Robert Hockett —
Introduction: From ‘Accounting For’ to ‘Accountable To’
In an earlier post I welcomed legislation recently proposed by Senator Elizabeth Warren. Her Accountable Capitalism Act, I suggested, not only bids fair in the long run to render incorporated business firms less sociopathic, but also affords in the short run a fine opportunity to recall what corporate privileges are for. The latter, I argued,
are both analytically and historically best understood as ‘publicly’ conferred advantages accorded ‘private’ entities for ‘public goods’ that they provide. This interpretation of the origin and function of the corporate form, I noted, is simply inescapable when we observe the practice of conditional corporate chartering, and the law of corporate action taken ultra vires, that predominated from the dawn of American incorporation well into the 20th century.
Unfortunately, I also noted, once the 19th century conditions of capital scarcity and unreliable public revenue that had recommended incorporation as a necessary mode of ‘outsourcing’ public functions to private entities in the first place had receded, corporate history took a darker turn. Subnational state governments that once had chartered firms conditionally to discharge public functions now began to bribe them, with a view to gleaning franchise revenue. Charters now grew unconditional and firms were treated as accountable to no one but their largest shareholders. Firms grew ever larger in this new environment, and states grew weaker and ‘divide-and-conquerable’ where holding privileged ‘private’ firms to ‘public’ account was concerned. A ‘race to the bottom’ began.
What, then, I asked, is requisite to restoration of some version of the status quo ante – the world in which the truly extraordinary privileges of perpetual existence and asset-insulation (particularly limited liability, an illuminating synonym for which would be ‘limited accountability’) were conditional upon provision of some public benefit? The answer, I suggested, would involve a number of essential measures, all of which would capitalize upon the fact that it’s our federal government now that stands to mega-firms as our state governments once stood to smaller firms. I therefore promised in a sequel post to lay those out, and then to indicate how Senator Warren’s legislation would begin to take those necessary steps.
Well then, here we go.
Requisites to Restoration
So might a restored or renewed conditional incorporation regime – that is, an accountable incorporation regime – look like? In broad outline, I think that what’s ultimately needed are some seven measures, all of which will 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, when our subnational states were more prominent. That is our federal government, which is now needed much more than ever before to assist our subnational state governments in doing their jobs. Those measures are as follows.
First, to eliminate large firms’ capacity to ‘divide and conquer’ the states that incorporate them, we should require all incorporated and other limited liability entities that reach certain size thresholds to apply for a new, federal charter. This charter would be in addition to, not instead of, any state charter. We might analogize this arrangement to that we employ in the regulation of mutual funds and other investment companies, which must register with the SEC once certain thresholds are crossed, in addition to seeking a state corporate or trust franchise. We might also analogize to systemically important financial institutions as determined by FSOC under Dodd-Frank, which fall subject to enhanced forms of prudential regulation additional to those to which smaller, less systemically significant firms are subject.
Needless to say, federal chartering should also be required of any non-domestic firm seeking access to the American market once it has reached the specified size threshold. Any covered entity reaching these thresholds and not acquiring a federal charter would be prohibited from doing business in the United States, irrespective of any state or foreign charter – e.g., a charter conferred by an ‘offshore financial center’ such as the Cayman or Channel Islands – that it might hold. And any relevant executive of such a firm who fails to seek a federal charter for the firm would be held personally liable for causing his or her firm to do business unlicensed.
The size threshold, for its part, could be determined on the basis of any one or more of the following indicia: value of total assets held, understood in terms of some absolute dollar threshold; portion of assets held within a specific industry, understood as a relative dollar threshold; total market capitalization; share of market capitalization within an industry; market share within an industry; employment share within an industry. By the same token, we should be cautious about using total employment within an industry, or market share within states or localities, for fear of certain perverse incentives to which such determinants might give rise.
The reason for introducing this new chartering regime would be twofold. First, as the size threshold ‘trigger’ suggests, the goal is to end the ‘race to the bottom’ among small states that large firms are able to play off against one another. Second and relatedly, the ultimate end to which ending that race is aimed is to restore public-benefitting conditionality to incorporation and corporate privilege.
What conditions would have to be met for the federal charter to be granted? Recommendations doubtless will vary, but I suspect many would agree to the following minimal core.
