Arnold Kling  


The Disputation... The Problem with Schools...

I would like to try to answer the question that I ducked at the Disputation on Friday evening. That question was whether corporations should have the same rights as people. One panelist, Lisa Graves, answered "no" emphatically (to loud applause, given the audience). She said the corporations are chartered by the government and the government can tell them what to do, without any limits. Another panelist, Dean Baker, said that it would be almost impossible to stop corporations for exercising the right to contribute to political causes. Then he said something weird which sounded as if he thought that limited liability enabled corporations to get away with criminal activity. Tim Carney, who was supposed to be on my side, said that he sometimes thinks that corporations should not exist.

I am not a student of corporations. I believe (perhaps wrongly) that the corporate form of organization originated as charters granted by kings, which gives it a dubious provenance. I believe (perhaps wrongly) that the corporate form of organization facilitated the accumulation of capital to build large industries, such as railroads.

I am not a legal scholar. I do not know where the corporation fits in with legal philosophy. That is why I ducked the question. But I am willing to put my personal views out for comment. I assume that somewhere in the world of legal scholarship, views like these have been discussed.

Basically, I think that every time the word "corporation" is used as if it were a person, the term should be viewed as short for "management, acting on behalf of shareholders." So, instead of saying that a corporation lobbied for the government for favors, we should say that management, acting on behalf of shareholders, lobbied for government favors.

One of Tim Carney's points was that the corporate form of organization could require a company to do something immoral if this would increase profits. That is because management is obligated to maximize shareholder value. But I disagree. Management acts on behalf of shareholders. If shareholders prefer to direct management to forego profits in order to behave morally, it seems to me that this is their prerogative. So, on the issue of "corporate responsibility," it seems to me that if shareholders prefer corporate responsibility, so be it. I do not see how being a corporation forces management to maximize profits. I assume that most of the time that is what shareholders want. But should it be against the law for shareholders to want something else?

Should management, acting on behalf of shareholders, be allowed to pay for political advertising? To me, it makes sense that this should be allowed. As Dean Baker pointed out, if the "corporation" is prevented from paying for advertising, it is easy for the shareholders to get around this and to find other ways to pool funds for political advertising.

But I did not get what Baker was trying to say with his point about crime. For example, suppose that management, acting on behalf of shareholders, steals paintings, sells them, and distributes the proceeds as dividends. Then it would seem that at the very least the directors and officers of the corporation are liable for their criminal behavior.

I have a different concern with limited liability. If a bank has some of its debts guaranteed by the government and its shareholders have limited liability, then the moral hazard problem is severe. One approach to counter that is to make it a crime for government-guaranteed institution to engage in excessive risk-taking, so that directors and officers can be prosecuted for it. Hardly anyone else likes that approach, but I think it has merit. Of course, taking away government guarantees has merit as well, but we have gotten far away from that.

The bottom line is that when you ask me what rights a corporation should have, I would answer by rephrasing the question. What rights should management have, acting on behalf of shareholders? If the shareholders have a right to engage in activity X, then management has the right to engage in that activity on their behalf.

But can't management act against the wishes of shareholders? Possibly, but I still see that as an issue between shareholders and management. While government courts may have a role in enforcing corporate agreements, I am skeptical that government legislators can fix problems of corporate governance.

Comments and Sharing

COMMENTS (24 to date)
Michael OBrien writes:

Good points, Arnold. However, in my opinion (and perhaps I just need to read the previous post) you missed one of the more important discussion points when it comes to corporations: Is limited liability immoral due to the protection of shareholders from damages caused by actions they (as a group) sanction, or management sanctions on their behalf?

Nikolaj writes:

The 1.000.000 $-question is the one about limited liability: Should a person or group of persons be able to create a liability shield? That question probably has a thousand answers but the one I’m most on par with goes something like this: If the purpose of a corporation is to establish a liability shield then it shouldn’t be allowed to be formed. I believe the LLCs, etc., goes against the core values of what is capitalism, by circumventing the disciplining forces of the market.

