OK to do crime as long as one is willing to pay financial damages)
Smith has no choice but to suffer the crime, or himself "incorporate" for his own protection, and thus strengthen and support further monopolistic practices.
Published: December 24, 2007 12:59 PM
This article strikes me as a prime example of "vulgar libertarianism" - the tendency of some libertarians to treat currently existing corporate structures as if they would exist on a free market, or as if they are the consequence of one.
I don't believe the existance or rise of private police or arbitration (something I'm all in favor of) does anything to prove that the currently existing corporate structure is or can be the result of a free market.
It's not that the government "invented" corporations, it's that the government has skewed incentives and provided special legal privileges as to allow them to amass power in a way that they otherwise could not.
Published: December 24, 2007 1:04 PM
There's so many arguments against this piece that I'm not sure where to begin. I generally don't comment on these articles even if I disagree with their conclusion, but this one was a little too much.
1. If the free market would provide something, is that a justification for government to implement something similar? It seems like it would be the opposite.
2. There is a big difference between contractual limited liability and government LLCs: In the first, someone else voluntarily takes that liability. The total liability does not change.
With government LLCs (where the liability is capped), random members of society pay the cost. In the oil spill example, that could be through a government cleanup, a charity cleanup, or by having the spill not cleaned up at all. Brad claims it is inappropriate to have stockholders in a company bear some of the risk of the company suddenly owing more than its net worth. How is it more appropriate to pass that risk to me, someone who has never invested in the company at all?
3. The bit about small-time investors being on the hook for a lot of money just seemed like scaremongering. Owing $5000 from a $500 stock purchase? When was the last time a company suddenly owed 10 times its net worth? And why would that company be a substantial portion of your portfolio? Diversification defends against the risk of excessive liability just as well as it defends against other investment risks.
4. Continuing the oil example: when someone directly involved faces the true costs of oil spills, the proper incentives are in place to ensure an "optimal" allocation of resources to preventing spills, resulting in the "proper" cost of producing oil.
Assigning the liability elsewhere distorts the market by allowing people to sell oil below the true cost, leading to an overproduction of oil and overallocation of capital toward the production of oil, with a net negative impact to society.
The shareholders of a company are its owners. There is nobody else that can (or should) bear the risks inherent in running a business. Taking away that risk (without someone else voluntarily assuming it) is unethical and harmful.
Published: December 24, 2007 1:21 PM
I want to associate myself with all of the prior critical comments on this article, and add a few more as yet unspoken.
If state force can be used to arbitrarily limit the liability of some people at the expense of others, the only limitation on what state force can be employed to accomplish is politics, which can range from genuinely liberal to rabid national socialist or worse.
If a massive industrial or other project requires such a large amount of capital that it can only be assembled through enFORCED taxation or the FORCIBLE abrogation of some persons' human rights, which is what the privilege of state incorporation wreaks upon the unincorporated, than we know for a fact that the general welfare of society would be better served if the project never came to fruition. How do we know? We know because the teachings of two great men have demonstrated apodictically that it is so.
Jesus taught that a bad tree cannot bare good fruit; that the initiation of force in the conduct of human affairs--as in taxation and incorporation--is bad and will never produce anything good.
Ludwig von Mises demonstrated that any intervention by the state in the operation of the free market, which is what statist incorporation is or does, will have a deleterious impact upon society.
Like a prvious critic, I think the impeachment of any opposing view as perforce economically ignorant only serves to demonstrated that the author's thesis cannot be logically supported by sound economics.
Published: December 24, 2007 1:37 PM
I agree with the raising capital point in the article, but I don't see it as an argument for the details of the corporate form. It indicates that there would be a stock market and publicly traded company, but does nothing to defend limited liability.
The limited liability point, on the other hand, I disagree with very strongly. Sure, something similar could develop on the market - like companies that require their customers to waive all rights when doing business. Such companies, though, would have to compete with other companies that don't ask customers to waive their rights. This is not the case when the liability waiver is a government grant.
The point about small investors is actually precisely the point, in reverse. As a small investor, I own a small portion of the company. I bought it, and if the company profits, I sure take my share of the profits. Why should I not bear the cost when the company harms someone else? To say "then no one would buy stock" doesn't answer the moral question, which must come first. We hold the officers liable - but the officers work at the pleasure of the owners, and are employees. Why should employees be held liable for decisions while their bosses are exempt?
The historical examples don't help, since all occurred under governments.
Published: December 24, 2007 1:42 PM
Why is my investment in a company assumed to confer "ownership" and therefore an issue of liability at all?
It seems to me that once that assumption is addressed, we can get past the liability issue and on to how to attract investors without selling parts of the company itself.
Such as, buying shares of the stock being produced/shipped/sold, and therefore recouping some portions of the profits from the sale of that stock. Which reminds me to ask, since when is "stock" a word which means a portion of the company itself and not its "stock in trade"?
Maybe the assumptions about liability were created by the state interventions themselves distorting the investment environment?
Just a thought. I don't think the original article is very accurate either.
Published: December 24, 2007 3:33 PM
Corporations would certainly exist without the state charters. Large-scale capital structures would certainly lead to mass ownership organizations, as, indeed, they did. The limited liability issues are minor, in my opinion. Few corporations have ever been liable for more than their net equity, and nothing in the libertarian canon would lead to a shareholder being liable for more than his actual stake without such an large liability, and many of these large judgments are more likely to actually be paid by continuation of the corporate business.
Many of the objections raised to corporate structure are, in my opinion, veiled attacks on the political influence that corporations have, but in that case, the attack should be on the state and its power, not the corporate owners excercising their rights of political activity.
Published: December 24, 2007 4:40 PM
Sadly, Mr. Edmond's article provides no explanaton why this might be so. The post is basically a host of conclusory statements tied together with a slathering of derisive comments regarding non-believers.
But, Mr. Edmonds is correct in surmising that someone needs to address this issue. I have yet to see a comprehensive response or elaboration on Van Eeghen's two-part article in the Journal of Libertarian Studies.
Published: December 24, 2007 5:22 PM
"Why is my investment in a company assumed to confer "ownership" and therefore an issue of liability at all?" -- Curt Howland
Curt, because IT IS an ownership claim. That IS the definition of share of common stock. If you want to invest in a company, yet have no ownership stake, then you buy a bond issued by the company.
I think most of the comments about this article are more than a little naive and mostly exaggerated. Such claims as,
"If state force can be used to arbitrarily limit the liability of some people at the expense of others, the only limitation on what state force can be employed to accomplish is politics, which can range from genuinely liberal to rabid national socialist or worse.",
are true as far as they go, but lenders and bondholders know precisely the risks of lending to companies with different levels of liability under the law. I say precisely, because the law is there for all to see and banks, as well as bondholders, consider this when they are deciding whether to lend money to companies. The law also says that bonds and other loans are to be paid back first if the company goes bankrupt, which means that if a company fails to meet its debt obligations, the banks and bondholders get to start liquidating the company and they get paid first.
As for all other arguments, such as the state could change the law and the state is overly corporatist, I don't disagree and the article didn't either. But look at the reasons why corporations behave badly? The tax and accounting rules (laws) are atrocious. The anti-takeover and anti-trust laws are nuts. The list goes on, but the point is that it is not "limited liability" that is causing the many (real) problems.
Published: December 24, 2007 6:08 PM
Isn't a company that doesn't have limited liability really just a business partnership? And how many businessmen, big and small, does/did something similar to what Homer Simpson did? Make Marge the actual owner of his business? More often in the real world the businessman owns the business but everything he 'owns' really belongs to his wife. It's alway 'her house', 'her car', 'her furniture', etc.
But the article rightly pointed out in the world of unlimiited liability the investor would share the losses of the investment. What was not mentioned is the real world example of one partner who takes the money and leaves the other partners high and dry. Likewise what if you're a new investor who buys a few shares in large company, it goes belly up, all the other investors had steps to protect 'their' assets, but you don't and lost everything but the shirt off your back? Similarly, just because I own a few shares of Microsoft I doubt Bill Gates will like me entering a business meeting with my two cents about the future directions for Microsoft.
A hint hint hint towards making gold the premier investment in a free markett. *
Published: December 24, 2007 6:48 PM
Good article, it has clarified for me just what exactly limited liability consists in. However, I agree in part with Mr Knott's and Andy's criticisms of the article.
