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Corporations

Well, my friend Greg Swann disagrees with my assessment of corporations:

The essential defining characteristic of a corporation, as against
other ways of organizing a business enterprise, is liability
limitation, a conspiracy between the proprietors and the state to
defraud tort claimants of all they might otherwise obtain in redress
for their injuries. It’s pure Hamiltonian Social Engineering,
Mercantilism at its worst. The idea is to encourage investment by
limiting the risk. But by limiting responsibility, investment is
distorted away from the individual integrity that is the sine qua non of enlightened self-interest. The limited liability corporation is the rope by which Capitalism hung itself.

I agree with Greg that limiting liability is an essential aspect of the corporation. I had left that out when I said:

The essential defining characteristic of a corporation is that it is a voluntary association of individuals (stockholders, directors, officers, employees) under a complex hierarchy of agreements, contracts, policies, authority, responsibility, and accountability. It conducts business, voluntarily, with clients of all sorts. Yea, it’s a legal construct too. So is marriage, but marriage can hardly be defined as essentially nothing more than a state-recognized contract.

The thing is, I’m not convinced that limited liability for stockholders is incompatible with fee-market anarchism, i.e., a free-market system where all the players police themselves and each-other by mutual consent.

What this comes down to is a simple question: is it ethically permissible for an individual (or business) to invest in some other business enterprise, i.e., own a part of it, and not be held liable if that corporation later cause injuries or damages, the value of which exceeds the liquidated asset value of that corporation? For example, you own stock in GM. GM builds a car with a defect that reasonably should not have been. That car ends up killing thousands, and the trickle-down damages end up being more than GM is worth. Should you have to write a check proportionate to your share of the company in order to make up the difference?

If not, why not? After all, as a stockholder, you’re an owner. You take part in selecting the Directors who run the company. Should you not then be held responsible for its wrongdoing?

On the other hand, in a free market, the stock market would still exist. Investment in business enterprises would exist on the open market (publicly traded). Limited Liability is a valuable product. People are going to want it, but can they legitimately have it without imposing limited recourse on others should they be damaged?

Corporations exist not only to limit liability, but to create a separate and distinct entity ("legal" is superfluous) which simplifies things. For example, let’s say that you want to buy a car from GM, and instead of signing a sales contract that’s also signed by a single representative of the corporate entity, it has to be signed by the millions of "partners" who together own GM. In practical terms, that would not happen anyway, but it gives you a sense of how difficult things could be without the business structure provided by the corporate entity concept.

Of course, there are ways to organize complex businesses without affording limited liability to investors. Lloyd’s of London is one such company. Investors worldwide are liable for the damages the insurance company has to pay down to "their last pair of skivvies," as I once had a Brit tell me. However, for the last 10 years, Lloyd’s is evolving to a limited liability model, in part because unlimited liability was forcing huge numbers of its "Names" into bankruptcy.

So, I really don’t have a complete answer. All I know is that personally, I would have no problem in the world recording a general statement certifying my willingness to accept my own risks and consequences beyond the value of any corporation with which I interact. Of course, that leaves those who’d not be willing, as well as 3rd parties who are injured outside of any business dealing with the entity.

Guess I’ll have to give it more thought. My gut feeling is that corporations exist and provide limited liability because it makes a lot of sense in a lot of ways. I’m unconvinced that some equivalent would not exist were it not for the state.

I also reject completely that limited liability on the part of shareholders implies any sort of slippery slope with respect to the propriety with which things are run. There are plenty of market mechanisms to ensure that public corporations are well run. And, moreover, they are well run. As for non-public corporations, well, the notion of limited liability there is a complete fiction and fantasy. If you own shares in a non-publicly traded corporation, you are likely to face liability if push comes to shove.

Richard Nikoley

I'm Richard Nikoley. Free The Animal began in 2003 and as of 2021, contains 5,000 posts. I blog what I wish...from health, diet, and food to travel and lifestyle; to politics, social antagonism, expat-living location and time independent—while you sleep—income. I celebrate the audacity and hubris to live by your own exclusive authority and take your own chances. Read More

12 Comments

  1. Kyle Bennett on May 10, 2005 at 13:59

    I'm not sure that limited liability is the essential characteristic of the concept of corporation. The creation of a distinct entity is essential, and they can't both be the essential. If one is, then the other can be eliminated without invalidating the concept. But I'm open to argument.

    More to the point, you wrote:

    "For example, you own stock in GM. GM builds a car with a defect that reasonably should not have been. That car ends up killing thousands, and the trickle-down damages end up being more than GM is worth. Should you have to write a check proportionate to your share of the company in order to make up the difference?"

