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Source link: http://archive.mises.org/4269/in-defense-of-the-corporation/

In Defense of the Corporation

October 27, 2005 by

Piet-Hein van Eeghen’s article “The Corporation At Issue, Part I: The Clash With Classical Liberal Values and the Negative Consequences for Capitalist Practices,” in the latest issue of the JLS, argues that “the corporate form of business organization is inherently incompatible with the principles of classical liberalism.” (Further summary of van Eeghen’s piece reprinted below.)

I have elsewhere posted a brief reply to other libertarian critics of the corporation (that reply is reprinted below), and more or less defended the pro-corporation view of Objectivist Robert Hessen. Part II of van Eeghen’s article, to be published in JLS 19.4, will offer a critique of Robert Hessen’s defense of the corporation, but I will go ahead now and summarize some of my comments on Part I.

I found most of van Eeghen’s arguments to be beside the point, at least for what to me is the basic question, which is: does respecting corporate status violate anyone’s rights?

Van Eeghen implies it does, because of limited liability. It seems to me that the corporation basically says shareholders are not liable for contractual obligations of the corporation. Obviously this could easily be recreated solely using private contracts. The person or company who does a deal with ABC Corp. is in effect agreeing not to pursue the assets of the shareholders if the company owes him money. So whose rights are violated?

As for tort liability–well, I am not aware of corporate law limiting the liability of any person, shareholder or otherwise, for torts he commits. In libertarian law, if you have a complex organization or business, you need to show some given person is responsible for the tort committed by someone else if you want to hold them responsible. It’s a causation question (Pat Tinsley and I go into the issue of causation and responsibility in Causation and Aggression).If the FedEx truckdriver negligently runs over you, is the shareholder responsible? Well, why would he be responsible in the first place? Because he gave a bit of money to the company? But so do customers! And banks. And suppliers. (And actually, most shareholders never gave money to the company–they bought the shares from a previous shareholder.) Because they control the company’s actions? Well they had no more influence over the concrete decisions of the truck driver, or his direct supervisor, than an influential creditor or customer. The point is if you can make a case that a given person other than the one directly responsible (the truck driver) is causally, jointly liable, fine–then under libertarian principles this person is also liable. In such a case I am not aware that corporate law grants them immunity from suit; and if and to the extent it does, then it should not (I don’t think it does but would need to check this).

If there is a problem with the law in this regard, it is with the law’s failure to assign liability according to sound principles of causation. If some critic of the corporation thinks some managers, and perhaps some directors, in a given incident are causally responsible for the tort, then fine, say so, and make the case. I would not oppose this in general. I believe it’s very difficult in most cases to connect the actions of the shareholder to damage caused by an employee of a company in which the shareholder holds stock. But if it could be shown in a particular case, then fine, he is liable. What has this to do with corporate law, which as far as I know primarily is aimed at limiting the liability of shareholders for contractual debts of the company–which is perfectly libertarian.

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From Roderick Long’s summary of the JLS issue:

Walter Block has argued in an earlier issue — JLS 16.4 (Fall 2002) — that “Henry Simons Is Not a Supporter of Free Enterprise.” In “The Corporation At Issue, Part I: The Clash With Classical Liberal Values and the Negative Consequences for Capitalist Practices,” Piet-Hein van Eeghen offers a qualified defense of Simons by taking up what he sees as one of Simons’s key insights: that the corporate form of business organization is inherently incompatible with the principles of classical liberalism.

The problem with the corporate form is that it grants to private business a distinctive governmental feature — legal personhood, and the accompanying privilege of limited liability — without the correlative burden of democratic accountability; granting such a status, van Eeghen argues, constitutes an un-libertarian surrender of individual responsibility, and confers the benefits of ownership without its corresponding costs, thus enabling corporations to concentrate power and externalize risk in ways to which libertarians should object. (Part II, to be published in JLS 19.4, will offer a critique of Robert Hessen‘s defense of the corporation as an institution.)

