Reinventing the Corporation


April 1, 1996
Washington Monthly


Browse in Corporations

Corporations benefit from the public, so it is fitting that the public should expect something in return from business. The current climate of greed, cynicism and corruption is discussed, along with ways of holding business more accountable.

When an act of simple human decency appears heroic, it’s time to ask some basic questions about the culture in which that act takes place. That’s what happened last December in an old mill town in Massachusetts. AT&T had just announced it was laying off 40,000 workers, even though profits and executive pay were soaring. U.S. corporations had inflicted over three million such layoffs since 1989, and there was a depressing new litany on the evening news: jobs down, stock market up. (More recently, it’s been the equally revealing counterpart: jobs up, market down.) The new Republican Congress was giving these corporations the store. Yet the more they got, the less they seemed willing to give back in return.

Amidst this grim backdrop, Aaron Feuerstein’s textile mill in Lawrence, Mass. burned down. Without hesitation, he announced that he wasn’t going to pull up stakes and move to Mexico. He was going to rebuild the mill right there, in the state conservatives deride as “Taxachusetts.” Not only that, he was going to pay his workers a month’s wages to get them through the Christmas season.

Soon everyone was talking about Feuerstein. He was an ABC News “Person of the Week.” He sat next to Hillary Clinton at die State of the Union address. Yet Feuerstein himself couldn’t understand the fuss. “What?” he asked. “For doing the decent thing?” While his modesty may be excessive, his instinct is on the mark. By his example, he raised a pointed question: Why do we expect so little from major businesses these days?

Certainly, that thought is abroad in the land. Not since Ralph Nader’s heyday in the early seventies have the words “corporate responsibility” come up so often in political debate. Because die prime messenger this time is Pat Buchanan, much of the mainstream media has dismissed the issue as the benighted economics of Bible-thumping ignorami. But the notion that corporations have responsibilities, just like real people, touches a deep chord; and while the term “corporate responsibility” may strike jaded modem ears as oxymoronic and naive, historically it is exactly right. “The corporation is a creature of the state,” the Supreme Court observed back in 1906. “It is presumed to be incorporated for the benefit of the public.”

How to get back to that original intent–to traditional moral values in the economic realm–is an urgent question. Conservatives say, correctly, that government should do less and individuals and business more. But if that’s so, we have to consider whether the dominant form of business is up to the job. If there is to be less top-down regulation and more voluntary well-doing, then we have to ask whether the Wall Street-oriented corporation of today is capable of such a thing.

The issue here is not the hoary ideological debate between the government and the market. Rather, it concerns the kind of entities that will comprise the market. The corporation is an artifice of government, no less than the welfare system or foreign aid. Historically, it has evolved as society has changed. The time has come to ask what the next phase of that evolution should be. In simple terms, how can we reconnect the corporation to the social and community concerns it was originally intended to serve?

The way the corporation drifted from that role is a story that has all the elements of a neoconservative morality play. Corrupt government; self-serving politicians seeking to fill the public coffers and give the voters something for nothing; elite Eastern lawyers riding roughshod over traditional moral values; liberal permissiveness, economic style, and unintended consequences galore–it’s all there.

Racing to the Bottom

Today we assume that corporations exist to make money. Ideologists-qua-economists like Professor Milton Friedman of the Hoover Institution assert this as a moral imperative. Yet if we travel back in time five or six hundred years, the European corporations of that era were very different from those of today. They were regulatory bodies, not acquisitive ones, which served to reconcile individual behavior with larger social ends. Gilds, boroughs, monasteries, and the like–today we would call them “mediating institutions,” bulwarks of the civil society that has fallen into such disrepair. “Corporations have constituted, for the most part, the framework of society subordinate to that of the state,” as John P. Davis put it in his exhaustive two-volume study back in 1905.

