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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.