Robert Hockett —
Last month Senator Elizabeth Warren proposed an innovative – or better yet, restorative – new piece of legislation to the US Senate. Something like the Senator’s Accountable Capitalism Act, which would, among other things, hold corporations accountable to other stakeholders besides shareholders, is long overdue. It is in consequence much more than welcome. This owes less to the bill’s likely passage, however – it will probably die in committee this time around – than to the occasion its proposal affords us to recollect (a) what incorporation legally is and (b) what incorporation actually is for.
We seem as a society and as a legal culture to have forgotten how the corporation as a ‘publicly’ privileged mode of ‘private ordering’ came into being. Hence we have come likewise to overlook how the irreducible public/private hybridity of this now-ubiquitous institutional form gives the lie to familiar liberal and neoliberal clichés concerning a supposed fundamental divide cleaving both life in communion with others, and that life’s legal emanations, into radically distinct public and private ‘spheres.’
Senator Warren’s proposal accordingly provides not only lawyers, but also the broader public a rare opportunity to recall the true nature and purpose of incorporation – and, with those, the institutional continuum along which our contiguous public and private modes of life and collective agency are arrayed. In so doing, it also affords us an opportunity to restore to America’s productive life a critical institutional element that lay at the core of its economic ‘growth miracles’ and ‘social contracts’ alike during its most prosperous past eras.
I’d like in two posts, then, first to recall in detail what needs restoring and why, then to sketch how to restore it. In the present post I’ll stick to that what and why. In the follow-on post I’ll turn to the how – I’ll elaborate, in short, how Senator Warren’s proposal can be viewed as a sequence of first steps toward the requisite restoration.
In the Beginning: Why Incorporation?
‘Private’ legal entities ‘publicly’ authorized to crystalize into existence, act, and hold assets in their own names while shielding their owners from legal accountability are now so ubiquitous, and have been part of our legal landscape for so long, that many Americans have forgotten both the circumstances surrounding and the reasons behind their invention. Many have likewise forgotten how extraordinary a departure these entities represented from widely shared understandings of responsibility and legal accountability when first they were introduced. And thus many have also forgotten the strictly conditional nature of ‘the corporate privileges’ when first they came to be granted by the quasi-sovereign states of our federal republic.
In the early days of the American republic, productive capital was in short supply. State revenues were accordingly often both limited and unpredictable. In response our law developed a pragmatic method of ‘outsourcing’ the construction of vital public infrastructures and the supply of widely needed public goods. Building on British antecedents that had ‘publicly’ encouraged and facilitated imperial expansion effected by swashbuckling ‘privateers,’ that method was to permit – solely for specific and well-defined public purposes – the chartering of legal entities whose owners could not be held liable for losses inflicted or caused by those entities, and which could not be sued by creditors of their owners, so long as the losses occasioning suit were inflicted by the entity only in its authorized course of operation. This is all that ‘the corporation’ was when invented – and remains all that the corporation should be to this day.
Hence, for example, a US state in need of canals, turnpikes, or other transportation networks in the early days of the American corporate form would confer a corporate charter on syndicates of individuals who credibly promised to construct such infrastructures. It would thereby shield those individuals’ personal assets from suits that might be brought against their corporation for harms caused by defects in the relevant roads or bridges, for example. At the same time it would shield the corporation itself from suit that might be brought by some creditor of one or more (in the limit, even all) of its owners should the latter default in their individual capacities on obligations owed to third parties. This two-way ‘asset-segregation,’ along with indefinitely protracted – aka ‘perpetual’ – existence, facilitated long-term private investment in infrastructure and other public goods. And that facilitation was the sole purpose of this extraordinary insulation from ordinary accountability.
These privileges were, it cannot be emphasized enough, both morally and legally extraordinary. That is why they were conferred only for limited, well-defined public purposes. Ordinarily, one who provides funding to terrorists or other harm-causing enterprises, for example, is both morally and legally accountable for facilitating such harms, even if she or he does not ‘directly’ inflict the harm. Likewise, one who is found liable for harms will see his or her assets attached by his or her ‘judgment creditor’ if unable to pay damages determined by judgment in a court of law, even if he or she has put those assets temporarily at the disposal of others. Corporate privilege represented a profound departure from these longstanding background principles of moral and legal responsibility – a departure that only sovereigns or near-soereigns like US states could authorize, and only for reasons of extraordinary necessity. Hence the familiar ring, until relatively recently, of phrases like ‘the [state-conferred] corporate franchise,’ and adages like that pursuant to which corporations are observed to be ‘creatures of the state.’
The corporate privileges were also, again, meant solely to encourage the owners of scarce capital to organize and finance projects for the public good, during a time when capital was indeed scarce and reliable public revenue correspondingly hard to come by. For this very reason, the privileges were operative only insofar as the incorporated entity was actually pursuing such projects. They were, in other words, strictly conditional. And both the state’s Secretary of State and committees of interested citizens had to agree that the conditions were likely to be met before any firm’s corporate charter would be conferred or renewed.