When the British Crown was eager to claim the wealth of the New World, it required commercial ventures of enormous scale. But few investors would come forward because they could be held responsible for the enterprise as a whole. The solution was the “joint stock company,” die forerunner of today’s business corporation. The corporate entity became a legal buffer zone between the enterprise and the actual owners. Ownership and responsibility were severed, so that a larger enterprise could result.

This was a radical step. Individual responsibility is a bedrock principle of the common law tradition. People must stand accountable for their actions and those taken on their behalf. To compromise this principle, something had to be given in return; specifically, the enterprise that gained this exemption had to serve the public in concrete ways.

Accordingly, in the early days, corporate charters were not granted to all comers the way they are today. They were granted selectively, one by one, for ventures that seemed worthy of public promotion and support. The trading companies that served as commercial agents of British foreign policy were prime examples; in today’s terms they were much like Amtrak or the Tennessee Valley Authority.

This basically was the form of corporation that existed in Adam Smith’s day. When Smith called England a “nation of shopkeepers,” he was speaking literally. His notion of a divine market mechanism guiding individual ambition towards the betterment of all was premised on a world of individual business people, rooted in locality and place and subject to social mores and conscience. In one of the less prescient passages in the Wealth of Nations, Smith contended that corporations would never amount to much in the international marketplace. They weretoo cumbersome and bureaucratic, he said. Individual business people, with their superior “dexterity and judgment,” would run rings around them.

In other words, the notion of the invisible hand is premised on a pre-corporate world that no longer exists. So too were the founding premises of the American republic. The colonists were extremely suspicious of corporations, which were seen as oppressive agents of the Crown and potential usurpers of the public will. At the time of the Constitutional Convention, only some 40 business corporations had been chartered in all the colonies. Most of these were for bridges, toll roads, and similar public-works endeavors. So it’s not surprising the Founding Fathers omitted the corporation from the scheme of checks and balances by which they hoped to keep institutional power under restraint.

Even as business corporations became more common, they stayed grounded in the premise that they were agents of a larger public good. Charters typically spelled out that the corporation in question was created to serve “the public interest and necessity.” Some required shareholders to be local residents, and some benefit of even vested part ownership in the public. Before 1842, for example, the State of Maryland chose one third of the directors in the Baltimore and Ohio Railroad. There were also mandates to serve the public in specific ways: A bank charter in New Jersey, for example, required the company to help local fisheries.

As decades passed, the nation’s surging commerce pushed against these restraints. Legislatures were besieged by supplicants seeking the privilege of operating as a corporation. In addition, the corporate charter process had gotten a taint of special privilege. The result was the general incorporation laws, which made the corporate form available to everyone.

This didn’t mean that the suspicion of agglomerated power had died, nor the conviction that the corporate privilege was connected to a public purpose. Until 1837, for example, every state still required that corporations be chartered only for a particular kind of business. It took almost half a century for states to permit blank-check incorporation “for any lawful purpose.” Restrictions on size were common too. New York, which was not unfriendly to business, limited corporations to $2 million in capital until 1881; and to $5 million until 1890.

Similarly, as late as 1903, almost half the states limited the duration of corporate charters to 20 to 50 years. Legislatures would actually revoke charters when the corporation wasn’t fulfilling its responsibilities. With the rise of corporate megatrusts and the robber barons, the role of the corporation in American life became a topic of almost obsessive concern. The public wanted more accountability. They ended up with less.

The reason was an outbreak of corporate charter-mongering among the states that eventually dragged them all down to the lowest common denominator. The downward spiral actually began when John D. Rockefeller’s lawyer concocted a way to evade the state charter laws. (The story is laid out in one of Ralph Nader’s less-noted studies, called “Constitutionalizing the Corporation,” which he wrote 20 years ago with Mark Green and Joel Seligman.) The device was the infamous secret trust agreement which enabled the Standard Oil empire to grow far beyond the size the state laws permitted. Rockefeller’s conniving set off a wave of trusts–whiskey, sugar, lead, and others–which came to control much of the commerce in their industries.