    Let's try another example. You carelessly fall asleep at the wheel and slam into a busload of kids, killing them all but miraculously surviving. Who has to pay the difference when the damages are more than your insurance coverage, and more than have or will ever have?

    Liability is always limited. There's always a possibility of doing more damage than you can possibly repair. Not every wrong can (or even should, as I believe Greg has argued) be compensated, even by the wrongdoer. Loss is not a claim in and of itself, just as need is not.

    How far does responsibility regress? The guys who made the faulty car are backed by the management who approved the designs, backed by the board of directors who hired the managers and built the facilities, backed by the major investors who chose the board….

    What's next? The smaller investors (and even some of the larger investors) are not part of this chain, they are a branch. They are not responsible for creating the company, hiring the board, choosing the managers, approving the plans, leaving a bolt loose. They may have some influence, voting at board meetings and the like, but they are not decisive.

    What they do is put their money to work at the service of all of this, and take some profit for it. Is profit alone enought to convey responsibility? Is Smith & Wesson responsible for the gang banger who shoots an old lady?

    Is there any positive principle tying a passive investor to responsibility for wrongdoing, even intentional wrongdoing?

  2. Kyle Bennett on May 10, 2005 at 14:20

    It may be uncouth to respond to myself in somebody else's blog, and with a quote to boot, but I just thought of something.

    I wrote:

    "Liability is always limited. There's always a possibility of doing more damage than you can possibly repair."

    This implies that limited liability, in it's broadest sense, is an essential characteristic of the concept of an entity, or at least one that is a moral agent. If so, and if limited liability is essential to the concept of the corporation, then it is only because it is subsumed under the concept of a distinct entity.

  3. Richard Nikoley on May 10, 2005 at 15:52

    "How far does responsibility regress?"

    Well, I think it's at least arguable that it must regress to the owners, and of course, can not regress any farther.

    So, then the question becomes, given that liability is limited in every case, no matter how far one regresses, is it rational or arbitrary to place that limit at the assets of the entity (the corporation), or at the assets of the entity and then the owners if insufficient.

    I think Greg has a valid point, but I'm just not sure how important it is. Given that in practical terms, owners of small, closely held corporations can not typically escape personal liability, and for large public corporations, it's quite a rare thing for assets to be insufficient, then I'm not sure this issue goes that far beyond political theory.

  4. John Lopez on May 10, 2005 at 21:28

    Swann makes his point better http://www.presenceofmind.net/2005_05_08_archive.html#111577424552153374>here.

    The *problem* is socialized law.

    The LLC is a *consequence*.

  5. Richard Nikoley on May 11, 2005 at 14:36

    Bill:

    I think you missunderstand. A corp (or LLC) acts on behalf of owners. If it causes damages, liability goes only to the capital of the corp and does not extend to the owners. They are shielded, even though the corp is acting in their behalf.

    It's true that some entities with which the corp interacts imclicitly or explicitly accept this limitation. However, 3rd parties, such a people who get their dogs run over don't.

    Suppose a UPS cargo-jet pilot decides to do a 9/11 on some skyscraper. The damages are likely to exceeed to the total capital value of UPS. So, who pays? Do the owners of UPS escape completely? They get to keep their homes, some $multi-million homes while the vitims and families are left far from whole?

    That's the question.

  6. Bill on May 11, 2005 at 14:00

    Silly rabbits. "Limited Libility" only applies to CREDITORS and INVESTOERS, both of whom volunteered to enter in such a contract. The "liablility" in the term only applies to the CAPITAL structure of the organization, NOTHING MORE.

    Even in today's statist world, if UPS runs over your dog their limited liability doens't mean they get out of paying you. If you poison a river, you are held liable, etc. Limited "Liability" doesn't mean all liabilities, even if that is the term.

    But rahh rahh, liberatarians are leftists now (because of evil Bush and evil imperialism, because Rothbard dictated such, blah blah blah) so let's all get on the anti-capitalist bandwagon and help the commies. Good work!!!

  7. Richard Nikoley on May 12, 2005 at 09:56

    Bill:

    In addition to Kyle's important deconstruction, I would add that there's a clear distinction to make between investing money and loaning money. When you invest, you are purchasing equity (stock, ownership). When you loan, you are purchasing a form of promise to repay with interest.

    You invest (stocks) primarily to seek capital appreciation while you loan (bonds) primarily to seek income on assets.

    At any rate, when you loan, in the form of a promisory note, deed of trust, or bond, you are just doing business with the enterprise. You do not own it, have any part in owning it, and no say whatsoever in its direction. Therefore, you cannot be held liable for it's actions.

