SETTING COMPANIES FREE: THE BIRTH OF THE MODERN COMPANY

Two new lifeforms were set free in 19th century Britain – one was legal and non-sentient, the other sentient but fictional. The first – the limited liability company - would come to dominate modern society, the other – Frankenstein’s monster - would be rejected by it.

The genius behind the fictional lifeform was Mary Godwin. Godwin led a bohemian life. Her mother was a feminist philosopher and her father a political one. As a teenager, she had an affair with the then married, and by all accounts rather naughty poet, Percy Shelley. They later eloped.

The idea for Frankenstein’s monster was formed during a wet summer spent on the banks of Lake Geneva. The monster (he never had a name) was emotional, well mannered, and well educated. Companies, by contrast, are arguably none of these things. Rejection of Frankenstein’s creation, first by its creator and then by the family of the blind man who educated him, set up a devastating sequence of events.

The difference between society’s fictional treatment of Frankenstein’s creation and the actual treatment of companies could not be greater. To say the modern company was embraced by society would be an understatement. Nowhere was this truer than in the United States of America.

After the final curtain had closed on Utopia, Limited, a fierce contest was taking place in the US. It was not quite the competition between companies for customers Adam Smith might have hoped for. It was not even competition over where companies operated. Rather it was competition between US states to be the place where companies were registered.

Chief amongst the combatants were New Jersey and Delaware. Both sought to lure lucrative company registrations through a combination of friendly legal arrangements and long-term tax advantages. This triggered what was, to many eyes, a race to the legislative bottom. Delaware ultimately won. Even today, a single building in Delaware is the registered address for almost 300 000 companies from all over the globe.

Legislative change in the US was driven by competition and a youthful land-of-the-free exuberance. In Britain, the behaviour of the East India Company and disastrous South Sea Bubble of 1720 created more cautious change. The difference would help shape the world.

The great experiment

Views on the outcomes of what we might call the US great corporate experiment varied.

One early judgement came from US President Rutherford B Hayes. Hayes, whose facial fuzz was Marx-like in abundance, was concerned about the concentration of wealth and political power companies were bringing. In 1886, he wrote ‘this is a government of the people, by the people, and for the people no longer. It is a government of corporations, by corporations, and for corporations.’ Hayes, by the way, represented the same political party as Donald Trump. How times have changed.

Twenty-five years later a very different view was expressed by the then President of Columbia University, Nicholas Murray Butler. Butler saw the limited liability corporation as the ‘greatest single discovery of modern times’, more important than harnessing steam or electricity. It was a bold statement. But he may well have been right.

In Butler’s mind, the company’s contribution was more than economic. He argued that the social and ethical contribution of companies were ‘manifestly’ positive as would its impact on politics be ‘once we understand and know how to use it’.

Butler’s judgements, it must be said, were somewhat hit and miss. He won the Nobel Peace Prize for his work running the Carnegie Endowment for International Peace. But he was also a longstanding supporter of fascism and an admirer of Adolf Hitler. Nobody is perfect; but even so.

What Adam Smith saw as a problem Butler saw as an advantage. For Butler, the magic of the company was as a vehicle for large scale cooperation. By removing the unlimited liability, the company allowed large numbers of unrelated people to collaborate in a common (profitable) endeavour safe in the knowledge that their exposure to loss from the behaviour of others was fixed.

From almost nothing, large companies sprung up across the US fuelling economic progress in a way never before seen. The result was a ‘gilded age’ of US prosperity. Technology had certainly played its part, but so had the company. It was a marriage made in heaven.

Controlling the monster

The wealth the combination of companies and new technology created was enormous.

One beneficiary was a young assistant bookkeeper. John D Rockefeller was the son of a con-artist and deeply pious mother (imagine the dinner conversations). He became the richest man in modern history. At its peak, Rockefeller’s net worth was equal to between 1.5 and 3 per cent of total US GDP. His holding company (Standard Oil was a complex corporate trust) was registered in, you guessed it, Delaware.

