Today I’m having a look at an issue you might not generally associate with Libertarianism, but whose existence directly impacts on the liberty of us all, thousands of times every day: the company. Specifically, the limited-liability, joint stockholder corporation.
Most of you will regard the corporate entity as a core plank of free-market capitalism; in fact, it is so ingrained into the notion of the capitalist society that it rarely bears any scrutiny. To question it at all is an open invitation to be branded an anti-capitalist, or even a Marxist. Yet, to my non-economist view, the rights and privileges today accorded a joint-stockholder company far outstrip its responsibilities, which are in any case imputed to no one individual: in other words, a textbook case of moral hazard. This is what has happened when the corporation went beyond its original purpose—the pooling of capital in a co-operative enterprise beyond the means of any one investor—to become a collectivist activity whose purpose was the maximization of profit while palming off the investor’s rightful risk onto others further down the food chain. I was reminded of this fact by James’ recent blog article on General Motors, which prompted me to say something about it today.
A little history first. Prior to the Industrial Revolution, companies in the United Kingdom were comparatively rare beasts, generally created only for very large-scale enterprises. They could only be formed (incorporated) either by direct Royal Charter (as, for example, in the case the East India Company, granted a Royal Warrant by Elizabeth I in 1599), or by a Private Member’s Bill in parliament (such as Lloyd’s of London). Of course, most commercial enterprises at the time were small farms, guild-regulated trades, retailers or service providers, all of which were owned and operated by a single person, who by law was directly and personally responsible for all the actions of his business, including those of his employees, as well as all debts incurred, without limit. Common law recognized the magnitude of responsibility this represented, and balanced it by giving the business owner far greater freedom of action than he enjoys today.
As the Industrial Revolution progressed, however, smaller workshops gradually coalesced into larger and larger mechanized factories, which often faced a stark economic choice: either hand over control to an individual (generally of the aristocracy) capable of raising the capital to build or purchase the infrastructure required, and maintain an ever-expanding workforce, or find some way of “collectively” pooling resources that did not require the patronage of an MP to pass a bill in the House. The result in 1844 was the Joint Stock Companies Act. Prior to it, the large, unwieldy, ad hoc enterprises (known legally as unincorporated associations) generally used for this purpose were almost impossible to sue, as writs against every single investor (possibly hundreds) had to be filed. The 1844 Act provided for the creation of a single corporate identity, regarded for most purposes at law as a legal person. Rather than requiring a separate bill in parliament, a group of investors could incorporate upon payment of a modest administrative fee. The Act, however, did hold investors fully responsible for the actions of the company, and all debts incurred; this despite criticisms that unlimited liability dissuaded many from investing in enterprises other than those with which they were intimately familiar and professionally knowledgeable, and thus retarded economic growth generally.
All that changed in 1853 with the outbreak of the Crimean War, generally regarded as the first “technologized” war of the industrial age, with combatants employing both railways for the mass movement of troops, and the electric telegraph for the transmission of orders. Desperate to free up nascent British industry to produce the requisite matériel for the war’s prosecution, Parliament relented and in 1855 passed the Limited Liability Act, and in 1862 the Companies Act, which had the effect of transferring responsibility from investors to company directors. Crucially though, complete liability could not be transferred to directors who, while bound by fiduciary duty, not only were not required to personally possess the means to cover all liabilities the company may incur, but in any case were careful to take steps to place their personal wealth beyond the reach of creditors (for example, by transferring title into their wives’ or childrens’ names). Directors could go to jail for breach of trust, but that didn’t mean the company’s creditors would ever be paid. This article’s title, an epithet against corporations, is generally attributed either to U.S. President Andrew Jackson or, a half-century earlier in England, the first Baron Thurlow, Lord Chancellor from 1778 to 1792.
