Markets and Democracy: The Illegitimacy of Corporate Law
74 University of Missouri - Kansas City Law Review 41-105 (2005)
Corporate law does not conform to ordinary democratic norms: unlike human citizens, corporations may decide which law will govern their most fundamental acts of self-governance. The corporate law corporations choose, in turn, influences the corporate goals and decision-making processes that determine what the corporation looks for in corporate law, in a reflexive system independent of ordinary political processes. This system seems on its face to violate the most fundamental principle of popular sovereignty. All non-Delaware citizens of the United States are excluded from even formal participation in the process of determining American corporate law. Instead, corporate law’s content is determined by the market for corporate control and the internal norms of a self-replicating system of law that has escaped from political control.
Corporate law scholars have devoted many pages to debating whether the surrender of corporate law to a market for corporate reincorporation generates substantively good or bad results, but there has been virtually no discussion of whether this process can be squared with the American commitment to self-governance. This Article aims to address that latter issue—with its obvious implications for other areas in which we, consciously or unconsciously, decide to subordinate politics to markets or vice versa.
I. Introduction
Corporate law defies basic democratic principles. While democratic theory insists that the governed should choose their governors, and even more importantly, their system of government, the American system of corporate law removes most important questions of corporate law from the political process. Citizens, acting through the political process as presently constituted, have effectively no say in the formation of corporate law. The law and the corporations formed under it are instead products of a market that, by historical accident, has freed itself from political control.
Our corporate law is chosen by the very corporate managers who ought to be controlled by it, and created by lawyers, legislatures and judges unanswerable to the people whose lives are affected by it. Large corporations and Delaware determine the nation’s corporate law, and the rest of us are not even “virtually represented.”[FN1] Under the Delaware system, corporate managers are entrusted with stewardship of enormous concentrations of wealth and power—in many instances both larger and more important in our daily lives than most governmental units—with little supervision or answerability to the political process.[FN2] These autonomous power concentrations, in turn, are granted the strikingly unusual right to choose the law that governs them, thus guaranteeing that corporate law will continue to respect their independence from the will of the people. In short, we have created institutions of major importance and power and then set them on their way to do good or ill with little control or influence by the citizens whom, ultimately, they should serve.
Moreover, the primary legal guidance we do give the directors and managers of these autonomous entities is to direct them to act as honest agents and professionals. Ordinary principles of fiduciary duty and agency law require them to set aside their own values, interests and political views in favor of those of their client, the corporation itself (or sometimes its shareholders, taken as a legal fiction consisting solely of a desire to maximize the value of a particular company’s common stock without regard for any competing economic or non-economic value).[FN3]
Conventionally, this professionalism is viewed as a solution to the democratic and republican critiques of corporate law. So long as managers and directors are constrained to this professional role, the argument goes, we need not fear the enormous aggregation of power in their hands.[FN4] As a result, much of corporate law centers on the so-called agency cost problem: how to keep managers working for the firm rather than merely themselves.[FN5]
But even were managers to act in complete good faith according to the role norms of fiduciary responsibility, the republican problem would not be solved. Even role-bound managers are not statesmen balancing the multifarious and conflicting interests of a diverse population in pursuit of an elusive public good. Indeed, they are not even agents representing human citizens. Rather, their client is a legal fiction, an abstraction deemed by the law (and the sociological structures in which managers are enmeshed) to have only one interest and one goal.[FN6] Rather than balancing, managers acting in good faith simply ignore all but one of the goals and interests of the human citizens involved in the corporation.
Moreover, were the republican problem solved, the democratic one would remain. No one elected these non-philosopher kings. The value conflicts they mediate—by ignoring them—are central political issues in any democratic society. Wealth maximization inevitably conflicts with other environmental, aesthetic, cultural or economic goals, as well as freedom, liberty, equality and justice. What to do when those values conflict, ought to be the subject of political debate, not “expert” dictat, let alone concealed and decided always in favor of maximizing returns to shares.[FN7]
In short, the current Delaware corporate law system creates institutions governed by managers and directors who are commanded to set aside all values but profit, and then to pursue law that maintains this peculiar institution without popular review.
The paper proceeds as follows. Part II motivates the study, especially for readers inclined to accept the conventional wisdom that corporate law is empty and apolitical. Contrary to the mythology, I first contend corporate law is centrally important in a republican democracy. Public corporations are vehicles by which we make difficult value choices in a value-laden world. But under our current law, they make those choices independent of the values of the citizens who are affected by their decisions. Second, the common rhetorical strategies used to present corporations as powerless and passive—the metaphors of contract, property, agency, fictionality and individuality—cannot do the work demanded of them. Through the “mists of metaphor” a harsher reality peeks.[FN8] Corporations are power centers, loci of value struggles, political fora. They are not citizens but governance structures and not neutral but deeply influential—if illegitimate—participants in our political struggles.