First, the firm should have to state what public purpose or purposes will be served by conferral of the extraordinary corporate privileges – perpetual existence, asset insulation, limited liability – upon an entity of the relevant firm’s size. We might think of this as a sort of ‘B Corp‘ requirement triggered by any firm’s becoming large and systemically important enough to cross one or more of the aforementioned size thresholds that render them uncontrollable by states. The firm would then have to report on an annual or biannual basis to the chartering authority and a committee of affected citizens, more on which below, what it has done over the previous period in furtherance of its stated public purpose.
Second, the firm would be required to maintain liability insurance in an amount adequate to cover any harm that limited liability might otherwise incentivize its shareholders or managers to ‘externalize.’
Third, the firm would have to include both employee and other stakeholder representation on its board. One possibility that I find attractive is a tripartite classified board structure comprising one-third representing shareholders, one-third representing wage and contract labor, and one-third representing ‘typical communities’ in which the firm regularly operates. Consumer representation might also be considered. In effect, large firms would be governed a bit in the way regional Federal Reserve banks are meant to be governed today, with governance structures reflecting the principal constituencies whom their operations routinely affect. Another partial analogy here is to the ‘codetermination‘ regime applicable to certain firms in Germany – a jurisdiction whose economic arrangements were explicitly patterned on the earlier American model, and one that is not known for unsuccessful or inefficient business firms.
Fourth, the firm would have to disclose publicly, and regularly update, all political expenditures and donations that it or its executive officers make. We might even do well simply to prohibit such expenditures in the case of such firms. While a prohibition of this sort might be challenged under Citizen’s United, it is not clear that such a challenge could be sustained. For the federal charter would be a privilege, not a right, and firms could readily avoid triggering the federal chartering requirement simply by remaining under the size thresholds that engage it.
Fifth, the firm would be subject to regular audits by appropriate ‘functional regulators,’ such as the Department of Labor, the Federal Election Commission, the Federal Trade Commission, or the SEC, to ensure that it is not acting in manners that exploit its size, as determined by the chartering threshold criteria, at the expense of consumers, the American electorate, labor, or smaller competing firms. The appropriate functional regulator would of course coordinate with the federal chartering authority, more on which below, in discharging this oversight task – rather as functional financial regulators such as the Commodity Futures Trading Commission and SEC coordinate with the FSOC and Fed under the Dodd-Frank and Gramm-Leach-Bliley Acts today.
Sixth, if the firm compensates its executive officers in the form of stock or stock options, conditions should attach to these so as to prohibit their liquidation, over some dollar threshold, until several years or more after the relevant executive has terminated his or her employment with the firm. This would help remove incentives to engage in short-term manipulations of share prices in manners that benefit corporate fiduciaries without benefitting their firms and those firms’ constituents.
Finally seventh, the firm might also be required, or perhaps instead offered more ‘positive’ inducements (‘carrots’), to adopt Employee Stock Ownership Plans or similar plans that enable non-executive employees also to accumulate small ownership stakes in their firms. This can both ‘align incentives’ and enable more Americans to augment their labor incomes with capital incomes.
One can imagine additional requirements on which federal chartering might be conditioned. But any number of the foregoing proposed requirements, I think, would constitute a reasonable and promising start.
Who would be the chartering authority? I think that a 21st century rendition of the original corporate chartering regime would be best. First, then, an office newly created within the Department of Commerce for this purpose would be established. And second, committees of likely affected citizens would be impaneled to aid the Authority in its charter-conferral and charter-renewal functions. These committees might be selected from pools of applicants responding to notices published in the Federal Register in connection with specific charter applications. Perhaps needless to say, these same announcements can be used to solicit APA-style public comment on the same applications.
This Chartering Authority’s role relative to Commerce here might be analogized to that of the Office of the Comptroller of the Currency relative to Treasury, and the public role in chartering decisions can correspondingly be analogized to its role in connection with bank-chartering decisions. There would, however, be one very important difference. Whereas national bank charters operate separately from and parallel, as alternatives, to state bank charters, the federal corporate charter would be an ‘add-on’ to state charters, applicable only to ‘big’ firms that states acting separately cannot adequately oversee. This suggests that the national chartering authority would do well to coordinate not only with concerned citizens, but also with state chartering authorities in the interest of holding large firms with corporate privileges accountable to the public.
In this sense, the new chartering regime that I here advocate would serve further to empower the states in our federal system. It is the very model of that subsidiaristic ‘federalism’ which the American ‘founders’ crafted over 230 years ago.
