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The Legal Ontology of the Corporation As a Description of Its Goal, and Its Role in Society

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The Legal Ontology of the Corporation As a Description of Its Goal, and Its Role in Society Social Innovation Centre The Legal Ontology of the Corporation as a Description of its Goal, And its Role in Society _______________ David RONNEGARD 2009/09/ISIC The Legal Ontology of the Corporation as a Description of its Goal, and its Role in Society by David Ronnegard* * Post -Doctoral Fellow of Ethics and Social Responsibility at INSEAD, P.O.Box: 48049, Abu Dhabi, U.A.E; Ph:+971 2 446 08 08; Email:, [email protected] A working paper in the INSEAD Working Paper Series is intended as a means whereby a faculty researcher's thoughts and findings may be communicated to interested readers. The paper should be considered preliminary in nature and may require revision. This working paper was developed using funds made available through the Abu Dhabi Education Council, whose support is gratefully acknowledged. Printed at INSEAD, Fontainebleau, France. Kindly do not reproduce or circulate without permission. ABSTRACT The purpose of the corporation in society has been an issue of contention ever since the Berle-Dodd debate in the 1930’s and still resonates as part of the “basic-debate” in the field of business ethics today. Prescriptions on the purpose of the corporation should be argued in relation to a robust description of the purpose it actually has so that we know what change is being argued for. As the corporation is a manifestation of law it provides a privileged perspective for describing the purpose of the corporation. This paper provides a description of the purpose (the goal and role) of the corporation in society through an analysis of four primary attributes of the corporate legal form. These attributes are the shareholder primacy norm; that the corporation is a separate legal entity from the shareholders; the transferability of corporate shares; and the limited liability of shareholders. The paper explicates these legal attributes and describes their development in the UK and the US. The function of these attributes is then analysed in the context of the industrial revolution when they arose. It is maintained that the attribute of shareholder primacy provides a description of the goal of the corporation which is to serve the interests of shareholders mainly through profitable production of goods and services. The role of the corporation is provided by the four attributes taken together. The paper maintains that the attribute of shareholder primacy serves the function of allocating resources efficiently while the other three (non-governance related) attributes function to ease capital solicitation and enable stock markets. Therefore, as a point of pure description, the purpose (the goal and role) of the corporation in society is to serve as a vehicle for production and economic growth. 2 I. INTRODUCTION Ever since the Berle-Dodd debate in the 1930’s the purpose of the corporation has been an issue of contention. Adolf Berle argued that corporate law should be regarded as essentially a form of trust law thus placing focus on the fiduciary obligations of managers to run the corporation in the interest of shareholders.1 Merrick Dodd on the other hand thought that corporate law was rightfully heading in the direction of allowing corporate managers to take into account the interests of a wider set of constituencies in their decision-making.2 The issues at the heart of the Berle-Dodd debate still resonate today in the field of business ethics. What is known as the “basic debate” in business ethics concerns whether the corporation’s purpose should be to further the interests of its shareholders or whether it should have responsibilities to a wider constituency of stakeholders. This is usually referred to as the Freidman – Freeman debate due to Milton Freidman’s advocacy of what has been called Shareholder Theory,3 which is usually considered opposed to Edward Freeman’s Stakeholder Theory.4 These theories are primarily seen as prescriptive in business ethics arguing for the purpose the corporation should have.5 1 See, Adolf A. Berle, Corporate Powers as Powers of Trust, 44 HARV. L. REV. 1049, (1931); Adolf A. Berle, For whom are Corporate Managers Trustees: A Note. 45 HARV. L. REV 1365, (1932). 2 See, Merrick E. Dodd, For Whom are Corporate Managers Trustees?, 45 HARV. L. REV. 1145, (1932). 3 See, Milton Friedman, The Social Responsibility of Business is to Increase its Profits, in ETHICAL THEORY AND BUSINESS, (Tom. L. Beauchamp, & Norman E. Bowie eds. 2003). 4 See, R. Edward Freeman, STRATEGIC MANAGEMENT: A STAKEHOLDER APPROACH, (1984); William M. Evan & R. Edward Freeman, A Stakeholder Theory of the Modern Corporation: Kantian Capitalism, in ETHICAL THEORY AND BUSINESS, (Tom. L. Beauchamp, & Norman E. Bowie eds. 2003); R. EDWARD FREEMAN, JEFFREY S. HARRISON, & ANDREW C. WICKS, MANAGING FOR STAKEHOLDERS: SURVIAVAL, REPUTATION, AND SUCCESS, (2007). 