Is a private corporation somehow vested with a public interest? Do the facts that formation of a corporation requires a (purely ministerial) state act, that the state provides a set of off the rack rules for corporate governance in its business corporation law, and that that law provides both affirmative and defensive asset partitioning via the rules on limited liability and private creditor access to firm assets make the corporation somehow uniquely subject to regulation in the public interest?
To be sure, some scholars have argued that incorporation—and, in particular, limited liability—is a privilege granted by society that can be revoked at will.[1] This is the once widely shared “concession theory,” pursuant to which the corporation was regarded as a quasi-state actor exercising powers delegated by the state.[2] But it has been over half-a-century since corporate legal theory, of any political or economic stripe, took the concession theory seriously.[3] See, e.g., Citizens United v. Fed. Election Commn., 558 U.S. 310, 432 (2010) (Stevens, J., concurring in part) (noting that "many legal scholars have long since rejected the concession theory of the corporation").
I note in passing that concession theory is especially problematic for those of us who accept the contractarian model of the firm, because our preferred understanding of the corporation treats corporate law as nothing more than a set of standard form contract terms provided by the state to facilitate private ordering.
Todd Henderson (Chicago Law) and I tackled concession theory as it relates to limited liability in our book Limited Liability: A Legal and Economic Analysis. In it, we explained that:
The notion that the purported privilege of limited liability amounts to a social subsidy in return for which society may demand certain forms of corporate behavior is also flawed. Limited liability is properly regarded as a subsidy only if it constitutes a wealth transfer from one segment of society to another. As Professor Herbert Hovenkamp concludes, however, “[i]t is hard to make such a showing about limited liability.”[4] To the contrary, society benefits in a variety of ways from limited liability.[5]
In addition, limited liability could be created by contract, at least among the creditors that bargain with the firm. As applied to these creditors—for example, banks, trade creditors, employees, and government agencies—the concession theory makes little sense. In the absence of a limited liability rule, one could be created by contract for them. Nor does it make much more sense for tort creditors. Although tort creditors cannot literally bargain before they are injured, for the reasons discussed in this section, it is likely that the hypothetical bargain they would strike if they could would be limited liability. Of course, after one is injured in a tort, one strictly prefers shareholder unlimited liability. But this is also true for contract creditors! The relevant time of the hypothetical bargain inquiry is before the tort happens. And, at this time, the question is not whether the firm should pay or not, but rather which party is the most efficient bearer of risk. The firm can provide insurance to the victim for the tort, but the party can buy first-party insurance directly from an insurance company, and the government (through the social safety net) can also provide insurance. Once the tort system is seen merely as a way of providing insurance, then the question becomes which of these can provide the lowest cost insurance with the best incentive effects. When answering this question, one must take into consideration both the relative incentive effects the choice will have on the parties, but also the costs of obtaining a judgment or settlement of the claim, including error costs. So, for instance, if obtaining a judgment in litigation is more expensive and more uncertain than obtaining the same relief from an insurance company, net of fees paid, then the latter may be preferable. This is especially true if under prevailing legal standards companies can avoid paying (that is, being pierced) by doing things (such as dotting the I’s and crossing the T’s) that do not materially reduce the risk of harm to potential tort victims.
[1] See, e.g., Claire A. Hill & Brett H. McDonnell, Reconsidering Board Oversight Duties After the Financial Crisis, 2013 U. Ill. L. Rev. 859, 860 (2013) (“Corporations were able and inclined to behave in a manner that imposed externalities because of a privilege the society, or more precisely the state, grants them: their owners get limited liability.”); Lyman Johnson, Law and Legal Theory in the History of Corporate Responsibility: Corporate Personhood, 35 Seattle U. L. Rev. 1135, 1164 (2012) (noting that even “the editors of the market-favoring publication the Economist noted that “limited liability is a privilege” and “a concession—something granted by society because it has a clear purpose.”); Charlie Cray & Lee Drutman, Corporations and the Public Purpose: Restoring the Balance, 4 Seattle J. for Soc. Just. 305, 308 (2005) (arguing that “it is worth resurrecting the notion that corporations must fulfill certain obligations as part of their “contract” with the society that grants them the privileges inherent in the corporate form (e.g. limited liability)”).
[2] The concession theory is commonly traced to Chief Justice Marshall’s opinion in Trustees of Dartmouth College v. Woodward, 17 U.S. (4 Wheat.) 518 (1819), which held that “[a] corporation is an artificial being, invisible, intangible, and existing only in contemplation of law.” Id. at 636. Subsequent commentators understood Dartmouth College as establishing “the idea that corporations are created and empowered as a ‘concession’ from the state political authority.” Eric W. Orts, Beyond Shareholders: Interpreting Corporate Constituency Statutes, 61 Geo. Wash. L. Rev. 14, 68 (1992). “Under [this] concession theory, limited liability is a ‘social subsidy’ of the private sector in exchange for which society can demand socially responsible behavior.” Jonathan D. Springer, Corporate Constituency Statutes: Hollow Hopes and False Fears, 1999 Ann. Surv. Am. L. 85, 102-03 (1999).
[3] William W. Bratton, Jr., The “Nexus of Contracts” Corporation: A Critical Appraisal, 74 Cornell L. Rev. 407, 433-36 (1989). For a more detailed rebuttal of concession-based theories of limited liability, see Larry E. Ribstein, Limited Liability and Theories of the Corporation, 50 Md. L. Rev. 80 (1991).
[4] Herbert Hovenkamp, Enterprise and American Law: 1836-1937 54 (1991).
[5] See Frank H. Easterbrook & Daniel R. Fischel, Limited Liability and the Corporation, 52 U. Chi. L. Rev. 89, 97 (1985) (“Both those who want to raise capital for entrepreneurial ventures, and society as a whole, receive benefits from limited liability.”); Jonathan R. Macey, The Limited Liability Company: Lessons for Corporate Law, 73 Wash. U. L.Q. 433, 449 (1995) (arguing that “limited liability generates social benefits that offset the social costs” it creates).
