“In his nuanced analysis, corporations need to align their aims with society, becoming viable communities, institutes and financial, human and natural capital ‘factories’.”
Corporation 2020: Transforming Business for Tomorrow's Worldby Pavan Sukhdev
There is an emerging consensus that all is not well with today’s market-centric economic model. Although it has delivered wealth over the last half century and pulled millions out of poverty, it is recession-prone, leaves too many unemployed, creates ecological scarcities and environmental risks, and widens the gap between the rich and the poor. Around $1
There is an emerging consensus that all is not well with today’s market-centric economic model. Although it has delivered wealth over the last half century and pulled millions out of poverty, it is recession-prone, leaves too many unemployed, creates ecological scarcities and environmental risks, and widens the gap between the rich and the poor. Around $1 trillion a year in perverse subsidies and barriers to entry for alternative products maintain “business-as-usual” while obscuring their associated environmental and societal costs. The result is the broken system of social inequity, environmental degradation, and political manipulation that marks today’s corporations.
We aren’t stuck with this dysfunctional corporate model, but business needs a new DNA if it is to enact the comprehensive approach we need. Pavan Sukhdev lays out a sweeping new vision for tomorrow’s corporation: one that will increase human wellbeing and social equity, decrease environmental risks and ecological losses, and still generate profit. Through a combination of internal changes in corporate governance and external regulations and policies, Corporation 2020 can become a reality in the next decade—and it must, argues Sukhdev, if we are to avert catastrophic social imbalance and ecological harm.
Corporation 2020 presents new approaches to measuring the true costs of business and the corporation’s obligation to society. From his insightful look into the history of the corporation to his thoughtful discussion of the steps needed to craft a better corporate model, Sukhdev offers a hopeful vision for the role of business in shaping a more equitable, sustainable future.
“In his nuanced analysis, corporations need to align their aims with society, becoming viable communities, institutes and financial, human and natural capital ‘factories’.”
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Transforming Business for Tomorrow's World
By Pavan Sukhdev
ISLAND PRESSCopyright © 2012 Pavan Sukhdev
All rights reserved.
The Legal History of the Corporation
If you would understand anything, observe its beginning and its development.
To tell the story of the corporation is to tell the story of a grand bargain gone awry.
Through history, governments have granted corporations special privileges such as corporate personhood and limited liability, with the expectation that corporations would serve the interests of the state and the broader public. And yet legislative history and the ascendancy of free-market capitalism have ensured that most modern corporations seek only to advance their own self-interest. Billions of dollars are spent every year on corporate and trade association lobbying to tilt the field of commercial opportunity toward maximizing private financial capital. Responsibilities of maintaining public capital are ignored, in particular those of natural capital and social capital, even though these are respectively the ecological bedrock and institutional masonry of any successful human economy. Dire results follow for both the public good and trust in the corporate institution.
Civilizations have repeatedly recognized the value of corporations. Henry Ford never visited the great Swedish Stora Kopparberg mine (chartered in 1347, the oldest corporation in continuous operation), but he would have recognized its genius. Ancient Rome's societates publicanorum and the Mauryan Empire's sreni in India arrived at astonishingly similar approaches to pooling capital and reducing risk. History suggests that the corporation is one of mankind's most useful inventions, as essential for continuity and achievement in commerce as the advent of the written word was for ideas.
At the same time, corporations have always come with risks, and they are centrally implicated in many of today's most serious problems. While the history of corporations reaffirms their value, it is also replete with examples of governments struggling to constrain corporate power and negative externalities. This chapter narrates the history of the legal innovations that have given us today's corporation.
The earliest attempts to share risk and pool capital occurred in ancient Mesopotamia. However, not until the Mauryan Empire in India and the rise of the Roman Republic did the concepts of limited liability and corporate personhood emerge. It should be said in this context that the early official accreditation of the corporation into civilized society occurred unfettered by societal controls designed to protect those outside the corporation. The notion of "undue corporate influence" would not emerge until nearly the eighteenth century. The early corporation completely lacked introspection.