The market-like evolutionary method of law is quite different from democracy, even in its debased interest-group competition form. One result is that Delaware corporate law commands the consent of the governed corporations (but not of the people who compose them) in a strong sense unattainable in ordinary democratic regimes governing human beings. This system, then, is not a democracy but a “corporation-ocracy”: we have given our corporations a strong citizenship denied to mere humans.
The free bargaining aspects of our current system of corporate law creation necessarily mean that the most powerful get the law they want. Indeed, the great race to the top/bottom controversy[FN9] can best be understood as a debate over whether managers or shareholders are more empowered by the economic and legal landscape, and thus more able to form corporate law in their own interest. In my view, the relative power of shareholders and managers is highly contingent, and greatly influenced by current corporate law. As a result, our current system does not head towards a single inevitable equilibrium, but rather has the potential for radical shifts. Thus, the dramatic shift in the allocation of corporate proceeds that characterized the 1980s (empowering shareholders) and then, differently, the late 1990s (empowering managers above all) were neither anomalies nor proof of the progressive nature of corporate law: the structured competition of corporate law creation cannot yield a determinate outcome.
Part III takes the next step. Were corporations citizens, the American corporate law system arguably would avoid some of the most troubling theoretical problems of democratic process, particularly the majoritarian difficulty and the social choice paradoxes. Similarly, it would avoid many of the potential practical problems of democratic action in a world of limited attention and limited citizen interest. Corporate law derives much of its ideological power and persuasiveness, it seems to me, from this picture: the entity, aggregate and property views of the corporation each suggest that corporations can be seen, metaphorically, as citizens. If they were citizens, our corporate law would not merely be democratically acceptable but extraordinarily successful. Corporate law would be our closest approximation to the liberal democratic ideal of a non-coercive state.
But the claim that corporations are citizens is false. Once corporations are understood as power sources, a part of our governance system rather than an object of it, then the market for law appears radically illegitimate, an example of the powerful seizing the power of the state to increase their own power. Rather than seeing corporations as Tocquevillian intermediate institutions restraining the state,[FN10] we should see them as state-like themselves, part of the classic liberal nightmare of a state acting in its own interest and not that of its citizens.
Contract views of the corporation assert that the firm is simply a private transaction or set of transactions in the market, to which only restitutive, non-distributive, justice issues apply.[FN11] For much the same reasons that have led us to reject Lochner[FN12] and laissez-faire generally, the claim that the market for corporate law is fair or non-coercive must fail.
Part IV completes the picture by arguing that corporate law affects all of us, not just the corporations who are its alleged subjects. In the perfectly competitive equilibrium market of economic theory, all proceeds of corporate activity are imagined to go to consumers, with shareholders, employees and managers understood to be mere factors of production paid their marginal cost. But life is lived at disequilibrium. In disequilibrium markets, successful corporations should generate a surplus above those costs (even assuming that the relevant markets are competitive enough to make the concept of “cost” determinate). In ordinary language, corporations seek to produce a profit and sometimes do. The resulting producer’s surplus is a pure rent, available for appropriation by any corporate participant without efficiency implications.
Corporate law, however, favors one side in the struggle over the surplus created by corporate (collective) activity. It holds that employees, suppliers, customers, bondholders and neighbors are all outsiders, with whom the corporation bargains at arms length. Following the “morals of the market place,”[FN13] it should therefore treat them as inputs to be exploited to whatever extent possible. For the corporation to voluntarily act in the interest of these factors of production solely because it cares about them would be an egregious breach of legally imposed duty. Corporate law, in turn, determines that certain other corporate participants—in the ordinary course, just shareholders—are the objects of a fiduciary duty; when the corporation acts in their interests it is acting in its own interests by legal definition.
The distinction between insiders and outsiders is central, deeply political, and legal rather than economic. It is not an artifact of the market but rather defines the structure within which the market will function. In the imperfect markets of reality, that issue is centrally important. A corporation that is directed to maximize shareholder returns will systematically act differently than one that is directed to minimize customer costs, to maximize quality or job satisfaction, or to consider all these goals and to balance them in some political, legal or professional process. The argument that corporations are perfectly private fails, then, because it is the law—a law with no democratic credentials—that determines for whom and for what ends corporations act.
The decision about who is a member of a firm is thus an intensely political one, likely to affect almost every aspect of our collective life. The market generates an answer, or competing answers, under particular conditions. But those answers reflect market power—not justice, efficiency or even political victory. Moreover, the market-based system hinders the political debate that could properly balance the values of economic growth against its costs: increased relative inequality, mobility and change, and, most importantly, the devaluing of human effort that comes from being understood as a means rather than an end.
