RoR: Forum

The initial thought was nice. However, as has been discussed fairly extensively in this forum and many, many places elsewhere, you have a somewhat fundamental misconception - that the corporation is an example of free trade.

The corporation is not a free market entity at all. At the very least, corporations are used by real human beings to offload risks and other espenses, which they foist off on the rest of us by state fiat. The very name "corporation" is taken from the latin for "body," as in "habeus corpus" (do you have the body?). A corporation is legally an artificial person, created by the state, who takes upon him/her/it (?) 's self the burdens that would otherwise have to be paid by the owners, executives, shareholders, employees or customers - whoever is actually responsible.

By legally declaring a corporation to be a separate person under law, the owners, executives and investors are then free to take otherwise impossible risks, knowing that if the risk falls due, and their petroleum refinery blows up in the midst of a million people, then, barring provable malfeasance, the cost is born by and limited to the assets of this ficticious person. They can even create and then hire another ficticious person just to buy the unsustainable debts, as ENRON did in spades. The creditors were, of course, real, at some point in the game.

There is no way that I can see that a corporation as such could arise in a free market. Contracts could certainly be drawn up between a company and all the people it deals with, limiting liability to some reasonable maximum, but there will always be the people outside the contracts, and without such a prior voluntary contract, they are due the full cost of any damages sustained due to error, intent or negligence.

In fact, corporations, far from an example of "capitalism" in the sense that Ayn used it to refer to free markets, are precisely a case of fascism. Corporate fascism is redundant. The state and the corporation feed off each other, with the corporation benefitting from special legal privilege as a "child of the state," while the state's political minions are paid millions of dollars to support more feed to the trough in the form of government contracts, sudsidies, exemptions from safety standards or pollution (which, BTW, is the initiation of force), etc.

Post 1

Tuesday, June 26, 2007 - 10:17pm

You should read - In Defense of the Corporation, by Robert Hessen, which gives a different take on the nature of a corporation, and whether it really is a 'creature of the state'....

Post 2

Wednesday, June 27, 2007 - 11:09am

Mr. Osborn- I respectfully disagree with your negative characterization of the corporation. The difference between a proprietorship and a corporation is that shareholders of a corporation can lose no more than 100% of what they invested, whereas in a proprietorship, creditors can come after the owners for all they’re worth if their business loses money (hence, increasing the risks of personal bankruptcy, caused by business bankruptcy).

How do corporations manage do offload the risks? It’s simple—corporations have access to public bond markets, whereas proprietorships do not. The bondholders bear the risks of bankruptcy because they could lose what they lended to the corporation if the firm goes bust, but they also get compensated for those risks through the interest rate that the corporation pays them. The riskier the corporation, the more it must pay in interest to its bondholders. Far from dumping risks on unsuspecting bystanders, the corporation pays willing counter-parties to bear it so that the business can pursue growth opportunities to a degree that would otherwise not be possible, because many owners don’t want to carry that kind of liability. That’s why we insure our houses and cars, for example- we want the benefits of owning and using them, but we also want to pay to transfer the risk that they are damaged.

Corporations are a sign that capitalism is alive and well and that American financiers can invent useful methods of risk transfer to lubricate growth and therefore increase our happiness—they are not, however, a signal that we live in a fascist state, as you suggest.

Post 3

Wednesday, June 27, 2007 - 3:57pm

I'm not as charitable to Mr. Osborn as Scott Richard Monroe is. While, admittedly, a corporation is not a "person" it provides a mechanism for people like myself to participate in the rewards and risks of capitalism. It brings capitalism to the people. Almost everyone in this country has a stake of one kind or another in the fortunes of corporations — it may be in the form of retirement funds, union investments, whatever. To try to make a case that

"By legally declaring a corporation to be a separate person under law, the owners, executives and investors are then free to take otherwise impossible risks, knowing that if the risk falls due, and their petroleum refinery blows up in the midst of a million people, then, barring provable malfeasance, the cost is born by and limited to the assets of this ficticious person."