5 Although these theories about the purpose of the corporation in society are primarily prescriptive they can also have descriptive interpretations. See, e.g. Thomas Donaldson & Lee E. Preston, The Stakeholder 3 Corporate law has an important contribution to make to the field of business ethics by offering a solid foundation for a description of the purpose of the corporation in society. The purpose of the corporation can be divided into two perspectives, its goal and its role.6 The goal of a corporation is its purpose seen from the perspective of the corporation, while the role of the corporation is its purpose seen from the perspective of society.7 The Berle-Dodd debate was primarily a discussion about the goal of the corporation looking at whose interest’s managers should represent. This is also a central concern in business ethics although it often gets intertwined with the role of the corporation. The subject of corporate law is not much considered by those who engage in the field of business ethics; however it is occasionally discussed with regard to the goal of the corporation because some scholars claim that the shareholder primacy norm in the common law constrains managers from considering the interests of non-shareholder stakeholders in their decision-making.8 On the other hand corporate law has been absent from any discussion on the descriptive role of the corporation in society. Theory of the Corporation: Concepts, Evidence, and Implications, 20 ACADEMY OF MANAGEMENT REVIEW 65, (1995) 6 Please note that I will use the term “purpose” throughout this text to collectively refer to the terms “goal” and “role”. 7 An example of this type of goal vs. role distinction is how the goal of each actor in a competitive market is to further their own interest, but the role this competitive behaviour plays in society is to achieve efficient allocation of resources. Note that the goal and role of the corporation are not independent from each other. In particular the goal of the corporation will influence how corporations operate with regard to their stakeholders and thus affect the role of the corporation in society. Conversely, given the role that we desire the corporation to have in society one may then evaluate what this requires from the goal of the corporation. 8 See, John R. Boatright, Fiduciary Duties and the Shareholder-management relation: Or, what’s so Special about Shareholders?, 4 BUSINESS ETHICS QUARTERLY 393, (1994); John L. Campell, Why would Corporations Behave in Socially Responsible Ways?: An Institutional Theory of Corporate Social Responsibility, 32 ACADEMY OF MANAGEMENT REVIEW 946, (2007); Evan & Freeman supra note 4; Robert C. Hinkley, How Corporate Law Inhibits Social Responsibility, 62 THE HUMANIST 26, (2002); Phillips, Freeman & Wicks supra note 4; Kellye Y. Testy, Linking Progressive Corporate Law with Progressive Social Movements, 76 TUL. L. REV. 1227, (2002). It has however been convincingly argued 4 Friedman prescribed that the corporation should “use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game”9 whereas business ethics scholars like Freeman prescribe that the corporation should be a vehicle for managing stakeholder interests. It is unclear whether Freidman and Freeman intend their prescriptions to apply to the goal or role (or both) of the corporation, they simply do not make this distinction. Irrespective of where one stands in the prescriptive debate it is clear that the corporate legal form is a manifestation of law and therefore a descriptive account of the legal ontology of the corporation can be given. The purpose here is to provide a description of both the goal and the role of the corporation. This is not only interesting as a descriptive insight in itself, but importantly it provides a starting point for any prescriptive argument about the purpose of the corporation. These prescriptions should be made in relation to the goal and role the corporation actually has because it is only then that we understand what potential change is being argued for. Looking at the purpose of the corporation in society through its legal attributes does not merely provide yet another descriptive perspective. The basis for the corporation’s existence is the corporate legal form which places the description of the purpose of the corporation in society through this perspective in a privileged position. Any other descriptive perspective should at least not be inconsistent with this description. that the shareholder primacy norm is no longer efficacious as a legal norm. See, D. Gordon Smith, The Shareholder Primacy Norm., 23 J. CORP. L. 277, (1998) (argues that the shareholder primacy norm is muted by the business judgment rule). 9 MILTON FRIEDMAN, CAPITALISM AND FREEDOM 133 (1962). 5 I will give an account of the legal ontology of the corporation by explicating its primary legal attributes. In turn, understanding the economic function of these attributes through the historical context under which they arose provide us with a description of the purpose of the corporation in society.
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