B.A. writes:

I agree with you on the point that corporations are just legal entities allowing a group of people (shareholders) to act collectively under a certain legal regime.

The neglected point in the debate seems to me to be about the problems of rent seeking in general. Many people seem to ascribe the problem of rent seeking solely to corporations. As if only incorporated shareholders had the power to petition governmet for special treatmet at the expense of society!

The fact is that the prisoners dilemma of asking for special treatment at the expense of society as a whole exists regardless of the possibility of acting as a corporation.

The real focus for political reforms should be consitutional ameds making sure that the government would not be able to give out special favors at any group of citizens at the expense of society - regardless of their being incorporated or not. Such politac reforms being a stregthening of federalism with the increased power of individuals/groups to remove themselves from exploitative legislation, or a non-discrimination-clause as Buchanan and Hayek favored as a tool to limit rent seeking.

Jason Collins writes:

Arnold, could we rephrase one of your statements slightly? Does the following still hold?

If the shareholders have a right to engage in activity X without limited liability, then management has the right to engage in that activity on their behalf with limited liability.

P.S. I recognise that shareholders do have some limited liability - i.e. bankruptcy - but it seems that protection through the limited liability of the corporate form is qualitatively different.

me writes:

[Comment removed pending confirmation of email address. Email the to request restoring this comment. A valid email address is required to post comments on EconLog.--Econlib Ed.]

Jim Ancona writes:

Nikolaj, if you don't wish to contract with limited-liability corporations, you should be free not to (although you won't be once the Obamacare mandate go into effect). Given that the corporate form seems to have real advantages, why shouldn't other people be free to contract with them, if they choose?

Bob writes:

One difference in the idea that a "corporation == a person" is ownership. Can one corporation own another? Yes. Can one person own another? No.

With corporations owning other corporations, that leads to a concentration of power that may bother many. If a pyramid of ownership is constructed with multiple layers of holding companies, it seems like that distillation leads to the top-most corporation far from its base.

Dean Baker writes:


I was just referring to limited liability in the case of negligence or other civil actions. I didn't mean to imply that corporations could engage (in principle) in criminal behavior with impunity. I realized as soon as I said it that my example was confusing (burning down the hotel), but i meant that as the result of negligence, as opposed to arson.

In my view, this special privilege (along with a few others) is what separates a corporation from other group of individuals. The latter should have all the rights of the individuals that comprise the group.

Ak Mike writes:

The corporations themselves don't have limited liability - all of their assets are fully available to creditors, just like individuals.

Limited liability of investors is a necessary part of a modern economy (and, by the way, is a feature of all government activities as well as corporate activities). Passive investors will not put their money into businesses they are not running if putting some money in exposes all their assets to unknown potential liabilities.

Thus if you think it better that cars are produced in large factories by machinery rather than in small shops by hand labor, you should support limited liability of investors.

The limitations to liability affect two classes of creditors. The contractual creditors (lenders, suppliers, etc.) know that liability is limited to corporate assets when the debt is created, so they have no complaint about not being able to go after the shareholders.

Tort creditors (e.g., accident victims) had no say in the creation of the liability, but in general corporations are more financially responsible than individuals are, more likely to be insured, etc. If not, there is a doctrine called "piercing the corporate veil" that holds the stockholders of inadequately financed and uninsured corporations personally liable.

Lars P writes:

When this is discussed, it is often pointed out that corporations are "legally obliged to maximize shareholder value" in the USA. With the implication that

I couldn't find the legal ground, if any, for that claim during 10 minutes Googling, but it is a widespread belief.

MichaelM writes:

Dr Kling, while your way of looking at things might have some intuitiveness to it, the law of the matter does end up being important.

You see, neither management nor shareholders are the corporation. The shareholders are the owners of the corporation, and management are employees of it. Management have natural rights as natural persons, the same as shareholders. Corporations are somewhat different as a thing in themselves. In current Constitutional case law they have rights as persons, but they are not natural rights because they are not natural persons. Instead, they have rights granted to them by courts at the courts' prerogative.