is ludicrous. The shareholders all suffer hugely from the misfortunes, or malfeasance, of the corporation, as surely Mr. Osborn knows. In the above quote it seems that Mr. Osborn is somehow trying to separate "investors" from shareholders while, in fact, they are the same. The shareholders control the election of the officers and if they are deficient in their judgment then they pay the price when the officers may mismanage the business, for whatever reason. Check the share price on any stock that has a negative report, e.g. Merck withdrawing Vioxx on Sept. 30, 2004. The fact that the shareholders are the owners of the corporation seems to be lost on Mr. Osborn.

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Post 4

Wednesday, June 27, 2007 - 4:40pm

All corporations carry liability insurance as well. It's not like the risk corporations take are not being paid for in insurance premiums.

Post 5

Wednesday, June 27, 2007 - 6:22pm

The insurance that corporations take out is generally limited to the actual risk that they face in losses. Otherwise, they would be spending shareholder money irresponsibly, right?. Those losses are limited to the assets of the corporation, not to the assets of the management, shareholders or other investors, or employees.

It is fairly easy to set up a corporation such that the on-the-books assets are virtually zero, even though the corporation is doing millions of dollars in business and thus limit the maximum losses even further.

I hate to have to keep retyping the same information, but the classic case of this was and is the nuclear power industry. Their lobbiests convinced congress that nuclear power was the wave of the future. Just one little glitch stood in the way of power too cheap to monitor - the risk factor.

In a free market, the experts at assessing risk are the insurance companies. Because of a large number of unknowns in the case of nuclear power, the insurance companies refused to offer insurance at all, as even the largest of them might be wiped out in a serious nuclear accident.

So, Congress passed a law, which limited the damages that could be assessed for a single nuclear accident to 800 million dollars. Then, of course, the insurance industry was eager to jump in. Of course, a real serious nuclear accident in a populated area would likely run into many billions of dollars, which the victims would have to cover - minus the $800 million. However, this is just a special case of the general corporate model.

The reason that people opt for the corporate model for their businesses is specifically the limited liability. But risk does not go away any more than gravity, regardless of what laws are passed. It is simply moved from one party to another, in this case from the guilty to the innocent.

And I would strongly agree that the court system is to blaim for the lure of the corporate model.

Corporations used to be rare, as in the East India Corporation, which was responsible for much, perhaps most, of the British Empire. In that case, however, the situation was similar to when the police want to arrest someone, but realize that the law is not on their side, so they persuade someone to make a citizen's arrest. Then the police and their city or town are out of the line of fire of a false arrest lawsuit, and the arrester may be someone who is bankrupt or has few assets, leaving the victim with no recourse. The Crown needed someone to do something - go out and enslave millions of people - without it actually being directly legally linked to them. For the corporate shareholders, it was like being given the keys to the kingdom, or a 007 license to kill, which they did, en masse.

Through most of the 19th Century, the preferred business model was not the corporation, but the trust, which is purely a private contract between shareholders and trustees. I.e., the trust is in fact a free-market entity. However, the corrupt legal system failed us. On the one side, the very large trusts were able to buy judges and juries and get away with murder. On the other hand, the popularity of punitive lawsuits that could bankrupt the trustees made it hazardous for the small trusts and other business forms, such as partnerships, to continue in business.

Instead of reforming the courts, so that damages were limited to the actual damage caused, we chose to move to the corporate model.

The people pushing for this move were not free-marketeers. On the one hand, they were the home-grown analog to Italian fascism, the "Progressives," who saw the citizen as having meaning only as a part of the larger entity, the state. Businesses should be run in accordance with state policy, and the corporation would be the way to get there. They were naive.

In fact, the money behind their simple-minded fascist idealism was coming directly from the pockets of the very trust owners who were about to see their trusts "busted." They did not get to positions of power by being stupid. They saw that they would have the concentrated interest (see Bastiat's "The seen and the unseen") to bribe the politicians who were ultimately in charge of the various bureaucracies and who would serve on them. They would be able use these various boards then to establish rules and regulations that ensured that no newcomers could compete with them and that real damages would be substituted for by slap-on-the-wrist fines.