From 800 BC to AD 1000 India experimented with a powerful tool: the sreni. Like later corporations, sreni had dispersed ownership structures, with shares that could be sold. Unlike modern corporations, sreni operated under a pro rata system, in which shareholders were liable for the sreni's debts in proportion to their investment. When engaging in expensive and risky endeavors, such as international trade, merchants could create an entity holding assets separately from its owners.
The sreni were the engines of ancient India's economic growth. Because of their power, they were also highly regulated. While the security provided by the Mauryan dynasty fostered the development of the sreni, it was the fall of the Mauryan Empire in the second century BC and the emergence of smaller and less centralized states that allowed India's sreni substantially to expand their influence, control, and wealth over the next 1,200 years.
Although India's sreni prove that it is untrue that the invention of companies "belongs entirely to the Romans," Rome did play a crucial role in advancing the idea that a corporation can have an identity separate from its human components. Rome's societates publicanorum, or "societies of government leaseholders," were constituted to meet state goals such as providing public works, manufacturing weapons of war, and collecting taxes. Beginning in the third century BC, groups of investors (the publicani) would bid on state contracts for activities deemed vital for the advancement of the republic. Although for business done in the private sector Rome provided essentially no protection from liability, in the public sector, government-granted limitations on liability allowed investors to purchase shares without absorbing personal responsibility. Within two centuries of the formation of this business structure, the largest societates publicanorum resembled modern companies, with hundreds of limited partners trading their shares on a stock exchange. These vibrant exchanges were promoted by the limited liability of investors, with the tradability of shares in turn encouraging increased capital formation and corporate growth.
In ancient Rome, corporations only provided services to the state and not to private parties. Thus, the state would maintain a strong interest in ensuring that the firm was managed efficiently and honestly, and it could readily take action against corporate misdeeds. For business in the private sector, however, there was essentially no ability to shield the entity from liability, although the Romans did indeed build some corporate structures that could be used for general purposes. They developed and made extensive use of a corporate form that looked remarkably similar to that of a modern public corporation, which could easily have been utilized for general business endeavors. The reason that this did not happen might be due to the high transaction costs for ensuring governance structures sufficient for protecting investors and the public. After Rome's transition from a republic to an empire in the first century BC, the emperors grew wary of the influence of the publicani, so the state began to take over public works projects. The role of the publicani was limited to collecting taxes, but they were barred from even this activity by the end of the second century as Rome entered its slow decline. By the fall of Rome in AD 476, the societates publicanorum had dissolved into the fabric of history.
The Era of the Social Corporation
It would take almost a millennium for governments and commercial enterprises to once again develop a robust corporate form within Europe. The Middle Ages saw the incorporation of Europe's nonprofit social institutions, such as churches and universities. In the case of for-profit corporations, the important limitation of the times was that incorporation occurred only via royal charter. Frequent reference is made nowadays to a corporation's "social license to operate," or its implicit acceptability to society at large, but royal charter was in essence an early, explicit, and legal form of a "license to operate," a contract between society and the corporation.
The oldest commercial corporation in continuous operation—Stora Kopparberg—obtained a charter from King Magnus Eriksson in 1347, and still maintains a strong presence (as Stora Enso) in Northern Europe. The evolution of royal charters reached a watershed in 1600 in England with the creation of the East India Company, which became the first truly multinational corporation. Shortly thereafter, in 1602, the chartering of the Dutch East India Company followed this multinational model, eventually becoming perhaps the most powerful corporation ever formed. Both of these corporate giants' charters, as a result of the risks associated with global commerce, granted shareholders limited liability on ventures related to their respective investments. More significantly, they also represented two of the earliest examples of the role of corporate influence in shaping policy. As attested in the annals of both the British and Dutch governments, these companies shaped the foreign policies of their respective countries for nearly two centuries.