Published: December 24, 2007 7:16 PM
--
Assigning the liability elsewhere distorts the market by allowing people to sell oil below the true cost, leading to an overproduction of oil and overallocation of capital toward the production of oil, with a net negative impact to society.
The shareholders of a company are its owners. There is nobody else that can (or should) bear the risks inherent in running a business. Taking away that risk (without someone else voluntarily assuming it) is unethical and harmful.
--
Truer words have never been spoken. Brad Edmonds, your claim that we need corporations smacks of social engineering. Why not let the free market decide if the LLC will survive or not.?
Published: December 24, 2007 9:06 PM
"Taking away that risk (without someone else voluntarily assuming it) is unethical and harmful"
But someone else is voluntarily assuming it. Lenders voluntarily assume it when they lend to a corporation or any company that has taken on a form of limited liability legal status. CEOs voluntarily assume the risk when they accept the high-paying job.
Published: December 24, 2007 9:47 PM
I encourage everyone to read Adam Knott's and Andy's criticisms, and keep in mind that for praxeology, all action is exchange. All action has costs and profit, and just because the incentives to perform certain non-financial transactions aren't as objectively obvious as monetary profit doesn't mean they are any less real.
Published: December 24, 2007 9:51 PM
I agree with most points made in this article, especially this:
The alternative is unthinkable: imagine getting a letter in the mail telling you that, by virtue of your day-trading investment in $500 worth of stock of some oil company, you must fork over $5,000 to help pay for the latest oil spill. Not one of us would voluntarily risk such liability; and without the limitation on liability, our level of technology and standard of living would be far lower.
Very true. Mises said that the cross over from statism to socialism is the elimination of the stock market. On the ethical issue itself, libertarian theory has nothing against the socialization of risk per se, but of private property, so the limited liability of shareholders is a legitimate property transferring contract.
Although without the state this process would probably be much more localized. Big companies like walmart would compete with some basement retail startup when negotiating limited liability contracts with shareholders. Currently, as I understand it, incorporation has many legal barriers and is a sort of government enforced oligopoly, so small start up and local merchants have to do so much more before being allowed to participate in limited liability.
But my only real issue is the one the article doesn't address, though very related and intertwined: the question of corporate legal person hood, that a corporation can declare bankruptcy, forfeiture, etc like a "body without a soul". Who will cover the losses of damages made by a company that has "legal person hood"? Restitution has to be somehow dealt with privately among the corporate directors with no "bailout" .
If not, then there will be strong incentives for uncompensated victims to demand some enforced "socialization of restitution" a "central monopoly of funds" a.k.a. the corporate income tax courtesy of a nation state
Published: December 24, 2007 11:09 PM
"Curt, because IT IS an ownership claim. That IS the definition of share of common stock. If you want to invest in a company, yet have no ownership stake, then you buy a bond issued by the company."
And thus you prove my point, that talking about investment as necessarily meaning buying shares in the company is false. There are alternatives.
You've still done nothing to tell me why a "share of stock" is and must equate to "share of the company". Oh well, semantics.
Published: December 25, 2007 8:54 AM
It's interesting to me that the purists are willing to give up the benefits that corporations provide in order to remain pure in their ideology. They share that trait with socialists.
No one will ever know whether corporations would develop in anarchy because the first corporations were tainted with the approval of government. But this is close to an ad hominem attack simply because corporations have always been associated with governments.
I can't find anything about a corporation that might disqualify it from the possibility of its being developed under natural law through the courts. Here's another way to look at it: what if, instead of ownership, shares of stock were nothing but loans? Have courts under natural law ever held the lender personally liable for every action of the borrower? I don't think so. So my guess, and it's just a guess, is that without corporations, people would simply loan money to large organizations by purchasing bonds or notes from them, which they actually do to some degree. The only difference between the bonds/notes and stock is that the investor takes all of the risk and the corporation none. In exchange for taking on that risk, the holders of stock are allowed a small amount of participation in how managers run the business.
Opponents of corporations fixate on the corporate structure, but that's not the issue. The real issue is whether or not common law would permit entrepreneurs to create new financial instruments to raise money, or would it limit them to bonds and notes. If common law would permit the creation of new financial instruments, then I see no reason they couldn't create an instrument called a stock that limits the liability of the holder just as a bond would, but allows the holder to participate in decision making through rights to vote for members of a board. In other words, the financial instrument creates the corporate structure, not the government; it's just a coincidence of history that the state has always given its stamp of approval to it. But just as the market created bonds, bills of exchange, etc., so could it have created stocks without the aid of the government.
Published: December 25, 2007 10:01 AM
It's interesting to me that the purists are willing to give up the benefits that corporations provide in order to remain pure in their ideology. They share that trait with socialists.
The "purity" label is one of most misused, most inappropriate and useless perjoratives. The Communists were not wrong because they were pure. They were wrong because they had no comprehension of the Calculation Problem -- i.e., that an economy cannot be run without prices, since economic actors have no means of making informed economic decisions. Their purity was not itself the problem -- it was the pure implementation of deeply flawed economic thinking. The more pure Communism becomes, the more clear this basic error becomes. But the purity is not, itself, the error.
And who is giving up these "benefits"? Benefits for whom? Are the benefits equally distributed? Not likely. Every economic transaction has secondary effects beyond the immediate, and it is one of the contributions of Austrian economics to identify and explain the secondary economic effects of socialist governmental action. That is the entire premise of "Economics in One Lesson."
I agree that limited liability COULD be created by contract, and doing so is generally fair and economically beneficial. But the problem with state-created limited liability is that it can never duplicate the limited liability as the market would have created.
Parties to contracts can (and do) bargain with one another over the allocation of risk of loss. But statutory limited liability supplants and destroys the parties' ability to BARGAIN for this allocation of risk.
When negotiating contracts, some parties may decide that one (or both) of them will enjoy limited liability if something goes wrong. But that limited liability, in and of itself, has an economic value, and therefore it has a price. Like everything else, different people place different value on it. The only way to know the proper price of limited liability is to allow it to be bargained for in the marketplace.
When the State declares that ALL corporate parties automatically have limited liability, the State in effect destroys the market for limited liability.
Published: December 25, 2007 10:42 AM
A few observations: (1) The poor quality of State courts makes limited liability more valuable than it would be under natural law. (2) Fiat money, inflation, and differential taxation of interest make owning equity more attractive relative to debt than would be the case under natural law. (3) If incorporation privileges did not exist under natural law, limited liability participation in the success of a corporation would likely still be available in the form of in-the-money call options, or warrants.
Published: December 25, 2007 11:26 AM
Corporations are inextricably linked to and continue to drive the growth of the state, and their manipulations continue to evoke efforts by others to use the state in opposition.
As I noted in a post elsewhere, "The concentrated wealth and long lives of corporations have long made them a special and powerful class of rent-seekers, eliminating liability for shareholders and vanquishing restrictions on life and acceptable business activities. Are citizens wrong to seek to counterbalance corporations, using in part the very tool of government that corporations have effectively seized?
"While ultimately the way forward lies in hacking back government, one cannot deny that rent-seeking by corporations has been and continues to be a major factor in politicizing and hardening conflicts that could otherwise be resolved privately. While bashing "socialists", "enviros" and other citizens groups, it behooves us not to forget the 800 lb. gorilla in the room.
"I agree completely that the best way to lessen rent-seeking is to reduce the rents that are available through government.
"This implies smaller government, but also suggests that we can make progress by focussing on breathing more life into the federalist structure of power-sharing with the states, the checks and balances between the branches of government, by limiting the ability of either political party to get a local lock on power by gerrymandering.
"I appreciate the agreement that citizens are not wrong to seek to counterbalance corporations, but you've missed a point. Corporations are the 800 lb. gorilla not because of ongoing corporate welfare - that's simply the effect. Their powerful advantages over citizens comes from their size and financial power, which derives from legislative grants of unlimited life, unlimited purposes and limited liability for their investors. To reduce government, some effort must be made to moderate these advantages."
http://mises.com/blogs/tokyotom/archive/2007/10/17/fighting-over-the-wheel-of-government.aspx
Was Jefferson was wrong when he urged:
"I hope we shall crush ... in its birth the aristocracy of our moneyed corporations, which dare already to challenge our government to a trial of strength and bid defiance to the laws of our country.