How the Accountable Capitalism Act Begins the Restoration
Senator Warren’s Accountable Capitalism Act does not go as far as what I here advocate. It does, however, take critical first steps in beginning to realign our regime of incorporation with its original purposes along the lines sketched above. Specifically, it does so by doing the following.
First, by recognizing a new category of very large American corporations called ‘United States corporations,’ which must obtain a federal charter that obligates company directors to consider the interests of all corporate stakeholders, not just mega-shareholders, in their decision-making: American corporations with more than $1 billion in annual revenue must obtain a federal charter from a newly formed Office of United States Corporations at the Department of Commerce. The new federal charter obligates company directors to consider the interests of all corporate stakeholders – including employees, customers, shareholders of all sizes, and the communities in which their companies operate – not just large shareholders. This approach is derived from the (now only optional) benefit corporation model adopted by 33 states and the District of Columbia.
Second, by requiring robust worker representation on the boards of United States corporations: Every United States corporation must ensure that no fewer than 40% of its directors are selected by the corporation’s employees. Again Germany has a similar requirement for large corporations and has seen robust economic growth and wage improvements for decades.
Third, by imposing restrictions on the sale of company shares by the directors and corporate officers of United States corporations: To ensure that corporate decision-makers are focused on the long-term interests of all corporate stakeholders, rather than on enriching themselves on the basis of short-term gains in their companies’ manipulable share prices, the bill prohibits United States corporations’ directors and officers from selling any company shares within five years of obtaining the shares or within three years of an open-market stock buyback.
Fourth, by requiring United states corporations to obtain shareholder and board approval for, and publicly to disclose, all political spending: In keeping with a proposal from John Bogle, the founder of Vanguard Group, United States corporations would have to receive the approval of at least 75% of their shareholders and 75% of their directors before engaging in political expenditures. They also would have to disclose all political and lobbying expenditures.
And fifth, by establishing a process for revoking United States corporations’ charters when they engage in repeated misconduct: State Attorneys General are authorized to submit petitions to the Office of United States Corporations to revoke a United States corporation’s charter. If the Director of the Office and the Secretary of Commerce find that the corporation has a history of egregious and repeated misconduct and has failed to take meaningful steps to address its problems, they may grant the petition. The company’s charter would then be revoked a year later – giving the company time before its charter is revoked to make the case to Congress that it should retain its conditional charter in the same or in modified form.
All five of these features would facilitate state and federal collaboration in beginning to tame the nation’s largest incorporated firms, bringing their operations more into line with the original purpose of the corporate form and its extraordinary privileges. In so doing, they would also begin the process of restoring an ingeniously pragmatic and quintessentially American mode of partnering the ‘public’ and ‘private’ sectors in delivering broadly inclusive, sustainable prosperity to our citizenry. That is how we did things during our ‘miracle’ years, when we fostered and grew the largest middle class that the world had ever known. Senator Warren and others are right, I believe, in holding that this is how we must do things again.
Conclusion: Accountable Incorporation and Accountable Capitalism
If we wish to preserve capitalism, then, we must make our capitalism accountable capitalism again. And that means accountable incorporation. The corporate form is a hybrid organizational form. It is both ‘public’ and ‘private’ in character. This is so whether we forthrightly recognize and act upon the hybridity or not – just as the auto whose accelerator you’re pressing will press forward whether you forthrightly ‘take the wheel’ or not. The only question is whether the thing will be guided productively.
We used to have a name for the ‘macro’ counterpart of the ‘micro’ corporation. We called it ‘the mixed economy.’ Arrow-Debreuvian fabulists, imperious neoliberals, and vulgar libertarians alike seem to think ‘mixing’ here miscegenation. But just as inbreeding among biological organisms breeds degeneration, so does would-be theoretic or practical apartheid where our productive activities are concerned produce idiot savant economics and imbecile economies.
A vital economics and vital economy require dispensing with crude, unsustainable categorical distinctions – particularly that between ‘public’ and ‘private’ – where our productive relations are concerned. There will be much more to say on this later, across the full terrain of theoretical-practical legal-economics. For now, though, theoretically and practically recovering the corporation in its true nature as a legally constructed unit of productive organization will help set us on our way.
If I am right about that, then Senator Warren is to be thanked for more than a worthwhile proposal. She’s to be thanked for providing occasion for a long overdue national deliberation.
Robert Hockett is the Edward Cornell Professor of Law at Cornell Law School.