A history of the Corporation – Wonkish

There have always been large organizations that have done the kinds of things corporations sometimes do, but for most of human history, those organizations were were organized as religious hierarchies or governments rather than as for-profit businesses. Businesses were small (which is defined as less than 500 employees today) and they were often run by families until the rise of the corporation and subsequent large businesses (trusts and partnerships) of the industrial revolution.

The earliest precursor of the corporation were the publicani of the Roman Republic. These were fairly large organizations that were similar to the modern corporation with a few differences. William N. Goetzmann and K. Geert Rouwenhorst argue that there are three distinguishing features of a modern corporation:

First, its existence is not affected by the departure of individual members. This stability enhances its ability to participate in economic transactions.

Some Roman publicani did outlive individual members/owners, but that isn’t really unique to corporations. Most organizations share this feature: Churches, cities, governments, etc. It is actually remarkable that only a very small percent of private businesses in all of history have been able to survive the death or departure of an owner. Most businesses have always been very short lived.

Second, designated members of the company can represent it, in other words, they can enter contracts without assuming rights or duties themselves. Instead, the company becomes the bearer of all obligations.

This is the idea of a corporation having legal personhood so that it can make contracts and bear responsibility for problems rather than transferring liabilities on workers or owners. Legally, only a person can be sued which has never been a problem for a businesses that is either a sole proprietorship or partnership, but it is more complicated for corporations. The legality of limited liability is a modern phenomenon (see below).  This was technically illegal under Roman law, but there was a huge loophole. A slave could be entrusted to manage a publicani and the owners could argue that they should not be held responsible for what the slave did, and then the slave could bear all the liability.

Corporations necessarily need to empower their CEO or managers to take on liabilities (and all contracts involve some sort of liability), but the practice of simply insulating shareholders from all liability didn’t become legal until the middle of the 19th century. However, before that, some corporate entities were able to shield their members from liability by structuring their shares as debts rather than shares of ownership because debts always have limited liability.  Lenders can only lose as much as their past contributions, just like modern corporate shareholders.

Third, …ownership is fungible and shareholders can react to changes in a firm’s prospects …by buying or selling shares. The separation of ownership and management makes it easier to attract human and financial capital.

This is a big difference between modern corporations and the Roman publicani. Although many authors claim that one kind of shares were bought and sold, there is no primary evidence that that is true. There was no stock exchange. And it isn’t even clear if the ‘shares’ in question were actually variable-interest-rate loans or if they were actual ownership stakes. The kind of shares that clearly had ownership control were considered a kind of membership and were not bought and sold on a secondary market.

A fourth big difference between publicani and corporations is the fact that publicani were not businesses that served the private sector at all. They were solely government leaseholders or contractors. They were most famous for managing tax collection and in many ways they functioned more like a form of government bureaucracy than today’s private corporations. It was a competitive form of bureaucracy, but it served as an arm of government, not a creature of markets.  After the Roman Republic turned into the Roman Empire, the government phased out publicani contracts and, “Without the support of the government, the societas publicanorum drifted into obscurity.”

Although the publicani disappeared, Romans had other forms of corporations that were non-profit and served religious and public functions which survived the fall of the Roman Empire such as cities, hospitals, guilds, monastic orders, and the Catholic Church itself. No for-profit corporation arose for several centuries until the Italian city-states of northern Italy redeveloped something like the publicani, and again their main purpose was tax farming. Nick Szabo:

The medieval organizations that most resembled later joint-stock corporations were the Genovese maone. … The Italian cities often sold off their tax receivables to wealthy merchants at a discount as a way to borrow funds. …The debts were divided into equal shares called loca or partes. Legally, these shares were personal property (chattels) and could be freely traded.

Technically, no organization was created when the city sold its tax receivables to merchants. However, to effectively collect the taxes, the holders of loca formed an organization called a maona or societas comperarum. This organization would then subcontract to tax farmers to collect the taxes. By the fourteenth century, Genovese maone also engaged in military conquest and colonization… Normally, maone were temporary, but some of them ended up lasting for a long time. In 1346 the Maona di Chio e di Focea … was formed. This organization’s members obtained from Genoa the exclusive right to collect taxes from Chios (an Aegean island) and Phocaea (a port on the Anatolian coast). But first the company would have to conquer them! Although technically a temporary organization, it lasted until 1566.

Rather than going to buy receivables from Genoa, subscriptions to the di Chio e di Focea’s loca shares (still legally debt, but to be paid out in dividends as taxes and trading revenues were collected) went to fund 29 galleys to conquer Chios and Phocaea. The Genovese Republic, for a fee, granted the organization exclusive rights to collect taxes from the conquered territories as well as special trading privileges. The conquests, taxes, and trading were at least partially successful, and by the 16th century more than 600 persons owned loca of the maona.

Glyn Holton recounts when private corporations first began to take their modern form:

This changed around 1600, when new business forms emerged to challenge the might of Spain and Portugal… Portugal had discovered the East Indies as the source of spices, and Spain was plundering the Americas for gold and silver. The Vatican legitimized this arrangement, ruling that lands discovered in the Eastern Hemisphere belonged to Portugal while lands discovered in the Western Hemisphere belonged to Spain. Holland and England flaunted the Vatican’s law. Not only did they practice a different religion, but they adopted different methods. While the Spanish and Portuguese sovereigns shouldered the expenses and risks of overseas ventures, English and Dutch traders formed private corporations to challenge them.