Eventually these agreements came to light, and die state courts struck them down as exceeding the powers granted in the charters of the individual corporations that comprised them. The charter laws had done their job. Therefore, the charter laws would have to go, and the first to fall was New Jersey.

As Nader’s study recounts, in 1890 a young New York lawyer named James B. Dill made an offer that the governor of New Jersey couldn’t refuse. Enact the most liberal and permissive law in the land, Dill said. Let corporate managements do whatever they want, shareholders and public be damned. Corporations will flock to your state for new charters; revenues will pour into the treasury. Plus the clincher: Dill would form a company to handle the paperwork for the incorporating process, and the governor would get a cut.

Soon, Standard Oil, U.S. Steel, and other major companies were lining up for New Jersey charters. Prompted by the permissive new laws, there was an orgy of mergers and combinations, which hastened America’s transition from a nation of entrepreneurs to one of corporate employees.

But politically, the New Jersey regime reaped its reward. By 1905 the state was running a surplus of almost $3 million. “Of the entire income of the government, not a penny was contributed directly by the people,” the governor boasted. These revenues enabled him to push a rash of new social programs and public works projects, all without burdening ordinary taxpayers. In other words, tax-and-spend liberalism was boosted by the movement that set corporations free of every vestige of social accountability and restraint.

Other states were helpless to counter New Jersey’s dirty deal. So, why not get a piece of the action? Those revenues were pretty attractive, as were the other benefits that flowed to politicians more directly. West Virginia was among the first; the “Snug Harbor for roaming and piratical corporations,” a contemporary legal treatise called it. Maine, Delaware, Maryland and Kentucky followed in this new race to set the lowest standards and collect the most booty. At one point, the New York legislature enacted a special charter for the General Electric Company, based on the lax New Jersey standards, to prevent the company from absconding across the Hudson River. The Commission on Uniform Incorporation Law declared that the evolving system ensured “the maximum protection of fraud” and “the minimum of protection and cover… for honest dealing.”

There was a brief fluffy of rectitude in New Jersey when Woodrow Wilson became governor in 1910. But others were only too ready to fill the temporary gap at the bottom–Delaware most of all. By the time of the Great Depression, Delaware had become home to more than one third of the industrial corporations on the New York Stock Exchange; 12,000 corporations claimed legal residence in a single office in downtown Wilmington.

When other states made their own runs for the bottom, Delaware dropped standards even further. In the 1960s, it simply turned over the drafting of a new law to a bevy of corporate lawyers. The legislature rubber stamped the results. By the mid-1970s, half the nation’s largest 500 corporations were chartered in tiny Delaware. Now only directors, rather than shareholders, could propose amendments to the corporate charter. On top of that, corporate officers and directors could be indemnified for court costs and settlements of criminal and civil cases without shareholder approval.

In other words, the concept of individual responsibility for corporate management was entirely out the window. This trend had troubled the upholders of traditional morality from the very beginning. “The pernicious movement has decreased the personal responsibility on which the integrity of democratic institutions depends,” Professor Davis observed seven decades earlier. William Carey, former chairman of the Securities and Exchange Commission and author of a leading textbook on corporate law, declared that the only public policy left in Delaware’s corporation law was “raising revenue.”

Such developments did not go unnoticed politically. Theodore Roosevelt, a Republican, actually established a Federal Bureau of Corporations to monitor the impact of these new and disruptive entities. Presidents Roosevelt, Taft, and Wilson all proposed federal chartering for large corporations, in order to stop the state charter-mongering and set minimum standards for national businesses. (Most corporations chartered in Delaware had little presence there besides a file in a lawyer’s office.) These corporations “are in fact federal,” Taft said, “because they are as wide as the country and are entirely unlimited in their business by state lines.”

But Congress chose instead the routes of antitrust and regulation, trying to restrain what the permissive state charter laws had set loose. The first big growth of federal government came from new agencies,such as the Interstate Commerce Commission and the Federal Trade Commission, that were supposed to keep the burgeoning corporations in check.

