The Modern Corporation and Private Property

Gardiner Means

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781351479349
• Edition: 2
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

This monumental work on the corporation is one of those enduring classics that many cite but few have read. Graced with a new introduction by Weidenbaum and Jensen, this new edition makes this classic available to a new generation. Written in the early 1930s, The Modern Corporation and Private Property remains the fundamental introduction to the internal organization of the corporation in modern society. Combining the analytical skills of an attorney with those of an economist, Berle and Means raise the central questions, even when their answers have been superseded by changing circumstances.The book's most enduring theme is the separation of ownership from control of the modern corporation and its consequences. Berle and Means display keen awareness of the divergent interests of directors and managers, and of each from owners of the firm. Among their predictions are the characteristic increase in size of the modem corporation and concentration of the economy. The authors view stock exchanges and stock markets as essential by-products of the rise of the modem corporation, and explore how these function. They address the difficult questions of whether corporations operate for the benefit of owners or managers, and explore what motivates managers to make effective use of corporate assets. Finally, they examine the role of the corporation as the prevailing form of organizing the production and distribution of goods and services.In their new introduction, Weidenbaum and Jensen, co-directors of the Center for the Study of American Business at Washington University, critically assess the impact of developments not fully anticipated by Berle and Means, such as the rise of the service sector, and the significant role played by institutional investors in the owner/manager equation. They note the authors' prescient observations, including the complex role of and motivating influences on professional managers, and the significance of inside informatio

BOOK TWO

Regrouping of Rights: Relative legal position of ownership and “control”

CHAPTER I: EVOLUTION OF THE MODERN CORPORATE STRUCTURE

AS PROPERTY has been gathered under the corporate system, and as control has been increasingly concentrated, the power of this control has steadily widened. Briefly, the past century has seen the corporate mechanism evolve from an arrangement under which an association of owners controlled their property on terms closely supervised by the state to an arrangement by which many men have delivered contributions of capital into the hands of a centralized control. This has been accompanied by grants of power permitting such control almost unexplored permission to deprive the grantors at will of the beneficial interest in the capital thus contributed. It is necessary to glance at this phase of legal history, since without it no fair comprehension of the present system can be attained. At the same time certain checks and balances, partly legal and partly economic, have come into existence. They also, and their effectiveness, must be examined in due course.

The evolutionary phase of the modern corporation in recent legal history has been both protracted and confused. Protracted, because it has been accomplished not by any great change either in concept or in statutory enactment, but rather by a long process of grant of management powers piecemeal. The aggregate of these various grants makes up the charter of almost absolute power which the control, commonly through the management, asserts today. Confused, because the various accretions of power appear partly in statutory amendments over more than a century, partly in decisions purporting to declare the common law; partly in statutory enactments which purport to recognize or declare the common law; partly in clauses inserted in the charters; partly in powers merely assumed by lawyers and managements which, becoming traditional, work their way into the system. It would be both impracticable and unnecessary to review the entire process.¹ The major lines of the development must, however, be indicated.

American law inherited the corporation from English jurisprudence in the form in which it stood at the close of the Eighteenth Century. At that time a corporation was considered as a “franchise” (Norman-French “privilege”): i.e., the very existence of the corporation was conditioned upon a grant from the state. This grant created the corporation and set it up as a legal person independent of any of the associates. Not infrequently the same grant gave to the corporation other privileges such as a monopoly to run a ferry; a franchise to maintain a railway line in a particular place; a sole right to trade in the Hudson Bay area. Such privileges, except in the case of railways, public utilities and banks, have largely passed out of the picture today. The real privilege² which the state grants is that of corporate entity—the right to maintain business in its own name, to sue and be sued on its own behalf irrespective of the individuals; to have perpetual succession—i.e., to continue this entity although the individuals in it changed. From all this necessarily flowed a limited liability of the associates. Since only the entity was liable for debts, which did not attach to the various individuals, it followed that a stockholder was not normally liable for any of the debts of the enterprise; and he could thus embark a particular amount of capital in the corporate affairs without becoming responsible beyond this amount, for the corporate debts.

At the same time, the document of grant (commonly called the “charter,” or today the “certificate of incorporation”) embodied the outlines of the arrangement among the associates. It set up the number of shares of stock, and the officials to whom the immediate management of the corporate enterprise was to be delegated; indicated by whom these officials were to be selected and under what conditions; and included provisions establishing both how the business was to be conducted and how the profits were to be distributed, and how the assets were to be disposed of on ultimate dissolution. As a result, each corporate “charter” was the product of a threefold negotiation involving the state and the combined associates, and between the groups of associates acting for themselves. It was recognized as a “contract” and has been consistently so dealt with in American law. The classic statement, (which does not bear analysis), envisaged the result as a contract between the corporation and the state, the stockholders and the corporation, and the stockholders inter sese .³ Of course, the state as a sovereign, does not usually enter into contracts in the ordinary commercial sense. It is impossible to have a contract which at once creates the corporation and embodies a bargain between the corporation and the state, since a contract presupposes two parties capable of contracting before the negotiations begin. There may have been and probably was something resembling a real contract between the associates in early days, since they must have agreed among themselves as to the management of the enterprise and the distribution of the proceeds in a manner justifying the use of the word “contract” in its ordinary sense.