By the early eighteenth century, corporations were increasingly common and were moving away from a system based on royal charter. In England, however, the Bubble Act of 1720 banned all corporations not authorized by royal charter, putting a halt to British corporate evolution. Ostensibly a response to a series of speculative frenzies, the Bubble Act was in fact originated by the South Sea Company, which sought to protect its monopoly. What began as a cynical attempt to manipulate investment patterns turned into a condemnation of "[a]ll undertakings ... presuming to act as a corporate body." Its official name gives a hint of the vitriol heaped on the corporate form: it was entitled "An Act to Restrain the Extravagant and Unwarranted Practice of Raising Money by Voluntary Subscriptions for Carrying On Projects Dangerous to the Trade and Subjects of this Kingdom." The Bubble Act meant that England's Industrial Revolution, perhaps the most significant turning point in recorded history, took place outside the corporate form.
Because of this, the next great shift in the corporate model would occur in the United States. There, every state could issue corporate charters; in 1832 authors Joseph Kinnicut and Samuel Ames Angell complained of "an infinite number of corporations aggregate, which have no concern whatever with affairs of a municipal nature." The proliferation of corporations rekindled debate about the relationship between shareholders and the state, which Justice John Marshall reflected on in the 1819 case, Trustees of Dartmouth College v. Woodward. In this case, the state of New Hampshire had attempted to alter the charter of Dartmouth College. In his final opinion, Marshall asked whether the act of incorporation by the state made it possible for the state to take over the corporation. In oftquoted language, Marshall held that "[a] corporation is an artificial being, invisible, intangible, and existing only in contemplation of law." Having created the corporation, the state could not simply treat it as an extension of itself.
Marshall's decision established the legal principle that private corporations can exist in isolation from the state. Though still typically "imbued with public purpose," corporations were evolving into more independent entities—a trend that would accelerate dramatically in the coming decades.
Private Enterprise and the Corporation
Traders, merchants, craftsmen, and their guilds were the mainstay of commerce in medieval times. However, the nineteenth century saw private enterprise discover and rapidly embrace the benefits of corporate personhood and limited liability that came with incorporation. In 1800, there were just 355 corporate charters in the United States. By 1890, the number was almost 500,000. Two legal developments lay behind this explosion: the advent of general incorporation statutes and the adoption of limited liability.
Starting in the 1830s, state-level incorporation statutes in the United States began to allow individuals to form corporations without special charters from legislatures. In 1844 the Supreme Court stated that a corporation "seems to us to be a person, though an artificial one ... and therefore entitled, for the purpose of suing and being sued, to be deemed a citizen...."
The rise in general incorporation statutes and their increasing popularity with business entrepreneurs and their investors mirrored a rise in limited-liability acts. Protected from risk, shareholders increasingly bought stocks as investment vehicles. The resulting growth of corporations led to a change in the impacts corporations had on stakeholders. As opposed to shareholders, stakeholders are those who lack an ownership role in a corporation, but are still affected by its actions. Historically, corporate stakeholders were mostly limited to customers, but in the nineteenth century the growth of corporations expanded the stakeholder sphere. In particular, the negative externalities of railroads affected larger and larger numbers of people. Because of limited liability, defrauded stakeholders became unwilling creditors for corporations, with no way to seek compensation. This unintended consequence of limited liability remains one of the central negative realities of the corporate form today.
At the same time, Britain was also engaging in a debate over limited liability, though preoccupations with class provided a twist that would not have been familiar to an American. With lords and ladies disdaining industry, commerce was seen as the province of the lower and middle classes. Partly because of this it was not until 1850 that the House of Commons appointed a committee to "inquire into the subject of investments of the middle and working classes." In 1855, the English Parliament passed the Limited Liability Act, which conferred limited liability on most joint-stock companies. While this event would eventually have profound effects on the way that corporations were structured, it is interesting to note that banks were at first hesitant to take up this form, as their owners' unlimited liability was regarded as a "badge of prudence." The banks weighed the benefits that the two systems provided; the new law of limited liability afforded the value of investor protection, while the previous system of unlimited shareholder liability could drive business by giving confidence to depositors that their funds were secure. It was not until the failure of the City of Glasgow bank in 1878 over two decades later, causing 80 percent of the bank's shareholders to go broke, that banks realized the value of limited liability and quickly adopted this form. By 1889, there remained only two British banks with unlimited liability. A recent extension of the concept of limited liability is the emergence of "limited liability partnerships" in the United Kingdom. This shows that liability limitation has crept into even the partnership form which, thus far, had not provided safety from losses beyond invested capital to its owner-partners.