In the New Deal-era, people like David Lillienthal, the first chairman of the TVA, tried to tilt the balance back toward individual entrepreneurs and local enterprise. But this group lost out, first to the megaplanners, and then to the new Keynesian technocrats, who reduced the economic problem to the manipulation of the valves and levers of taxation, expenditure, the money supply, and the maintenance of “consumer demand.” Those who raised questions about corporate governance and the scale of enterprise were dismissed as descendants of the bumpkins and small-town nostalgics whom Richard Hofstadter ridiculed in The American Political Tradition.

Chartering A New Course

That is pretty much where things stand today. The Keynesian policy nostrums no longer hold, but the fixation on scientistic “macro” policy still dominates the national debate. Just get taxes right, cut federal spending, and the Red Sea will open wide. When a Robert Reich or a Pat Buchanan suggest that something more is involved–that the economic entities that do so well in America perhaps owe America something in return–they are dismissed as demagogues and know-nothings.

But Buchanan has let the genie out of the political bottle. Whether you agree with his remedies or not, he has tapped a genuine feeling of betrayal. Americans think the high and mighty as well as welfare mothers have responsibilities–and that corporate America has been obscenely derelict in this regard. Business Week put it well when it observed, “U.S. corporations may have to strike a new balance between the need to cut costs to be more globally competitive, and the need to be more responsible corporate citizens.”

The problem, of course, is that corporations today aren’t constituted to be responsible. The large corporation whose stock is traded publicly on stock exchanges has become an extension of the Wall Street mind. A CEO who did what Aaron Feuerstein did–that is, who forsook a measure of profit for acts of decency to employees and the community–could have furious portfolio managers to contend with. Shareholders might have his or her scalp. The publicly-traded corporation does to the economic realm what the political action committee does to politics–it reduces people to the lowest common denominator of self-seeking, and subordinates their best instincts to an institutional mandate to maximize pecuniary gain.

This might have been tolerable for a period in our history. But in a global economy, with the sense of community coming apart, institutional self-interest has flown out of orbit, sweeping up even smaller companies in its centrifugal pull. Yvon Chouinard, founder of Patagonia clothing, has put the problem eloquently. The goal in the entrepreneurial world today is to “grow (your business) as quickly as you can until you cash out, and retire to the golf courses of Leisure World,” he wrote. “When the company becomes the fatted calf, it’s sold for a profit and its resources and holdings are often ravaged and broken apart, disrupting family ties and jeopardizing the long-term health of local communities.”

Chouinard, a mountain-climber who happened into the gear-and-clothing business, has gone the opposite route. Instead of cashing out, he decided to keep the company at a scale at which it can still embody die values he seeks to live.

You can’t legislate that kind of decency. But it is possible to encourage the kind of enterprise that gives it room to operate. Individual and family owners, for example, at least have the ability to temper their profit-seeking with civic and other concerns. (The Cleveland Browns’ owner, Art Modell, is a good reminder that not all of them will.) Family-owned newspapers have done this for decades, which is one reason that the corporatizing of the media is a tragedy.

Local ownership also can have a salutary effect, even from a business standpoint. Consider the Green Bay Packers football team, which is owned by about 2,000 individual shareholders, most of them residents of Green Bay. The Packers have a stability that is rare in business today, let alone pro sports. Packer fans don’t worry that a greedy owner will skip town–because they are the owner. The Packers won the first two Superbowls and made it to the conference championship this year. Yet NFL rules now bar franchises from Packers-style local ownership.

If community-centered ownership works in pro sports, which have become the ultimate business, then why not in other businesses? Inner cities, for example, have trouble luring supermarkets and other essential services. There’s lots of money to be made, but it takes a level of patience and hands-on commitment that most major corporations aren’t willing to expend when there’s such easy pickings in the suburbs. Local and community-based ownership can fill in the gap.

