Sen. ElizabethWarren (D-Mass.) has just introduced a transformative — or rather, restorative — new piece of legislation. The Accountable Capitalism Act bids fair to begin the process both of correcting long-festering problems in our corporate governance and of restoring a system of incorporation that works for all corporate stakeholders. It will also begin to restore to our business environment a key to our nation’s economic “growth miracle” and “social contract” during its most prosperous era.
Legal entities that shield their owners from legal accountability have been part of our legal landscape for so long that many have forgotten the reasons behind their invention.
Many have also forgotten what a departure these entities represented from commonsense understandings of responsibility when first they were invented, and hence why corporate privileges have always been part of a “social contract.”
{mosads}In our nation’s earliest days, productive capital was in short supply. State revenues were accordingly unpredictable. Our law developed an ingeniously pragmatic way to “outsource” the construction of vital public infrastructures. That was to permit, solely for well-defined public purposes, the chartering of entities whose owners could not be held liable for losses inflicted or caused by those entities, and which could not be sued by the creditors of their owners, so long as the losses they caused were inflicted only in an entity’s authorized course of operation.
This two-way “asset-segregation” facilitated long-term private investment in vital infrastructure and other public goods, which was the sole purpose of this extraordinary insulation from ordinary accountability. Ordinarily, one who provides funding to terrorists or other harm-causing activities is legally accountable for facilitating such harms. Likewise, one who is found liable for harms will see his or her assets attached by his or her “judgment creditor” if unable to pay damages determined by judgment in a court of law.
Corporate privilege represented a profound departure from these long standing principles of legal responsibility. Hence incorporated entities that strayed from their publicly defined purposes were said to have acted “ultra vires” — outside of their limited powers — and thereby forfeited their privileges.
The corporate form as originally designed was a highly successful means of pragmatically partnering the public and private sectors to provide transportation infrastructure, energy grids, sewage and water systems, schools and libraries, public assistance and other social services in a world of scarce capital and unpredictable public revenue. In the modern era, however, things began to change.
For one thing, capital grew much less scarce. Stock and real estate bubbles throughout the 20th and early 21st centuries, the current wave of “stock buybacks,” and the related wave of “taking firms private” have all made plain. For another thing, public revenue became more reliable. And finally, because of the first two developments, corporate chartering itself changed.
As “private” investors became less necessary for the financing of public infrastructure, states began competing with one another for the “franchise tax” revenue that comes by charging a fee for granting corporate charters. This competition took the form of lenient conditions’ being placed on the granting of corporate charters, along with more “manager-friendly,” “small shareholder-unfriendly” bodies of corporate.
The chartering competition, which remains underway, amounts to an arms race, a classic collective action problem, that no state can exit save by “unilateral disarmament.” This is why the race is now called a “race to the bottom.” The bottom is a legal landscape in which nearly all states have unconditional, “general incorporation” statutes, and few states encourage shareholder or stakeholder “activism” of any kind.
The products of this “free incorporation” environment are disturbing. High-powered executives often run firms more for their own benefit than for the benefit of small shareholders, let alone other stakeholders and surrounding communities.
Unaccountable firms impose massive inefficiencies upon the public thanks to the negative externalities actively encouraged by the limited liability regime. All the while, incorporated firms amass more and more capital from fewer and fewer ultra-wealthy interests, growing too large for states to monitor.
The states are too small, too “divided and conquered” to solve these collective action problems. Only their and the public’s authorized collective agent — our federal government — is large and central enough to enable our states to address these challenges and restore the great American tradition of conditioning publicly conferred corporate privilege upon the fulfillment of public purposes.
Enter Warren’s Accountable Capitalism Act. While some, including myself, would like to go further than the act does, many will agree that this legislation takes critical first steps toward realigning our regime of incorporation with its original purposes. Here is how.
First, by recognizing a new category of very large American corporations called “United States corporations,” which must obtain a federal charter that obligates company directors to consider the interests of all corporate stakeholders, not just mega-shareholders, in their decision-making. This approach derives from the (currently only optional) benefit corporation model adopted by 33 states.
Second, by requiring worker representation on the boards of United States corporations: Every such corporation must ensure that no fewer than 40 percent of its directors are selected by the corporation’s employees. Germany has a similar requirement for large corporations and has seen robust economic growth and wage improvements for decades.
Third, by imposing restrictions on the sale of company shares by directors and officers of United States corporations — to ensure that decision-makers focus on the long-term interests of all corporate stakeholders rather than on enriching themselves on the basis of short-term gains in their companies’ share prices.
Fourth, by requiring United states corporations to obtain shareholder and board approval for, and publicly to disclose, all political spending — in keeping with a proposal from John Bogle, founder of Vanguard Group.
Lastly, by establishing a process for revoking United States corporations’ charters when they engage in repeated misconduct.
These features will enable state and federal cooperation in taming the nation’s largest incorporated firms, bringing their operations more into line with the original purpose of the corporate form. They will also begin the process of restoring the uniquely pragmatic, quintessentially American mode of partnering the public and private sectors in delivering broadly inclusive, sustainable prosperity to our citizenry.
Let us restore that original contract.
Robert Hockett is the Edward Cornell Professor of Law and professor of public policy at Cornell University, senior counsel at Westwood Capital, and a fellow of the Century Foundation.