This post is part of a series on the Methods of Political Economy.
We imagine we live in a bourgeois capitalist economy, in which the means of production are owned by natural persons, the “capitalists” of capitalism. On this, the Marxist economist, the liberal economist, and the neoliberal economist agree. But we do not. Ours is a corporate economy. Overwhelmingly, the means of production are owned, not by natural persons, but by abstract legal entities—corporations. Marx was thus right in predicting that the fetters of bourgeois, individually-owned property would be burst asunder to be replaced by socialized property. But it is not at the level of the state that productive property has been socialized. It is at the level of the corporation. It is, notes Paddy Ireland, “capitalism without the capitalist.” The implications of this are manifold and take us outside the confines of what conventional economics can illuminate.
As a political theorist reading around in what, a dozen years ago, was the latest literature on corporations, my epiphany came upon encountering the work of Henry Hansmann and Reiner Kraakman on “entity shielding.” While “limited liability” protects the stockholder from the debts of the corporation, “entity shielding” (a term the authors coined) protects the corporation from the debts of the stockholder. The stockholders’ personal creditors may take their stock. But they cannot in addition pull assets out of the corporation. Indeed, the stockholders themselves cannot pull assets out of the corporation. If one wishes to take one’s investing dollars elsewhere, one cannot demand that money back, but must find someone to “take one’s place,” that is, find someone to buy one’s stock.
This sharply distinguishes the corporation from the classic general partnership. Departing partners pull out their portion of the firm’s assets. Furthermore, the personal creditors of individual partners can levy against the partnership assets and, those exhausted, even against the personal assets of the other partners (by the principle of “joint and several liability”). In a classic partnership, the assets of the partnership simply are the assets of the partners. They are legally entangled. In contrast, the assets of the corporation and the assets of the stockholder are legally “partitioned.”
This partitioning of the assets of the corporation from those of the stockholder brings a number of economic benefits to the corporate firm—from tradeable shares to more specializable assets. The details need not detain us. But to me, the implication was clear. Although Hansmann and Kraakman, eminent members of the “law and economics” movement, persisted in speaking of stockholders as the “owners” of the corporate firm, their arguments showed that there is no meaningful sense in which this is true. Stockholders cannot use the assets, exclude others from them, lend them out, borrow on them, sell them, and they have no legal claim to the proceeds from the sale of assets or to company profits.
Instead, all of these rights of ownership belong to the corporate entity, which management exercises on its behalf, because it is the corporate entity that is their true owner. This is just what it means for assets to be fully “partitioned”: they have different owners. Moreover, stockholders do not even have a right to the profits that remain after all contractual obligations have been met—the so-called “residual.” The corporate entity is the residual claimant, and this residual profit is then allocated at the discretion of management.
That the corporate entity is the true owner came to me as a revelation. But it shouldn’t have. It is the defining legal feature of all corporations and has been emphasized by corporate charters and incorporation statutes for hundreds of years and from the very first.
Yet it is precisely this legal entity that is missing from the typical neoclassical and law-and-economics treatment of the corporate firm. Had it been acknowledged, there would have been no need to invent novel terms like “lock-in” and “entity shielding,” or even “limited liability.” Of course stockholders can’t pull out assets. It isn’t their property. Of course the creditors of stockholders can’t levy on corporate assets. It isn’t the stockholders’ property. Of course stockholders have no liability for the debts, torts, or crimes of the corporation. It isn’t their property, and they exercise no control over it. All the specialized law-and-economics vocabulary for corporate firms is but an artifact of the false premise that the stockholders are its owners.
Set this aside, and the analytical and normative edifice erected around the corporation by neoliberal commentators crumbles. Corporate firms are not creatures of private property and private contract alone. The legal entity at their core, which carries all the property, contracts, and liabilities, is created by “legal fiat” of the state, and cannot be fully replicated through private contract (not even with the help of the common law trust). Corporate firms are public-private hybrids—the original public-private partnership in the economy—first developed in an age when kings and legislatures granted the privilege of incorporation to private individuals, enlisting their private capital in the pursuit of purposes with clear benefits to the Crown or public, such as opening trade to distant lands or building infrastructure.
Even more significant is the source of the right by which corporate boards enjoy, by law, complete control over the property and personnel of the corporate firm. Sole proprietorships and partners derive their “right to rule” from property (indirectly) and contract (directly). As owners, they can exclude others from their property, or more usefully, they can give them access to it on condition that they sign a labor contract. It is widely thought that, analogously, corporate boards derive their right to rule from the stockholder-owners. But this cannot be the case. The stockholders are not the owners of the assets and have no right to exclude anyone from them, nor control them. Indeed, corporate boards are created by the charter and begin running the firm before stock is even issued. The board creates the stockholders; the stockholders do not create the board.
From where, then, does the board’s authority come? From the charter, which comes from the state. The authority of corporate boards does not derive from private ownership and private contract, but from the sovereignty of the public authority. This raises many questions. If stockholders are neither the owners nor authorizers of the corporate firm, then why are they treated as its “principals,” with the presumption that management should work strictly in their (pecuniary) interests, over the well-being of workers, consumers, the community, and the environment? After all, they are just one contributor to the success of the firm among many, and far from the most important. The criterion of “efficiency”—that Protean word of the utilitarian economist—is of little use as an alternative guide, even if we construe it narrowly as “profit maximization.” If a firm maximizes profits, the next question is, how are these to be distributed among stockholders, workers, consumers (as rebates), research and development, plant expansion, philanthropy, and so forth? “Efficiency” can provide no answer to this.
Furthermore, if stockholders are neither owners nor authorizers, why are they given (in Anglo-American countries) the sole right of electing the board members? If the board’s authority comes from the state, and the state is constitutionally mandated to guarantee to its citizens a republican form of government (Article IV, Section 4), could it be argued that workers, who are the subjects of the board’s government, have a constitutional right to a republican form of corporate government, in which they elect the board? Similarly, does it make them quasi-public employees, deserving of some of the protections of public employees? Again, conventional economics can tell us little beyond making the obvious point that any governance alternative must at least maintain firm profitability to be viable.
And if the board’s authority is of public provenance, then is private profit a sufficient rationale to justify a corporation’s creation? Were earlier generations of legislators not correct to expect from corporations some public benefit beyond the ordinary, especially given the moral hazard that attends any institution in which those who control it do not bear liability for the consequences of this control?
Economists in the mainstream tie all economic phenomena (and many non-economic phenomena) back to the interaction of natural persons, their preferences, and their endowments. They are, by methodological choice, nominalists, atomists, materialists. But ours is a world teeming with abstract legal entities, chartered by the public authority as owners and principals, and managed by corporate fiduciaries that exercise governmental authority and distribute the profits. These corporations are not creatures of the market, but public-private hybrids licensed to colonize the market. This greatly heightens the “political” in “political economy,” and specifically in the corporate economy. And it frees us from the straitjacket of believing that, by rights, all power and perquisites belong to the stockholder. Given what has become of today’s prototypical stockholder—ignorant of the business, free of liability for its conduct, and focused on short-term gains, others be damned—it is time to search for viable alternatives.