26 March 2015


Back to Berle and Means? 'How the Company Became an Entity: A New Understanding of Corporate Law' by Susan Watson in (2015) Journal of Business Law 120 argues 
for an entity-based understanding of the modern company, recognising capital was severed from the holders of shares with the advent of limited liability. This division was instrumental in the development of the modern company and was implicitly recognised in Salomon. The modern company is an entity created by statute comprising a capital fund normatively controlled by the board of directors. Shareholders’ ownership rights are so attenuated in the modern company that shareholders are significant only because collectively, or individually with a block of shares, they can exercise indirect control. The focus when regulating companies should therefore be on control.
Watson comments
Modern companies are descendants of, and share characteristics with, two earlier forms that existed prior to the general incorporation statutes of the mid-nineteenth century: the classic corporation and the old joint stock company. The combination of joint stock with the corporation, together with the statutory enablement of limited liability and the resulting requirement that corporate accounts be kept that distinguished capital, led to the severance between shareholders outside the company and capital inside the entity. Although the modern company and statutory limited liability existed from the middle of the nineteenth century, the consequences of and advantages of the modern corporate form were not fully recognized and exploited until the latter part of the nineteenth century leading to the inevitable concentration of economic power in the company. This agglomeration of capital was identified and correctly predicted to intensify by Berle and Means in 1932. However, attributing its cause to a separation of ownership from control has led to regulatory solutions being built around shareholder empowerment. In this article it is argued that instead the regulatory focus should be on control of the corporate fund.
Adam Smith, in The Wealth of Nations, argued that the joint stock company was a business vehicle of limited utility that would succeed only for a certain class of enterprise. The first section of the article shows how Adam Smith was initially correct in his predictions but ultimately wrong. The paper suggests this was because the corporate form itself changed with the general incorporation statutes of the mid nineteenth century. Limited liability and the separation of capital from shareholders meant that the modern company incorporated by registration was fundamentally different to the old joint stock company.
The second section of the paper is divided into four parts. The first part traces the prehistory of the modern company in more detail, contrasting the classic corporation with the old joint stock company. The second part sets out how the understanding of the development of the modern company incorporated by registration changed through the nineteenth century. Originally conceived of as an association of persons, a partnership incorporated by registration, understanding gradually shifted to the idea of a company as an artificial legal person that existed for some purposes, a type of quasicorporation. By the late nineteenth century in Salomon, the company was viewed as a real entity separate from its shareholders. The section shows how statutorily mandated company accounts that required the identification and maintenance of capital because of limited liability and which used double entry book keeping that separated shareholders from the capital they contributed, made this legal separation seem possible.
The third part argues that the importance of Salomon rests in the recognition of the modern company as a real entity rather than a legal fiction that existed for some purposes, and that Salomon marked an extension, albeit an inevitable one, of the understanding of the modern company. It is argued that the significant difference between the resulting modern company and a classic corporation is that a classic corporation is a collective of people that is a legal person for some purposes, whereas a modern company is an entity that contains a fund. The final part of the section looks briefly at the development of the understanding of the company after Salomon. The next section sets out a new model of the company placing it as a type of organisation. In terms of form, it is argued that in the modern company capital contributed by shareholders is severed from those shareholders in the corporate entity. Shareholders hold shares that have rights attached to them but shareholders do not “own” the company in any meaningful sense. The modern company contains joint stock; a fund broadly defined to include intangibles such as brand and goodwill. That fund is under the control, at least in a normative sense, of the board of directors at the times when it meets. The final section sketches out some possible consequences of a new understanding of the corporate form.