When it comes to criminal proceedings, things are complicated by the de jure existence of the corporate person. You can't very well arrest a corporation, because a corporation does not have wrists to bind nor a body to imprison. However, it then becomes possible to question whether corporations can commit crimes at all: Without a body, corporations can only act through agents. Those agents are liable for any criminal acts they engage in.

I think you need to pay more attention to the law of the situation because its INCREDIBLY important to understanding how corporations work in the modern economy. Without it you can only use second-best models, like your attempt to treat corporations as just another kind of partnership. They really aren't.

I suggest, if you really want to make informed judgments about corporations, you research more into their nature at law.

Ray writes:

First of all, ducking the question for the reasons stated signifies your wisdom, and a genuine desire to be correct, not just win an argument. That's huge.

I liked what you posted, but I'm no legal scholar either so I'll have to think about that, but I will look up what RIchard Epstein has to say on the subject.

Ed Bosanquet writes:

Since a corporation is legal and distinct entity from myself, I shouldn't be allowed to "incorporate" to skirt legal issues.
As it stands now, my contributions to political causes is limited due to government regulations(I believe there is a moral case against this but it exists in our current environment). I shouldn't be able to incorporate to do something otherwise not legal. Creating a shell corporation called "Bosanquet LLC." funded only by my own pocketbook, only "employing" myself and only existing to forward my personal political views by giving donations to friendly political parties, lobbying and encouraging political advertising toward my views is inappropriate if I am not allowed or have reached legal limits to do so myself.

I am not a legal scholar but as I see it, this issue has more to do with the restriction of individuals to allocate money and effort toward goals of their own choosing then what a corporation is allowed to do.

I am also under the same (possibly mistaken) belief as Lars P. that a corporation is somehow legally obligated to maximize profits. If this belief is true, this is also another major problem. This problem would resonate a strong legal argument against a corporation to behave in the least. If this were true, it would seem the best answer would be to remove this government restriction forcing maximization of capital.

To me, a corporation is collection of capital to make a product to sell at the market. I don't think the current US law supports this view and that is more likely the source of conflict.

Frederik Marain writes:

"I assume that somewhere in the world of legal scholarship, views like these have been discussed."
Here is a very good overview of recent and not so recent articles on the subject of 'Firms and organizations: fictions or real persons?'

Jamie_NYC writes:
If a bank has some of its debts guaranteed by the government and its shareholders have limited liability, then the moral hazard problem is severe.

Arnold, I think that there is a problem with your reasoning here: what I think you are saying is that the government's (implicit) guarantee of financial sector's debt lead to higher leverage, which increased the probability of these companies going under. Right?

Well, no. Increased leverage leads to higher probability of bankruptcy ceteris paribus. If the government's guarantee reduces the borrowing costs, and the companies become more leveraged as the result of lower borrowing costs, then the probability of bankruptcy does not necessarily increase. Companies adjust their leverage in response to movements in interest rates all the time, but these adjustments are not viewed as a factor that changes the likelihood of bankruptcy.

andy writes:

There's a hillarious story about some scottish bank default in the early 1800's. There were only 2 or 3 scottish banks with limited liability; the other ones were with unlimited liability (I hope I remember it correctly).

One day one such bank (actually, this was almost the only time it happened) defaulted; suddenly there were court cases when people tried to persuade the judge that they are _not_ shareholders :) In the end quite a lot of shareholders had to pay lot of money, however the people who had money in the bank were paid almost to the last penny...

Dale Moses writes:

Arnold; Throughout your piece you are working under the incorrect assumption that is is possible for management to act on behalf of the wishes of their shareholders.

Disavow yourself of this notion and reassess. You ought to find that this changes the situation even under the naive Libertarian view that everything is always better when people can do what they want.

MikeDC writes:

The philosophical answer is that a corporation should have the same rights as an individual because it is merely an association of individuals.

Our right to free association is obvious, fundamental, and constitutionally protected. Exercising that right along with others does not and should not cause us to lose other rights. If two people can legally do something alone, we can legally do it together.

