Are Modern Corporations Natural?

Defenders of free markets need not justify the existence of limited-liability corporations. That recognition would go a long way toward better relations with the New Right.

Photo by Adeolu Eletu on Unsplash

A thorny issue for defenders of market freedom is the myriad ways in which the modern economies of the West, and that of the United States in particular, seem to create so many undesirable conditions.

I refer here not just to fake, falsely attributed, arguable, or overstated harms attributed to business, such as economic inequality and climate catastrophe. We must admit that business enterprises have engaged in many damaging activities, such as environmental pollution; regulatory capture; market manipulation; censorship; eager adoption of diversity, equity, and inclusion mandates; and other actions that have done harm and without which they could probably have made nice profits anyway.

My first observation is that many, if not most, of these endeavors are either encouraged by government—such as Biden-era private-sector censorship and DEI—or allowed by government through corruption or neglect. It is obvious that business people who do these harms are morally responsible for them, but as a policy matter, our concern should be the failure of government, and remedial action should be directed at that, not at enterprises that have not engaged in these actions and in fact in many or most cases were harmed by it.

That, however, is what the habit of government regulation does: punish everybody for the offenses of a few.

The role of government in corrupting the private sector is the issue to which the British writer Bryan Mercadente turns in a recent essay for The Libertarian Alliance, which he serves as director of communications: “to what extent actually existing capitalism—that is the legal and economic order of countries called capitalist—corresponds to what I mean when I talk about free markets.” I am going to quote it at length because Mercadente does such a fine job of stating the argument (and because I have the Alliance’s permission to do so).

Mercadente begins with a capsule description of libertarianism, which applies well to the free-market position on the economy:

Now, libertarianism, as I understand it, is a political philosophy insisting that all actions between consenting adults should be legal, except those involving fraud or the initiation of force. It is a doctrine of individual sovereignty, of voluntary exchange, of personal responsibility.

Mercadente then examines a common form of business enterprise in the West, the joint stock, limited liability corporation:

All those countries that are loosely called capitalist allow the existence of what used to be called joint stock limited liability corporations, otherwise called limited companies. These are organisations that have three main features. They are “artificial persons”—that is they are treated by the law as entities separate from those who own shares in them: they can own and use property in their own right; they can make contracts for the acquisition and use of property. They are, leaving aside accidents of insolvency or some external shock, immortal.

Following from the first, their owners are liable for the debts of the organisation only up to the amount they have invested: beyond that, they are not jointly and severally liable for the debts of the organisation. These organisations were first routinely enabled in England by the Limited Liability Act 1855 in England, which allowed companies to incorporate with limited liability provided they met specific capital requirements.

This program was extended over the next seven years, finally allowing limited liability “to apply to all companies by registration, leading to the modern corporate structure,” Mercadente writes.

Limited liability made investment easier and safer:

Before these acts, business partnerships and sole proprietors were fully liable for all debts and obligations incurred by their enterprises, meaning creditors could claim against their personal assets, including homes and savings, to settle unpaid debts. Limited liability altered this dynamic by ensuring that a limited company’s own assets alone were at risk in the event of insolvency. The utilitarian argument for this change was that it reduced personal financial risk for investors. This made investment more attractive and enabled the growth of large enterprises, better able than small enterprises to develop new products and take advantage of economies of scale.

Although this new legal status was convenient and obviously benefited investors, these operations had not arisen naturally in a free market. They were created by the government. Mercadente proceeds to ask whether limited liability would arise in a free market or is in fact even compatible with market freedom:

What does interest me is whether the general status from which limited liability follows could exist in a libertarian free market. Would a libertarian free market be “Tesco minus the State”? Or would it be a society of small and often informal economic interactions between consenting individuals?

Some libertarians, such as Stephan Kinsella, claim that limited liability would emerge in a libertarian free market. For Kinsella, it is a matter of contract:

“[S]omeone loaning money to, extending credit to, or engaging in a contract with a corporation is implicitly agreeing to pursue only the assets of the corporation itself in case of a claim, not the personal assets of shareholders (unless it insists on some shareholders personally guaranteeing a loan or contract, as if often the case for smaller companies). (Kinsella, 2011)”

Financing, however, is only one side of a corporation’s activities. What a corporation does with that money is its reason for existence, and dealing with people’s uninvited effects on other people is one of the core responsibilities of government (what economists call externalities):

If creditors voluntarily choose to lend money to limited liability companies, they must be assumed to know the risks involved; and they should have no right to complain if they are unable to collect. But this defence covers only contractual matters. It does not cover torts—that is, harms done to third parties who never agreed to any limitation of liability.

Unlike contractual creditors, who knowingly engage in transactions with a limited company, victims of corporate negligence or misconduct are not given a choice in the matter. If a limited company injures an individual—whether through defective products, workplace accidents, or corporate malfeasance—the shielding of shareholders from complete liability means that the costs of the injury are often externalised. They are shifted to the victim himself, or to the state, rather than carried [by] those who ultimately benefit from the company’s profits.

