The Logic of Incorporation

By JIM MCNIVEN
Published January 24, 2014

The great French historian, Fernand Braudel, saw capitalism in its basic form as the injection of capital between the actions of buyer and seller. This is both simple and profound. It explains the difference between a farmers’ market and a supermarket. In the former, the producer/seller and the buyer meet face-to-face for the exchange. In the latter, the producer sells to an intermediary, who then may process, transport and resell the good to a supermarket chain that, in turn distributes it and resells it once more to the final buyer. Capital is used to conduct the producer/buyer economic relationship at a distance.

Capitalism is as old as many other economic activities. When seashell ornaments were discovered in the Anasazi ruins in the American southwestern deserts, there had to be a capitalist exchange going on. There had to be an intermediary with capital between the shell-gatherers of the Pacific coast and the cliff dwellings hundreds of miles inland. The Romans got pepper from Indonesia, a place no Roman had ever visited, in the same way. The question in early America was how to provide people all over the wide and distant frontier with what they felt were the necessities of life, as well as how to collect and transport to Britain or to other colonies the goods that would pay for these necessities. Clearly, a capitalist relationship had to be established, but how could this be organized?

Historically, there have been only four generic ways to organize people for productive activity. All of the organizational permutations and combinations that exist today are but variations on these four. They are the sole proprietorship, the partnership, the joint-stock corporation and the government agency. The most common has been the sole proprietorship and the rarest, the joint-stock corporation. Even in Roman times, a shopkeeper might be a sole proprietor, the owners of a merchant vessel would form a partnership and a government agency would manage a silver mine.

The Romans, though, have been considered the founders of the components of the modern corporation. Individual tax-collectors found they could not personally guarantee the receipts required by the growing Roman Empire, so they came together with other rich men to form societates, in which shares were distributed. These financial companies used some of their profits to create other large companies to make, among other things, arms for the Legions. The societates used professional managers, formal accounting methods, and launched the idea that a group could have a separate identity from that of its individuals.

Incorporation existed in medieval times. Free cities and towns, monasteries and universities all involved charters of incorporation provided by royalty. Other forms of organization were not adequate to the task of overseeing common property or to performing some other public purpose. A church building and its cemetery could not be ‘owned’ by a sole proprietor or a partnership. Instead, a legal device was created—a ‘legal’ person as opposed to a real, physical one. The ‘legal’ person would be given a legal ‘body’, or ‘incorporated’, and its behavior would then be controlled by a group of trustees or directors. Much of the medieval use still exists, though its connection to the state is muted. Probably the most obvious remnants lie in government-owned, or state corporations, and in incorporated municipalities.

It does not take a great mental leap to see the potential value of the corporation for economic or business purposes. Control over the legal ‘body’ could be divided in terms of ‘shares’ of its ‘stock’, or assets, that could be assigned or sold to different people or other corporations. Selling shares would then constitute a means for accumulating large amounts of capital from many investors. The business corporation would have the advantage of ‘outliving’ any or all of its owners, something that plagued the heirs of sole proprietorships and partnerships.

Colonization by Corporation

 

The prevailing view of incorporation from the 1600s until the 1800s was that it was a device that could or should only be used for specific public purposes and benefits. If a business corporation were to be chartered by the government, it had to have a well-understood public purpose. Two of the most common such purposes were for a nation to profit from foreign trade and for colonization.

In the 1600s, the Dutch found it convenient in building their empire in the East to use the Dutch East India Company. The Dutch, who founded what later became the British colony of New York, developed many of the instruments of modern capitalism, and this legacy was passed on in America and has coloured the behavior of New York City in particular, since then. The British and the French also picked up and used incorporation in the manner of the Dutch. The tendency was to give the company both commercial and civil powers. In the case of the Dutch and the English, the most successful of these companies ruled huge territories in what are now Indonesia, India and northern Canada. Perhaps the most successful was the British East India Company that gradually took over and administered most of the Indian sub-continent, only being displaced by the British Crown following the 1857 Sepoy Mutiny.

In the case of colonization, Yankee origins can be traced to the Virginia Company, whose charter gave it rights to much of the Atlantic coast of North America. The Plymouth colony in today’s Massachusetts began as a kind of subsidiary of the Virginia Company. Shortly thereafter, the Massachusetts Bay Company was chartered as a separate organization to settle the area of Boston and north. Some other colonies were created by corporations as well, though most were based on royal grants given to ‘sole proprietors’, like William Penn. Not only was much of America created as a result of corporate organization, but the first corporate merger in its history came from the absorption of the Plymouth colony into Massachusetts in the mid-1600s.

While the British government, for all practical purposes, stopped providing charters of incorporation for businesses in 1719, in the aftermath of the trauma of the South Sea Bubble, the colonial legislatures were not so inhibited. Thus, the Massachusetts legislature chartered an ironworking company at Saugus in the 1640s, in order to provide a means for producing iron and iron products locally, rather than importing them. During the 1700s, the most common activities of colonial corporations were transportation, banking and, to some extent, land speculation and development. At the time, transportation meant turnpikes and canals, where public benefits were fairly clear and whose investors would require relief from competition. They were not unlike today’s utilities.