II. The Illegitimate Origins Of Corporate Law
A. What Is at StakeCorporate law matters. Corporate law structures the ways in which corporations make decisions, respond to the pressures or constraints of markets, constituents and other laws, allocate their surplus and balance conflicting moral or political demands.
Current corporate law directs corporate managers—the proximate decision-makers—to set aside all values other than share value maximization. More importantly, it directs those managers to view all participants in the corporation, with the sole exception of shareholders, as outsiders to be bargained with at arm’s length or tools to be exploited (within the limits of the law), rather than, for example, fellow adventurers or partners in a common enterprise. In a kind of anti-Kantianism, people are always means, never ends in themselves, always exploited as if we had no value of our own. Managers following these rules will view their fellow citizens, both inside and outside the firm, much as old-fashioned imperialists viewed the colonized natives of a foreign territory. We, self-colonized, are merely tools to a greater end: an ever-rising stock market.
Corporate law structures the incentives of managers in a way largely consistent with this narrow understanding of their role, with one large exception: managers have both incentives and ability to betray their obligations to shareholders in the cause of pure self-interest. Our corporate law, then, creates an apparent dichotomy. On the one hand, managers stand as fiduciaries and professionals, who work selflessly for their masters—the shares—as good colonial officials exploited the natives incorruptibly for the benefit of their masters in the imperial center. On the other hand stand managers as self-interested kleptocrats, appropriating what is not theirs for their own self aggrandizement.[FN14]
Under current corporate law models, corporate law debates are largely about the extent to which corporate managers are constrained to place share value maximization above manager wealth maximization. Almost no one argues that the latter is a legitimate goal; the debate is rather whether it is a useful means to the primary, share centered, goal, or an unfortunate side effect of market and regulatory failure.
But the dichotomy of current corporate law is deceptive. Public corporations are more than their shares and their managers: they are also our jobs (and thus, for most of us, a primary focus of our creative and social lives), the architects of our cities, the sources of our salaries, medical benefits and pensions, our neighbors, the manufacturers of our consumer goods and the suppliers of our services. These values are not fully captured by the interests of either the shares or managers.
Corporations could be run with an eye to many values that drop out of our current system or appear only as external constraints. Thus, one could imagine a corporate law that directed corporate managers to maximize job creation or wages, or work-place creativity or autonomy, or product quality, or civic responsibility, or environmental quality, or family quality time, or enhancement of republican self-definition, or encouraged consideration of the myriad ways in which those disparate goals conflict or support one another. In such a firm, share value might be a constraint rather than a goal, much as employee wages are a constraint on the share value maximizing firm: shares would be allocated only so much of the firm’s assets as is necessary to attract the minimum necessary amount of capital.
A world in which corporate managers were directed to consider corporate participants as partners and their diverse goals as goals of the firm would look quite different from our own. Under current corporate law, it is always proper for corporations to cut “costs” at the expense of society as a whole, for example by failing to use the best available environmental protection technology, or at the expense of corporate participants specifically, for example by refusing to honor (legally non-binding) promises of long-term employment on good behavior or generous pension or medical benefits. Corporate law debate, instead, concerns the difficult issue of whether managers are obliged to cause their corporations to free ride in this manner whenever it is share value maximizing to do so, and whether (as a matter of corporate law) they may free-ride even when according to non-corporate law norms they should not. At the limit, current corporate law norms suggest that corporations assess all law according to the share value maximization principle: they should violate even the criminal law if it is share value maximizing to do so.[FN15]
Were corporate law different, corporate managers would make different decisions. If they were told they should consider other values, they would do so more often. If they were told to treat employees (or customers, pensioners, local governments, creditors or the biosphere) as partners rather than opponents, they would do so more often. To be sure, in order to manage a firm effectively, managers often must at least pretend to treat employees as members of the team. Generally, there is no other way to induce employees to work hard and effectively. However, current law reminds managers that such pretenses are only instrumental: ultimately, managers are required to exploit employees (including themselves), not work for them.[FN16]
Similarly, asbestos and cigarette companies, nuclear power plant builders, forex and energy traders, accounting firms and the like are directed by current corporate law to ignore the possibility of truly massive liability: if the worst happens, the corporation’s shares will not bear the bulk of the costs.[FN17] Even if something less than the worst happens, torts liability “counts” only to the extent that the courts translate collective disapproval into monetized damage awards—and that is not how courts work.[FN18] If corporations were not invited to externalize costs through liberal limited liability rules, managers would do so less often.
