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
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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.
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.
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.
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.
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.
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.
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?
Brad, allow me to note that you have completely failed to address the point that the limited liability that shareholders (and initial investors) have with respect to involuntary creditors of a corporation – that is, those who are injured by the acts of the agents of the corporation – is indeed a grant by the state and one that could not, by definition, ever be contracted in advance.
Stephan Kinsella acknowledges this and attempts to address the problem (unsatisfactorily, I believe) here:
http://blog.mises.org/archives/009070.asp
http://blog.mises.org/archives/009084.asp
Brad kindly responded by email; here is our exchange:
Brad: Oh — so indemnification clauses are invalid under ancap? Good to know.
Brad, while A may agree to indemnify B for his liability to C, such indemnification doesn’t eliminate C’s rights against B.
B is always liable for his own acts – though the party to whom he is liable might agree in advance to limit the resources of available to cover liabilities, that simply can’t happen in the case of an involuntary creditor.
Do you have a different understanding of libertarian principles, or of how indemnifications work?
Tom
That’s how I read it. A may (or may not, in a worst case) end up covering everything for B that B has to do for C – but B is still on the spot and can’t just walk away saying “A will handle it” unless C accepts that. So B still has to front up, even if it’s only to sign off while A gives him what he gives C. If it turns out that A can’t handle it after all, in full and straight away, B will find that he doesn’t just have to do some tedious compliance, he really is out on a limb.
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