Incorporated entities that strayed from their publicly defined purposes were correspondingly said to have acted ‘ultra vires‘ – that is, outside of their limited powers – and thereby to have forfeited their privileges. An entity that acted outside of its authorized powers could then be dissolved and its assets made available to creditors of its owners. Those owners, for their part, then could be sued for harms caused by – or rather, through – their incorporated entity, just as one might be sued, for example, were his or her negligently parked car to roll down a hill and cause injury. All of this was because the owners of the firm had strayed from the sole purposes that had warranted the departure from ordinary rules of moral responsibility and legal accountability in the first place. Fail the purpose of the privilege, the thinking went, and you forfeit the privilege.
After the Fall: Latterday Superfluity and Abuse of Incorporation
The corporate form as originally designed and just described proved a successful means of pragmatically partnering the so-called public and private sectors to provide transportation infrastructure, energy grids, sewage and water systems, schools and libraries, public assistance and other social services in a world of scarce capital and unreliable public revenue. In the modern era, however, things began gradually to change. For one thing, capital grew much less scarce, as (a) stock and real estate bubbles throughout the 20th and early 21st centuries, (b) the current wave of ‘stock buybacks,’ and (c) the related wave of ‘taking firms private‘ all have made plain. For another thing, public revenue became much more dependable, as it remains to this day when tax codes are not radically changed by plutocrat-owned and –operated legislators over-frequently. And finally, in part precisely because of the first two developments, corporate chartering itself began to change.
As incorporated firms grew less necessary for the supply of specific forms of public infrastructure, states began competing with one another for the ‘franchise tax’ revenue that can be had by charging a fee for the granting of corporate charters. This competition took the form of increasingly lenient conditions’ being placed on the granting of corporate charters. It also brought more and more ‘manager-friendly,’ ‘small shareholder-unfriendly’ bodies of corporate law. State corporate codes increasingly insulated elite corporate executives from accountability to their firms’ smaller shareholders where executive compensation, corporate political activity, and corporate policy more generally were concerned.
This chartering competition, which remains underway to this day, bore all the attributes of an arms race – a classic collective action problem – that no state could or can exit save by ‘unilateral disarmament.’ This is why the race came to be called, and is still called, a ‘race to the bottom.’ ‘The bottom’ here is a legal landscape in which nearly all states have unconditional, so-called ‘general incorporation’ statutes, and few states encourage shareholder or stakeholder ‘activism’ of any kind that might appreciably limit the prerogatives – or pay – of increasingly unaccountable elite corporate executives, executives who use the corporate form principally to enrich themselves and large shareholders rather than to benefit smaller shareholders, rank and file employees, or the local and national economies.
The results of this historically anomalous ‘free incorporation’ environment are as familiar as they are legion. High-powered executives now familiarly run firms more for their own benefit than for the benefit of small shareholders, let alone other stakeholders and surrounding communities – the very people who used to have to approve grants of corporate charters in the first place. Unaccountable firms, meanwhile, impose massive inefficiencies upon the public thanks to the ‘moral hazard’ and negative externalities permitted – indeed, actively encouraged – by the limited liability regime that we first came to permit solely in order to encourage private investment in public infrastructures. All the while, precisely because capital is now so abundant as not to require the conferral of special privileges on corporate investors, incorporated firms amass more and more capital from fewer and fewer ultra-wealthy interests, and in so doing grow much too large for subnational states to monitor and control even were those states not already locked in the aforementioned ‘race to the bottom.’
Clearly what we are confronted with now, then, is in many cases an alien form of legally constructed ‘Frankenstein’s monster,’ originally created by states and now well beyond state control. ‘Private’ firms enjoying publicly conferred corporate privilege in our states’ coerced ‘race to the bottom’ now monopolize or oligopolize entire industries – including such de facto public utility industries as the news media, telecommunications media, social media and payment platforms, banking and finance, healthcare and health insurance, and even transport and retail in some cases. The same firms’ executives set their own pay and choose their own regulators – indeed, even their, and our, legislators – by determining through unaccountable and even shareholder-unapproved campaign donations and expenditures who wins many of our elections.
Ironically, these firms even effectively make elections themselves, and hence our democracy’s very capacity for self-government, exorbitantly expensive. This they do by charging candidates for public office huge fees for access to the public’s own airwaves and communications infrastructure, which corporate executives control only through public license. This of course necessitates many of our lawmakers’ spending hours each day seeking corporate money for reelection rather than listening to, learning from, and doing the bidding of their constituents.
The states are, as mentioned before, now both too small and too ‘divided and conquered’ to solve this massive cluster of collective action problems with which the regime of ‘free incorporation’ now confronts them. Only the states’ and the public’s authorized collective agent – our federal government – is both large enough and central enough to aid our states in addressing these collective action challenges and thereby restoring the great American tradition of conditioning publicly conferred corporate privilege expressly upon the fulfillment of cognizably public purposes.
A Tentative Conclusion: Why – or On What Conditions – Keep Incorporation?
What, then, might a renewed corporate public purpose regime – that is, an accountable incorporation regime – look like? In broad outline, I think what’s ultimately requisite are several measures, all of which lever the scale and centrality of that collective agent in which much more of our power and sovereignty vest now than they did in the 19th century. That is our federal government, which is now needed much more than ever before to assist our subnational state governments in doing their jobs. I’ll elaborate those measures, along with those proposals of Senator Warren’s that move us in their direction, in the sequel to this post.
Robert Hockett is the Edward Cornell Professor of Law at Cornell Law School.