Corporate law, then, affects how corporate managers make a series of difficult value choices, directing them to consider some values—principally share value maximization—and ignore others, or treat them only as means to the accredited end. Different ends would lead to different corporations. Accordingly, corporate law matters. And like other controversial issues that matter, it ought to be the subject of significant political debate. In fact, however, we see little political debate about corporate law.
To some degree, the silence surrounding corporate law results from an illusion of triviality. Corporate law often appears to be less important than it is as a result of over-simplified modeling. Corporate law discussions often take place against a background assumption of efficient, equilibrium markets.[FN19] Clearly, were our markets perfect, little would be at stake in the wider debate I propose.
In a friction-free market at full equilibrium, all corporate participants, including shares and managers, would be paid only their marginal product, which would be equal to their marginal cost.[FN20] In such a market, corporations would make no economic profit and would be fully constrained in all their actions: were they, for example, to pay shares more than other companies, they would have higher capital costs, resulting in higher production costs, causing failure in the product market. For familiar Coasian reasons, the law would be largely irrelevant, since parties that were allocated legal burdens would bargain to shift them to the most efficient cost bearers.[FN21]
But in the real world, markets are never fully at equilibrium. Successful corporations do have surpluses to distribute, and our current corporate law culture (if not the law itself) directs that those surpluses be given to shares, even while inviting top managers to take some for themselves.[FN22] The predictable result is that top managers have become quite wealthy and shares have rapidly increased in value, while little of the economic growth of the last several decades has reached less powerful corporate participants. Moreover, contrary to the simplistic model of a fully effective market, many corporate participants have no ability to bargain to reallocate the law’s burdens—most obviously, retirees and tort victims are just stuck with whatever corporate law allows them to claim against.
Similarly, corporate law is sometimes discussed as if its central issue is managers ignoring their fiduciary duties (the “agency cost” problem). Current law gives managers plenty of room to cheat (that is, to place their own private interests above the ones that, as professionals, they are directed to consider). Given this weak law, if managers respected their duties only when forced to do so, the details of fiduciary duties as expounded by the law would not be very important.[FN23]
But the model of managers as constant cheats is deeply implausible. If all managers were perfect cheats, the economy would collapse. Under current law, investors buy shares with only weak protections against self-interested managers.[FN24] They must be assuming that the moral imperative—the law’s (often unenforceable) demand that managers set aside their own interests to work for that of the shares—will be enough to cause managers to work for the shares. The necessary implication is that moral imperatives matter. If we told managers to do something else, they would—not in all instances, but in enough to matter.
The issues raised by corporate law are quintessentially political issues. We as a society value wealth maximization, but we also value how that wealth is distributed, quality of work, number of jobs, family time, environmental quality, safe products and perhaps even urban architecture. These values necessarily conflict in a disequilibrium market: the more of the corporate surplus that is given to shares, the less that is available for other corporate claimants. If corporations are told that it is “cost cutting” to find ways to renege on pension promises, but not “profit maximizing” to reduce dividends, it is predictable that they will do more of the former and less of the latter. (This is why the accounting treatment of stock option grants to top managers matters: if decision-makers are directed to view options as a “cost,” they will give out fewer of them than if they are told they may see them as a pure free will offering costing their fiduciaries nothing.) Because our values and interests conflict, and we will disagree on how to mediate those disagreements, choices must be made. And the choices are the classic choices of democratic politics.
Political decisions, however, should be debated in political fora. Possibly such a debate would ratify the status quo. We might conclude that directing managers to consider one goal and one goal alone of all the possible worthy aims in the world so simplifies their task and the tasks of those who must supervise them that it is worthwhile to pay the cost of ignoring other important needs and desires. But the political debate might go a different direction. We might conclude, for example, that we would rather have our most important economic actors putting environmental considerations front and center, instead of treating them as mere constraints on profit maximization. We might conclude that at some point increased financial wealth is less important than quality of life issues, and we would like the central decision-makers concerned with those issues on a day-to-day basis to consider quality of life directly rather than only as it impacts profits. Most importantly, we might conclude that at some point total wealth is less important than preserving the rough equality that is necessary for republican government: that the American social contract means that we should be willing to have major employers sacrifice some growth in return for job stability or job increases or more egalitarian wages.
None of these value conflicts are easy issues and in this Article I do not pretend to offer any account of how the political debate about them would or should proceed.[FN25] The point of this Article is more basic: our process for creating corporate law cuts off the debate about the goals and purposes of corporate law. The race to the bottom/top, driven by the anomalous right of corporations (meaning corporate managers) to choose their own law, eliminates the forum in which we, as citizens rather than as shareholders, ought to be arguing about when share values ought to be sacrificed for other republican, democratic, or simply civic values. We need a political debate and a democratic process for making a decision as self-governing citizens, not victims and perpetrators of self-colonization.