--Thomas Jefferson to George Logan, 1816.
http://etext.virginia.edu/jefferson/quotations/jeff5.htm
Published: December 25, 2007 12:27 PM
So far as I am aware, the state is unique among human institutions in that it alone claims and asserts the "authority" to initiate the use of force against innocent individuals, if for no other reason than to collect the taxes upon which the state utterly depends for its existence. Of course once it has those taxes and that authority, it always discovers a plethora of other good reasons for exercising its unholy authority and collecting more taxes to pay for those "benefits," and so on ad infinitum. In Western societies we can scarcely comprehend what institutions and associations would develop in the absence of the state and force, because we and our ancestors have seldom enjoyed that stateless state of freedom.
By no means am I anti-corporation. I am anti-state. I would be personally poorer without Walmart, but should I be grateful to the state for allowing me such crumbs of relative freedom and prosperity? Actually, freedom doesn't come in degrees. One is either free or not. I used to write letters to the editor in defense of Walmart when under attack by unionists, protectionists and the like, but I stopped doing so because Walmart is in many respects a manifestation of the state upon which it depends as utterly as the state depends upon taxation. However, in my condition of limited choice, I still shop there.
Without the state and its imposition of limited liability, a huge retailer with the buying power to keep costs and prices low like Walmart does might not exist, but my life would be richer and more abundant than it is now because of all the frivolous costs imposed upon the society I live in by the many governments exercising dominion over us, all of which are more or less corrupt. Without the state and the distortions it creates with mega-projects such as Hoover Dam, which most likely could not have been built privately, many areas of the west would not have developed and grown. However, 75 or so years later, it is just beginning to look like the great benefits of Hoover Dam may have been over development and overpopulation as the waters of Lake Mead dry up.
Published: December 25, 2007 4:30 PM
TT: "Their powerful advantages over citizens comes from their size and financial power, which derives from legislative grants of unlimited life, unlimited purposes and limited liability for their investors."
I was pretty much with you up until the statement above. Maybe I'm blind, but I can't manage to see what power corporations have over citizens. I have never had a corporation persuade me to do something I didn't want to do. As for unlimited life, that exists only as long as the corporation remains profitable; many corportions have died in the past. I'm not sure what "unlimited purposes" means. But as for limited liability, I simply repeat what I wrote above and ask 'how is limited liability for the owner of a share of stock more damaging than limited liability for the owner of a bond?' Do you corporate phobic types want to eliminate limited liability for bond owners, too?
Would we have greater freedom, wealth, or whatever measure you want to use for "better" if we outlawed stocks as a financial instrument and forced businesses to raise money strickly through bond sales? I don't think so. What's the opposite of the straw man argument? Whatever it is, I think a lot of the anti-corporate attitude is guilty of it. In the same way that conservatives exaggearated the dangers of communism and turned it into the hyper-evil enemy (and neo-cons are doing the same with muslim jihadis), libertarians and socialists are doing with the corporation.
Published: December 25, 2007 7:07 PM
TT,
The way to cut back on the power of corporations is to cut back the power of the state. Corporations are just collectives of citizens, nothing more, nothing less- to circumscribe their power is unlibertarian.
Published: December 25, 2007 11:14 PM
There is enough "Vulgar Libertarianism" going on here that it needs a thorough spring cleaning (see Kevin Carson's mutualism blog for more on "Vulgar Libertarianism" - you could possibly put that under the heading "anticorporate libertarians and self-described anarchists"). Taking things in the order of the article:-
We do not "need corporations if we want any decent standard of living"; we know this because other societies, including Victorian Britain, attained them for many people - and Britain was well on its course for greater gains before corporations became significant. Then came the First World War...
These corporate powers could exist without the state - we know that from the existence of specialised cases like monasteries in the Dark Ages or various East India Companies that provided their own state-like environment - but we don't know that they would exist without the state to anything like the extent they do today (so it isn't actually true that "No one will ever know whether corporations would develop in anarchy because the first corporations were tainted with the approval of government", as fundamentalist wrote). In fact, from the way corporate structures with state assistance crowd out other forms of activity and organisation, it doesn't seem very likely that many would exist without the state.
"The advantages of the corporate form - limited liability and raising capital - have been known for as long as mankind has had the technology to produce useful things whose production is too expensive for a single investor to handle." But those are (a) only advantages over single investors today, not over other organised forms (municipal provision of plant and premises for lease, partnerships, mutual societies, Lloyd's syndicates... there are many variants), and (b) without crowding out of individual and family wealth between the Scylla and Charybdis of corporations and government burdens like taxes, individual and family investors could do a lot more. We know this because they did, in earlier times and places: consider partnerships like Boulton and Watt, or Rolls and Royce, or the way individuals owned mines and factories in the early 19th century and even later.
A minor point: "In England, before the 19th century, a corporate charter originally could be granted only by the king, and later also by Parliament" is wrong - it needed an Act of Parliament, which means it still needed royal assent; Parliament alone couldn't do it. The process was deliberately hard, so that each application would receive full parliament scrutiny during debate. The history of the 18th century, like the South Sea Bubble, had shown the risks; Britain only relaxed the process in the face of capital going to (often German) corporations in the late 19th century. But this is as much evidence for a "race to the bottom" as for a need for corporate structures, since they had not been necessary before. In fact, early companies deliberately started as ways of keeping out competition, the way the Dutch East Indies Company started as a way of keeping non-Dutch "interlopers" out; they were deliberately created to be market imperfections.
"As to raising capital, it is obvious enough that producing inexpensive yet functional automobiles, airplanes, and even soft drinks and barbecue sauce requires huge investments of startup capital" - that is nonsense. We know because it used to happen. You can only do those things cost effectively on a large scale for certain designs, ands when you do that you often do compete better than the smaller, simpler approaches. That makes it worth working that way because you create barriers to entry, but it doesn't mean it's the only cheap way to do things at all. Even so, mass production does not need today's corporate approach; you could do mass production quite practically with a managing partnership supplying working capital and specialised equipment with other plant and premises leased from groups that funded it with bond issues, groups like mutual societies, syndicates of wealthy people, or municipalities (see above). That is not intended to be an exhaustive or mutually exclusive list of alternative approaches to concentrating capital.
"As to limited liability, the most important aspect of limited liability is that it is the investors whose liability is limited (to the amount of their investment). That means that limited liability applies to you and me, the small-change investors whose 401k retirement accounts are invested in a diversified assortment of stocks and other securities. We need this insulation from corporate liabilities to take any advantage of technology and the division of labor."
It's hard to make out what that means. Do the small investors need it to take advantage of technology and the division of labour? (a) there are other ways, and (b) they no more get real gains than the people in "People's Republics" really owned was done in their name. Does an economy need it for those things to occur within it? Again, there are other ways, and ones with actual track records too.
"The alternative is unthinkable: imagine getting a letter in the mail telling you that, by virtue of your day-trading investment in $500 worth of stock of some oil company, you must fork over $5,000 to help pay for the latest oil spill. Not one of us would voluntarily risk such liability; and without the limitation on liability, our level of technology and standard of living would be far lower."
Nonsense. Precisely that sort of thing has indeed happened. In his book Frozen Desire, James Buchan describes his great-grandfather's experience of precisely that sort in relation to a Scottish bank that failed (in those days, Scottish banks had unlimited liability). Even today, many people waive their otherwise limited liability by giving personal guarantees. What happens is, people accept the risk because they don't take it seriously. I have already covered the errors in the last sentence, but even if it were true that you need limited liability to make things work, you can get that in other ways, e.g. reinsuring your risk to a Lloyd's style syndicate.
"It is true that there are statutory protections and insurance policies available to insulate directors and officers from bad business decisions they might make. This is fitting, as we want to encourage them to take risks in the creation of wealth - we want them to attempt to develop newer and better products and services, and not all those attempts will be successful." As Brad DeLong has noted, these things make the managements expected volatility, not expected long term wealth. When things go negative, they move on. And agency costs are huge. It's like expecting politicians to transmit electorate sentiment well; the system breeds individual motives that work against it, and a cultural dynamic too. As in, "it doesn't matter who you vote for, a politician always gets in".
That systemic effect is what makes nonsense of "Your protection from their bad business decisions is to invest in a variety of securities - stocks (equity) and bonds (debt) of a variety of companies, as well as insurance, precious metals, foreign currencies, and so on. Diversify in every possible way, and a few bad business decisions out there in the corporate world won't hurt you." A couple of decades ago people tried to "diversify" loans to Mexico that way - but the loans to Mexico all had the same catches in common.