It is obvious that such shifting of liability is unjust. Limited liability makes that injustice a central feature of the economy:

Let us imagine that I and a friend set up a limited company and offer our services as builders to the public. Let us imagine that we negligently harm a customer’s property. The customer sues for compensation. Because we acted as the servants of a limited company, the customer must sue the company, not us. The company may have no assets. My friend and I walk away from the case with no costs but those of setting up another company to replace the one that has been made insolvent.

And this is what happens on a larger scale with limited liability. In a system without limited liability, shareholders would have to ensure that officers and employees of a limited company acted prudently, as their entire assets would be at risk. I repeat that limited liability allows those having it to externalise costs onto those who have no say in the risk-taking.

This creates moral hazard, encouraging greater risk-taking without accountability, which ultimately harms market efficiency. Above all, it contradicts the basic libertarian principle that individuals and organisations should bear full responsibility for their actions.

After answering some objections offered by libertarians in defense of this (government-created!) system, Mercadente notes that the owners of a limited-liability company—the shareholders—have no excuse for neglecting their duty of care and should be held responsible accordingly for any harms done in the pursuit of their interests:

In short, shareholders have the legal right to run the business like a Greek democracy, voting on every matter. If they decline to do so, this is negligence, not a lack of ownership.

I will do short work with Kinsella’s further claim that a shareholder may not be aware of the character of the managers he elects, or he may be aware, but be outvoted. This is a poor defence. He has a natural responsibility to make reasonable enquiries and inferences. If he does not, he should bear the same consequences as if he were to buy a house without a survey, and then find that the roof was collapsing. Or, if he is outvoted in the election of officers he considers unsuitable, he should sell his shares if he wants to avoid responsibility for what he fears likely to happen.

This is all about the law assigning responsibility to those who hold the authority. In corporations, stockholders are the ultimate authority. Their investments make the business possible. If the stockholders fail to exercise their power over the company, or if they deny that they have that power, that is their choice.

They are free to make that choice. They should not, however, be able to escape responsibility for their choices.

Government-granted limited liability reduces corporations’ sense of responsibility for their actions and encourages irresponsibility.

The loss of one’s entire investment in a corporation over harm done to others is certainly something people will generally want to avoid, and the use of draconian criminal and civil punishments against corporate officers and managers also acts as a deterrent. Simple justice, however, requires the owners of a joint stock company to bear all the costs of any damage done in the pursuit of profits for them. They stand to receive the benefits, and they should have to compensate fully for any harms the company may do. Ensuring compensation for harms is one of the very few tasks appropriate for government.

Limited liability greatly intensifies the concentration of economic power both in individual nations and globally, Mercadente notes:

[T]he effects of limited liability are profound, and they affect everyone. Because investors do not need to fear unlimited personal liability, limited companies grow larger than they otherwise would. Some of these corporations operate on a global scale, spanning multiple jurisdictions and influencing economic policy across nations.

Many have existed for centuries, surviving changes in ownership and management. They can do this because limited liability allows for a shifting cast across generations of shareholders and managers, ensuring continuity when individuals come and go. This insulation from personal risk fosters the growth of oligopolies that would not exist in a truly free market. They create vast bureaucracies of employees who think like state functionaries rather than entrepreneurs.

Many people on the political right in the United States and Europe today are casting ever-greater skepticism toward market capitalism. Recognizing the effects of corporate gigantism and globalization, many want to use government directly to rein in powerful multinational corporations. Mercadente aptly calls this position “statist conservatism,” which seeks “to use the state to enforce social norms or moral codes beyond preventing force and fraud.”

It is clear to me that adding more rules and regulations is the wrong medicine. The solution to the distortions government pushes into the economy is to remove the distortions. In government policy, addition by subtraction is nearly always the best course, and in modern democratic republics such as the United States, there is an enormous amount of subtraction that needs to be done.

Those of us who are dedicated to market freedom must continually bear in mind that what we have today in the United States is nothing like a free market. We should root out all artificial distortions, wherever they may be. It is our duty to question the logic even of sacred cows such as the limited liability corporation and to press policymakers to remove the distortions whenever and wherever we find them.

Limited liability, as Mercadente notes, is not an entirely natural phenomenon that would arise in a place with a sound government that maintained a fair justice system devoted to ensuring that people who harm others are held responsible and required to give just compensation:

[W]hile actually existing capitalism is superior to all other economic systems that have so far existed, and is therefore to be preferred to these systems, limited liability is not a natural feature of a free market. It is a state-created privilege that fosters economic centralisation and promotes corporate socialism.

A truly free market would not allow businesses to externalise their risks onto the rest of society. The solution is to abolish limited liability and restore full responsibility to business owners, as would be the case in a truly libertarian order.

Those of us who support market freedom should take this argument seriously and discuss it openly. Ending government-granted limited liability would cause much economic and social disruption and require great forethought and a wise transition plan. That is a practical concern. As a matter of principle, however, this government-granted privilege has not been proven to be an outcome of market forces, and it can be argued that it undermines markets and reduces public support for economic freedom.

The libertarian critique of limited liability fits the facts, fosters a greater respect for liberty, and would have immeasurably positive consequences in reordering economic activity toward natural, just, and scalable human relationships in the production of goods and services.

It would also have the highly positive effect of building a bridge between the free-market right and the cultural right, which would greatly advance progress on the political front. Let’s have that discussion.