Download Corporation

Law and Economics of
Corporations
1)Corporations contrasted with other business
forms
2)History of corporations
3)Limited liability – a special privilege?


Nader: yes
Hessen: no
4)Modern corporate democracy
5)Non-profit corporations, mutual companies,
benefit corporations
How Businesses are Organized

Sole proprietorship




An individual owns the business.
The owner keeps profits, if any, and is fully liable
for any debts
Owner pays taxes on his/her own tax return
Partnership




Formed by two or more people who want to pool
their money for a business purpose
Partners fully liable for debts
No partnership income tax
Partners pay tax on their share of partnership
profits irrespective of any distributions
How businesses are organized

Limited partnerships

General partner




Limited partners




Fully liable for debts
Usually manages the business
Gets bonus payment
Not liable for partnership debts
Some limited partnership units traded on stock
exchanges
No partnership income tax
Partners pay tax on partnership net income
whether distributed or not
Problem with partnership tort
liability



Each partner (generally) is fully liability for
the partnership’s torts
As with all tort actions, recovery of damages
limited by partners’ assets
Tort remedies generally fall on parties with
deep pockets

Wealthy people reluctant to enter partnerships,
more likely to incorporate, making tort victims
less well off, not better
Corporations






Latin corpus, body
A new corporation sells shares of stock to
investors.
New corporations are usually closely held


Only qualified persons can buy shares
Shares cannot be sold freely


Sell shares to general public
Raise additional funds for the business
An existing corporation may “go public”
Chartered by state governments (except
banks)
Enjoy limited liability
Limited liability

Usually evidenced by a suffix such as






AT&T, Inc. (Incorporated)
Oracle Corporation
Lucasfilm, Ltd. (Limited)
BP, PLC (Public Limited Company)
Shareholders cannot be held personally
responsible for corporate debts or employee
torts. At worst, shares become worthless.
Contrast: when a partnership commits a tort,
the partners’ entire wealth is at stake
History of corporate charters

East India Company, 1600-1874



Granted monopoly of trade with India
Evolved into a colonial quasi-government
Early America




Corporate charters created by an act of the
colonial assembly (later, by state legislatures)
Usually came with a grant of monopoly power
Endowed with perpetual existence and limited
liability for shareholders
Resentment, especially against banks, fueled
Jacksonian revolution

Second Bank of US, nominally private, abolished
1836
Rise of and reaction to large
corporations, late 1800’s


Railroads greatly reduced transportation
costs, enhanced opportunities for large,
efficient corporations
Standard Oil achieved dominant market
share






Kept expenses minimal
Got preferential shipping rates from railroads
Bought out less efficient firms
Consumers benefited from drastically falling
prices
Sherman Anti-Trust Act, 1890
Subsequent anti-trust acts
Supreme Court on Corporations

A corporation is an artificial being, invisible,
intangible, and existing only in contemplation
of law


Chief Justice John Marshall, 1819
The corporation is a creature of the state. It
is presumed to be incorporated for the
benefit of the public. It receives certain
privileges and franchises, and holds them
subject to the laws of the state and the
limitations of its charter

Hale vs. Henkel, 1906
Mitt Romney on Corporations




“Corporations are people!”
Democrats: “No they’re not!”
Romney meant corporations are groups of
people
Democrats’ interpretation: a corporation is a
separate person
Delaware, a corporate haven?

A specialty for a state with few comparative
advantages






Low filing fees and taxes
Annual meetings need not be held in Delaware
Stock transfer records need not be kept in
Delaware
“Absolute” limited liability for shareholders
State government heavily influenced by
duPont family
Rules further liberalized in 1963 in response
to competitive threats from other states
Competing views of
corporations

Ralph Nader



“Taming the Giant Corporation” (1976) and many
other publications and speeches
General theme: corporations have far too much
power and must be reigned in by federal
chartering and other means
Robert Hessen



“In Defense of the Corporation” (1979), response
to Nader
Corporations do not get special privileges from
government
Corporate features are created by contract, not
by government. Could exist without government.
Nader complaints about
corporations (1976)





Industrial pollution
Toxic substances
Racial discrimination
Alienated whitecollar workers
Political power





campaign contrib.
friends in gov’t
revolving door
lobbyists
Corporate welfare


sugar industry
merchant shipping









Privacy invasions
Dominance of local
communities
Deceptive
advertising
Unsafe products
Unreliable
technology
Market power
Multinational corps.
Concentrated wealth
Corporate crime
Is a corporation a “person”
in a legal sense?


“Incorporated” suggests a body (corpus)
Can sue or be sued or convicted of a crime




Can “live” indefinitely regardless of
management or stockholder turnover



BP was held criminally liable for Gulf oil spill
BP also paid civil damages
Apple recently won a patent lawsuit against
Samsung
IBM incorporated in 1911 as ComputingTabulating-Recording
Corporations subject to income tax
Shareholders not liable for corporate debts
Is limited liability a special
privilege?