B. The Metaphors of Corporate LawCommentators have attempted to legitimize this anomalous system by three related models: first, a contractual model treating the firm as a nexus of contracts, second, a property model, treating the firm as a thing owned by its public shareholders, and third, an entity theory that confuses the corporation with individual citizens.[FN26] All three models portray corporations in ways that make them appear private—more like citizens than government—and powerless.
1. Contract and Market Metaphors
The contractual model contends that corporations are private entities of concern mainly to those who contract with them.[FN27] As Easterbrook and Fischel put it, “[b]ecause the choices do not impose costs on strangers to the contracts, what is optimal for the firms and investors is optimal for society.”[FN28] Since corporations (on this model) appear purely voluntary, the appropriate role of the state is merely to enforce private agreements. In the most consistent form of the contractual model, the corporation tends to lose its corporeality: it is described as a mere nexus of contracts and dissolves into a moment in the market.[FN29]
The model of corporate law as contract is misleading on several levels. Perhaps most fundamentally, it trades on a simplistic and ideologically driven portrait of contract. In the contractual model of corporate law, contracts are fully negotiated free bargains between equals.[FN30] But in the real world, bargains are rarely between equals, voluntariness is always a matter of degree, most terms are assumed or presumed rather than negotiated, and many agreements do “impose costs on strangers.”[FN31] For this reason, contract law in general is highly interventionist, and the contracts of most interest to ordinary citizens are highly mediated by substantive law.[FN32] Consumer, loan, insurance and employment contracts are read (to the extent that they are written at all) in light of strong substantive policies developed by both legislatures and courts.[FN33]
In contrast, corporate law is not interventionist at all. The process by which corporate law is made, especially the right of corporations to choose their own law, means that states do not impose substantive values in corporation law “contracts” to protect weaker contracting parties, let alone the many non-contracting parties deeply affected by corporate law’s background rules. Were a state to try to introduce such values into corporate law, the party with stronger bargaining power would simply cause the corporation to use a different state’s law.[FN34]
Theorists of the contractual model have largely conceded that state corporate law cannot impose protection on parties to the corporate contract.[FN35] Instead, they have argued that the market participants will insist on law that adequately protects them.[FN36] The contractual model, then, is not so much a claim that corporate law is like contract law—it clearly is not. Rather, it is a claim that the economic markets in which corporations participate will generate the appropriate legal regulation or guidance by their own processes. Market results, however, are always heavily mediated by market regulation; here, paradoxically, the claim is that the regulated market will generate its own proper regulation.
This market/contract model’s claim to solve the democratic problem is false. Democracies have long known that markets can be tools for good or ill. That is why we attempt to suppress markets in, for example, protection rackets or cocaine. Markets generally fail to account for important values that are not reflected in price. That is why we have environmental regulations, child labor laws, tort and criminal laws. Markets also tend to contain incentives to self-destruct.[FN37] That is why successful markets are surrounded by effective disclosure requirements, bars on fraud, and bans on monopoly. To allow a market—or a firm recharacterized as a market—to set its own rules is unlikely to reach results satisfactory to a self-governing people.[FN38] Or so we have presumed since the demise of Lochner.[FN39]
2. Property Metaphors
The second model uses the metaphor of property: a corporation is conceptualized as an asset—a thing—owned by an individual (or a group of individuals, a difference not seen as meaningful). As a subset of property law, corporation law is seen, then, as largely about agency issues: corporations are property managed by agents, and the central issue is only whether the agents are acting in the interests of their principals.
This agency/property concept of the private corporation conflicts with the contractual/market model—agents are fiduciaries, governed by different norms than the ethics of the contractual marketplace[FN40]—but it shares with it the underlying claim that corporate law does not affect the rest of us. By portraying corporations as property, it suggests that protecting corporations is protecting the property-owners, and thus a system of law that allows corporations to choose precisely the protection they want is not problematic (or is problematic only to the extent that corporate agents use corporate law to lessen their obligations toward the “owners”).