And that's exactly what happened. The trust giants did not lose a dime from "trust-busting." They simply acquired effective legal immunity. In the State of California, the document of incorporation states explicitly that the State creates this corporate entity in order to serve the public welfare, and that failure to do so is grounds for revoking the corporate charter. It is the job of the Attorney General to enforce this against fraudulent or destructive corporations. Guess how many California corporations have EVER been prosecuted.....

Post 6

Wednesday, June 27, 2007 - 7:03pm

Phil: You put a lot of words on paper about the nuclear industry but you don't propose any other method of financing such an enterprise. You complain that a corporation isn't a person (but it isn't a daffodil either) as if that has any relevance. You seem to be trying to make a point that if a single "person" took entire responsibility for financing and running the enterprise and putting up his personal fortune as collateral that somehow that would be OK. How do you suppose any person would be so foolhardy to undertake it? Even if they did, the person probably wouldn't have over $800 million in personal assets to compensate the injured population. A limited partnership still wouldn't satisfy that liability.

Of course you might be advocating that the government undertake the whole thing. In that case the government would provide compensation to the injured parties by funds garnered from taxes, thus innocent taxpayers would be the ones forfeiting their assets.

You are far from clear about what you are getting at apart from just trashing the concept of corporations.

As a person with libertarian views, I think that the government has no business in legislating how financial enterprises should structure themselves. They do so for taxation purposes and other control issues.

Post 7

Wednesday, June 27, 2007 - 9:11pm

Corporations, Vagrants, and Moral Hazard

I won't pretend to any knowledge in this area of the law where I have little interest. I am, however, familiar with the idea that a corporation is a legal fiction, a "person" that bears legal risk so that the officers themselves are not open to unlimited risk should the corporation become insolvent.

My understanding of Osborn's objection in part is that a corporation can destroy much more than its own value and recoverable assets, and thus the existence of corporations is a moral hazard, inviting corporations to undergo activities whose risk no real individual or set of individuals would take upon themselves.

Yet, this risk that a corporation will be the cause of damages that far outweigh its own values and assets seems to me an empty objection. Criminal and criminally negligent behavior is not protected by limited corporate liability. If the boss is actually a killer, he can't say that the corporation committed the murder - the real person is not relieved of liability. Likewise, even real individuals like homeless people can be the cause of highly destructive events such as wildfires which have been set in California and the case of a man who broke a dike during the Mississippi flood, doing hundreds of millions of dollars in damage, in order to get a day off from his job. Whether or not corporations exist, individuals can always destroy much more value in one brief malicious act than they can ever create or compensate for. Complaining that the existence of corporations allows businessmen to foist off risk is a case of special pleading. So long as corporate law is well written, there should be no reason I can see why the creation of corporation for investment purposes is any more scary than the fact that people with minimum wage jobs are allowed to walk near river dikes or vagrants with lighters can pass by dried sagebrush lots.

And of course, if one still finds corporations objectionable, they don't exist under communism or strict sharia law either.

Ted Keer
(Edited by Ted Keer
on 6/28, 12:09am)

Post 8

Thursday, June 28, 2007 - 8:06pm

Sam, Sam, please read and THEN comment...

Did I not refer specifically to the "trust," as the free market alternative to the corporation? In fact, the largest business entity in the State of California is a trust called Calpers, which handles the retirement funds for millions of state employees, but is itself a private business entity.

The purpose of a trust is to provide limits to the liability of investors, which it does by leaving the total control of the trust to the trustees. Since the investors cannot exert goverence over the trustees, they bear no liability.