Rockefeller’s fortune was built on two things - oil and monopoly power. By his late 20s Rockefeller owned the biggest oil company in the US. By 40, he had bought out so many of his competitors that he controlled 90 per cent of the US oil business. Along the way, he reportedly became the most hated man in America.

Thanks to our friend Adam Smith the economic and political problems created by monopolies were well understood. In response, the US government passed legislation designed to curb monopoly power in 1890. The act was known for its proposer, John Sherman.

The Sherman Act was ultimately used in 1911 to break up Rockefeller’s empire. Ironically, many of the resulting companies were subsequently absorbed into other entities (Amoco was bought by BP and Esso is now part of ExxonMobil). But two – Chevron and Penzoil – remain separate companies today.

Rockefeller may no longer have controlled the oil market, but he remained mind-bendingly rich.

A moral question

The gilded age set forth a kind of cat and mouse game between the creators of the company (government) and the entities they had set free. Anti-trust laws were only part of a complex regulatory relationship which evolved as government sought to promote the benefits and curb the excesses of its legislative golden-egg-laying creation. It is a game that continues today.

Beneath it all remained a moral question. What, if any, duty did this new lifeform owe to the society which created it? Was it simply to make profit for its owners by fair means or foul?  Was it to comply with the law and nothing more? Or did companies owe society something more?

In 1970, the towering intellect and modest physical stature of Milton Friedman strode into the fray.

Friedman was the antithesis of Marx. Not only were his economic views very different, so was his hairstyle. The little hair Friedman had was scrupulously controlled, as was the more bouffant hair of Ronald Reagan and Margaret Thatcher, both of whom Freidman advised. It seems that political theories of socialist control and capitalist freedom do not necessarily extend to personal grooming. Of course, it may also be that hair control is the ultimately act of economic freedom.

Friedman’s overarching argument was simple. Only people can have social responsibilities. Companies, as an artificial person, cannot. They should act legally in pursuing profits, but owed society nothing more. 

Friedman’s view sprang, in part, from the relationship between managers and owners that had so exercised Marx and Smith. Freidman (like Smith) thought that managers had a duty to act solely in the interest of owners. Decisions by executives to pursue broader social aims were inconsistent with this duty and involved imposing a tax on owner profits.

The nuance in Friedman’s thinking was that owners could unanimously agree to forgo profits to achieve an agreed social end. But, he argued, unanimous agreement would not be possible in most companies due to shareholder diversity. He also felt that social responsibility was often used by managers as a cloak to pursue their own interests.

Friedman’s broader views are often reviled today as neo-liberalism. They certainly sit uncomfortably against the type of public expectations revealed in relation to Qantas and the 2019 Banking Royal Commission. They also suggest that, implicitly anyway, the only way for society to prevent bad behaviour from companies is to regulate them. More regulation was the very last thing Friedman wanted.

Friedman’s views also contrast to the differing, and more modern, visions of Joel Bakan and Rebecca Henderson.

For Bakan, government needs to assert a higher level of democratic control over companies to ensure they act in the public interest. He also argues that national governments also need to work together to challenge neo-liberalism as the prevailing political philosophy behind the treatment of companies.

Henderson’s reimagining of capitalism centres on company owners and managers placing more emphasis on achieving broader societal objectives. She argues that owners and managers (aided but not controlled by government) need to establish a ‘deeply rooted’ set of common values which can drive profitable, purpose driven firms that can save the world.

Despite their differences, the visions Henderson and Bakan outline both seem closer to today’s zeitgeist than Friedman’s. Henderson’s view broadly aligns with the idea of woke capitalism. Bakan’s views can be seen in national efforts to impose stricter environmental requirements on companies and international efforts to prevent global tax havens.

Ultimately, however, they describe conflicting visions of the future of the company. One emphasises government, the other emphasises private markets. Their agreement only lies in the need for change.