The property/agency model fails, however, to answer the democratic claim for two reasons. First, the “property” in question is fundamentally a set of social relations among people, many of whom are not parties to the alleged agent/principal relationship. Second, the metaphor conflicts with the law. Shareholders own shares, not the corporation. The shareholders, viewed alternately as principals or property owners, lack most of the rights ordinarily associated with either. As a consequence, the corporate agents lack a principal and the corporate property lacks an owner, so that protecting the corporation does not protect the humans associated with it, even those this theory characterizes as “owners.”[FN41]
3. Individual Person Metaphors
Third, corporations are often conceptualized as individuals. In one variant, the firm is ignored altogether, reduced to the individuals thought to make it up (usually the shareholders, rather than the people who actually act for it), and it is assumed, without evidence, that the individuals and the entity are the same, or at least share interests.[FN42] In the other variant, the firm itself is seen as an individual, as if it itself were a citizen to be protected from government and entitled to participate in the governing process, rather than a tool of the citizenry not dissimilar from the government itself.[FN43] These two models—the aggregate and entity theories of corporate personality—are seen as radically opposed in the academic literature,[FN44] and for some purposes they are. But in their most common forms, each sees the firm as an “intermediate institution” that must be protected to protect citizens and civil society from the state.[FN45]
On the aggregate view, protecting the corporation is seen as no more than shorthand for protecting the individual citizens (or shareholders) whom it “really” is.[FN46] But this theory of corporate personality should be strikingly unpersuasive in a liberal democracy: just as liberal theory attacks the notion that the state can be identified with the citizens who make it up, so too it should question the naive idea that the corporation and its “citizens” can be conflated.[FN47]
In contrast, the entity model treats the firm itself as a citizen.[FN48] Thus, it harks back to the pre-democratic view of the state as composed of estates or corporations each entitled to rights independent of (and often in opposition to) rights of the individuals who compose them. Like a medieval church or university, modern corporations maintain internal disciplinary and justice systems that are largely unreviewed by and independent of the state system. Paradoxically, then, this private model of the corporation claims to justify granting the corporation state-like powers.
The corporation as a state-within-the-state, however, can not be justified under any democratic theory, because this state-like entity defies all democratic norms internally. No corporation operates by the principle of one person, one vote. All economically significant corporations disenfranchise a substantial portion of the affected populace, while even shareholders vote according to the number of shares they hold. Moreover, standard corporate law sharply limits the control that even the “voters” have over “their” entity. The law bars them, in the absence of unanimous consent, from making fundamental value choices, for example, from balancing the pursuit of profit against other potential corporate goals, such as quality products, interests of non-shareholder participants or even the actual financial interests of the real human beings who own the shares.[FN49] Moreover, it even bars them from electing directors pledged to particular interests: directors, unlike ordinary politicians, are bound by law to pursue the interests of all (and only) shares, and courts will enforce this duty—subject to the often significant limitations of the business judgment rule—at the behest of any shareholder, regardless of election results.[FN50] Theorists, therefore, usually resort to market-based explanations of why the corporation is unable to exert any power over its shareholders, employees and other participants.[FN51]
The entity model must fail for the same reason as the aggregate model: corporations are tools of human beings, not values in themselves. They are, that is, state-like rather than citizen-like. And their lack of internal democracy means that they have only weak claims to be alternative representative institutions in a federal or pluralistic system.
4. The Metaphors of Powerlessness
Each of these metaphors takes much of its power from an underlying economic theory combining elements of all of them. In standard micro-economic theory, corporations are sometimes viewed as mere black boxes subject to consumer sovereignty through the product market, and therefore not power loci at all. If a corporation has no choice but to follow the market, the argument runs, then its internal organization is of no importance; corporate economic actors will behave the same as individual ones. In a reasonably competitive market, only the lowest cost producers will survive.[FN52] Accordingly, corporations will be compelled—if only the state will allow them—to adopt the lowest cost organizational form, including the lowest cost corporate law.
The “genius” of the American system, then, is that the corporation’s right to choose its state of incorporation creates a market for laws: an interstate competition which, in turn, precludes meddlesome reformers from imposing unnecessary costs on corporate organizational form.[FN53] In this model, then, the corporation is seen as a purely economic actor, important mainly as a producer of consumer goods, and properly subject to purely economic forces. The necessary conclusion is that the best corporate law is that which governs least. Corporate law should simply allow the market free rein (or should it be reign?). Our competitive federalism does just that. To the extent that this model holds, corporate law is largely irrelevant and uninteresting. The only socially important regulation of corporate law will be by the product market itself; the only socially important law will be regulation of the underlying product market, not of corporations.[FN54] The argument is, in short, that political democracy is unnecessary because market control is sufficient.
But to state the argument in this way is to point to its implausibility. We have long since rejected the notion that unregulated markets can even exist, let alone that they inevitably lead to the best of all possible worlds (or even to a better world than a market limited and guided by politically plausible regulation). More fundamentally, the line between market and democracy is, in a democracy, one for democratic politics to determine, and so the “genius”[FN55] of a system that lets the market decide when politics should apply is anti-republican and anti-democratic.