***

Legitimizing the Corporation [from LRC blog]

Marginal movements tend to draw their share of nuts and cranks; unfortunately, libertarianism is no exception. In addition to claims that we don’t (not “shouldn’t” but “don’t”) owe income tax, or “that hiring an attorney means abandoning personal sovereignty before the law, or that having a yellow-[or gold-]fringed flag in a room means you are under martial [or admiralty/maritime] law,” there are also a fair number of libertarians who view the modern corporation with suspicion. They are concerned that the corporation is viewed as a “person” and believe, erroneously, that corporations shield corporate employees from liability for negligence.

I usually find that the opposition to corporations comes from leftists, or, if libertarians, from ignorance of contract and corporate law…. most people don’t even realize that if a FedEx truck runs you over negligently you can sue the driver. They think he is immune from suit or something. But it is the other way around; if a FedEx truck negligently hits you, it is of course the driver that is responsible. His employer is responsible for its employee’s own negligence and liability only because of the doctrine of respondeat superior; but if the employee is found to be non-negligent, the employer-corporation is off the hook too. This is in fact why corporations usually defend their employee and themselves when sued for the employee’s actions.

But opposition does not always stem from ignorance of the law or leftism: for example, one critique comes from two libertarian-Austrian attorneys: “De-legitimizing the Corporation: An Austrian analysis of the firm”, Jeffrey F. Barr & Lee Iglody, Austrian Scholars Conference 7, March 30-31, 2001, Auburn, Alabama.

Robert Hessen’s (a Randian) In Defense of the Corporation is a good defense of corporations. He shows that they don’t require privilege from the state to exist; they can be constructed from private contracts. One of Hessen’s articles nicely summarizes some of his views. Some excerpts are pasted below. My view is that corporations are essentially compatible with libertarianism. As for voluntary debts being limited to the corporation’s assets; this is no problem since the creditor knows these limitations when he loans money. What about limited liability for torts or crimes? As mentioned, the person direclty responsible for a tort or crime is always liable; sometimes the employer (which is often a corporation) is also liable for the employee’s actions, via respondeat superior. Who else should be responsible? In my view, those who cause the damage are responsible. Shareholders don’t cause it any more than a bank who loans money to a company causes its employees to commit torts. The shareholders give money; and elect directors. The directors appoint officers/executives. The officers hire employees and direct what goes on. Now to the extent a given manager orders or otherwise causes a given action that damages someone, a case can be made that the manager is causally responsible, jointly liable with the employee who directly caused the damage. It’s harder to argue the directors are so directly responsible, but depending on the facts, it could be argued in some cases. But it’s very fact specific. Perhaps the rules on causation should be relaxed or modified, but this has nothing to do with there being a corporation or not–for the laws of causation should apply to any manager or person of sufficient influence in the organization hierarchy, regardless of legal form of the organization (that is, whether it’s a corporation, partnership, sole proprietorship, or what have you).

Excerpts from the Hessen article

The actual procedure for creating a corporation consists of filing a registration document with a state official (like recording the use of a fictitious business name), and the state’s role is purely formal and automatic. Moreover, to call incorporation a “privilege” implies that individuals have no right to create a corporation. But why is governmental permission needed? Who would be wronged if businesses adopted corporate features by contract? Whose rights would be violated if a firm declared itself to be a unit for the purposes of suing and being sued, holding and conveying title to property, or that it would continue in existence despite the death or withdrawal of its officers or investors, that its shares are freely transferable, or if it asserted limited liability for its debt obligations? (Liability for torts is a separate issue; see Hessen, pp. 18-21.) If potential creditors find any of these features objectionable, they can negotiate to exclude or modify them.

Economists invariably declare limited liability to be the crucial corporate feature. According to this view the corporation, as an entity, contracts debts in “its” own name, not “theirs” (the shareholders), so they are not responsible for its debts. But there is no need for such mental gymnastics because limited liability actually involves an implied contract between shareholders and outside creditors. By incorporating (that is, complying with the registration procedure prescribed by state law) and then by using the symbols “Inc.” or “Corp.,” shareholders are warning potential creditors that they do not accept unlimited personal liability, that creditors must look only to the corporation’s assets (if any) for satisfaction of their claims. This process, known as “constructive notice,” offers an easy means of economizing on transactions costs. It is an alternative to negotiating explicit limited-liability contracts with each creditor.