"How can I be confident corporate limited liability and aggregation of small investments into big piles of money would be possible without the state? Because contracts are possible without the state - for an interesting sort of confirmation, just check the Constitution of the United States, which admits indirectly that private contracts should be binding and untouched as private law; and that such contracts predate the Constitution (Art. I, § 10)." We don't even have to go into whether contracts could achieve this to see it is nonsense. Contracts, as understood today, positively require the state to exist, as an outside enforcing agency. States existed before the Constitution of the United States. For non-state analogues of contracts, consult the Feudal System - but with that, the buck stopped with you if someone you welched on came after you. With that no court would stop you yielding up your pound of flesh (the decision in the Merchant of Venice is based on bad law, incidentally; the original contract implies anything necessary to fulfilling it, if not invalid on other grounds).
The mechanism specified for limiting liability by contract is nonsense, because "nemo dat quod non habet", no-one [can] give what he does not have. While a business could indemnify its passive shareholders up to a point, (a) it could not stop them being joined in an action, and (b) damages in excess of what the business could cover would end up back where they started. The only practical approach I know of is the Anonymous Society common in the Romance language world, so that even if shareholders were held liable under the law they could not be held down for it (that was actually introduced to give investors confidence that the state wouldn't harass them, which the anglophone world didn't feel the need for at the time). But without state enforcement, how would investors control directors or directors control managers?
Let's conclude by finishing off the last paragraph.
"The next time you encounter economically ignorant claims that corporations are mere creatures of the state, that they could not exist without state coercion and privilege, you know what to reply: no, they're not; yes, they could." Today's corporations could not, and certainly not in such numbers, any more than today's household pets could exist in the same number and type without people, even though some of the right sort of dog can live feral.
"Corporate obeisance to and dependence on the state today is a nonargument. Corporations today don't have a choice in the matter." But this does matter to us because we aren't concerned about whether they chose it, we are concerned about whether it works to limit our own individual options. Corporate activity does crowd out other forms of economic activity, both in the unfree market place and by just as unfreely drawing in capital that could have been used by others in other ways. And, of course, this feeds the strength the state uses to keep this sort of thing going and change the very nature of corporations from emanations of freely associating individuals to something more far reaching and insidious. Even if all this didn't harm us directly through the corporations themselves it would still harm us indirectly by feeding the beast. So Yancey Ward is wrong to write "Corporations are just collectives of citizens, nothing more, nothing less - to circumscribe their power is unlibertarian".
Published: December 26, 2007 1:29 AM
I think the real key to the article is revealed by some of the wording:
"As to limited liability, the most important aspect of limited liability is that it is the investors whose liability is limited (to the amount of their investment). That means that limited liability applies to you and me, the small-change investors whose 401k retirement accounts are invested in a diversified assortment of stocks and other securities." (With "you and me" italicized for emphasis.)
"The alternative is unthinkable: imagine getting a letter in the mail telling you that, by virtue of your day-trading investment in $500 worth of stock of some oil company, you must fork over $5,000 to help pay for the latest oil spill. Not one of us would voluntarily risk such liability; and without the limitation on liability, our level of technology and standard of living would be far lower." (Note "your", "you", "us", "our".)
"Your protection from their bad business decisions is to invest in a variety of securities — stocks (equity) and bonds (debt) of a variety of companies, as well as insurance, precious metals, foreign currencies, and so on. Diversify in every possible way, and a few bad business decisions out there in the corporate world won't hurt you." ("Your", "you".)
"Ultimately, limited liability mainly protects you, the small shareholder." ("you")
"Such clauses, whereby the business agrees never to hold its passive shareholders liable nor allow them to be sued without covering for them, would be relevant to tort creditors of the business — people who do not contract with the business voluntarily (e.g., someone who slips on a banana peel in the grocery store in which you own a few shares of stock)." ("you")
Etc.
In short, I believe that the real reason that this Brad Edmonds character favors limited liability is that he fears that without it, he might be held accountable for his chosen investments. He hopes to convince readers to favor limited liability by convincing them by making them share this fear.
The argument also relies on the old stock strawman (you've seen it on LeftLibertarian2 if you've been here for a while) that there are only two possible options regarding shareholder liability: (1) absolutely unlimited liability; and (2) liability limited to the amount invested.
A more reasonable option goes unmentioned: (3) liability limited to the shareholder's responsibility, calculated by the amount of the investment along with what the shareholder could and should have known. If a shareholder could not possibly have known that the corporation would commit the tort in question, this might mean limitation to the amount of the investment. But the shareholder should be expected to make some reasonable amount of research regarding his investments.
In a case like UNOCAL, for instance, anyone who typed the corporation's name into a search engine would have known about the crimes it was committing, and shareholders therefore ought to be held liable for investing in UNOCAL.
If investors were held to this standard, it would not require unreasonable effort on their part. Instead, the market would ensure that it became even easier than now to check out corporations; third-party investigators would make their findings known, for instance. In fact, we already see this happening on the market now, with socially-conscience mutual funds, for example.
If this sort of system were implemented, we could expect to see investments shift from the worse corporations to the less bad. It is hard to predict just how much this would affect things overall, but I would guess that it would greatly mitigate our state-corporate economic-political system.
News & Views for Anarchists & Activists: http://groups.yahoo.com/group/smygo
Published: December 26, 2007 9:45 AM
Well, when you have a complicated issue, break it down to its constituent parts. Incorporation is two things: 1) a way of organizing a company that separates 'ownership' of a company from its management, and 2) government-granted set of legal privileges. I think we can all agree (on this forum, anyway) that 2) is wrong and should be abandoned. But 1) is easily doable without government privileges. The key question seems to relate to the concept of 'ownership' and limited liability.
Is limited liability a government-enforced privilege, or is it possible to privately and voluntary contract for limited liability? Obviously, if government says a company is only liable up to some certain amount and then NO ONE is liable after that point, that would be a privilege, and unenforceable without government interference. But if 'limited liability' is merely the transference of liability from one party to another, that is again doable without government power, assuming the party taking on the liability is, in fact, in a position to take it on.
Having a share of stock is generally considered to be ownership, but while even common shareholders get to vote on some issues, the large majority of actions of a company are directed by CEO's and upper management. People complain about CEOs making huge salaries, perhaps a greater degree of culpability should held by CEO's as well.
Still, even a small shareholder has some degree of liability, if only because they are providing funds for the management to utilize as they see fit, so why shouldn't stockholders be held liable for up to the amount they have invested in the company? As someone else suggested, the way around that is to issue bonds instead of stocks. Perhaps more people should be bondholders, not stockholders. In any case, the first step is to get rid of the government distortion and see what the market would actually develop (along with common or customary courts).
Published: December 26, 2007 11:13 AM
Michael: "As someone else suggested, the way around that is to issue bonds instead of stocks."
So far, no one has explained to me why bond holders should retain limited liability and stock holders should give it up.
Published: December 26, 2007 12:58 PM
Two important acronyms MLM & LLC go hand in foot. I wish i knew more about the workings of them but know they are funnels.
Published: December 26, 2007 5:53 PM
If people know in advance that they are dealing with a limited liability organization, whether religious or secular, and CHOOSE to do so - then there is nothing unlibertarian, or government dependent, about this.
Examples of both religious and secular limited liability activity (both in production and trade) go back for thousands of years.
Published: December 26, 2007 5:58 PM
By simultaneously treating the corporation as embodiment of the shareholders' will (as "entrepreneurial" property owners, a la Manne's argument for "the market for corporate control"), and arguing for the practical benefits of limited liability, Edmonds creates a bit of a contradiction. The effect is simultaneously to enable shareholders to have all the benefits of ownership (because of the ability to take one's business elsewhere and invest in firms with higer returns), while avoiding any of the liabilities that would normally be associated with genuine property ownership. It amounts to a position in which (at least according to the theory put forward by proponents of the "market for corporate control) the shareholder can threaten corporate management with capital flight if it doesn't maximize returns by any means necessary--and then maintain, via the corporate veil, plausible deniability regarding any of the actual means taken by corporate officers in maximizing returns. "If only someone would rid me of this turbulent priest...."