Each of these metaphors tends to distract attention from the basic democratic issue: corporations, which are not citizens, choose their own law. In a democracy, however, citizens must govern themselves and that includes controlling their social and economic creations. Americans have abdicated that self-governing function to a self-replicating legal structure that, following its own legally mandated norms, chooses the law that regulates it. This is neither democracy nor consumer sovereignty but a golem: a creature we created to be our servant that we are, instead, allowing to govern us.[FN56]
C. The Value of DemocracyDemocracy is not, however, the only value in our politics. There might be good reasons for voters to choose to disenfranchise themselves, selecting the evolutionary model of corporate law over the deliberative-voting model of standard democratic law. For example, sometimes goals are best arrived at indirectly: perhaps, there is reason to believe that the non-democratic process of corporate law will produce results that would be more likely to be approved by a democratic process than a direct democratic process will. Or, perhaps, the non-democratic process is fairer for some reason than a democratic one. Or, perhaps, it is more likely to fulfill some other goal—such as wealth creation—to such a degree that a democratic decision would decide to restrict democracy. The peculiar anti-democratic status of corporate law, however, requires a special justification.
In the next sections I consider possible democratic arguments for this anti-democratic system. The conclusion, however, is that when we proceed beyond the rhetoric of private right, none of the available public defenses suffice.
III. The Political Critique
Were corporations citizens—the subjects and objects of a political system—our system of free choice of law for corporations would be an extraordinarily attractive solution to long standing problems in democratic theory. Corporations, and firms more generally, choose their own law quite free of external pressures and thus under conditions of freedom and non-coercion rarely found among democratic communities. Thus, taking corporations as entitled to the freedom and respect of citizens, corporate law could be described as the ultimate liberal solution to the problem of governmental coercion. But corporations are not citizens, and there is no reason in democratic theory, and little reason in any other context, why they should be treated as if they were. Firms are human tools created for human purposes; they ought to be created, regulated or given rights only to the extent that they serve those human purposes.[FN57]
Our publicly traded corporations are a major locus of power in society today. Measured by the wealth they control, the major firms are far larger than most governmental units. Measured by the degree to which they affect our lives, corporate decisions designing and delivering cars, clothes, word processors, telephone service or electricity have at least as much impact as do most local governmental activities. In terms of coercion, it is easier to escape local governmental taxation than to avoid paying fees to corporations such as Microsoft, cable companies or major food processors; hospital bills are more likely to threaten our way of life than governmental traffic tickets.
Those who work for major corporations are subject to a degree of potential violation of privacy that no governmental unit could contemplate. For example, employers are permitted to monitor e-mail and phone conversations routinely and employees have no expectation of privacy with respect to their employers in their email or desks.[FN58] For many people, losing a job or pension would be more traumatic than any encounter they are likely to have with the government. Corporate legal decisions—for example, to change seniority rules or reorganize production, switch types of pension plans, deny customers the right to share the software or music they have purchased or to commandeer portions of their hard drives for corporate purposes—can be profoundly determinative of important aspects of our lives. Even on the simplest measure, the ability to wield physical force, corporations are as powerful as other governmental units: private security forces employ more people than public police departments.[FN59]
Traditional liberal theory teaches that we ought to be suspicious of government even in a democracy. Just because the government is responsive to the majority doesn’t mean (simple readings of Rousseau notwithstanding) that it will consistently act in our individual or even collective interests.[FN60] American law treats corporations as if they were private bulwarks of power protecting us from the government.[FN61] Thus, the Supreme Court has granted corporations constitutional rights to due process, free speech and so on, but refused to give us constitutional rights against them.[FN62] Popular culture has not always made such a sharp distinction: big government and big corporations, private and public bureaucracies, Washington and Wall Street often have been seen as indistinguishable enemies by populists of various varieties at least since the Jacksonian Era.
In my view, publicly traded corporations are far more analogous to government than to citizen. Like governments, they are basically bureaucratic enterprises performing a mission that may be given to them in some loose sense by the population as a whole, but which permits plenty of room for independent and potentially heavy-handed action.
This is the issue in this section. Is protecting corporations, by granting them the right to choose their own law, a way of protecting citizens, as conventional theory often suggests? Or, on the contrary, is allowing corporations to choose their own law closely analogous to allowing governmental units to choose their own law—that is, to escape from democratic control? If the latter, democratic republicans should be quite suspicious of the race to the bottom/top regardless of the efficacy of the particular results it reaches at any given time. Just as enlightened despotism remains despotic even if the despot really is enlightened, so too the decision to free a major governmental unit from popular control ought to be scary even if it does not seem to be substantively problematic at the moment. Corporate leaders, unlike judges and governmental bureaucrats, are not appointed by elected officials or answerable to them. To the extent that corporate law is determined by the race to the bottom/top, corporate managers do not even nominally follow norms set by the democratic process. They are, rather, analogous to autonomous self-perpetuating power structures: a sort of open aristocracy.