Creditors, however, are not obligated to accept limited liability. As Professor Bayless Manning observes; “As a part of the bargain negotiated when the corporation incurs the indebtedness, the creditor may, of course, succeed in extracting from a shareholder (or someone else who wants to see the loan go through) an outside pledge agreement, guaranty, endorsement, or the like that will have the effect of subjecting non-corporate assets to the creditor’s claim against the corporation.” This familiar pattern explains why limited liability is likely to be a mirage or delusion for a new, untested business, and thus also explains why some enterprises are not incorporated despite the ease of creating a corporation.

Another textbook myth is that limited liability explains why corporations were able to attract vast amounts of capital from nineteenth-century investors to carry out America’s industrialization. In fact, the industrial revolution was carried out chiefly by partnerships and unincorporated joint stock companies, rarely by corporations. The chief sources of capital for the early New England textile corporations were the founders’ personal savings, money borrowed from banks, the proceeds from state-approved lotteries, and the sale of bonds and debentures.

Even in the late nineteenth century, none of the giant industrial corporations drew equity capital from the general investment public. They were privately held and drew primarily on retained earnings for expansion. (The largest enterprise, Carnegie Brothers, was organized as a Limited Partnership Association in the Commonwealth of Pennsylvania, a status that did not inhibit its ability to own properties and sell steel in other states.)

External financing, through the sale of common stock, was nearly impossible in the nineteenth century because of asymmetrical information–that is, the inability of outside investors to gauge which firms were likely to earn a profit, and thus to calculate what would be a reasonable price to pay for shares. Instead, founders of corporations often gave away shares as a bonus to those who bought bonds, which were less risky because they carried underlying collateral, a fixed date of redemption, and a fixed rate of return. Occasionally, wealthy local residents bought shares, not primarily as investments for profit, but rather as a public-spirited gesture to foster economic growth in a town or region. The idea that limited liability would have been sufficient to entice outside investors to buy common stock is counterintuitive. The assurance that you could lose only your total investment is hardly a persuasive sales pitch.

No logical or moral necessity links partnerships with unlimited liability or corporations with limited liability. Legal rules do not suddenly spring into existence full grown; instead, they arise in a particular historical context. Unlimited liability for partners dates back to medieval Italy, when partnerships were family based, when personal and business funds were intermingled, and when family honor required payment of debts owed to creditors, even if it meant that the whole debt would be paid by one or two partners instead of being shared proportionally among them all.

Well into the twentieth century, American judges ignored the historical circumstances in which unlimited liability became the custom and later the legal rule. Hence they repeatedly rejected contractual attempts by partners to limit their liability. Only near midcentury did state legislatures grudgingly begin enacting “close corporation” statutes for businesses that would be organized as partnerships if courts were willing to recognize the contractual nature of limited liability. These quasi-corporations have nearly nothing in common with corporations financed by outside investors and run by professional managers.

Any firm, regardless of size, can be structured as a corporation, a partnership, a limited partnership, or even one of the rarely used forms, a business trust or an unincorporated joint stock company. Despite textbook claims to the contrary, partnerships are not necessarily small scale or short-lived; they need not cease to exist when a general partner dies or withdraws. Features that are automatic or inherent in a corporation–continuity of existence, hierarchy of authority, freely transferable shares–are optional for a partnership or any other organizational form. The only exceptions arise if government restricts or forbids freedom of contract (such as the rule that forbids limited liability for general partners).

Update: See further discussion and my list of resources on this in Sean Gabb’s Thoughts on Limited Liability.

Update: Roger Pilon’s Corporations and Rights: On Treating Corporate People Justly also has some very good stuff on why limited liability does not give any special privilege to shareholders. See also my post Legitimizing the Corporation and Other Posts.

{ 55 comments }

Georgist November 6, 2005 at 1:04 am

But it’s not that limited of a point–the entire attack on corporations rests on this little thing.

I thought leftists attacked it on the grounds that you could conceivably have a bunch of people pool their money together, commit some crime, pay off the proceeds as dividends, and when people sue, you stiff them because the “corporation” is bankrupt.