Following the rapid evolution of corporate law in the United States came competition to attract corporations to particular states. Beginning in the 1870s, this competition led to major legal innovations. The first important development, albeit with limited effect, was an attempt by Congress in 1876 to control the influence of corporate lobbying by requiring the registration of lobbyists with the Clerk of the House of Representatives. The second was the rise of the business judgment rule, which holds that boards of directors possess powers not delegated by shareholders. By 1905, the principle was so well established that a court could write that "it is [the board's] judgment, and not that of its stockholders outside of the board of directors ... that is to shape [a corporation's] policies.... This principle is not disputed, and the citation of authorities in its support is unnecessary."
Equally important was the decline of the ultra vires doctrine, which held that a corporation could not act contrary to the powers conferred on it by the state. The doctrine was a response to the potential for abuse that came with limited liability. Yet competition for commerce now offered states an incentive to loosen corporate regulations. In 1896, New Jersey eliminated its prohibition against corporations owning stock in other corporations. The spread of corporate laws permitting incorporation for "any lawful activity" sealed the decline of the ultra vires doctrine.
Absent the ultra vires doctrine, corporations were not compelled to meet society's needs. From 1865 to the early 1890s, large corporate enterprises became the norm for American business activities. Following a wave of consolidation, corporations grew even larger, and Americans got their first taste of the Robber Barons. Names like John D. Rockefeller and J. P. Morgan became symbols of both the promise and perils of corporate growth. Indeed, the reign of these influential barons' corporations occurred with virtually no government efforts to control how their influence was wielded. Despite President Theodore Roosevelt's use of the Sherman Anti-Trust Act (which actually existed for nearly 15 years before its first use), it would not be until 1936 that the government took a consistent stance on limiting corporate influence on the political process.
The Nail in the Coffin
The final blow to the social corporation came with a 1919 Michigan Supreme Court case, Dodge v. Ford. Prior to this case, the centrality of the profit motive of the corporation was like an old wives' tale—frequently repeated, but never tested. After Dodge v. Ford, the corporation could exist only to promote financial gains for its shareholders.
Excerpted from Corporation 2020 by Pavan Sukhdev. Copyright © 2012 Pavan Sukhdev. Excerpted by permission of ISLAND PRESS.
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Meet the Author
Pavan Sukhdev is the Founder-CEO of GIST Advisory, an environmental consulting firm that helps governments and corporations value and manage their impacts on natural and human capital. A former banker at Deutsche Bank, he founded and chaired Global Markets Centre – Mumbai, a leading-edge front-office offshoring company. He has been Special Adviser and Head of UNEP’s Green Economy Initiative, lead author of their “Green Economy Report”, and Study Leader for the G8+5 commissioned project on The Economics of Ecosystems and Biodiversity (“TEEB”). Pavan chairs the World Economic Forum’s “Global Agenda Council” on Biodiversity and serves on the boards of Conservation International and the Stockholm Resilience Centre.
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Un-put-downable!. A must read for anyone looking to get a brief history of how the current form of corporation evolved and took shape...and what the future corporations will look like. Pavan's background shines through the book with lots of figures and facts thrown in to make the business case - which is what we need - putting numbers to costs that companies have been conveniently externalizing. Chapter on Accountable Advertising made the most impact, putting the responsibility squarely back on the organizations. In short, this book sits at the intersection of economics & ecology by bringing the love back between the step brothers!