    Also, your identification that corps are not people really supports my devil's advocacy of Greg's argument. Ojnly people act, so only people can be held responsible for anything. If you can argue that the owners are not morally liable, then how can you possibly argue that anyone is morally liable?

    By the way, there's a whole new entry on this thread, in case you've not seen it:

  8. Richard Nikoley on May 12, 2005 at 10:42

    Bill:

    You're equivocating, a bit. When you buy stock, you're an owner. It's that simple. A company's owners are comprised of its stockholders and nothing but its stockholders.

    Then, you go on to describe how limited liability works, which is no surprise to any of us, 'cause what we're arguing about is whether that's ethically appropriate. We all understand perfectly the legality of it, i.e., what the state has dictated in the matter.

    I, as potentially opposed to Greg, see and accept the essential value of liability limitation and have stopped short of condeming it in the form it now exists as he has. I'm not certain, yet, but I'm not going to be disengenuous to his argument, either.

    That said, the rest of what you say is precisely why I'm not yet in Greg's court fully on this. What I'm trying to work out for myself is how much of this limitation is because humans have a natural reasoning tendency to set limits (let people off the hook), so it's a reflection of that, or a state-invented mechanism designed to tweek with capital "efficiency."

  9. Bill on May 12, 2005 at 06:26

    No, the UPS cargo jet PILOT goes to jail and is sued.

    Maybe is even executed. As are the co-conspirators.

    This isn't rocket science. It shouldn't even be a question. If own stock in a cable company or loan it money, am I liable because the cable guy rapes your sister?

    The criminal pays for the crime and the cable guy (the individual doing the criminal act) pays for his actions.

    "Limited Liability" for corporations (bundles of contracts) only apply to voluntary contracts surrounding the capital structure and always has. Corporations are not people, even if some ancient judge once called them "virtual people" ( and even then he was only talking about the capital structure). People are people. A is A.

  10. Kyle Bennett on May 12, 2005 at 07:25

    Bill,

    Richard's example might ahve confused the issue by bringing in criminal intent. Suppose, instead, that the plane took out a skyscraper full of people because of a mechanical failure, or a non-criminal pilot error.

    Sure, A is A. But since you're quoting from Rand, try getting at the essential characteristic of the concept. Omit the measurement of the specifc cause, and the essential characteristic
    (of Richard's argument) is that there is some cause that would bring liability to the company as a whole, in an amount greater than the assets of the company.

  11. Bill on May 12, 2005 at 10:17

    I'm a stockholder. I invest money in an enterprise to make money. If it makes money, I own part of the profits. If it loses money, I lose my investment.

    As part of this I hire management and employees to run the business and extend them agency to attempt to run the enterprise. But I don't own them, as you can't own human beings. I only own the assets, and the profits my employess create using these assets (at the risk of losing the assets).

    That is the extent of my involvment. This is what everyone means by "limited liability." It only applies to the capital structure and "losses" can never exceed the amount of capital sunk into the business.

    I never extended the my emploees agency to crash my 747 into a building (either intentionally or not), so I am not liable for THEIR actions, since I don't own people or their actions. If anything, I should sue the pilot for breaking his contract to me to not crash and destroy my assets.

    None of you are looking at this concept from methogical invidiualism. Only individuals can act, not companies or organizations (regardless of their capital structure).

    You are also looking at this from a "cosmic justice" perspective. Yeah, in a perfect world liablity would always be paid in full. But resources are limited in the real world, and invidiual liablity exceeds invidiual resources all the time. You can't squeeze juice from a rock. It sucks the pilot I hired crashed my airplane into your house. It sucks the same pilot is poor…and though you can sue him, you still will not get your house back.

    But it isn't my business.

  12. Bill on May 12, 2005 at 11:24

    But what do I own? The actions of the people I hire? I am a slave owner? Nope, I own the assets and profits gained from people using those assets at the risk of losing the assets. That's it.

    I own a pizza company. You make the pizza in my oven and take my car to deliver it to a customer (for wages). If you punch the customer in his face or throw the pizza at him and burn his face, how am I liable? Because you used my car and my corporate identity in an innapropiate way and broke your contract to me?

    Sure I broke the contract to deliever the pizza, but I am liable to the customer for the cost of the pizza only. You need to explain to me how I own the actions of the pizza driver who broke his contract.

    The "limited liablity" part only applies if my pizza business goes bust and we need to split the assets and conctracted liablities. The "limited liabilty" says my contracted liablities (to other investors, creditors, vendors, employees, customers) only applies to the assets, which what all parties agree to in the first place.

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