Wolf DeVoon November 6, 2005 at 1:12 am

Do individuals have a right to organize by means of contract in a way that resembles the features of a state? or a socialist commune? I say no.

Limited liability regardless of purpose? purely to make money? Sure, you can do it today, by riding on Bill Gates’ coat tails or Warren Buffett’s — but it presupposes greenbacks and the NYSE. An anarchist society is not very likely to resemble the current one.

Anyway, I quit, having said my piece many times in this thread. Hold shareholders responsible for the actions of directors and managers, who are their fiduciary agents.

Paul Edwards November 6, 2005 at 1:36 am

Since protection against prosecution for criminal action isn’t what incorporation provides, i guess the leftists have no valid complaint. I am sure that Stephan has made this point more than once and in more than one way. Corporations don’t commit crimes. Individuals commit crimes. All incorporation does is protects investors’ personal assets from creditors; and that only if the creditor doesn’t insist in changing the contract to be able to go after some investors’ assets. It does not protect individuals from criminal prosecution.

Stephan Kinsella November 6, 2005 at 9:54 am

Georgist:

I thought leftists attacked it on the grounds that you could conceivably have a bunch of people pool their money together, commit some crime, pay off the proceeds as dividends, and when people sue, you stiff them because the “corporation” is bankrupt.

I don’t think so. As far as I am aware, corporate laws regarding limited liability do not exempt you from liability for commission of a crime. Where do people get this notion?

Do individuals have a right to organize by means of contract in a way that resembles the features of a state? or a socialist commune? I say no.

This argument by analogy is question-begging. You have yet to show that a group of people having a certain contract with third parties is unlibertarian.

Limited liability regardless of purpose? purely to make money? Sure, you can do it today, by riding on Bill Gates’ coat tails or Warren Buffett’s — but it presupposes greenbacks and the NYSE. An anarchist society is not very likely to resemble the current one.

Okay. THe purpose is to make money by any legal means.

Anyway, I quit, having said my piece many times in this thread. Hold shareholders responsible for the actions of directors and managers, who are their fiduciary agents.

You throw “fidiciary agents” around as if it’s some magical term that does all your work for you–you have failed to even attempt to show how or why shareholders are causally responsible for torts or crimes committed by employees of the corportations in which they are shareholders.

Since protection against prosecution for criminal action isn’t what incorporation provides, i guess the leftists have no valid complaint. I am sure that Stephan has made this point more than once and in more than one way. Corporations don’t commit crimes. Individuals commit crimes. All incorporation does is protects investors’ personal assets from creditors; and that only if the creditor doesn’t insist in changing the contract to be able to go after some investors’ assets. It does not protect individuals from criminal prosecution.

Yes, but these people are not listening; they have been somehow brainwashed by leftist anti-corporate propaganda. In my view, this issue has become so muddled that any libertarian who has a critical view of the corporation without having first read Hessen’s book is irresponsible and holding forth on serious, complicated matters that he has not bothered to educate himself adquequately about.

Gregory White November 7, 2005 at 2:38 pm

sk> In the free market it would be the same.

I think this is the pivot, so I snipped all the rest. You essentially claim universal equivalency when it comes to rights (legislation v. non-legislation), and I do not. There is little argument on particulars — and you’ve given some valid examples that I have agreement with. I haven’t even questioned that your assertion is substantially true. However, a set of true particulars does not prove the universalness (generality) of the theory. The limited set fundamentally can’t.

To be brief and restate, unlike you, I believe it is likely the legislation shifts (distorts) contract cost burdens such that some liability contracts­­­­­­ — those which might have been acquired by creditors without legislation — are in essence priced beyond the value of acquiring them (what I meant by “bargaining power”). Also, I have not been able to wave off the possiblity that the legislation effects competitiveness in acquiring these contracts due to the cost burden shift. If I am correct — and I cannot prove my assertion either — then I believe this is a rights issue, since it affects rights to form contracts and rights to property.

In any case, I have zero objection to free corporations since the idea is well within the rights of those choosing to do so.

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