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Tuesday, 11 October 2011

Frankenstein's Corporations

Immortal Corporations

Back in 1819 the US Supreme Court, an august group not usually known as a centre of radical creationism, took the unusual step of inventing artificial life. Moreover they then, in a Frankenstein moment, added the proviso that their monstrous offspring should be blessed with immortality.

The object of this life-giving largesse was the hitherto humble corporation, which was suddenly invested with superhuman properties. Unfortunately the lawmakers couldn’t artificially imbue corporations with morality or a sense of justice so having made them indestructible they left the rest of the world to deal with an ethical dilemma that sees companies given human rights without needing, or expecting, to behave so as to deserve them. Back to the courts ...

Joint-Stock Companies

The predecessor of the modern corporation was the joint-stock company, a deviously clever invention that allowed shareholders to own small parts of a company, known as “shares”. Sadly, as recounted in Sir Hugh Invents the Share and Gets Lost, creativity is often limited in its scope: in particular, financial innovation and navigation seem to be uncommon bedfellows. Nonetheless, this cunning invention allowed investors to spread their risks between multiple investments and encouraged capital into what would otherwise have been risky situations: would you put all your money in a single stock?

Not everyone agreed. Here’s one dissenting view:
"The directors of such [joint-stock] companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own.... Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company."
That was Adam Smith, in The Wealth of Nations. Smith was pointing out a couple of the fundamental problems of modern, quoted corporations. Firstly, that directors of companies who have little at stake are subject to a condition known as moral hazard, where they can take all of the rewards but suffer none of the consequences of what may be highly risky decisions. Secondly, that directors and shareholders are subject to what as known as agency issues – they have different objectives and unless these are aligned are unlikely to work for the same ends.

Chartered Monopolies

Smith’s joint-stock companies, however, weren’t quite the same as modern corporations. Back in his day companies had to be chartered by their governments, with quite limited remits. Well, relatively speaking: sometimes no-one was exactly sure of the scope of what was being chartered.  For example, in 1600 Queen Elizabeth I granted the East India Company the monopoly rights to trade between the east of the Cape of Good Hope and the west of the Straights of Magellan. Which turned out to be roughly everything between Africa and South America via India and Japan.

Of course, cartography in those days was somewhat less exact, so it was a while before it became clear exactly what was on offer but the East India Company ended up with a few interesting business lines. Stuff like selling opium to China, resulting in the First Opium War and the annexation of Hong Kong, the import of tax exempt tea to Boston, triggering the American Revolution, and the little matter of conquering and ruling India for a century or so.

Usually chartered companies were monopolies, which was one reason Smith didn’t like them. However, the general distaste for them originated in a corporation founded before Smith was born: The South Sea Company.

The South Sea Bubble

The South Sea Company was a gigantic scam created for the ostensible purpose of ridding the British government of its debt. Charles Mackay, in his Memoirs of Popular Delusions and the Madness of Crowds devotes a whole chapter to the unfolding events, which made dotcom fever look like a dose of man flu after a boys' night out.

The directors of this corporation engaged in a share price ramp of remarkable proportions, aimed at driving up the price of new stock with the specific intention of making themselves extremely rich. What’s entirely astonishing about the whole affair, when viewed from afar, is quite how any of the participants thought that the thing would end happily. Of course, we could apply the same reasoning to more recent scammers, but the best guess is that they start small and things snowball …

Anyway, the initial success of the South Sea Company – a corporation chartered to trade with South America but which, as far as we can tell, never actually put any representative within five thousand miles of that continent, let alone did anything so demeaning as to actually own a boat – spawned a whole host of imitators, all of which were eventually banned. Famously this list of defunct companies includes one that promised: “For carrying on an undertaking of great advantage, but nobody to know what it is”. The corollory to the story is that the founder of this  enterprise took £2000 of investor's capital, promptly scarpered to Europe and was never seen again.

Killing Corporations

Back in the days of the South Sea Company, however, corporations lived by permission of the monarch or government. Dubious companies could be sentenced to death by having their charters refused or withdrawn. These ancient corporations had no existence outside of the law.

