The limited liability corporation is a relatively recent development in the the business world. Two hundred years ago in the United States almost all businesses were individual proprietorships or partnerships. Individuals involved in such businesses were subject to unlimited liability for the debts of the business. Consequently people thinking of entering a business would have to think long and hard about doing so because their entire personal wealth could be lost. Because it was so difficult to get people to enter a business it was hard for anyone in a business to find a buyer when seeking to leave the business. The difficulty of getting out enhanced the reluctance of people considering entering a business. The end result was that the economy suffered from the difficulty of raising investment capital.
The limited liability corporation, which was invented in Great Britain, did make its appearance in the U.S. two hundred years ago but it was permitted initially only for special undertakings such as the building of a toll road. It took a special act of a state legislature to create a corporation.
But the limited liability corporation demonstrated its superior capabilities for raising capital. Investors still had to worry about the risk for the funds used to purchase shares but that was a far different matter than risking their whole fortune. Over the nineteenth century the restrictions on incorporation were reduced. One state, Delaware, became noted for its lenient requirements for incorporation. But generally there were no significant impediments to creation of corporations in any of the states. The limited liability corporation in terms of the capital invested is the overwhelmingly dominant form of business in the United States.
Although the corporation is superior to proprietorship and partnership in many ways there are some institutional problems. The shareholders of a corporation elect a board of directors who then choose the top management officers who run the business. In the early corporations the major shareholders were generally the managers of the businesses so it was not obvious that in a corporation there is potential conflict between the interests of the principals, the shareholders, and the interests of the agents, the hired managers.
In the twentieth century it became commonplace that the professional managers of corporations were not significant shareholders and also that the shareholders often had little interest in influencing the way the businesses were run. In time it became common for the corporataion managers to nominate and recommend candidates for the boards of directors. Instead of the managers being the creatures of the boards of directors, the boards of directors became dominated by the corporation managers.
James Burnham wrote a book entitled, The Managerial Revolution, in which he argued that around the world in all the major economic systems, the day-to-day direction of enterprises was being taken over by a professional management elite.
In a completely different line of development there was concern among some that the control of major corporations might be falling into the hands of a few wealthy families such as the Rockefellers, the Morgans and the Mellons. The amount of capital involved in a modern corporation is so enormous that to buy 51% of its stock would require most of the wealth of a very rich family. However, it was realized that with the ownership of the stock of a corporation widely dispersed and most shareholders not voting for the election of the directors, some shareholder owning 5 to 10 percent of the stock could effectively control the board of directors and the corporation.
In the early 1930's when people were trying to find an explanation for the depression that was devastating the country some thought that perhaps the control of the major corporations had fallen into the hands of groups like the Rockefellers. Congress thought that there was enough of a chance that such harmful concentration of power had developed that it set a Temporary National Economic Committee (TNEC) to investigate. The TNEC had the power to search records to identify major stockholder groups. The Committee did find that the Rockefellers did control many of the top corporations, as did the Morgans and the Mellons. The surprise was that of the top 200 corporations about one third were not controlled by any stockholder group; i.e., no individual or family controlled as much as five percent of the shares.
Adolph A. Berle, a political scientist, and Gardiner Means, an economist, were involved in the research and concluded that the corporations that were not controlled by a stockholder group were effectively controlled by the professional managers. The managers in such corporations had to earn enough profits to pay adequate dividends to shareholders but otherwise there was really no incentive for them to maximize profits. In effect, the managers of such corporations were the real owners and the shareholders were like debt holders collecting their interest payments. Berle and Means wrote a book on the topic entitled Power Without Property.
In the late 1940's when the control of large corporations was investigated again the researcher found that nearly 60 percent of the largest 200 corporations had no identifiable stockholder group in control. Thus the 33% of the 1930's had risen by 1950 to about 60R. Robert J. Larner, using 10% stock ownership as adequate for control estimated that in 1963 84 percent of the largest 200 nonfinancial corporations and 75 percent of the largest 500 nonfinancial corporations had no identifiable stockholder group in control and were therefore managerially controlled. This caused concern that the economic system of the United States had changed slowly but inexorably from capitalism to managerialism.
Managers in managerially-controlled corporations were thought to operate the company not so as to maximize profits but instead to generate prequisites and emoluments for the managers, such as big offices, corporate jets and other inessentiall luxuries. Corporate managers were seen to be a type of bureaucrats, no more efficient than public bureaucrats.
Another researcher, David Kotz, had a different explanation of the situation. He argued in his book, Bank Control of Large Corporations in the United States that Berle and Means were unjustified in presuming that the absence of a stockholder controlling group meant the management was in control. Kotz believed that some corporations came to be controlled by their debt holders. When a corporation needed to market a large issue of bonds it might have to approach major banks to find buyers for its bond issue. The institutions that buy a corporation's bond may demand representation on the board of directors of the corporation. Such representative have to be elected by the stockholders but with management support it would not be too difficult to get such people elected. Kotz contends that most of the major corporations are controlled by banks rather than stockholder groups or the professional managers.
There is another line of research on the matter of control of American corporations. A Russian researcher, Stanislaw Menshikov, on the basis of his study of interlocking directorships and stock ownership feels that all of the major corporations are members of 23 financial groups. Interlocking directorship refers to the fact that one individual may be on the board of directors of several corporations. Thus an individual X who is on the boards of directors of companies A and B can keep each of these companies informed about policy changes and plans of the other. If individual Y is on the board of directors of companies B and C then individual Y can keep company C informed about the plans and policies of not only company B but also company A because of the joint participation of individuals X and Y on the board of company B.
Menshikov's 23 financial groups are organized around banks for short term credit and insurance companies for long term credit for the member corporations. Menshikov compiled lists of corporations with the financial group he thought they belonged to. The financial groups included ones for the Rockefeller family, the Morgan family and the Mellon family. There is also a Bank of America group in his formulation.
While the phenomena of so called interlocking directorships does occur this may not be significant. Often corporations solicit well known persons to be on their board of directors to add prestige to the corporation. The board of directors may be powerless and influenceless in practice.
A French researcher, Chevalley, did a study similar to that of Menshikov. The interesting thing is that Chevalley comes up with a different membership for the financial groups than did Menshikov, which leads one to believe that the financial grouping may be more of figment of the researchers imagination than an objective result of the research.
Economists theorizing about the managerially controlled corporation hypothesized that such corporations maximize sales subject to the constraint that they have to earn enough profits to pay an adequate dividend.
Galbraith defined the technostructure of a corporations as being the system of technical committees that govern a corporation. The members of those committees are lawyers and engineers and so forth. The individual professionals are substituable elements and they have a role in the governance of the corporation only as a professional member of a technical committee.
The market's solution to the managerial control of corporation is corporate raiders and leverage buyouts. If the professional managers are operating a corporation in a manner that results in the value of the corporation being less than it could be then outsiders have the opportunity to take-over the corporation, change its mode of operation, increase its market value and thus reap capital gains.
The threat of a corporate takeover resulted in managers having an incentive to maximize profits. However, some mangers, instead of maximizing profits, looked for ploys that would make their corporations a less attractive takeover target. They reduced the cash holdings of their corporation, sometimes paying their income taxes years ahead. So a whole array of tactics were developed to discourage takeovers.