As in the Eighteenth Century negotiations for these contracts were carried on with the crown, so in America they were carried on with the sovereign power of the various states as successors to the crown. In practice this meant the state legislature. Prior to 1811, substantially every contract was separately legislated into the law of the state by a separate act; most charters continued to be specially legislated until well into the Nineteenth Century. To be valid, therefore, the arrangements between the associates themselves, and the powers granted to the corporate management had to be thoroughly thrashed over with the state authorities. During this period, the arrangement may be described as a “State controlled” agreement; since the various legislatures were required to approve every item in the transaction, and in fact they used their power to regulate severely the arrangements entered into.⁴

With a lively appreciation of the possibilities of the corporate mechanism, during the first half of the Nineteenth Century, the various states erected a series of protections. They were thinking primarily of three groups: the general public, the corporate creditors, and (to a less extent), the corporate shareholders. At this time there seems to have been no thought that shareholding might become so common as to make shareholders’ interests a consideration in protection of the public at large though the English experience with the South Sea Bubble a century before might have suggested caution. Shareholders were supposed to be capitalists reasonably able to protect themselves. Nevertheless the protections erected served to assist shareholders almost as much as any other group.

The typical protections were three:

(1)The enterprise was required to be defined and was carefully limited in scope. This acted as a check on the management of the corporation. In theory this was probably designed to prevent corporations from dominating the business life of the time; to the shareholder, however, it meant that he knew the particular enterprise, or at the widest, the type of business in which his capital was to be embarked.⁵

(2)The contributions of capital were rigidly supervised. The corporation was not allowed to commence business until a certain amount of its shares had been “paid-up.” It is probably at this period that such legislators expected such payment to be in cash. At the same time it was contemplated that all additional shares issued should be paid for at a fixed minimum rate—viz., the “par value” of these shares. The penalty for failure to do so was, among other things, that any shareholder who acquired shares without paying in the fixed minimum, presumably in cash, was liable to creditors to pay the balance in the event that the corporation became insolvent; but the Attorney General of the state could also enforce this requirement if he felt it necessary, which he frequently did not.⁶ This was designed frankly to protect creditors—the fear being that a corporation would run up bills and having no contributed capital would be unable to pay them. To the shareholder, however, it meant a certain protection against dilution of his interest. Every shareholder was required to contribute not less than a stated amount for his share; and the result was that “free” stock or stock which did not represent the minimum contribution could not legally be issued. This served as a powerful safeguard for his pro rata interest in the corporate assets.

(3)A rigid capital structure was set up. Shares even in those early days could be classified to some extent into preferred and common stock; but the entire system had to be carefully laid out, embodied in the charter, and passed upon by the legislature; so that the participations were thoroughly scrutinized by the state authorities; and their number and incidence were at all times subject to careful control.

On the top of these the common law added a few safeguards on its own behalf.⁷

(4)Under the jurisprudence of the time, residual control—i.e., decisions affecting the general interest of the group, lay in the shareholders or in a specified proportion. The management of the enterprise was by contract commonly delegated to the board of directors; but any change in the capital structure or in the nature of the enterprise, or any amendment of the arrangement had to be passed upon by the shareholders. In the event of any fundamental change the vote had to be unanimous, thus giving every shareholder a considerable degree of control over the policies of the corporation.⁸

(5)Likewise, the common law asserted that the shareholders had the sole right to invest new monies in the enterprise; and they worked this out by granting to each shareholder a pre-emptive right to subscribe to any additionally issued stock of the corporation. This rule, evolved by the Massachusetts courts in Gray v. Portland Bank (3 Massachusetts, 363 (1807))—the foundation of the present “law of pre-emptive rights,” was assumed to be sweeping and absolute.

(6)In general dividends were permitted to be paid only out of surplus profits arising from the operations of the business.⁹ This may have been an American invention, the English law not having laid down any clear principle until the latter half of the Nineteenth Century;¹⁰ but the result was that whenever a distribution of profits did take place, it represented in theory a real profit; the capital could not be frittered away in small payments to the contributors.¹¹ The rule was designed to protect creditors—i.e., to maintain the integrity of the capital subscribed for the purpose of paying corporate debts,^11a_ or rather to prevent its impairment through payments to shareholders; but it also operated to maintain a sound financial position for the shareholders.

Even at this period it was possible to qualify a good many of these protections by contract; but as the state insisted on supervising the contract, and was not favorably impressed by innovations, the corporate mechanism was rigid and carefully protected. The effect was to set up a business organism conducting a limited enterprise, with participations settled in advance, and safeguarded either by the statutory contract or by the common law in various ways. Investors could and did place their reliance at least partly on the state, since in theory the state would sanction no contract which was not approximately fair to all concerned including the shareholders.

The arrangement had one effect which would not be important today save that it still colors legal thinking.

Where an entity is created by the state and the state carefully and explicitly lays down rules of conduct for it, the assumption is naturally made that anything permitted to the organism has been expressly sanctioned by the sovereign power. As a result, much of the jurisprudence of the time turned purely on the question of power, and very little else was considered important. If, under the contract, a thing could be done, there was definite state authorization for the action taken, irrespective of its merits; if it was designed to prohibit the doing of a thing, presumably this prohibition would appear expressly or impliedly in the charter.¹² It was accordingly fashionable to...