Do Business and Economic Historians Understand Corporations?

Corporations are the preeminent capital-raising mechanism in the American economy, yet the nature of these institutions is misunderstood, if one judges by how the leading textbooks of American economic and business history explain the evolution of corporations. This paper focuses on why new businesses in the early 19th century increasingly were organized as corporations, rather than as partnerships or sole proprietorships. The textbooks stress the importance of Chief Justice John Marshall’s 1819 Dartmouth College ruling, in which he held that a corporate charter is a contract which the states cannot unilaterally abrogate or amend. However, the Dartmouth decision was totally irrelevant to corporations, because the case dealt with a charitable trust, not with a business for profit. Rejecting the traditional view that business corporations evolved from medieval “corporations” (boroughs, guilds, church-off ices and charitable trusts), this paper argues that they are so dissimilar that they cannot be subsumed under a single definition. It argues that the earliest prototype of business corporations was the royally-chartered joint stock companies of the 16th century (involving the creation and management of a permanent capital fund) and that the immediate ancestor was the unincorporated joint stock companies that flourished in England and America in the 18th century after passage of the Bubble Act. The textbook writers claim that the motive of business promoters in incorporating new businesses was to acquire “entity status,” “perpetual existence,” and limited liability. The absence of “entity status,” however, did not prevent partnerships from flourishing, and ‘perpetual existence” did nothing to enhance a corporation’s prospects for survival. The importance of limited liability as motive for incorporating has been vastly overrated because it was not an inherent corporate feature before the mid-19th century. Moreover, creditors of fledgling enterprises were not obligated to accept a limited liabiity arrangement, rather they could insist that one or more of the founder-promoters serve as a guarantor, surety or co-signer for the firm’s debts. In fact, the chief motive for incorporation was to secure various franchises (special privileges or exemptions) that required state authoriz- ation. Mounting resentment against corporate franchises during the Jacksonian era led to enactment of a new system for creating corporations, beginning in Connecticut in 1837. Instead of requiring a special law to be passed in the state legislature, a system that was costly, time-consuming and prone to corruption, a corporation under the new system was created simply by filing a form (a private contract known as “articles of incorpor- ation”) with a designated state official. The new system gave rise to an unwholesome competition between the states to see which could be the most lax or permissive, according to Justice Louis D. Brandeis (Liggett v. Lee, 1933). But the Brandeis thesis, which the textbooks implicitly endorse, is deficient. First, it fails to explain why Great Britain and Germany also enacted permissive or enabling corporate statutes in the mid-nineteenth century, since there were no competing legislatures (New Jersey vs. Delaware) in those countries. Second, it fails to notice that when state legislatures did try to impose limitations and restrictions, corporations could easily evade them, for example, by using a business trust (a common law device) to perform acts that otherwise might be challenged for being ultra vires. This paper, which views corporations as modified partnerships, stresses that every organizational form is a contract, and that with the right legal craftsmanship or tailoring, any form can be modified to accom- modate the needs of any business, regardless of its size or complexity. It concludes that if the leading American economic institution is to be understood, the whole subject of corporations needs rethinking by business and economic historians.