And I agree with happylee that Edmonds' "tell your ignorant friends that they're wrong because Brad Edmonds says so" approach is pretty ineffective. Last week he gave us a summary of Manne's assertions without either attribution or any of his supporting arguments. This week he gives us Hessen's assertions--again--without attribution and without any of Hessen's supporting arguments. The effect is the same as saying "God says it, I believe it, that settles it." Great technique for preaching to the choir.
Incidentally, it's extremely difficult to simultaneously argue for Mises' and Manne's "entrepreneurial corporation" with shareholders as genuine owners, and to argue for limited liability and against respondeat superior. The advocate of limited liability usually winds up making a strategic retreat from shareholder ownership and instead argue that the shareholder is de facto just another creditor or contractual claimant like the bondholder, and the management are the real owners. That's exactly what Kinsella did in an earlier article on the corporate form. Edmonds is able to make both claims in such absolute terms only by studiously avoiding any substance in support of either of them.
Published: December 26, 2007 7:24 PM
The greatest essay I have read for a case against the corporate form is van Dun's Personal Freedom and Corporate Liberties.
If a case can be made against the corporate form, not just certain privileges, and "limited liability," I think it is that presented by van Dun, which questions the very nature of it's personhood, ie. it's artificiality. It appears to be a deviation from natural law.
http://users.ugent.be/~frvandun/Texts/Articles/Persons&Corporations.pdf
Published: December 26, 2007 10:09 PM
Re some of Edmonds' historical contentions and P.M. Lawrence's responses:
PML is right that it's extremely historicist, or temporally provincial, to treat the modern corporation as the only expedient for aggregating investment capital. For example, Chesterton and Belloc (the right deviationists who are periodically targeted here, apparently) argued that had not the absolute monarchies conquered the free town communes, they or their component guilds would have served as vehicles for amassing capital and provided the investment funds for the industrial revolution. Of course that's counter-factual speculation. But the point is that, in a society with no state-enforced privilege or class exploitation, and no restrictions on voluntary association and federation, the possible forms of association for carrying on industrial enterprise are almost infinite.
As for the high capital outlays and scale required for some forms of production, e.g. cars and airplanes:
The jumbo jet probably wouldn't even exist without the military-industrial complex. It's one of those things that just wouldn't pay if everyone had to put up their money voluntarily. In fact the aircraft industry was headed for bankruptcy in the late '40s until the Cold War helped it back into solvency. And the new jumbo jets, in particular, were a spinoff of the heavy bomber program. The machine tools for building them were extremely expensive, and the production runs wouldn't have been anywhere near long enough to fully utilize them without heavy bomber contracts.
Henry Ford's first Model T plant required a capitalization of around $20,000, I believe--well under a million $$ in today's prices. It's true that the kind of heavy engine blocks produced by postwar Detroit require much larger plants and capital investments. But then the design of automobiles around such heavy internal combustion engines is a conscious choice of product design--a product design that is useful primarily in the context of a society with massive subsidies to highways, government promotion of sprawl, and other state promotion of the car culture. In a decentralized society of small communities built within walking and bike or streetcar distance of downtown areas, and linked together by light rail, private vehicles would probably be much lighter and fewer in number (e.g., a light electric truck for hauling in produce from farms outside the city limits, or for other special needs).
In other words, Edmonds justifies the "necessity" of extremely large-scale, capital intensive production in terms of "needs" presented by existing society, when those needs themselves reflect a particular structure of power and history of state intervention.
Published: December 27, 2007 12:44 AM
I can't manage to see what power corporations have over citizens.
Fundamentalist, my point was not that corporations have power over citizens (though that is certainly an interesting avenue to explore), but that corporations have ADVANTAGES over citizens in trying to influence government. These advantages consist in unlimited life, purposes, depth of organization and deeper pockets. Rent-seeking corporations deploy these advantages to great effect in picking our pockets and extracting benefits.
Published: December 27, 2007 1:35 AM
TT: "but that corporations have ADVANTAGES over citizens in trying to influence government."
I agree, but their power is no different from that of wealthy private individuals. The problem is not the corporate form, as much as corrupt politicians and a government with control over too much of the economy.
Published: December 27, 2007 8:10 AM
Is no one going to answer my question about why bond holders should enjoy limited liability and stock holders should not?
Published: December 27, 2007 8:11 AM
"It should be clear that the problem of the limited liability corporation is not the fact that the liability of managers is limited. Managers typically are linked by contract to the corporation that employs them. Under the doctrine of freedom of contract, their contracts can stipulate any distribution of liability between the employer (the corporation) and the employee. To attract managers, a corporation generally will offer the protection of its own vicarious liability for many of the risks associated with the manager’s role and function within the corporation. There is no reason why these contracts should not touch on liability for torts. Hence, Hessen’s recommendation that ‘in corporations, the officers would be liable (whether they are owner-investors or hired managers)’ for torts goes against the grain of his own inherence or freedom of contract theory of corporations.
"It also should be clear that the problem of the limited liability corporation is not the fact that the liability of shareholders is limited. That limitation of liability too is entirely contractual. You buy the shares in return for the prospect of sharing in the profits of the corporation, of being able to sell your shares to anyone who might want to buy them, and to get a share of the positive residual value of the corporation if it ever should be dissolved. However, you do so on the understanding that you in no way will be held accountable or liable for any action undertaken by the corporation. In that sense, shareholders do not have liability at all. Issuing shares is a way to raise capital. To make the buying of shares more attractive, a corporation my throw in others sorts of goodies, for example voting rights in the shareholders’ general assembly and lavish receptions when it meets. However, these extras do not change the fact that the sale of such shares is purely a matter of contract. One cannot suggest therefore that shareholders should be held fully liable for the corporation’s acts of commission or omission without violating the principle of freedom of contract.
"Accepting the validity of Hessen’s argument, Stephan Kinsella53 asks: “[D]oes respecting corporate status violate anyone's rights?” He obviously expects us to answer in the negative, his argument being that corporate law does not (or should not) allow the doctrine of vicarious liability to divert liability for torts from the actual managers or employees of a corporation to the corporation itself. However, that diversion is the very point of corporate personhood as far as liability is concerned, even if there are defences in cases of actions outside the scope of ‘normal business practices’ (crimes, abuse of authority, conduct unrelated to corporate action or policy, and the like54). To hold the managers or employees personally responsible and liable for all non-contractual debts that may result from the execution of their corporate tasks, even when there is no contract in which they explicitly have assumed the risk of full liability, would be blatantly unjust—unless one assumed either that the corporation’s ‘normal business practices’ carry no risk whatsoever of accidents or mishaps (which is absurd) or that the managers are (or own) the corporation. The latter assumption obviously contradicts Kinsella’s position that the shareholders own the corporation. However, he also holds that shareholders are not liable for corporate debts of any kind. Hence, the result is that the corporate status implies externalising liability (without contractual sanction): either from the shareholders to the managers and employees, as Kinsella would have it, or from the corporation to [some of] those who otherwise would have enforceable claims against it. Thus, the answer to Kinsella’s question is: “Yes, respecting corporate status does violate the rights of persons.”"
- Frank van Dun, Personal Freedom and Corporate Liberties
http://users.ugent.be/~frvandun/tekstmenu.html
Published: December 27, 2007 1:09 PM
If a case can be made against the corporate form...I think it is that presented by van Dun, which questions the very nature of it's personhood, ie. it's artificiality.
I would simply argue that "personhood" by corporations IS one of the government privileges, and not the essence of the corporate structure.
Published: December 27, 2007 1:38 PM
Skye, Can you translate the last paragraph of the quote from van Dun? I'm not even sure he's writing in English.
Published: December 27, 2007 4:11 PM
Ive read the comments on this with interest, and I find myself agreeing with most of the criticisms of the article.
the bottom line is that limited liability insulates investors from the adverse consequences of the corporation's actions, at least to the extent that the potential costs of such consequences outweigh their investment. And that is quite enough to generate perverse incentives towards recklessness.
(yes yes I know that technically the company's officers remain personally liable for illegal acts undertaken by them in the course of their company stewardship - but that does nothing for third party damages that arise from acts that have not yet been politically defined as illegal!And besides, in this very real world, how many spectacularly failed CEOs have ever been made to pay the costs of their recklessness or negligence? Most of them get large severance packages to go away quietly, and all theyve lost is the opportunity of future earnings from continuing in the job they hashed up.