However, as I stated (sigh), when confiscatory punitive damages can bankrupt any private business, and there is no hope of legal reform - taking the courts back to the strict liability model of the Common Law - then the corporation becomes a logical alternative. However, that doesn't change the fact that it is not a free-market business, but rather a child of the state, that could not exist and would not be necessary in a free market with a good legal system.

As to your objections, Ted. You might want to take a look at my essay here:

http://philosborn.joeuser.com/index.asp?c=1&AID=8010

However, your objections were really of a different cast. Yes, Ted, bad people do bad things all the time. However, for the most part, we eventually catch criminals and there really isn't that much profit in private crime for most people, and none at all when you consider the psychological consequences of having to live a lie. So, what you're pointing at as a model is the occasional nut job. This is like using lifeboat cases to justify canibalism.

The problem with the corporation is that the ignoring of high risk / low likelihood possibilities is built into the cap on liability. If your net worth is $100 million, and you can make that again by ignoring a possible high end risk of $100 billion, then the following is your decision matrix.

Take the risk and lose: (-) $100 million times probability of occurence of catatastrophe
Take the risk and win: (+) $100 million

Don't do it: you make whatever you would make, but remember that you're competing with other corporations in the same field. It's not enough to just make a nice profit. In order to get the money to continue operations, you've got to have a "competitive" ROI. So, if your competitors take the option and win, then you may lose everything anyway.

Do it, and in many cases your probability of catastrophe is much less than 50/50. It might be only 1/1000, which - times $100 million - is an expected loss of $100,000 vs. an expected gain of $99 million nine hundred thousand.

If you're a good businessman, under the limited liability you will be forced to take the risk or very likely go out of business. The corporate mode makes that the rational thing to do. We aren't talking about criminal nut cases, but rational businessmen.

However, the REAL expected loss is 1/1000 times $100 BILLION, not $100 million. However, that loss - or 99% of it - is born by innocent victims who had no choice in the matter. And since there are tens of thousand of corporations, those risks do come due, yeilding a net loss that we are only starting to see the tip of, partially because, even with the economic incentives geared the other way, businessmen are still by and large good, honest, productive people. Note what's happening in China for a picture of where we are heading, as the good guys get winnowed out.

Post 9

Friday, June 29, 2007 - 7:24am

Phil Osborn approves of "trusts" but not "corporations." It is not real clear what he means by these two terms, but it is pretty clear that his objection to corporations is government mandated, artificially low, limited liability. However, I submit that a government dictated limited liability is not essential to a corporation and could be done for a trust as well.

A business corporation is an abstract entity, a joint venture involving more than one person, typically many. It allows for the separation of ownership and management (control of day-to-day operations). Ownership is by way of shares of stock. The shareholders have "limited liability" for the corporation's obligations, in the sense that their potential losses cannot exceed the amount which they paid for their shares. Such liabilities may be to lenders, suppliers, or customers. For passive shareholders who have no say in running the business beyond voting on board members and very broad corporate rules, this seems quite reasonable. If the corporation does something to incur liabilities it can't meet, it is a result of the actions of the corporate managers. Of course, typically the managers, at least higher level ones, are also shareholders. On the other hand, these shareholder-managers are not exempt from liability judgments simply because they are shareholders. Indeed, corporations often buy liability insurance for their executives, and courts sometimes find executives to be financially liable well beyond the value of the shares they own.

Phil cites CALPERS as a "trust" and "private business entity." It is more like a trust than a typical business corporation in that it doesn't have customers in the typical way, people who buy its products or services and have no role as owners or in running the business. CALPERS' "customers" are its owners, like a mutual insurance company. Nor does CALPERS take on corporate-style debt or issue stock. It's "debts" are also to its owners. (On the other hand, CALPERS is not totally private, since some of its board members are appointed by government office-holders and others are government office-holders.) Since CALPERS differs from a typical business corporation in several ways, I wonder if Phil approves of "limited liability" for a corporation's "passive shareholders" as described above. If not, why not? He apparently does approve of limited liability for CALPERS' investors.

Post 10

Saturday, June 30, 2007 - 2:36pm