At the more practical level, I hear lots of griping about limited liability, but I don't get it. Among other things:

1. Limited liability is an enormously beneficial piece of legal technology. It lets people engage in all sorts of economic relationships they otherwise wouldn't dare to. We're better off for it, by an extraordinary margin.

2. I don't get the idea that corporations can somehow skirt the law in a way that "real people" cannot.
a. Dean Baker's argument, for instance, is that corporations might be able to skirt something like a negligence tort. But if anything, they are at more peril in a civil trial than a person. No matter how big a civil judgement against a person is, courts allow him the right to live comfortably when paying it off. A corp facing a civil judgement can be dissolved, and the corporate officers can be liable in certain cases.

b. The basis of a corporate relationship is a contractual one, and I don't see any reason, pro or con to the question at hand, as to whether corporations have a legal obligation to maximize their shareholders' profits.

Let's suppose they do not. Someone explain to me why I should not have the right to, as an individual, enter into a corporate relationship?

MikeP writes:

MikeDC has it exactly right.

Corporations have exactly the rights that the individuals who compose them have.

And those individuals have the right to write down on a piece of paper "My liability is limited to X" and show it to anyone they have voluntary associations with and expect that limited liability to be respected.

But those individuals' liability is certainly not limited if they commit a crime or tort against an involuntary party. And neither is the corporation or any of its executives or employees who commit such acts.

Mr. Econotarian writes:

There are plenty of corporations whose charter requires them not to return a profit to an owner (such as the Corporation for Public Broadcasting).

The belief that corporations must maximize profit is likely an overstated result of shareholder lawsuits against incompetent management of for-profit corporations.

The charter is what sets up the guiding principles of an organization. If it says to carry out a type of business and return profits to the owners, it must. If it says it must use revenues to achieve a philanthropic goal, then it must do that.

floccina writes:

My philosophy on corporations and limited liability is that it should not be but that the corporate tax is an insurance premium against corporate wrong doing and that the tax exceeds the harm by a wide margin. The corporate tax advantages partnerships over corporations but corporations still out compete partnerships, meaning the limited liability is worth more than the cost of the tax. Also before getting rid of limited liability it would be good if we instituted looser pays.

One of the reasons that I see the corporate tax with limited liability as second best is that all companies not matter how safe or dangerous pay the same corporate tax. Electronic Arts, Inc pays the same rate of tax as Massey Coal Co. and BP and highly leveraged Lehman Brothers. An insurance company would charge much lower premiums for Electronic Arts because there is very little liability to what they do compared to the others that I listed.

Dan Weber writes:

Isn't limited liability essentially only a shield against debts? If my corporation racks up $50,000 in debts and goes bankrupt, my creditors can't come after me. And nearly all debts to corporations are willingly entered into with full knowledge. (Some vendors require small companies to have some owner make a personal guarantee.) If things don't fit into this are often grounds for piercing the corporate veil.

Also note that making investors liable for a corporation's debt will not do anything to harm Wal*Mart or Microsoft or GE or Exxon. It will harm small corporations, though. It would essentially stop new corporations from coming into being.

mark writes:

I think the most effective response to those who say "corporations should have no rights" is to inquire how they would respond if the government were to dictate the content of the New York Times and all other media, which are corporate businesses.

More broadly, modern corporations evolved from joint ventures that kings and queens and other states were forced to create to induce private parties to capitalize and operate risky projects the state deemed important, such as foreign exploration and infrastructure creation. However, corruption in the awarding of such privileges, when successful, triggered adverse public reaction which in turn led to liberalized access and eventual privatization of the privilege.

The main reason in today's economy for most corporations is the absurd unpredicability of the tort system, which is like playing Russian Roulette. The other is that it creates an off-the-rack method for capital attraction that reduces transaction costs and further economic development.

Doc Merlin writes:

I agree with MikeDC and so does the US Supreme Court. In Citizen's United vs Federal Election Commission, Scalia's concurring opinion (joined by Thomas and Alito) explains this in detail.

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