Very few ever face the music unless there is large political capital to be made out of a high profile trial, a la Kenneth Lay. And even then, they may well not even have done wrong beyond falling foul of byzantine regulations, and/or rubbing up against popular sentiment. (like Martha Stewart).
The most fundamental principle of economic freedom is that if people are to be free to make their own decisions, they must not be shielded from the consequences of those decisions, beneficial or adverse alike. Any dilution of these principles, and we have by definition stepped into socialist/welfare state territory
And, unlike the entirely acceptable contractual passing on of risk through insurance agreements, limited liability has the effect of capping the downside risk at no cost to the parties who retain the full benefit of the upside. Which effectively translates to a no-premium insurance contract with the State, effectively passing all potential risk in excess of the value of the company's net assets, on to the entire surrounding citizenry. Which makes the limited liability corporation a creature of the State. Theres no escaping that conclusion.
Published: December 28, 2007 2:00 AM
"...Which effectively translates to a no-premium insurance contract with the State, effectively passing all potential risk in excess of the value of the company's net assets, on to the entire surrounding citizenry. Which makes the limited liability corporation a creature of the State. Theres no escaping that conclusion."
Much as I would like to agree with this, and accurate as it is as a description of how limited liability companies are generally implemented (at any rate in the English speaking world), unfortunately you can achieve precisely this effect by implementing an Anonymous Society through non-state contractual means (of course, as a matter of convenience, Anonymous Societies are usually implemented through state-provided means).
Here's how it works. Investors buy bearer shares that they can trade or hand on in any convenient way, that have coupons that they detach to send in or present in order to get their dividends. When all the coupons on a share certificate are used up, it is exchanged for a fresh one with a new set of coupons. Likewise a coupon approach could be used to send in an anonymous vote, but more often it isn't set up that way and active shareholders have to turn up at AGMs with share certificates or send a confidential agent to do it for them, either way producing votes in person. The company does not even try to assert that it is limited liability, but if it folds the investors just keep their heads down. Even the original investors never gave identifying details, and of course the shares could well have changed hands several times since that point.
Continental European countries first allowed Anonymous Societies because investors there were reluctant to make themselves known to the state, which might target them for their other assets once it knew who they were. By deliberately making that impossible, states at least got the benefit from the companies being able to form and operate. By coincidence, it creates de facto limited liability too. In effect, the shares can theoretically go negative in value, but they come with a de facto put option with a zero price.
Published: December 28, 2007 4:44 AM
david: "limited liability has the effect of capping the downside risk at no cost to the parties who retain the full benefit of the upside."
So, does the limited liability that bond holders enjoy have the same effect? If so, should bond holders lose their limited liability, too?
Published: December 28, 2007 8:05 AM
fundamentalist,
You will receive no answer to your question- the fact of bondholders pierces many of the anti-corporate arguments made above.
Published: December 28, 2007 10:05 AM
Fundamentalist said:
david: "limited liability has the effect of capping the downside risk at no cost to the parties who retain the full benefit of the upside."
So, does the limited liability that bond holders enjoy have the same effect? If so, should bond holders lose their limited liability, too?
Response: no and no. the difference between a bondholder and a stockholder is that the bondholder is a creditor (viz a lender) to the enterprise. He is not an owner of a share in the enterprise. His reward for risking the amount he lends is restricted to the coupon rate on the bond, irrespective of how much profit the corporation may make over and above that, whereas the stockholder is in principle exposed to unlimited profit potential.
So if the bondholder is not exposed to the full upside profit potential , it is reaonable to expect that he should not be liable for the company's excesses or reckless third-party damages , beyond risking default in respect of the amount he ( or one of his predecessors-in-title) LENT to the corporation when the bond was issued in the first place.
(Analogously, is it reasonable for a damages tort claim against a negligent property owner to also be pursued against the mortgage holder who financed the owner of the property? no? didn't think so.)
Published: December 28, 2007 1:50 PM
David: "So if the bondholder is not exposed to the full upside profit potential , it is reaonable to expect that he should not be liable for the company's excesses or reckless third-party damages..."
Well, it may make sense to you, but not to me. I don't see what the profit potential has to do with rights or legal status. Besides, the stock owner isn't an owner in the usual sense. He's a passive owner. He has no say in the day-to-day operations of the company. He's like the passive investor in a limited liability partnership. In exchange for giving up control over the operations, the stock holder is awarded limited liability. The only difference between the bond holder and the stock holder is that the bond holder is guaranteed a return on his investment and the stock holder isn't. Also, if the company fails, bond holders get paid and stock holders get nothing. As for the limited profit potential for the bond holder, he is compensated by taking less risk; the greater returns for the stock holder are the result of taking greater risks.
The issue of liability has traditionally dealt with control. Bond holders get limited liability because they don't control the operations of the borrower. Stock holders get limited liability for the same reason.
Published: December 28, 2007 3:11 PM
Fundamentalist, pay attention to which shell the pea is under. You obscure that when you use the passive voice. Let's work through it piece by piece...
"I don't see what the profit potential has to do with rights or legal status." It's the marker that shows you where the pea, so to speak, was when it all started.
"Besides, the stock owner isn't an owner in the usual sense. He's a passive owner. He has no say in the day-to-day operations of the company. He's like the passive investor in a limited liability partnership." And a driver who goes to sleep at the wheel, or takes his hands off the wheel, is just like a passenger to outward appearances. A better analogy might be, a helmsman who goes off watch without handing control over to his relief (the equivalent is, passing the shares on). After that he looks just like all the rest of the crew who are off watch. But if something goes wrong, the enquiry traces it back to him.
"In exchange for giving up control over the operations, the stock holder is awarded limited liability." Now see what happens if you try turning that back to the active voice. Who awarded it? The state? If so, that proves the point at issue. The directors and/or management? But "nemo dat quod non habet" - it wasn't theirs to give in the first place.
"The only difference between the bond holder and the stock holder is that the bond holder is guaranteed a return on his investment and the stock holder isn't." Well, ignoring things like income bonds for the moment and the limits of any guarantee to only being preferred creditors (some bond holders are not guaranteed a return on their investments), that's like saying that the only difference between the helmsman who goes off watch without being relieved and the rest of the crew is his mess privileges. It's misdirection, focussing on his current circumstances and ignoring how he let go.
"The issue of liability has traditionally dealt with control. Bond holders get limited liability because they don't control the operations of the borrower." You'd better read up about covenants, guarantees, and such.
"Stock holders get limited liability for the same reason." Apart from the fact that this "reason" is only the case if there has already been a dereliction, this argument isn't how things are when the company first gets hold of the capital, with prospectuses and all.
Published: December 28, 2007 5:57 PM
P.M.:"And a driver who goes to sleep at the wheel, or takes his hands off the wheel, is just like a passenger to outward appearances."
As I have repeatedly asked, how is this driver different from the bond holder? The bond holder is just as much asleep as the stock holder.
P.M.: "Who awarded it? The state? If so, that proves the point at issue."
Who awards limited liability to bond holders? The state. So should bond holders lose their limited liability, too? You're using an ad hominem attack. Everthing the state does is not evil simply because the state does it. Much of state law is common law.
PM: "...that's like saying that the only difference between the helmsman who goes off watch without being relieved and the rest of the crew is his mess privileges."
Your analogy is confusing, but it seems that you equate the absent-minded helsman with the stock holder because the stock holder has limited liability. If so, why isn't the bond holder an absent-minded helsman, too? You claim they are different crewmen without stating why they are different.
P.M."You'd better read up about covenants, guarantees, and such."
I have, and stand by my argument. Why don't you show me where I'm wrong?
P.M. "Apart from the fact that this "reason" is only the case if there has already been a dereliction, this argument isn't how things are when the company first gets hold of the capital, with prospectuses and all."
I'm not arguing that every jot and tittle of corporate law is good and necessary. There are a lot of details I would change if I could. But the fact that current corporate law has flaws does not justify trashing the idea of limited liability for owners of stock. That would be a straw man argument.
The argument is simple; you're trying to muddy the waters with your inappropriate analogy. The issue is responsibility for control of operations. If your neighbor robs a bank, the police don't arrest you because you loaned or gave your neighbor money, or because you purchased something from him. Loaning, giving, sharing, purchasing or other transactions in a free market do not burden the parties involved with responsibility for the actions of the other party. With bonds or any kind of loan, no court has ever held the lender responsible for the actions of the borrower on the principle that the lender has no control, and therefore no responsibility for the actions of the borrower.
