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 usually run by families until the rise of the corporation and other large businesses (trusts and partnerships) that helped produce the industrial revolution.

The earliest precursor of the corporation is often said to be the publicani of the Roman Republic. These were were similar to the modern corporation in that fairly large organizations, but 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 big organizations share this feature: Churches, cities, governments, etc. But it is a remarkable fact 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 partly because most businesses have always been sole proprietorships (72% of US businesses today) or partnerships (10% of US businesses) which are designed to be embodied in the owner unlike corporations.  The word corporation literally means “body” partly because a corporation is a separate legal person from those who work in it.

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 modern authors sometimes claim that shares were sometimes bought and sold, there is no primary evidence that that is true. For example, there was no stock exchange of any sort and it isn’t even clear if the ‘shares’ in question were actual ownership stakes or if, more likely, they were just variable-interest-rate loans. The kind of publicani shares that gave ownership control were more like a kind of club membership and were not bought and sold on secondary markets.

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 argues that modern corporations evolved out of medieval guilds:

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…

One of the primary problems of government before the 20th century was that it was difficult to tax most economic activities and the fees corporations paid were one way to generate government revenues. 

The innovation that allowed corporations to dramatically expand was the printing press.  A corporation is a form of mass democracy and just as democratic participation in government is limited in scope by communication technologies, so is democratic participation in investing and managing a private company.  

A corporation requires cheap communication technologies to convince a wide array of investors that their money will not be squandered and in turn to give shareholders a say in how the company is run by giving them the power to elect representatives to the corporation’s board of directors.  Once printing became cheap enough to spread this kind of information, corporations became a viable way of bringing together not just a relatively insular group of acquaintances, but investors who have mostly never met in their lives.

The main difficulty of a corporation is achieving the shareholders’ trust in the management and that requires regular communication.  Mass communication allows trust to spread much more widely.  

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, most corporations were usually unpopular partly because most of them were corrupt and/or went bankrupt despite various advantages such as a government-enforced monopoly. For example, 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 a Dilbert cartoon.

…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.

This was a big difference between the corporations of the past which were supposed to serve the public and the corporations of the present which are supposed to serve their owners (mostly elites).  Most corporations also had a charter of limited duration,  generally 10 to 40 years, and had to be liquidated upon expiration if a new charter was not granted.  This was a reasonable expectation at the time when corporations were intended to serve a public purpose and if they failed to achieve that purpose within a reasonable time, they were expected to be held accountable for that failure.  

For all of this history of corporations, shareholders were at least theoretically responsible if the company caused harm to the public although actual liability was small in practice. That changed in 1855 with the UK’s Limited Liability Act which limited liability for most corporations with more than 25 shareholders. In 1892, Germany copied the UK and expanded the scope of limited liability to include all corporations and even protected sole proprietors if they established a wholely-owned corporation.

In 1886, the US ruled that corporations are legal persons whose freedoms cannot be restricted according to the recently passed 14th amendment which had been intended to protect the rights of emancipated slaves as persons, but which ironically was used to expand the rights of corporations instead. 

With each legal innovation, business lobbying expanded the expanded power of corporations to most other Western countries such as private equity companies which began in 1946, special-purpose entity (SPE) a concept that was first coined in 1973, and Limited Liability Companies (LLCs) in 1977 in Wyoming.  Most LLCs are sole-proprietorships or partnerships, but there are also some big private corporations like Crayola, Domino’s Pizza, and Ritz-Carlton that have become LLCs.  The big advantage is that LLCs eliminate personal liability without requiring any corporate income taxes and there are fewer restrictions on LLCs than on C-corporations or S-corporations. 

The success of businesses to lobby for more power can be seen in their recent success in achieving the right to spend unlimited money to lobby for more political power in the 2010 Citizen’s United case.  Before Citizen’s United, corporations had always been greatly restricted from using their might to influence elections and politicans and most financial  political process or at least  explicitly banned from .  Wealthy business people have always had lots of creative ways to get around those laws and use their money to buy influence, but it was legally constrained in well-run democracies.  Now that unlimited corporate money can flood into the American political process, the data shows a large increase in corporate political expenditures and that is just the money that we can track.  Citizen’s United also legalized unlimited dark money spending that intentionally  helps (often corporate) donors hide their identity to shield them from embarrassment.  

The original idea that corporations should serve some public interest was always part of the social fabric at least in theory.  Corporations often fell short of that ideal in practice, and that was one of the reasons why they were so unpopular going all the way back to Adam Smith and beyond.  But even the theory that they should serve the public good fell away in the 1970s and 80s with the rise of neoliberal ideology.  Notably, Milton Friedman published an essay in 1962 (republished in 1970 and several more times) in which he argued that, “The Social Responsibility of Business is to Increase its Profits.”  

That ideology was radical at first, but it began to spread in business schools and law schools and the idea that corporations should do nothing but extract profits for their elite owners has come to be the social norm which has even achieved some legal standing.  A CEO of an ordinary corporation can be sued by shareholders for doing anything that benefits society at a cost to profits.  It is rare, but it has happened beginning in at least 1919.  In response to this legal reality, the B Corporation was developed in 2010 in Maryland to give legal protection to management if they do something that benefits the public at the expense of shareholders.  

The powers, responsibilities, and structures of corporations have been changing for thousands of years up through recent changes for bad (such as Citizen’s United) and for good (such as the B Corporation).   Corporations are powerful and can be a force for good, but power is dangerous and as JK Galbraith claimed in his 1967 book, The New Industrial State, corporations have become so powerful that they have transcended competing sources of countervailing power such as democratic accountability.

Even though corporations are a growing fraction of the US economy, they comprised only 18% of US firms in 2010.  That may seem small, but they generated 82% of revenues. Thus, corporations are the core of the machinery of capitalism today and this machinery is continually changing as governments change the design of how corporations are legally structured. 

The government is even more deeply involved in designing the structure of the corporations that are the most important part of capitalism: finance. 

Posted in Managerial Micro
One comment on “A history of the Corporation – Wonkish
  1. […] companies was also impossible without mass literacy and easy written communication. In particular, the corporation was impossible because it was a form of mass democracy which relied upon cheap printed […]

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