This dissolution of individual responsibility also had profound repercussions for the employer-employee relationship, particularly those employees who were either unskilled or whose skills had limited transferability. In the case of trades, for example, a master craftsman historically took on apprentices by means of an indenture (a common law contract signed on the apprentice’s behalf by his parents) which bound master and apprentice together by mutual obligation; the apprentice bound in servitude and obedience, the master required to teach the apprentice his craft and provide board and lodging (typically becoming part of the master’s own household) by way of recompense. But from the mid-nineteenth century, an employee found himself suddenly without the protection which his master’s obligation had hitherto provided. Industrial historian L.T.C. Rolt (the subject of an upcoming LibertyGibbert article), in his 1947 magnum opus High Horse Riderless, put it memorably:
It has also been observed that the pursuit of power by the acquisition of wealth, which was the practical manifestation of the materialist doctrine, was accompanied by a dissolution of that responsibility which the possession of power should involve. In the first phase of the Industrial Revolution the manufacturer had no course but to accept full moral and financial responsibility for his actions in the conduct of his business, and no matter how strained by abuse it might be, the link of mutual dependency between employer and employed could not be severed. As the revolution progressed, however, the same change was effected in industry as had already been accomplished in government, responsibility being transferred from the individual to the group. In the interests of security, the factory system tended to imitate the great primary monopoly of banking and credit which had been the diabolic deus ex machinâ of the New World, by coalescing into larger and larger units. The doctrine of individualism, in fact, produced the opposite. As a result of this process the individual was relieved of moral responsibility and the tie between master and man was broken. Financial responsibility alone remained until the Company Act made possible the limited liability company. This represents no less than a ficticious and inhuman entity for whose policy no single individual can be held responsible, but which enjoys all the rights of individual freedom and is now mis-called “private enterprise”. By becoming a shareholder in such an undertaking, or in other words by lending his money and deriving an income from the interest on that loan, the individual was not merely free from any responsibility for the policy of the undertaking, but was also relieved to a great extent from liability for the debts incurred in the pursuance of that policy. Irresponsible power in the shape of functionless property thus became a practical reality.
Faced with the evaporation of employer protection in an increasingly corporatized, technologized and inhuman society, the emergence of trade unions and the rise of socialism in the late 19th century became inevitable. Put another way, faced with the collectivization of capital—which the limited liability company represented—labour merely responded by following suit.
In fact, what limited liability really represents is a state sanction, albeit with caveats, granted to entrepreneurs and investors. I won’t pretend this isn’t a contentious subject among Libertarians; you can get an idea of the range of discussion on this issue than occurs on Libertarian fora here, here and here. Critics of Libertarianism have pointed out (with considerable justification, I might add) the inconsistency of many Libertarians on the subject, and failing to grasp the difference between a limitation of liability freely agreed to under an individual contract, and a state fiat that to many represents no less than a “get-out-of-jail-free card”.
Incidentally, up to this point I have been implicitly referring, primarily to two separate types of liability as interchangeable, which they aren’t. First, there is liability to creditors. This one is certainly important, and is covered by limited liability law in most western countries. As a bit of Libertarian theory, it’s pretty straightforward: liability to creditors should not be a part of the limited liability state sanction, but rather should be written into individual private contracts, to cover the inability of one party to live up to the terms of the contract. It is then up to contracting parties to judge freely for themselves whether the entity with which they are doing business is capable of discharging their responsibilities under it, and the rôle of the state is eliminated entirely.
The second, and far thornier issue, is that of tort liability: injuries wrought by a corporation upon third parties. When BP or Exxon spills oil into the sea, either through accident, negligence or some combination of the two, polluting hundreds of miles of coastland; when a medical implant fails through a design flaw, injuring or killing thousands, or when tens of thousands die through asbestosis or mesothelioma, due to exposure to asbestos decades earlier, before its dangers were known, who is responsible? Not what company, what individual? If the answer is no-one, then clearly responsibility has evaporated.