In the case of stocks, the stock owner is a partial owner of the company, but a special type of owner--a passive one. The fact that the state recognizes the distinction between passive and active owners does not make it illegit. The concept could have developed under common law had it the chance. Passive investors do not control the actions of the company managers in exactly the same way that bond holders don't. That much is stipulated in the contract governing the exchange of passive ownership (the stock) for money. Since the stock owner does not control the activities of the managers, I seriously doubt any court would hold the stock owners responsible for the actions of the managers. It's just common sense.
I would like to know what great injustice you think stock owners commit that bond holders don't. What evil would you thwart if you removed limited liability from stock ownership? If you could make stock ownership illegal, or burden stock holders with full responsibility for the actions of management, what would happen? Stock owners would dump all of their stock. It would become so cheap that management would probably buy it all and become the sole owners of the company. They would become a partnership, since they are all active in the company. Or stock owners might convert their stock to bonds. But large companies wouldn't go away. They would simply raise funds through bond/note sales. What has changed? Nothing! Just as law and accounting firms perpetuate themselves by selling partnerships to younger managers, large corporations would continue do operate just as they do now. The only difference I can see is that the odds of default on bonds would increase dramatically, thus raising the interest rate.
Published: December 28, 2007 11:52 PM
Fundamentalist, you appear to have tunnel vision.
"As I have repeatedly asked, how is this driver different from the bond holder? The bond holder is just as much asleep as the stock holder." I told you, that's misdirection. The difference isn't in their similarity (not being in control) but in how they got that way (only the driver let go of control).
"Who awards limited liability to bond holders? The state." Actually, no. They start out with that as a default case.
"You're using an ad hominem attack." Where? What person is being attacked?
"Everthing the state does is not evil simply because the state does it. Much of state law is common law." Leaving aside the bad grammar (what that means is, - pure statism), that means that even if true it still has to be demonstrated.
"...it seems that you equate the absent-minded [you made that up - it's wilful, reckless or negligent, abandoning a post like that] helsman with the stock holder because the stock holder has limited liability." No! Because each of them had a responsibility and let go without having anyone else to take hold of it.
"If so, why isn't the bond holder an absent-minded helsman, too?" That wasn't why.
"You claim they are different crewmen without stating why they are different." Didn't you read "...who goes off watch without handing control over to his relief"? I did state the key difference, right there.
"I have [read up about covenants, guarantees, and such], and stand by my argument. Why don't you show me where I'm wrong?" On occasion, people only extend funds if they receive covenants, guarantees, and such; when they do that, they are controlling the operations of the borrower. That's what those things do.
"But the fact that current corporate law has flaws does not justify trashing the idea of limited liability for owners of stock. That would be a straw man argument." Yes - so don't make it up.
"The argument is simple; you're trying to muddy the waters with your inappropriate analogy. The issue is responsibility for control of operations. If your neighbor robs a bank, the police don't arrest you because you loaned or gave your neighbor money... no responsibility for the actions of the borrower." No disagreement on that (apart from the unjust accusation). However...
"In the case of stocks, the stock owner is a partial owner of the company, but a special type of owner--a passive one." Yes - and that constitutes a failure on his part.
"The fact that the state recognizes the distinction between passive and active owners does not make it illegit" - in general, yes, but neither does it have anything going for it. There is one way it can make it wrong; when the shareholder claims that his only basis for limited liability is because the state says so. Since the state hasn't got it to give, all that means is he was cheated.
"The concept could have developed under common law had it the chance." This seems unlikely, for the very reason that it did not do so in Britain during the rather long period from the early 18th century to the late 19th century when corporate structures of that sort were considered harmful in general.
"Passive investors do not control the actions of the company managers in exactly the same way that bond holders don't." This is precisely the basis for accusing the investors of a prior failure - they aren't wrong for what they do, but for what they don't do.
"That much is stipulated in the contract governing the exchange of passive ownership (the stock) for money." And, as I quite clearly pointed out, the projectors - people who put it together - have no authority to waive liability, other than the purported authority of company law. Even if they set up an Anonymous Society the way I described earlier, they would only be providing an effective shelter and not a justification (though trade creditors, trading knowingly, would by that very different process be agreeing to cap claims on shareholders).
"Since the stock owner does not control the activities of the managers, I seriously doubt any court would hold the stock owners responsible for the actions of the managers. It's just common sense." Courts work according to thge relevant law; common sense doesn't come into it unless that leaves a gap. Actually, common sense - and often the courts - says that someone who leaves a car on a slope without brakes, which later rolls over someone else, gets blamed precisely because it was out of his control since there is the additional element that he arranged it that way.
"I would like to know what great injustice you think stock owners commit that bond holders don't." I don't think that; I think they are acting "wilfully, recklessly, or negligently", as the saying is, so as, when, and if something goes wrong that company resources can't cover, they are morally culpable as they have made a serious error of omission.
"What evil would you thwart if you removed limited liability from stock ownership?" That's something like saying, what could go wrong if you don't set the brake if you leave a car parked. Most of the time, absolutely nothing.
"If you could make stock ownership illegal, or burden stock holders with full responsibility for the actions of management, what would happen? Stock owners would dump all of their stock." Maybe - but it takes two.
"It would become so cheap that management would probably buy it all and become the sole owners of the company. They would become a partnership, since they are all active in the company." That has been known to happen - and managements have been known to steer clear of buyouts, too.
"Or stock owners might convert their stock to bonds." Again, it takes two (i.e., someone has to become an owner of the firm to take up what is let go).
"But large companies wouldn't go away. They would simply raise funds through bond/note sales." Fewer and fewer would make sense, something they would experience through the cost of fund raising going up once the other costs of doing business couldn't be externalised the old way.
"What has changed? Nothing! Just as law and accounting firms perpetuate themselves by selling partnerships to younger managers, large corporations would continue do operate just as they do now." They don't do that, precisely. They also have to novate risk and - guess what - have a legal structure that allows them to do these things. Large partnerships only became possible after statutes created machinery that allowed them to operate (common law reflected natural arrangements, which had partners who each had working relationships with all the others). And, of course, what counts far more than whether existing large firms would remain after such a change is, whether new large firms would arise to make up the losses of large firms that shrank or failed for other reasons over time.
"The only difference I can see is that the odds of default on bonds would increase dramatically, thus raising the interest rate." It depends on the bond, of course. But don't you see that this forms a restoration of a natural financing cost profile to large corporations? That it removes a de facto subsidy they now have? And that that would have consequences?
BTW, I notice a certain tendency to try to turn things round as though people who don't want to support these artificial arrangements have to justify stopping, rather than seeing that it is the artificial arrangements that would need to be justified.
Published: December 29, 2007 1:22 AM
PM: "Yes - and that constitutes a failure on his part."
I still don't get why being a passive owner of stocks is a failure on the part of the investor. What principle are you claiming makes it impossible to be a passive owner?
PM: "This seems unlikely, for the very reason that it did not do so in Britain during the rather long period from the early 18th century to the late 19th century when corporate structures of that sort were considered harmful in general."
Corporation during those centuries were monopolies, unlike corporations today. Their monopoly status is what gave them a bad reputation.
PM: "This is precisely the basis for accusing the investors of a prior failure - they aren't wrong for what they do, but for what they don't do."
On what principle? If stock holders want to be treated like bondholders while taking on more risk than bondholders, what principle or common law forbids it? None. You seem to deny the possibility of passive ownership simply because you don't like it.
PM: "And, as I quite clearly pointed out, the projectors - people who put it together - have no authority to waive liability, other than the purported authority of company law."
Sure they do. If people have the common sense to realize that stock ownership is no different in principle from bond ownership, common law courts will allow it. You seem to think that business law and financial instruments should be stuck in the middle ages. According to your arguments, businesses should be happy with bills of exchange and nothing else.
PM: "Actually, common sense - and often the courts - says that someone who leaves a car on a slope without brakes, which later rolls over someone else, gets blamed precisely because it was out of his control since there is the additional element that he arranged it that way."
That's a stupid analogy. The owner of the car represents management of a corporation, not a stock holder. The stock holder would be someone like the banker who loaned money to the car owner. Would you hold the banker responsible? Oh, I forgot, you have outlawed passive ownership because you don't like it.