A. Corporate Law as Ideal Liberal Freedom: The Entity TheoryTwo contrary senses in which corporate law seems to meet the requirements of liberal theory need to be distinguished. In this section, I discuss the entity theory.
The entity theory contends that the corporation itself is a citizen, entitled to a set of rights that go along with a moral being, including respect and legal recognition. The theory’s power rests on two pillars. First, corporations are entities, even if not citizens, and the legal system does in fact grant them many rights of citizens. This combination of sociological and legal reality gives the normative claim a certain surface plausibility: if corporations are rights-bearing entities (and they are), perhaps they should be. Paradoxically, the fact that we give corporations rights they shouldn’t have makes it appear reasonable to view them as the type of being that ought to have rights.
Second, if corporations were citizens, corporate law would grant them a type of freedom to which we all aspire. The Internal Affairs Doctrine gives corporations, unlike human citizens, the right to choose their own law.[FN63] That right, in turn, is one of the fundamental Western understandings of freedom.[FN64]
The metaphor of citizenship thus powerfully supports the Delaware system. But the metaphor deceives. Corporations are not humans or ends in themselves. They are tools for our economic advancement; they shouldn’t be treated as ultimate values any more than governments should be. As a normative matter, the metaphor is simply deceptive.
Since Hobbes, liberalism’s ultimate defense of a limited government’s right to coerce has been based on the claim that there is no “real” coercion, because in a just society, we can see the subject as having chosen the law at issue, or can say that the subject rationally should have chosen it in a fair bargain. That is, the subject either has consented in an actual agreement at least tacitly,[FN65] or rationally would consent in a hypothetical ideal agreement.[FN66]
The hypothetical rational agreement is embodied in the state of nature or its modern analogue, Rawls’ original position,[FN67] and the emergence of government from it. On this view, governments should limit themselves to matters which rational individuals in a fair bargaining position (such as the state of nature) would have approved. The power of this argument depends, of course, on the persuasiveness of the description of the conditions under which rational individuals would bargain and on the rationality of the bargain they would make. For this reason, hypothetical consent arguments are often controversial.
In contrast, tacit consent arguments usually are variants on the position of the Laws of Athens as set out in Plato’s Apology: a subject who does not emigrate (and in Locke’s version, owns land), has tacitly consented to the laws as they stand.[FN68]
The problem with this theory of tacit consent is that the agreement it describes looks too coercive, too much like a contract of adhesion. In order to disapprove of an unjust law, the dissenting Socrates or his Lockean equivalent must accept exile.[FN69] Emigration, however, is quite difficult (even leaving aside the sometimes fatal problem that it is impossible unless some other country is prepared to permit immigration).[FN70] Émigrés must leave behind their country, friends and relatives, often their culture and language, jobs or profession. Indeed, Socrates argues that hemlock is preferable to exile.[FN71] In short, to refuse consent requires so high a price that little moral value can be placed on a subject’s failure to pay it.[FN72]
Of course, no actual government is the product of actual consent or meets the requirements that would be generated by hypothetical consent, if consent is taken even half-seriously. But corporations choose their (constitutive) law more freely and with fewer constraints than any human citizen. Citizens are limited to voting for representatives and, if they cannot accept the decisions the government makes for them, can only go into exile. In contrast, corporations have far more freedom.
First, corporate constitutive law is remarkably flexible.[FN73] Human citizens normally are allowed to organize their families in only a limited set of pre-established relationships. Standard corporate law, in contrast, is open to all sorts of unusual arrangements: virtually all of its key requirements are merely default rules, waivable at the option of the individual firm or its participants.[FN74] Even when the statute does not explicitly provide that its rules are optional, it is often relatively easy to plan around them.[FN75] For example, corporate law begins with a presumption of a separation between equity ownership and management, with a presumption of entity-level taxation, and a presumption that corporate funds are available for corporate creditors before corporate investors.[FN76] But the leveraged buyouts of the 1980s created corporations that avoided all three of these apparently compulsory aspects of corporate law even within the confines of the traditional statutes. By refinancing with high debt and low equity, firms were able to give high equity ownership (and associated votes) to managers, to virtually eliminate the corporate income tax (since most profits were paid out in the form of interest, deductible to the firm), and to ensure that investors (now classified as senior debt holders) received the first, instead of the last, claim on corporate income.[FN77]
Second, any firm that determines that its host state’s corporate law is insufficiently