Critics of Libertarianism observe that, having being gifted the immunity of state sanction, corporations, particularly larger ones, have actually come to resemble the governments that enable them. If Libertarians are so hyper-critical of the monopoly power of the state, they ask, why not also of the corporations, that differ from the state in little beyond the label? After all, the moral position of a manager in much of the private sector is not so far different from that of the bureaucrat: he has a vested interest in displaying short-term gains, and expanding his own remit; his duty to his ultimate employers (shareholders and taxpayers respectively) is several times removed and, being of no immediate moment, largely ignored. This recent open letter, written by a departing Goldman Sachs employee and published in the New York Times, illustrates perfectly, not only the disconnect between the corporate manager and the client he is supposed to serve, but the indistinguishability between the moral vacuum of his position and that of the state bureaucrat. Is this not precisely what Libertarianism is supposed to damn? Libertarianism’s critics are, on this issue, actually hoisting us on our own petard—and they are right to do so.
When engineer William Boeing in 1910 purchased a disused Seattle boatyard and, with his business partner, built his first aircraft (pictured above), a sea-going biplane with wings fashioned from wood, wire and linen, he could scarcely have imagined that, a century hence, the company which still bears his name could produce a machine capable of transporting hundreds of passengers across the Atlantic Ocean in the space of an afternoon. The science and engineering, however, that went into the building of such an object, is the culmination of tens of thousands of man-years of education, experimentation and experience. There is literally no-one on earth, and there never will be, who knows how to build a Boeing 787 Dreamliner. Yet they get built, and they work.
And not just Boeing: Ford, GM, Exxon, Microsoft, Apple and Google are all multi-billion-dollar corporations that began life as one- or two-man operations, but now create products which require the input of hundreds, if not thousands, of highly-trained specialists in a wide diversity of fields. Does this mean, then, that modern industry can only proceed along the lines of a vast corporation, whose owners (shareholders) are safely removed from all responsibility or liability beyond their investment’s face value? I’ll get to this in a moment. But it’s important to remember here that historically, the corporate structure was introduced as a response to the needs of the Industrial Revolution; that is, manufacturing, mining and other heavily-capitalized industries beyond the means of most single investors. Very soon after its inception, however, the potential for huge, risk-free profits was apprehended by the banking and financial world, and the unintended consequences of the 1855 Act in Britain, and its counterparts elsewhere in the West, are visible all around us today.
For example, recently I watched a documentary on ABC-TV’s Four Corners program dealing with the current debt crisis in Ireland, specifically the scandal surrounding Anglo-Irish Bank (full show and transcript at the link). In a nutshell, Anglo-Irish practised flagrantly reckless lending policies during the credit boom of the 2000s. When the boom eventually went the way of every other boom, Anglo-Irish collapsed, along with many other banks, and the Irish economy as a whole. But the European Central Bank required, as a condition of a Euro-bailout, that Anglo-Irish’s unsecured bondholders—the very people who bankrolled the whole financial profligacy in the first place, who had made out like bandits in the good times, and who should have been left to their just deserts in the bad—be paid out, in full, by the Irish government (read taxpayer). A government of just four million people, on the hook for €30 billion. Rights without responsibilities, writ large. The burden instead, demanded the ECB, is to be shifted onto the Irish taxpayer—the poor Brian and Mary on the street (many of whom are now literally on the street, having lost their homes)—for at least the next seventeen years. The imposition is doubly infuriating for Irish taxpayers, as a mere few weeks earlier, the same ECB negotiated a structured write-down of Greek government debt. One rule for Miklos, another for Mick.
Then there is the issue of the speed with which shares in limited-liability companies may be bought and sold. On the face of it, in a free market this should actually be a good thing, allowing economic agents to make decisions within a time frame of their own choosing. In theory, at least. What happens in practice is that the buying and selling of shares (and options, debentures, bonds, derivatives and other instruments) is driven, not by a company’s fundamentals, but by arbitrage; with moment-to-moment, or even nanosecond-to-nanosecond fluctuations in price, the difference between success and failure of Wall Street investment houses often boils down to who has the better supercomputer. There is simply no way that anyone who invests their money in a company in this manner can possibly have any notion of the business practices and liabilities they are (or should be) taking on, further separating investor and enterprise. And while Libertarian economists will defend instruments such as credit default swaps as being compatible with the operation of a free market, the multiplying of such layers between investor and enterprise has the practical effect of dispersing, and ultimately eliminating, responsibility. And that, to my mind, is profoundly illiberal.