PM: "Fewer and fewer would make sense, something they would experience through the cost of fund raising going up once the other costs of doing business couldn't be externalised the old way."
What does that mean? Why would the cost of fundrasing go up? Bonds are no more expensive to issue than stocks.
PM: "common law reflected natural arrangements, which had partners who each had working relationships with all the others"
And how is that different from partnerships today?
PM: "what counts far more than whether existing large firms would remain after such a change is, whether new large firms would arise to make up the losses of large firms that shrank or failed for other reasons over time."
And why wouldn't they? If a venture offers potentially good profits but requires large amounts of capital investments, why wouldn't wealthy people form partnerships and sell bonds to raise the money?
PM: "But don't you see that this forms a restoration of a natural financing cost profile to large corporations? That it removes a de facto subsidy they now have? And that that would have consequences?"
No I don't. Please explain it to me. I don't see that any "natural financing cost profile" exists, or has ever existed. And I don't see any subsidies to corporations or the consequences that might result.
PM: "it is the artificial arrangements that would need to be justified"
The only reason I can see for you thinking that corporations and passive ownership are artificial is that you're stuck in the middle ages. You seem to believe that no new business law or financial instruments should have been created since then.
Published: December 29, 2007 11:31 AM
Apologies for the delay replying - it's mostly the heat and other priorities that are slowing me down.
Fundamentalist, this is the last reply I intend to make, unless something new and of substance crops up. I've come to the view that, through no fault of your own, you simply don't get it, that you literally don't see certain distinctions I've been trying to make that are what really counts. So this is really to try to clear the air for the record, for anyone else who might come along.
"I still don't get why being [emphasis added] a passive owner of stocks is a failure on the part of the investor." It isn't. The previous letting go of control without making sure that someone is there to catch it, that is.
"What principle are you claiming makes it impossible to be a passive owner?" I did not claim that. But the people involved in setting up the corporation were holding the baby. Then they walked away in different directions - some saying that the company indemnified them, others that they were too remote in their capacity as owners for anything more than the limited liability to catch up with them. Bond holders per se were never in that position of dereliction.
"Corporation during those centuries were monopolies, unlike corporations today." Well, no. For instance railway companies competed, as did canal companies.
"Their monopoly status is what gave them a bad reputation." It wasn't (it was far more the South Sea Bubble and things like that). But even if it were all true, this would be the Fallacy of Irrelevant Knowledge. It doesn't matter why corporation structures were not readily available during the Industrial Revolution, the fact remains that all those factory owners and mine owners got on with setting up and operating without creating any body of common law to get corporations. Railway companies and such did get charters; after all, they needed legal authority, enabling acts, to get the land and rights of way they needed from the owners whether they consented or not.
"If stock holders want to be treated like bondholders while taking on more risk than bondholders, what principle or common law forbids it? None." Wrong. I spelled it out, how it was like abandoning a helm. Think "the buck stops here". ("...while taking on more risk than bondholders..." is irrelevant; that's not a price they pay to someone for taking responsibility off their hands.)
"Sure they do. If people have the common sense to realize that stock ownership is no different in principle from bond ownership, common law courts will allow it." This assumes what it seeks to prove, that there is no difference. I mentioned what happened to James Buchan's great-grandfather. He tried that line too. It didn't get him off the hook.
"That's a stupid analogy. The owner of the car represents management of a corporation, not a stock holder." This hasn't followed the analogy. It's not the "owner" of the car, it's the person who had control just before it went out of control. We aren't tracking what happened to that person later, in the back seat with another passenger for instance. You can't sort them out back there - that's the point. And the person who puts up the funds at start up without arranging for someone else to take responsibility remains linked to any fault. Someone who comes along and buys the shares assumes anything that goes with them.
"Why would the cost of fundrasing go up? Bonds are no more expensive to issue than stocks." Not the transaction costs of the process of raising the funds - the "price" of the funds themselves, as shown by how much they would have to be discounted (equivalently, the return needed).
'"common law reflected natural arrangements, which had partners who each had working relationships with all the others" And how is that different from partnerships today?' Partners now only need to comply with statutory requirements, which allows many more partners who do not all have the same nexus with each other that they needed to make things work as a private arrangement. Most partners only get a quick look at the books once a year in the presence of the senior partner and the managing partner, for instance.
"If a venture offers potentially good profits but requires large amounts of capital investments, why wouldn't wealthy people form partnerships and sell bonds to raise the money?" If. We should realistically expect there to be fewer of those around than at present, precisely because present institutional arrangements favour them. We are almost certainly getting more of them than would be optimal in a free market for funds and structures.
The remainder is basically a description of non-laissez faire, as though being current fashion kept breaking a free market from having adverse consequences.
Published: December 30, 2007 10:55 PM
Concerning limited liability for investors, I have been reading "A History of Interest Rates" by Sidney Homer and learned that Roman law recognized partnerships with limited liability (limited to the amount invested) in 179 b.c.
Published: December 31, 2007 6:39 PM
PM: "But the people involved in setting up the corporation were holding the baby. Then they walked away in different directions..."
Silly analogies aren't principles of common law.
Other than inappropriate analogies, you have failed to provide a principle that forbids limited liability for stock holders. You simply don't like it. That's all. You consider it unnatural, when there is nothing more natural.
In your analogies, the helmsman walks away from the helm, but for the analogy to be appropriate, the helmsman would have to turn the helm over to a responsible party before walking away. And to correct your baby analogy, passive investors don't abandon the baby, they turn responsibility for the baby over to competent people. With stock ownership, no one abandons their responsibilities; they turn over responsibility for managing the firm to competent people. In exchange for giving up control, they get limited liability. The principle is simple: liability holds only for those people making the decisions; people not responsible for the decision making process aren't held liable. It's one of the fundamental principles of common law: only the responsible parties are held liable. That's why you can't sue Smith when McDonald defrauds you; Smith isn't responsible for McDonald's actions.
Published: December 31, 2007 7:02 PM
Another way to look at the issue of limited liability is through the definition of property. A defining aspect of property is the issue of control. Capitalists have always argued that when the state takes away control of property, it destroys property rights, even though a person may still possess the deed to property.
So why would someone willingly give up control of their property to another party? They would do so only in exchange for something of equal value to the control, such as a share in the profits and limited liability. Limited liability for holders of stock is like any other commodity in a free market transaction. The purchaser of the stock certificate exchanges control of operations for limited liability and a portion of any profits, if there are any. Courts have always recognized that because owners of stock have traded control for limited liability, they are not responsible for the actions of the people who retain control. What could be more natural and simple.
From another perspective, someone who purchases a share of stock from another person does not purchase with it any control over operations beyond voting rights. And courts have never held anyone responsible for things they don't control. So no reason exists to hold owners of stock responsible for the decisions of the managers of a corporation when the managers have control and are directly responsible for their own actions.
As I wrote when I entered this discussion, there is no difference between bond holders and stock holders where liability for the actions of managers is concerned.
Published: December 31, 2007 7:44 PM
I will address the only thing here that is even partly new (apart from the ad hominem attacks, like "You simply don't like it. That's all.").
The new(ish) thing is the idea that "And to correct your baby analogy, passive investors don't abandon the baby, they turn responsibility for the baby over to competent people. With stock ownership, no one abandons their responsibilities; they turn over responsibility for managing the firm to competent people. In exchange for giving up control, they get limited liability."
The thing is, that is not what happens. The "competent people" do not accept full responsibility, but limit what they accept to "responsibility for managing the firm" - they are indemnified for improper acts just like the shareholders. So the investors haven't handed the rest over at all. The buck stops nowhere.
If that was what happened, it would amount to the management being a jointly and severally liable partnership, and the investors' situation would indeed match that of bond holders. But it doesn't happen that way.
Here in Australia, police union funds practically never pay compensation for improper acts, on the grounds that those weren't police acts but private misdeeds. The buck stays with the bad cops.
Published: December 31, 2007 11:27 PM
PM: "apart from the ad hominem attacks, like "You simply don't like it. That's all.")"
That's not an ad hominem attack. Look up the term in Wikipedia.
PM: "The "competent people" do not accept full responsibility, but limit what they accept to "responsibility for managing the firm" - they are indemnified for improper acts just like the shareholders."
Have you notice managers going to jail, lately? How are they indemnified for improper acts? What improper acts do you see management getting away with? What planet do you live on?
Published: January 1, 2008 9:40 AM