The reason for chartering some colonial land development companies tends to hark back to the founding of many of the original colonies. The aims were to enable capital to be pooled by either potential settlers, who might need a corporate structure to purchase a large tract of land, or by financiers who intended to purchase, survey and sell land to settlers, and who needed extra capital in order to provide local improvements as inducements to settle. The Ohio Company, chartered in Massachusetts in 1785 to settle southeastern Ohio, is an example of the former, while the Holland Land Company, chartered a decade later in Pennsylvania to purchase and sell land in New York and Pennsylvania, is an example of the latter. Once the Northwest Territory and the lands across the Mississippi were under federal control, after 1800, its survey and sales policies made creating more such corporations uneconomic.

‘Free’ incorporation

 

The critical point is that charters of incorporation were all one-off grants of privilege. Each charter had to be applied for and had to be approved as a separate Act of the Legislature. In general, this meant that incorporation was a tool reserved for the political and economic elites. Entrepreneurs often found it difficult to get their petitions acknowledged and passed.

There was a British alternative that had existed since Elizabethan times, when a statute provided for the relatively automatic incorporation of hospitals. A similar intent was shown by the State of North Carolina in 1795, when it allowed canal companies to incorporate without specific permission.  Democratic capitalism required ‘free’ or automatic incorporation for businesses.

In the early 1800s, a rash of charter proposals began to occupy more of the time of the State legislatures. Many were for the formation of banks, especially in the capital-poor western States. Other proposals arose for large-scale manufacturing, where the size of capital needs and the requirement that the capital remain in place regardless of the personal situations of the various people involved in the formation of the enterprise, made the corporate form more appropriate. Legislators in the northern States especially were faced with charter proponents arguing that, in these circumstances, they met the test for public benefit. This argument led both the public and the legislators to identify increases in business activity as being an important component of the wider public interest.

Faced with this pressure, the New York State Legislature in March, 1811, passed an Act that allowed any petition for incorporation that met the Act’s list of conditions to proceed. It went a long way towards the ‘free’ incorporation of businesses, but still there were a number of restrictions, including a narrow list of eligible types of businesses, an upper limit on the capitalization of a proposed company at $100,000 and a 20-year charter term limit. As early as 1817, the then-Governor of New York and later Jackson’s chosen successor as President, Martin Van Buren, proposed, as a ‘democratic’ reform, the creation of a more generalized ‘free’ incorporation law.

Other states largely did not immediately follow New York’s lead and it was left to the ‘Jacksonian revolution’ to ‘free’ the rules governing incorporation. One indication of this coming trend was an 1829 article in a legal journal complaining that ‘millions in capital were being diverted out of Massachusetts by the legislature’s refusal to grant adequate charters’.

In 1834, the editor of the New York Post, William Leggett, wrote a series of articles entitled “What is Monopoly?”, where he called for an end to chartered monopolies, including banks, and advocated equal rights in the use and protection of property:

Their only safeguard against oppression is a system of legislation which leaves to all the free exercise of their talents and industry, within the limits of the GENERAL LAW, and which, on no pretence of public good, bestows on any particular class of industry, or any particular body of men, rights or privileges not equally enjoyed by the great aggregate of the body politic.

Leggett, considered by the New York elite as a left-wing radical, went on to propose a general incorporation law, with no limits:

“Such a law would be the very measure to enable poor men to compete with the rich.”

Free bank incorporation in New York came in 1838 and general free incorporation, pioneered in Pennsylvania in 1836 and Connecticut in 1837, was provided for in the New York State Constitution of 1846, though the law enacting it came only in 1848. Gradually, other States followed in this direction, though a lot of restrictions on capital size and term of existence remained through the rest of the century.

Alongside these evolving provisions, the US Supreme Court made a series of decisions that both opened up competition and defined the nature of the corporation relative to the rest of society.  Ensuring competition emerged as the most common regulatory means to ensure that corporate prices and services would be in the consumer’s interest. The Court first struck down monopolies in interstate trade, then it said that the legislatures had to obey the terms of the charters they issue (1819), meaning that it was not their business to periodically and politically meddle in a corporation’s affairs. Then, the Court struck down the ability of State legislatures to grant monopolies to intrastate corporations (1837), followed by definitions of corporations as ‘legal citizens’ (1842,1844), which allowed governments to treat them under their general laws of taxation and regulation.

Besides New York, the use of incorporation as a business tool tended to be more concentrated in the northeast, including Massachusetts and Connecticut, than elsewhere. Pennsylvania, as well, saw a gradual increase in incorporations, but farther to the south and southwest, incorporation was less used. Southern and western State legislatures tended to treat even banking incorporation petitions cautiously, with the result that the northeast continued to dominate national financial and commercial activity. New York City continued to consolidate its role as the national economic center.

Democratizing prosperity would have been virtually impossible without ‘freeing’ the corporation

 

Democratizing prosperity would have been virtually impossible without ‘freeing’ the corporation. This is especially true as popular conceptions about wealth shifted from that of possessing land and fixed property towards seeing it as residing in the volume of exchange of goods and services.

Nicholas Murray Butler, Nobel Peace Prize laureate and President of Columbia University from 1901 to 1945, once called the corporation, with a degree of hyperbole, ‘the greatest single discovery of modern times’. There is no question that its use has become a large and continuing feature in the lives of Americans—and of the rest of the world. Today, the notion of free incorporation, or the ability to create a corporation by meeting a set of requirements and obtaining licenses, is now observed everywhere in the world.

Copyright © 2014 James D. McNiven

Contact: j.mcniven AT dal.ca