Employee ownership works much the same way. It’s not a panacea, but an employee-owned company is less likely to move jobs abroad or lay off 40,000 workers when business is booming. It is more likely to take seriously the impact of business decisions on the community at large. The New York Times recently highlighted this balance at United Airlines, where employee owners resisted taking over USAir because it would have caused layoffs there. But United has also found that employee owners are also willing to make sacrifices for the company, such as accepting pay freezes, in return for job security.

Unfortunately, the most common form of employee ownership is the Employee Stock Ownership Plan (ESOP), which is a passive investment scheme that often denies workers a real say in policy. Management frequently uses ESOPS as a financial ploy to fend off takeover bids. That’s not good enough. Ownership and control need to go together, as they do at United.

The nation can encourage socially-cohesive forms of ownership–family, local, and employee–in any number of ways. Taxes are obvious example. Currently, estate tax laws push heirs to sell a family business,such as a newspaper, to generate the cash to pay the tax. That’s insane; it should be possible to keep family businesses–up to a certain size–in the family, as long as there’s active management and ownership. Similarly, the tax laws currently encourage mobility instead of stability. If there’s a deduction for moving expenses, for example, shouldn’t there be one for staying expenses, as when a firm stays in die inner city when it would be less expensive to operate elsewhere? Deductions for moving expenses should not be permitted at all when a profitable company is enticed away by public subsidies offered elsewhere.

With the largest corporations, we must address the problem directly,and revisit the corporate charter laws themselves. Presidents Theodore Roosevelt, Taft, and Wilson were right. The largest corporations should be chartered at die federal level. Decentralization is great for some things, but it just doesn’t work for dealing with the largest economic institutions on the planet. A Delaware charter has become the business equivalent of a Liberian flag of convenience or a Haitian divorce. At the very least there should be a minimal federal standard, as with estate taxes, so the Delawares can’t drag everyone down.

That standard should include individual responsibility for corporate officials, of die kind that existed before Delaware’s lax and permissive regime. Charters should specify particular kinds of business, the way they used to. And charters should expire after a given period of years, for review under fair standards that ensure renewal except for egregious bad behavior. Nothing would do more to insure a minimum level of decent conduct–without a multitude of new regulations –than the knowledge that sooner or later, the corporate charter would come up for review.

Right-wing ideologues will fume about government “tinkering.” But the corporation itself is a form of tinkering; and if the government is going to establish something, shouldn’t there be some built-in accountability to the people? Let’s not forget: the period of American history that is most associated with rugged individualism and the frontier enterprise spirit–that is, die era of President Andrew Jackson–was one in which corporate charter restrictions were still strong. Individualism thrived when institutional economic power was held in check.

Finally, there’s a need to bring back a healthy dose of good old-fashioned shame, the kind that used to operate in small-town business settings. The way to do this, for sprawling corporations, is through public information regarding their behavior. Currently, the SEC collects elaborate data on corporate finances. Now we need to add information on community involvement, treatment of workers, investment in the U.S. and the rest. One of the environmental success stories of recent years has been the toxics inventory. Corporations have made significant steps towards cleaning up their operations, simply because they had to be good neighbors and make known the chemicals they used and were emitting. This approach works without cumbersome regulations and bureaucracy, and it can work in the broader arena of social responsibility as well.

An economy can’t thrive for long if the underlying social structure is falling apart. After two decades of reinventing the corporation to be more efficient, we have to ask whether the result is merely a more efficient machine for corroding the nation’s social glue. If Americans were asked which they thought the nation needed more right now, more corporate profits or more social cohesion and trust, there’s not much question which they would choose. Aaron Feuerstein, explaining why he chose to keep his mill in Lawrence, gave his version of the ancient Jewish teaching: “In a place where there’s moral depravity and no feeling of moral responsibility, do your damnedest to be a man.” Wouldn’t it be something if the chairman of AT&T would say that too?

Jonathan Rowe is on the staff of Redefining Progress and is a contributing editor of the Washington Monthly.