Corporation Nation

Robert E. Wright

• Publisher: University of Pennsylvania Press
• Year: 2013
• Print ISBN: 9780812245646, 9780812245646
• eBook ISBN: 9780812208962
• Topic: Business
• Subtopic: Business History
• Index: Business

From bank bailouts and corporate scandals to the financial panic of 2008 and its lingering effects, corporate governance in America has been wracked by crises. Amid a weakening system of checks and balances in which corporate executives have little incentive to protect shareholder interests, U.S. corporations are growing larger and more irresponsible at the same time. But dependence on corporate profit was crucial to the early republic's growth, success, and security: despite protests that incorporated business was an inefficient and potentially corrupting system, U.S. state governments chartered more corporations per capita than any other nation—including Britain—effectively making the United States a "corporation nation." Drawing on legal and economic history, Robert E. Wright traces the development and decline of corporate institutions in America, connecting today's financial failures to deteriorating corporate law.In the nineteenth century, checks and balances kept managerial interests aligned with those of stockholders, and public opinion grew supportive as corporations raised billions of dollars to finance infrastructure such as transportation networks, financial systems, and manufacturing operations. But many of these checks and balances were dismantled after the Civil War, creating a space for the managerial malfeasance that spiraled into economic crisis in the twenty-first century. Bolstered with archival and original data, including the first complete count of American business corporations before the Civil War, Corporation Nation makes a compelling argument for improved internal governance and more effective external government regulation.

Chapter 1

The Corporation Nation Emerges

If they were honestly and safely conducted, [corporations] would afford a safe and satisfactory investment for small sums and thus tend to equalize the wealth of the people.

—V. H. Lockwood, 1897¹

The development of the for-profit business corporation over time has never been well understood, even in the nation most responsible for its economic ascendance, the United States. “American-style corporate capitalism,” two business scholars recently proclaimed, “is an international juggernaut” (an overwhelmingly destructive force) and perhaps the single most important institutional feature of modern, developed economies the globe over.² Yet even leading scholars of the U.S. economy have underestimated the number, ubiquity, and economic importance of early corporations, creating the misapprehension that they were insignificant until after, or perhaps during, the Civil War.³

Two reporters for the generally astute economics weekly The Economist recently wrote a book that called the corporation “yet another quirky … invention” of “Victorian Britain.”⁴ Many contemporaries, however, believed that America, not the Mother Country, was responsible for raising corporations from vehicles of monopoly privilege to a widely used form of business. “In no other age or country,” wrote Andrew Allison in 1884, “have private corporations entered so extensively into the business of the country, never so thoroughly into the details of everyday life, as with us.”⁵ Moreover, while Britain embraced the corporate form before most other nations did, the economies of both America and Britain were significantly corporatized well before Victoria’s long reign began in 1837.

“By the time that [Supreme Court Chief Justice John] Marshall left the Court in 1836,” legal historian Arthur Selwyn Miller noted in 1968, “the corporation … had become a key institution in American life.”⁶ As the new data presented in Chapter 4 show, Miller’s intuition was right. In addition to setting the historical record straight, this book seeks to improve the internal governance and external regulation of corporations today. Business leaders as well as policymakers have forgotten the conditions under which corporations thrive and the circumstances in which they are likely to flail or fail. That memory lapse has caused Americans some serious consternation recently—in the form of Enron, Lehman Brothers, Comcast, Fannie Mae, Bernie Madoff, and others too numerous to mention—and, I fear, will cause even more serious trouble in the relatively near future. Until they relearn to govern themselves, corporations will continue to face two major risks: increased government regulation and the withdrawal of investor demand. Either outcome could injure the economy, while the occurrence of both—if investors widely believe that new regulations would burden corporate profits without improving governance—could prove economically devastating. Think dangerous drop in liquidity, withdrawal of foreign portfolio investment, stock market meltdown, and ultimately decreased incentive for entrepreneurs to innovate due to an anemic IPO market. Such a disaster scenario is not unrealistic. Money, it is said, “stays where it is well treated,” and currently, it is regularly abused by the nation’s regulators and its largest corporations. Currently, the public has more confidence in gas-station attendants than in bankers and more confidence in auto repairmen than in investment advisers.⁷

Corporate governance malfeasance has raised the cost of capital in the past and could do so again. After the Civil War, shady railroad managers frightened “legitimate investment,” nearly killing “the goose which lays the golden egg” in the words of one critic.⁸ “Worthy stock enterprises,” complained another, “languish from public distrust in stock companies.”⁹ In the late nineteenth century, investment gurus regularly cautioned individuals not to buy common stocks because good information about corporate financials was lacking. Legal reforms aimed to change that; but in the wake of numerous scandals, their success appears doubtful.¹⁰

Despite all the disclosure laws passed since, financial information remains of dubious quality. According to Jonathan Macey, one of the world’s leading experts on all things corporate, stockholders must “trust” that corporate executives will treat their money right because “shareholders have … virtually no contractual rights to corporate cash flows.”¹¹ Most investors today don’t know that, and they overestimate the power of regulators to monitor executives on their behalf. When investors realize that what they get in return for their hard-earned money is at the whim of overpaid corporate executives, not the rule of law, there will be economic hell to pay. “If the confidence of the public in great corporations is destroyed,” noted one scholar during the Great Depression, “as it has been already sorely shaken in numerous recent instances of gross lapses from duty, the entire stability of our institutions will be thereby undermined.”¹² Disgruntled investors today could also withdraw from the equities markets, some scholars warn. “The fundamental problem of the corporation,” noted economists Charles Calomiris and Carlos Ramirez in the mid-1990s, “is to secure funding from people who are not directly in control of the use of those funds.”¹³ Without safeguards, managers can, and will, bilk investors to the point that “suppliers of funds may not find it worthwhile to transfer their savings to corporations.” And because a majority of Americans now own stock, if only indirectly via their retirement accounts and other mutual fund holdings, the economic, political, and social risks of a “capital strike” are greater than ever. Even if such a strike were not widespread enough to result in economic meltdown, any sizable change in investor sentiments away from corporate securities would likely raise the cost of corporate capital and hence slow economic growth.¹⁴