These trading corporations had their roots in guilds. During the 14th and 15th centuries, guilds were chartered primarily to enforce a monopoly in certain businesses or geographic regions. In exchange for a grant of monopoly, a guild would make ongoing fee payments to its chartering [government]. Members of a guild might compete with one another, but outsiders were excluded.

Traders also formed guilds. Their purpose was to secure from the government a grant of monopoly over trade with specific geographic regions. In England, such guilds were called regulated companies. They were often referred to by names reflecting their monopolies—the India Company, African Company, Russia Company, Turkey Company, etc.

…Regulated companies that sponsored equity-financed voyages came to be called joint-stock companies. Two early joint stock companies were Holland’s and England’s respective East India Companies, which were chartered to challenge Portugal’s dominance of the spice islands. Initially, neither company had permanent equity. Each voyage would have its own equity subscription. This proved impractical, and soon capital from one voyage was being rolled over to finance subsequent voyages. In this way, the companies evolved to become much like today’s business corporations. They had separate managers and investors…

The joint-stock corporations cultivated influence at the highest levels of government. The Queen and nobility had significant investments in the English East India Company, and they looked out for the company’s interests in the halls of government. The joint-stock companies continued the guild practice of making ongoing payments to the state. In this we may perceive the origins of corporate taxation, but the people of the day viewed it as more akin to graft…

Although today it seems inevitable that corporations would eventually rule the world, corporations were often unpopular because of numerous corporate scandals and government bailouts. Although we remember the few big successes like the East India Company and the Hudson Bay Company, corporations were not popular and most of them went bankrupt even despite often gaining a monopoly from government. Adam Smith (1776) denounced corporations in The Wealth of Nations because he thought corporate governance was so inherently flawed, it could never achieve anything beyond what you might see in Dilbert.

…The directors of [joint stock companies] being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners of a private copartnery frequently watch over their own … Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. It is upon this account, that joint stock companies for foreign trade have seldom been able to maintain the competition against private adventurers. They have, accordingly, very seldom succeeded without a [monopoly]…

Adam Smith then goes on and on with examples of the foibles and crimes of his contemporary corporations that make episodes of The Office look like a well-run bureaucracy. In 1720, The British Parliament passed the Bubble Act which restricted the formation of corporations for over a century without permission from Parliament or a Royal Charter. But after the industrial revolution began transforming Britain, the government started making it easier to form corporations again. Glyn Holton again:

Incorporation by Registration

A recurring theme in the history of corporations is that they should exist to serve some public purpose, and they are granted certain privileges to facilitate this. The state would charter corporations that it deemed worthy. At first, the most important privilege was a grant of some monopoly—say a monopoly over trade with some region or an exclusive right to build a certain canal. Over time, transferability of shares and limited liability became more important. These gave corporations an enormous advantage in raising capital over sole proprietorships and partnerships. Investors with modest holdings and limited liability were comfortable letting specialists run their corporations, so the separation of investors and management became one of the great strengths—and great weaknesses—of limited liability joint-stock corporations.

The building of highways, canals and railroads was a quintessential public need, and numerous corporations were chartered for these purposes. For other businesses, the state’s monopoly on granting corporate status proved onerous. When entrepreneurs tried to form a new corporation, competitors could oppose their petition for incorporation. Inevitably, the process was marked by political intrigue. When incorporation was denied, entrepreneurs had meager options. They might buy a failing corporation as a shell and then raise capital for a business unrelated to that corporation’s original monopoly. This practice was called charter abuse. With the supply of failing corporations limited, a more common solution was to simply issue stock in unincorporated companies. This legally perilous practice became widespread in England during the late 1700s… In the early 1800s, competitors started challenging their legality in court.

The …courts and governments found themselves making increasingly arbitrary decisions about which businesses to favor. Something had to be done. The solution was a new concept: incorporation by registration. In various countries, legislation was passed [in 1844] allowing entrepreneurs to incorporate any firm they liked by simply filing paperwork. No longer would corporations be privileged associations granted monopolies by the state to pursue some public purpose. They had become a standard business form—along with sole proprietorships and partnerships—that was available to all.

However, there was still no limited liability and shareholders could still be held responsible for unlimited losses by the company. The next important development was the Limited Liability Act of 1855 which limited liability for most corporations with more than 25 members (shareholders). Then In 1892, Germany introduced the Gesellschaft mit beschränkter Haftung which limited liability for all corporations and even if one person owned the entire corporation. With each legal innovation, other Western countries often followed suit with pressure from business lobbying. New legal structures for business ownership continued to evolve and private equity companies took off in 1946, the term, special-purpose entity (SPE), was coined in 1973, and Limited Liability Companies (LLCs) were legally authorized in Wyoming in 1977 which expanded limited liability to partnerships and sole-proprietors.


Posted in Managerial Micro

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