Law and Economics of Corporations
1)Corporations contrasted with other business forms
2)History of corporations3)Limited liability – a special privilege?
Nader: yes Hessen: no
4)Modern corporate democracy5)Non-profit corporations, mutual companies,
benefit corporations
How Businesses are Organized
Sole proprietorship An individual owns the business. The owner keeps profits, if any, and is fully liable
for any debts Owner pays taxes on his/her own tax return
Partnership Formed by two or more people who want to pool
their money for a business purpose Partners fully liable for debts No partnership income tax Partners pay tax on their share of partnership
profits irrespective of any distributions
How businesses are organized
Limited partnerships General partner
Fully liable for debts Usually manages the business Gets bonus payment
Limited partners Not liable for partnership debts Some limited partnership units traded on stock
exchanges No partnership income tax Partners pay tax on partnership net income
whether distributed or not
Problem with partnership tort liability
Each partner (generally) is fully liability for the partnership’s torts
As with all tort actions, recovery of damages limited by partners’ assets
Tort remedies generally fall on parties with deep pockets Wealthy people reluctant to enter partnerships,
more likely to incorporate, making tort victims less well off, not better
Corporations
Latin corpus, body A new corporation sells shares of stock to
investors. New corporations are usually closely held
Only qualified persons can buy shares Shares cannot be sold freely
An existing corporation may “go public” Sell shares to general public Raise additional funds for the business
Chartered by state governments (except banks)
Enjoy limited liability
Limited liability
Usually evidenced by a suffix such as AT&T, Inc. (Incorporated) Oracle Corporation Lucasfilm, Ltd. (Limited) BP, PLC (Public Limited Company)
Shareholders cannot be held personally responsible for corporate debts or employee torts. At worst, shares become worthless.
Contrast: when a partnership commits a tort, the partners’ entire wealth is at stake
History of corporate charters
East India Company, 1600-1874 Granted monopoly of trade with India Evolved into a colonial quasi-government
Early America Corporate charters created by an act of the
colonial assembly (later, by state legislatures) Usually came with a grant of monopoly power Endowed with perpetual existence and limited
liability for shareholders Resentment, especially against banks, fueled
Jacksonian revolution Second Bank of US, nominally private, abolished
1836
Rise of and reaction to large corporations, late 1800’s
Railroads greatly reduced transportation costs, enhanced opportunities for large, efficient corporations
Standard Oil achieved dominant market share Kept expenses minimal Got preferential shipping rates from railroads Bought out less efficient firms Consumers benefited from drastically falling
prices Sherman Anti-Trust Act, 1890 Subsequent anti-trust acts
Supreme Court on Corporations
A corporation is an artificial being, invisible, intangible, and existing only in contemplation of law
Chief Justice John Marshall, 1819 The corporation is a creature of the state. It
is presumed to be incorporated for the benefit of the public. It receives certain privileges and franchises, and holds them subject to the laws of the state and the limitations of its charter
Hale vs. Henkel, 1906
Mitt Romney on Corporations
“Corporations are people!” Democrats: “No they’re not!” Romney meant corporations are groups of
people Democrats’ interpretation: a corporation is a
separate person
Delaware, a corporate haven?
A specialty for a state with few comparative advantages Low filing fees and taxes Annual meetings need not be held in Delaware Stock transfer records need not be kept in
Delaware “Absolute” limited liability for shareholders
State government heavily influenced by duPont family
Rules further liberalized in 1963 in response to competitive threats from other states
Competing views of corporations
Ralph Nader “Taming the Giant Corporation” (1976) and many
other publications and speeches General theme: corporations have far too much
power and must be reigned in by federal chartering and other means
Robert Hessen “In Defense of the Corporation” (1979), response
to Nader Corporations do not get special privileges from
government Corporate features are created by contract, not
by government. Could exist without government.
Nader complaints about corporations (1976)
Industrial pollution Toxic substances Racial discrimination Alienated white-
collar workers Political power
campaign contrib. friends in gov’t revolving door lobbyists
Corporate welfare sugar industry merchant shipping
Privacy invasions Dominance of local
communities Deceptive
advertising Unsafe products Unreliable
technology Market power Multinational corps. Concentrated wealth Corporate crime
Is a corporation a “person”in a legal sense?
“Incorporated” suggests a body (corpus) Can sue or be sued or convicted of a crime
BP was held criminally liable for Gulf oil spill BP also paid civil damages Apple recently won a patent lawsuit against
Samsung Can “live” indefinitely regardless of
management or stockholder turnover IBM incorporated in 1911 as Computing-
Tabulating-Recording Corporations subject to income tax Shareholders not liable for corporate debts
Is limited liability a special privilege?