Before the Civil War, investors in U.S. corporations enjoyed much more security than they do today. Many of the “glaring abuses” and “evils” of modern corporations, a Depression-era corporate critic argued, “are due to the transformation of small, closely held, personal business corporations of the type which existed in the earlier days of the Republic, into nationwide companies whose stock is widely held in many dispersed hands and which too often are characterized by loose, careless management and control.”¹⁵ The concomitant erosion of traditional governance checks and balances, this book will show, played perhaps an even larger role in the demise of investor security after the Civil War.¹⁶

Action is necessary because the corporation is too economically important to be allowed to wither. Within a few years of adoption of the Constitution, the corporation was ingrained in almost every aspect of Americans’ economic lives, from finance to transportation, as Joshua Gilpin discovered when he set out from Philadelphia “to the Western parts of Pennsylvania” in 1809: “After crossing the Schuylkill permanent Bridge [a corporation], we took the Lancaster turnpike [another corporation],” used money issued by corporate banks, and even slept in a hotel owned by a corporation.¹⁷ In 1835, a pundit noted that the great internal improvements of the period, “the roads, canals, tunnels, are the result of those laws which permit, and those systems of government which do not trammel, the association of wealth.”¹⁸ As another corporate booster put it that same year, “almost every instance of valuable public improvement that meets the eye, is to be traced directly or indirectly to the agency of that much-decried monster—Corporation!”¹⁹ Still another, writing two years later, noted that if contemporaries looked in “different directions” they could not “but see their beneficial influences upon the condition of the country.”²⁰ If anything, corporations are even more important to the nation’s economic health today.

Miller claimed that history provided “no convincing answers” for why America became the consummate corporation nation before the Civil War (1861–65). This book shows that a generally effective system of internal governance allowed early corporations to raise (what were then) significant sums of equity capital at start up without the aid of investment banks or other intermediaries. Americans did not invent the for-profit business corporation, but they did perfect the form—and far earlier than most believe—in the first half of the nineteenth century, surpassing the British and other precedents (discussed in Chapter 2) quickly and completely, despite the misgivings expressed by corporate critics detailed in Chapter 3. As Chapter 4 shows, by the early nineteenth century, the young nation had chartered more corporations than any other country on earth and sustained its lead throughout the antebellum period. As shown in Chapter 5, corporations proliferated widely throughout the nation, north and south, east and west, because the benefits of creating them generally outweighed the costs. Corporate privileges like the ability to sue and be sued in its own name, perpetual succession, use of a corporate seal, limited liability, entity shielding, share transferability, and relatively clear laws concerning the operations and governance of joint-stock companies allowed corporations to grow much bigger, much faster than they could have as traditional partnerships or sole proprietorships. That, in turn, allowed them to achieve scale economies (lower production costs per unit produced), the most profitable (Coasean) degree of vertical integration, and market power (some degree of control over prices and quantities). As eighteenth-century British political economist Sir James Steuart correctly noted, “by uniting the stocks of several merchants together, an enterprise far beyond the force of any one, becomes practicable to the community.”²¹

Incorporators had to pay postage, publishing, and other lobbying costs and were not assured of receiving a charter, but the expected direct costs of incorporation were typically minimal, especially after the passage of general incorporation acts in many states in the 1840s and 1850s. “The difference, in point of delay, trouble and expense, between forming a private corporation under a general law, and obtaining a special charter,” a late nineteenth-century jurist claimed, “may be likened to that between modern traveling by railroad and the old fashioned stage coach.”²² But the chartering of more than 22,000 businesses by special act before 1861 suggests that the “stagecoach” approach to incorporation was more an inconvenience than a barrier to entrepreneurs.²³

The indirect costs of incorporation and large size—the so-called agency costs of having numerous agents and employees complete important work tasks on behalf of the owners—were more substantial but could be mitigated by screening, employee incentives, and other governance principles, which are discussed in Chapter 6. A few early corporations survive to this day, but most eventually exited via bankruptcy, a deliberate winding down of their affairs, or merger (then typically called “amalgamation”). Most failed companies were driven out of business by more efficiently managed competitors, but a few were extinguished by corporate governance failures (various types of fraud), such as those detailed in Chapter 7. As described in Chapter 8, defalcations spawned regulatory responses that more or less prevented the exact repetition of earlier frauds but did little or nothing to prevent new types of expropriation from taking place. Chapter 9 takes up that theme by tracing the history of corporate governance and regulation from the Civil War to the present. The book concludes in Chapter 10 with the suggestion that a new approach to regulation is needed if the number and severity of corporate financial scandals are to be significantly reduced. Returning to the governance principles of our forebears is a good place to start.²⁴

Restoring internal governance to a semblance of health and improving external regulation will not be easy; no...

Table of contents

• Cover Page
• Title
• Copyright
• Contents
• Chapter 1. The Corporation Nation Emerges
• Chapter 2. Before the Constitution
• Chapter 3. Corporate Iniquity
• Chapter 4. Corporate Ubiquity
• Chapter 5. The Benefits of Big
• Chapter 6. Governance Principles
• Chapter 7. Governance Failures
• Chapter 8. Regulation Rising
• Chapter 9. Corporate Governance and Regulation since the Civil War
• Chapter 10. Reforming Corporate Governance
• Notes
• Index
• Acknowledgments