In fact nearly ninety of these dubious "bubble" companies were put out of their misery in the wake of the South Sea Bubble and a wondrous cross-section of seventeenth century business problems they represent: everything from one For trading in hair (remember this was the age of the wig, when men shaved their hair in order to wear something that looked liked a Pomeranian on their heads) to another For lending money on stock, annuities, tallies, &c” which at least proves that some things don’t change. Quite what the one which was trading in and improving certain commodities of the produce of this kingdom, &c was going to do we can’t say for certain, although it’s probably no worse a business case than most small commodities stocks have today.

Finally, the government of the time then legislated for the Bubble Act to ban the further creation of joint-stock companies without royal approval. This had an unintended consequence: it denied future enterprises easy access to the capital they needed to expand and may well have delayed the Industrial Revolution. This, as ever, is the dilemma of capital: do we let banks find new ways of making money to create investment capital which they'll eventually let blow up into a crisis, or do we prevent this happening and kill many enterprises at birth? Some problems never go away.

Immortality Beckons

The limitations on the eternal existence of corporations started to change with a single decision by the US Supreme Court in the case of Dartmouth College versus Woodward where the court opined:
“A corporation is an artificial being, invisible, intangible, and existing only in contemplation of law.”
This meant that, essentially, a corporation can exist independently of government charter, is a type of person, albeit an unusual one, and is recognised as such under the 14th Amendment of the US Constitution: which is the one that guarantees equal rights for all people.

On the face of it, this is an odd position to adopt, as the 14th Amendment was originally created to protect slaves freed after the Civil War. The idea was to ensure that they were accorded basic human rights rather than to assign those rights to something like a corporation which is demonstrably not human. Nonetheless, the law of unintended consequences applies, and through a series of judgements and laws the concept of “corporate personhood”, where a corporation receives many of the rights afforded to a normal person has come to apply.

Rights or Duties

What’s interesting, however, is that the same judgement acknowledges that corporations are not entirely normal people because they are created immortal. And so, we have the modern, immortal corporation which under US law has many the same rights as a person. Yet it doesn’t have the same duties, because the main duty of a corporation is to maximise returns for its shareholders.

This creates a very odd situation which the law is currently scrambling to unwind because in some circumstances it doesn’t make sense to allow corporations to inherit the rights of real people. Corporations have tried to plead the 5th Amendment, for instance, and been rebuffed since this would be obviously silly, although quite why it's sillier than allowing a corporation to be considered a person in the first place isn't entirely self-evident.

Psychopathic Corporations

According to law professor Joel Bakan, if you test corporations on a scale of mental disorders they classify as psychopaths. Now, if a real person acted as a psychopath, we would deny them certain rights, like possession of steak knives, access to threshing machines and liberty. Which leaves us with a tricky question: if corporations act in a way which is not in the common interest should we allow them eternal existence unfettered by common law?

Well, under the law as it stands, we have no choice. We can apply the death penalty to real people whose behaviour we find objectionable, but corporations are virtually immune to such strictures. At root this is because they're not just people, in an artificial sense, but also property and the right to prevent governments appropriating our property is a fundamental basis of participatory democracy.

Legal Humour

Anyway, the Supreme Court is at least trying to sort this out. Having previously decided that companies have free speech rights under the 1st Amendment it's now decided that, in the case of FCC v. AT&T INC., corporations have no right to privacy under the 4th:
"We reject the argument that because “person” is defined for purposes of FOIA [Freedom of Information Act] to include a corporation, the phrase “personal privacy” in Exemption 7(C) reaches corporations as well. The protection in FOIA against disclosure of law enforcement information on the ground that it would constitute an unwarranted invasion of personal privacy does not extend to corporations. We trust that AT&T will not take it personally."
Which suggests that the Supreme Court has a sense of humour, even if psychopathic corporations don't. A small victory in what is likely to be a long battle against the court's own Frankenstein creation.

Related articles: Sir High Invents The Company And Gets Lost, Moral Corporations: An Oxymoron?, Quality Signalling for Quality Stocks

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