Ralph Nader: yes Early 1800’s: justified by limited purposes and
limited lifetimes; attracted shareholder capital Robert Hessen
No, customers and suppliers are warned of the limited liability
Exception: one-man corporations are an abusive way to escape liability
Question If corporate shareholders can disavow liability
why can’t individuals? Answer(?) corporation has deep pockets and/or
insurance
The doctrine of vicarious liability
From common law: masters are responsible for torts committed by their servants (respondeat superior). Servant acts on behalf of the master Masters likely to have “deep pockets” for
compensation of tort victims Sends a signal to masters to be careful about
hiring and supervising Extended to general partners Hessen: should apply to shareholders who
are actively involved in management
Is a corporation a “person” in an economic sense?
Corporate actions are performed by management
No essential economic difference between corporations and other forms of business All raise capital to conduct business in hopes of
earning profits
Crony capitalism
A situation in which corporations and other business entities concentrate on seeking government favors rather than serving customers
An inevitable outcome of the increased power that has been assumed by governments, particularly Federal gov’t
All major corporations must engage in lobbying in order to survive Microsoft learned this lesson
Businesses increasingly beholden to bureaucrats, not consumers
Modern corporate structure
A small group of people start a business and incorporate. Individuals buy shares of stock Shareholders wishing to sell usually required to
offer shares back to the corporation Shares are not traded on an exchange. Share
value is hard to determine Shareholders may decide to “go public”: offer
shares for sale to the general public (IPO) Shares listed on a stock exchange (NYSE,
Nasdaq) where anyone can buy or sell
Modern corporate structure
Shareholders own the company Number of shares determines the fraction they
own (I own 250 of 150,000,000 shares) Shareholders not entitled to company assets Shareholders can get a share of profits, if any,
as dividends Shareholders elect a Board of Directors
Board of Directors Sets broad company policies Hires management (CEO, CFO, etc.)
Liability of corporate boards of directors
Directors’ duties Elected by shareholders (but in practice often
hand-picked by CEO) Act as agents for the shareholders Hire top management (CEO, CFO, etc.)
Director’s compensation Cash compensation, stock, options
Directors’ liability Open to shareholder lawsuits if they grossly
mismanage the company (Hewlett-Packard?) Corporation buys special liability insurance for
directors (“errors and omissions”)
Cypress Semiconductor
Typical corporation in some ways Shares traded on NASDAQ Quarterly dividends paid, about 4% Share repurchase $1.6 billion market capitalization $1 billion annual revenues Followed by about 16 Wall St. analysts $200M cash, no debt CEO salary $669,000 + $11.4M restricted stock
Atypical in other ways T. J. Rodgers, founder (1982) and CEO is a
dominant personality, outspoken libertarian T.J. owns almost 10% of the shares
Shareholder democracy
Annual meeting at which shareholders vote Nominees for board of directors Proposals submitted by management Proposals submitted by shareholders Very few shareholders attend meetings – voting
almost all online Reality: shareholder control is very tenuous
Nominations not contested Shareholder proposals almost always fail Shareholders subject to rational ignorance
Non-profit organizations
Definition: an organization that does not distribute profits
Non-profit organizations can and sometimes do make profits (revenue minus expense)
Profits (if any) are re-invested in the organization
Non-profit organizations generally seek tax exemption Organization exempt from paying most taxes Donors may deduct donations from their taxable
income
Non-profit organizations
Examples of non-profits CSAA (Auto Club) Sutter Health (hospital chain) Churches Family foundations (e.g. Gates) Private universities (Santa Clara U. owned by
the Society of Jesus – Jesuits) Some are organized as non-profit
corporations Executives of non-profits sometimes earn $1
million or more
“Public benefit” corporations
Special quasi-independent government agencies with little resemblance to profit-oriented corporations
Usually subsist on tax support Examples:
VTA Bus & light rail operations (very unprofitable) County highways
Port Authority of NY and NJ Toll bridges and tunnels (profitable) PATH commuter rail (unprofitable) World Trade Center
Mutual companies
Mutual insurance companies are hybrids Customers technically own the company but
exercise little control Excess income rebated to policyholders
Examples State Farm Insurance Vanguard Group (mutual funds & ETFs)
“Benefit Corporation” starts Jan. 1 in California
Board must must take into account the environment, community, employees and suppliers when they make decisions – maximizing “stakeholder” value
Requires filing a “Benefit Report” Does anyone remember Adam Smith?
By directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was not part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.