Ralph Nader: yes


Robert Hessen



Early 1800’s: justified by limited purposes and
limited lifetimes; attracted shareholder capital
No, customers and suppliers are warned of the
limited liability
Exception: one-man corporations are an abusive
way to escape liability
Question


If corporate shareholders can disavow liability
why can’t individuals?
Answer(?) corporation has deep pockets and/or
insurance
The doctrine of vicarious
liability

From common law: masters are responsible
for torts committed by their servants
(respondeat superior).





Servant acts on behalf of the master
Masters likely to have “deep pockets” for
compensation of tort victims
Sends a signal to masters to be careful about
hiring and supervising
Extended to general partners
Hessen: should apply to shareholders who
are actively involved in management
Is a corporation a “person” in
an economic sense?


Corporate actions are performed by
management
No essential economic difference between
corporations and other forms of business

All raise capital to conduct business in hopes of
earning profits
Crony capitalism



A situation in which corporations and other
business entities concentrate on seeking
government favors rather than serving
customers
An inevitable outcome of the increased
power that has been assumed by
governments, particularly Federal gov’t
All major corporations must engage in
lobbying in order to survive


Microsoft learned this lesson
Businesses increasingly beholden to
bureaucrats, not consumers
Modern corporate structure

A small group of people start a business and
incorporate.





Individuals buy shares of stock
Shareholders wishing to sell usually required to
offer shares back to the corporation
Shares are not traded on an exchange. Share
value is hard to determine
Shareholders may decide to “go public”: offer
shares for sale to the general public (IPO)
Shares listed on a stock exchange (NYSE,
Nasdaq) where anyone can buy or sell
Modern corporate structure

Shareholders own the company





Number of shares determines the fraction they
own (I own 250 of 150,000,000 shares)
Shareholders not entitled to company assets
Shareholders can get a share of profits, if any, as
dividends
Shareholders elect a Board of Directors
Board of Directors


Sets broad company policies
Hires management (CEO, CFO, etc.)
Liability of corporate boards of
directors

Directors’ duties




Director’s compensation


Elected by shareholders (but in practice often
hand-picked by CEO)
Act as agents for the shareholders
Hire top management (CEO, CFO, etc.)
Cash compensation, stock, options
Directors’ liability


Open to shareholder lawsuits if they grossly
mismanage the company (Hewlett-Packard?)
Corporation buys special liability insurance for
directors (“errors and omissions”)
Cypress Semiconductor

Typical corporation in some ways









Shares traded on NASDAQ
Quarterly dividends paid, about 4%
Share repurchase
$1.6 billion market capitalization
$1 billion annual revenues
Followed by about 16 Wall St. analysts
$200M cash, no debt
CEO salary $669,000 + $11.4M restricted stock
Atypical in other ways


T. J. Rodgers, founder (1982) and CEO is a
dominant personality, outspoken libertarian
T.J. owns almost 10% of the shares
Shareholder democracy

Annual meeting at which shareholders vote





Nominees for board of directors
Proposals submitted by management
Proposals submitted by shareholders
Very few shareholders attend meetings – voting
almost all online
Reality: shareholder control is very tenuous



Nominations not contested
Shareholder proposals almost always fail
Shareholders subject to rational ignorance
Non-profit organizations




Definition: an organization that does not
distribute profits
Non-profit organizations can and sometimes
do make profits (revenue minus expense)
Profits (if any) are re-invested in the
organization
Non-profit organizations generally seek tax
exemption


Organization exempt from paying most taxes
Donors may deduct donations from their taxable
income
Non-profit organizations

Examples of non-profits







CSAA (Auto Club)
Sutter Health (hospital chain)
Churches
Family foundations (e.g. Gates)
Private universities (Santa Clara U. owned by
the Society of Jesus – Jesuits)
Some are organized as non-profit
corporations
Executives of non-profits sometimes earn $1
million or more
“Public benefit” corporations



Special quasi-independent government
agencies with little resemblance to profitoriented corporations
Usually subsist on tax support
Examples:

VTA



Bus & light rail operations (very unprofitable)
County highways
Port Authority of NY and NJ



Toll bridges and tunnels (profitable)
PATH commuter rail (unprofitable)
World Trade Center
Mutual companies

Mutual insurance companies are hybrids



Customers technically own the company but
exercise little control
Excess income rebated to policyholders
Examples


State Farm Insurance
Vanguard Group (mutual funds & ETFs)
“Benefit Corporation” starts
Jan. 1 in California



Board must must take into account the
environment, community, employees and
suppliers when they make decisions –
maximizing “stakeholder” value
Requires filing a “Benefit Report”
Does anyone remember Adam Smith?
By directing that industry in such a manner as its
produce may be of the greatest value, he intends only his
own gain, and he is in this, as in many other cases, led
by an invisible hand to promote an end which was no
part of his intention. Nor is it always the worse for the
society that it was not part of it. By pursuing his own
interest he frequently promotes that of the society more
effectually than when he really intends to promote it.