Add in the corporate shenanigans of mergers and acquisitions, takeovers and tender offers and the like, and the moral hazard to those with inside information is multiplied a thousandfold. And none of this can be credibly claimed to going any way towards increasing the production of useful goods and services—particularly when the businesses in question are themselves merely bankers or financiers, several times removed from the actual engines of production. I can highly recommend James B. Stewart’s 1991 best-seller Den of Thieves, which traces the criminal activities of four New York businessmen—Michael Milken (the junk-bond king of the 1980s), arbitrageur Ivan Boesky (who originated the quip “greed is good”), Martin Seigel (takeover guru who invented the “golden parachute” and the “pac-man defence”) and Dennis Levine, an inside information go-between. Liquidity is invariably offered as the rationale for the law allowing situations to develop involving the quite monstrous conflicts of interest described in Stewart’s book. If that really is American capitalism (and I don’t believe it is), then call me an Austrian.
Greed may very well be good. But fraud is bad.
To some extent, the limited-liability, joint stockholder corporation will always be with us. It has served a useful function in enabling the industrialization of the West. But what I see coming in the post-industrial age, with employees being increasingly highly educated, with portable skills, autonomy and individual bargaining power, is a devolution of the corporate monolith to the smaller and smaller units of the past. It’s happening already, in the form of outsourcing. Increasingly, for example, large companies are reducing their IT departments to a shell, and contracting out to service providers to provide most of the hands-on grunt work. These, in turn, employ or subcontract individual technicians on a job-by-job basis. At each stage, contracts set out duties and remuneration, and with proper project planning and risk management strategies employed, the possibility of damage to third parties is minimized. Within that framework, and with all due diligence performed, insurance for public liability is the solution for protection against accidental damage to third parties.
I actually disagree on this point with Libertarians like Stephan Kinsella, who would impute liability wholly to corporate officers—those with hands-on control of a business—rather than investors, whose involvement he (IMHO) mischaracterizes as “vicarious liability”. There are two issues here; first, as I argued above, under most Western company law there is no requirement for corporate officers to possess personal wealth against the possibility of tortious damage (to do so would limit the hiring of senior management to the exceedingly wealthy), meaning he seemingly accepts the evaporation of responsibility; and secondly, the investor reaps the rewards of an investment, one would imagine that by natural justice he should also accept the risk of his capital, while in his service, causing injury to others. A contentious viewpoint, I accept. For an opposite opinion, here is an excellent article from the von Mises Institute.
The ideal situation for the application of limited liability to creditors is best summed up in Chapter 3 of Murray N. Rothbard’s Power and Market; according to him, any limitation of liability should be private and contractual, not an immunity grant of the state:
Finally, the question may be raised: Are corporations themselves mere grants of monopoly privilege? Some advocates of the free market were persuaded to accept this view by Walter Lippmann’s The Good Society. It should be clear from previous discussion, however, that corporations are not at all monopolistic privileges; they are free associations of individuals pooling their capital. On the purely free market, such men would simply announce to their creditors that their liability is limited to the capital specifically invested in the corporation, and that beyond this their personal funds are not liable for debts, as they would be under a partnership arrangement. It then rests with the sellers and lenders to this corporation to decide whether or not they will transact business with it. If they do, then they proceed at their own risk. Thus, the government does not grant corporations a privilege of limited liability; anything announced and freely contracted for in advance is a right of a free individual, not a special privilege. It is not necessary that governments grant charters to corporations.
It may be dismissed as idealism, but I believe a move away from the state sanction of limited liability, and towards the resumption of investors’ responsibility for actions taken by a company, while leading undoubtedly to a loss of liquidity in the market, would make investment a more concrete, less abstract activity, and with the fortunes of investors at stake, the actions of corporate officers directly answerable to them would in all likelihood avert the kinds of economic crisis we have witnessed over the last thirty years, fuelled as they were by the recklessness that is the inevitable consequence of the imbalance of power and responsibility.