Tuesday, 28 March 2017

From the comments

In the comments to the previous posting "A brief prehistory of the theory of the firm 2" Mark Hubbard asks,

I have no great problem with the corporation. Like all institutions it comes with advantages and disadvantages. I would argue that the advantages outweigh the disadvantages. For a start note that you don't have to form a limited liability company if you want to set up a firm. You could, for example, form a partnership, but most people don't. So the corporation wins out in the (competitive) market for ownership form. This I assume is because the corporation offers more to people that other forms of organisational form. Is it morally defensible to deny people an organisational form they see as advantageous?

In addition note that countries that did not utilise the corporation until recently suffered because of it. For example, see chapter 6 of Kuran (2011) for a discussion of the consequences of a lack of the corporation in Islamic law. Is it morally defensible to deny people the advantages of development?

Not all people love the corporation, Adam Smith is famous for being being against it, except for a few noticeable large capital cases such as banking, insurance, water supply and construction of aqueducts and canals. If you don't use a limited liability firm how do you amass large amounts of capital? One reason for Smith's opposition to the corporation was moral hazard, the managers of the firm may not act in the interests of the firm's owners. Also given limited liability owners only risk a part of their wealth in any given firm so may not monitor management was well as they would if their whole wealth was involved. Such issues have, to a degree at least, been overcome by developments in corporate governance that Smith had no way of knowing. See Fleckner (2016) for more.

Fleckner's abstract reads:
In 1784, Adam Smith released the third and definitive edition of the Wealth of Nations, the most influential work in economics ever written. Of the eighty pages he added, more than thirty deal with “joint stock companies” and other commercial organizations. While these additions caused many observers to praise Smith as the first to coin the governance problems in firms, a closer examination of his remarks reveals that Smith’s theory of the firm, or the lack thereof, is in fact one of his work’s weaker parts. Smith thought history had shown that joint stock companies cannot compete with smaller firms, attributed this fact to certain organizational deficits, and concluded that joint stock companies should be established only under rare circumstances. Yet, in the following decades, exactly the opposite came to pass, with joint stock companies thriving in almost all fields and markets today. What made Smith so pessimistic about the joint stock company? The answer lies, this paper argues, in the sources Smith consulted, the companies he studied, and the general beliefs he held. Why did Smith’s pessimism turn out to be wrong? Smith probably overestimated the joint stock company’s weaknesses and underestimated developments that helped overcome them, such as technological progress, organizational innovations, and regulatory responses.
Also limited liability may not be as important to the corporation as many people think. As Henry Hansmann and Reinier Kraakman have written,
In essence, we argue that the essential role of all forms of organizational law is to provide for the creation of a pattern of creditors' rights-a form of  "asset partitioning" - that could not practicably be established otherwise. One aspect of this asset partitioning is the delimitation of the extent to which creditors of an entity can have recourse against the personal assets of the owners or other beneficiaries of the entity. But this function of organizational law which includes the limited liability that is a familiar characteristic of most corporate entities is, we argue, of distinct!y secondary importance. The truly essential aspect of asset partitioning is, in effect, the reverse of limited liability namely, the shielding of the assets of the entity from claims of the creditors of the entity's owners or managers. This means that organizational law is much more important as property law than as contract law. Surprisingly, this crucial function of organizational law has rarely been the explicit focus of commentary or analysis (Hansman and Kraakman 2000: 390, emphasis added).
Ultimately I don't really see the use of the limited liability corporation as a matter of morals, its more a practical matter, can we more easily achieve ours goals using the corporation than by using other organisational forms?

  • Fleckner, Andreas Martin (2016). 'Adam Smith on the Joint Stock Company', Max Planck Institute for Tax Law and Public Finance Working Paper, 1 January 2016.
  • Hansmann, Henry and Reinier Kraakman (2000). `The Essential Role of Organizational Law', Yale Law Journal, 110(3) December: 387–440.
  • Kuran, Timur (2011). The Long Divergence: How Islamic Law Held Back the Middle East, Princeton: Princeton University Press.

1 comment:

Mark Hubbard said...

Interesting reply; thanks Paul.

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