The Activist Investor Blog
The Activist Investor Blog
Corporations are Peepul!
[With apologies to either or both of Charlton Heston and Marlo Thomas, do you know this reference?]
Who’da thunk that an arcane and obscure debate over the legal nature of corporate entities would blossom into a full-on dispute raging in the pages of national newspapers and the presidential campaign?
This fight does matter to activist investors. It sheds light on who owns public companies, and the rights of these owners related to company directors.
Mitt and Jack and Suzy
This decades-long (really) debate surfaced last year, when Mitt Romney heckled back, “corporations are people, my friend” during a speech on taxes. But, why would he say it that way, rather than “corporations pay taxes, too” or “corporations give to charity”?
After many other comments, including a notable critique from US Senate candidate Elizabeth Warren in Massachusetts, Jack (and Suzy!) Welch took up the defense, with their weepy polemic in the WSJ last week. They assert, “Of course corporations are people. What else would they be?”
A legal fiction
No one, not even Mitt Romney or Jack Welch, could reasonably think that a corporation is the same thing as a human being. If not, then what is it?
Numerous legal scholars call a corporation a “legal fiction”, an artificial entity created for a specific economic purpose. As one can recall from undergraduate business law, at its core a corporation permits multiple people (yes, people) to syndicate their investment in something, and limit their personal liability for that thing’s losses.
Since it exists solely as a creation of law, a corporation does have some of the same legal rights and obligations as people. A corporation can enter into contracts, collect income, and pay taxes. It doesn’t have others, like marrying another person or having custody over a minor child-type person.
The Supreme Court recently ruled that corporations also have certain rights to free speech under the First Amendment to the Constitution. This led a corporation to seek the first-ever election to Congress.
Who owns this legal fiction?
Beyond the legal rights and obligations, corporations also hire employees (people!), own assets, and borrow money. And, a few people create a corporation, and own it, or something related to it.
What, exactly, these people own is the subject of the decades-long debate that Mitt and Jack might have in mind with their simplistic remarks.
One might think that having shares in a corporation means that a person owns a fraction of that corporation. One conservative law professor, Stephen Bainbridge at UCLA, disagrees, and in the process probably disagrees with Mitt and Jack, too.
He posits “nobody” owns the corporation, and that shareholders at best have the right to residual proceeds after a corporation settles all other obligations. Because shareholders don’t possess or control the corporation, “the board [of directors] is...a better candidate as the corporation’s owner.” Of course, Bainbridge thinks little of shareholder efforts to influence directors, as a proponent of director primacy, and opponent of proxy access.
His argument, though, doesn’t make sense. Owning even the residual confers certain rights on the shareholders, beyond that of selling those shares, including some form of control over the company, say in fair, open director elections. Bainbridge doesn’t like those, either.
What Mitt and Jack may have meant
Back to the nature of corporations. Perhaps they meant to say that corporations consist of people, or employ people, or possess some of the same rights as people, or something like that.
With or without the flaw in his reasoning, even Bainbridge, loyal Republican and staunch defender of CEOs like Jack Welch, redeems himself slightly: “a corporation is an aggregation of people...”
So, a corporation is a legal fiction, similar in some legal respects to a person. A business or a firm, on the other hand, is a real organization, with employees, assets, liabilities, and all the features and flaws that real people bring to such an enterprise. When these flaws become serious enough, the organization’s owners, through their elected representatives on the BoD, have rights, because the firm is also a corporation, to act.
[Reference, for younger readers: Charlton Heston in Soylent Green; Marlo Thomas in Free to Be, You and Me]
Wednesday, July 25, 2012