Remaking the Corporation

Humans have been on earth for around 195,000 years. But it wasn’t till around 300 years ago that we started to defeat famine and plague and so begin to prosper. Global population had remained stuck at a few hundred million. But then it began to take off.  By 1800 it had reached a billion, doubled again to 2 billion by around 1930, since when it has more than tripled to today’s estimate of over 7½ billion.

What had changed? 

As a moral philosopher, Adam Smith wanted to find out. He identified the division of labour as the prime source of economic progression. He observed how the specialisation of tasks, machinery and equipment revolutionised pin making, massively increasing output and reducing costs. It was the industry and inventiveness of people working together that has driven all industrial revolutions, enabled by there being a market for such increased production.

That made the argument for free markets.  The only snag was that free markets naturally evolve to becoming monopolistic and exploitative.  But that’s another story!

The joint stock company, or corporation, was the key organisational structure in which people were enabled to work together.  It raised the finance to fund technological developments as well as the economic growth they generated. It was originally established and protected by royal charter or act of parliament, with investors being held fully responsible for corporate activity.

The 1844 Joint Stock Companies Act made company formation easier and cheaper, with limited liability added in 1855 freeing investors from any responsibility beyond paying for their shares in the company. The full potential for the exploitation and abuse of limited liability was not immediately recognised, but has long since been more fully exploited.

Since then, various Companies Acts have made minor amendments to the corporate concept, but the basic idea was settled: the company was established as a legal entity, enabled to sue and be sued, with its directors required by law always to act in the company’s best interests.

However, there was a flaw in the corporate system of governance.  If a single shareholder, whether a human individual or another corporate entity, achieved more than 50% of the equity, then they had effective control. The company then so owned, would cease, in effect, to be a legal entity in its own right, and became instead an item of private property which the owner could direct as they pleased.

Since the 1980s, the legal requirement for company directors to act in the company’s best interests, has been dominated by a demand to focus on maximising shareholder interests. Milton Friedman expressed that change as ‘corporate officials’ having no ‘social responsibility other than to make as much money as possible for stockholders.’ [i]

While the real legal position did not change, custom and practice did, justified by support for and promotion of Friedman’s assertion of the primacy of shareholder interests.

The quickest and easiest way to make money for shareholders was not by persevering in the manufacture of pins or anything else.  It was most readily achieved through mergers and acquisitions to increase monopolistic market power and/or to enable asset stripping for financial gain which could be more profitably invested in speculative betting. Such M&As might be activated by aggressive stock market raids or by the collusion of company directors acting in their own self-interest rather than their employing company’s. The funds extracted might earn fastest returns increasingly through automated systems, operating in nanoseconds, with price movements being increasingly manipulated by deliberate feed–in of fake news.  The overall result has been a predatory extraction of value from real economy corporations for purely short-term speculative gain by the owners.

Though that predatory destruction is justified by a false argument for shareholder primacy – which is in conflict with the law – the resulting actions are all perfectly legal. The corporate entity, as defined by law, is vulnerable to such predation. In the UK, it has been encouraged by a dominant financial sector supporting political leaders who proudly proclaim their economies as being ‘open for business’. 

There are alternative routes for political economic decision makers to take.  Remaking the corporation in alternative formats could provide protection against stock market raids or illegal collusion of company directors to destruct their legal entity. That could assist rebuilding the real economy to focus on what really matters: sustainability, human rights including those of future generations, equal opportunities, and some level of social balance.

Such protection has been achieved in various ways. Co-operative formation in its various forms – employee co-operatives, customer co-operatives, community co-operatives – all provide protection against predatory attack.

Japan has provided protection for its real economy corporations with its long established keiretsu system of interlocking shareholdings. It includes members of the banking sector which held equity for long periods and did not actively trade in most of the equity they held.  Keiretsu makes gaining the 50%+ of corporate equity extremely difficult for outsider investors, unless agreed by all.

German corporates are protected by the two-tier board system comprising a management board with responsibility for day to day running of the enterprise and a supervisory board with various legally defined responsibilities including the appointment of management board members, but with no common membership allowed. Employees must have 50% of representation on the supervisory board for companies with 2000 employees.

There are many alternative corporate formats which provide the necessary protection from destruction. They could also include combinations of the various systems noted here. It has also been proposed to make limited liability available only if the corporate formation is compliant with agreed protective conditions.

The purpose of this article is not to identify a magic solution, but to flag up the need to remake the corporation so that it might create value for the real economy, rather than making it vulnerable to financial predation for the benefit of the few, and even that only for the short term.  In the long run, as the Covid pandemic constantly reminds us, we are all in it together.

[i] Friedman, M., (1962), ‘Capitalism and freedom’, Chicago: Chicago University Press, p133