Legislating mandatory corporate death

I didn’t really expect that my recent posts about the somewhat indeterminate aims of the “Occupy …” protest movement would result in a lively discussion thread about what I imagined was the entirely uncontroversial proposition that the limited liability corporation is by and large not only a positive thing but a key element of the modern capitalist economy.  For Socialist Alliance types and at least one ultra-libertarian, it isn’t uncontroversial at all (though for almost diametrically opposing reasons).

I was discussing this with my CDU Law School colleague Geoff James over lunch a couple of days ago when he mentioned a corporate regulatory policy idea that I hadn’t heard before.  Given that the corporation is a “fictitious legal person”, Geoff said, why not take the analogy to its logical conclusion and legislate a mandatory corporate lifespan?  After (say) three score years and ten all corporations would be compulsorily liquidated and their assets and business undertaking sold.

Apparently this was a policy of the old Australia Party founded in the 1970s by eccentric transport tycoon Gordon Barton.  Be that as it may, it’s an interesting if fairly radical idea.  I’d be interested in the reactions of the diverse Troppo readership, especially the economists among us.

In a sense, it would bring the corporate structure more in line with that of trusts, which once had a maximum life span (perpetuity period aka rule against remoteness of vesting) delightfully defined as a “life in being and twenty one years”.  That equitable description gave rise to the equally quaint drafting convention of maximising the duration of any trust instrument by providing for vesting on the death of the “last currently living heir of Her Majesty Queen Elizabeth II”.  Sadly, most states and territories have now legislated for a more prosaic perpetuity period of 80 years or thereabouts.

Legislating for a maximum corporate life span might also be argued to enhance the prospects for business growth and productivity through harnessing Schumpeter’s notion of “creative destruction” as the principal engine of capitalist growth and renewal.  However it may be a bit more complex than that, as Arthur Diamond discusses (extract over the fold).

Schumpeter’s central message is that the process of creative destruction describes the form of competition in capitalism that is capable of dramatic improvements in the quantity and quality of our lives (Diamond, 2004). …

In Capitalism, Socialism, and Democracy, Schumpeter had a lot to say about his process of “creative destruction,” not all of which is given equal emphasis by those using the phrase today. Here, I will distinguish two accounts of the process of creative destruction: Schumpeter’s original ‘big-is-better’ account, and a more recent ‘small-is-better’ account. The process of creative destruction, in both Schumpeter’s original, and in the more recent account, is a process in which technological advance is the main source of economic growth and improvements in the quality of life. In both accounts, a significant part of the incentive to produce leapfrogging innovations is the prospect of achieving monopoly profits. Traditionally the main source of monopoly profits would have been through patent rights. But currently a full account of monopoly profits would also include network externalities as a source (as with eBay and Microsoft).

Beyond what the two accounts share, Schumpeter’s original ‘big-is-better’ account also claimed that large, monopoly firms are the most able and the most likely to produce new, leapfrogging innovations. This version is the one usually, but not always1, associated with Schumpeter’s own views. The ‘small-is-better’ account identifies smaller, often start-up, firms as the most likely source of new leapfrog innovation. I argue elsewhere (2004) that the ‘small-is-better’ account is what the vast majority of authors have in mind when they apply the phrase “creative destruction” to competition among computer and internet related firms.

Schumpeter’s claim was that the new process or product that results from a dynamic leapfrogging innovative competition, is more important in understanding capitalism, than the static standard model of price competition that emphasizes unconcentrated markets as the means to lowering prices, where the goods and the technologies are assumed constant. If one set of rules (standard price competition) maximized one good result (lower prices for consumers); and another set of rules (creative destruction) maximized another good result (new products), then we would have to measure the utility produced by each of the good results, which is very hard to do. What if the creative destruction is not only best at producing new products, but also, in creating new processes, is also best at lowering prices for consumers? Then we would know the essential fact about capitalism, without having to decide whether consumers benefit more from lower prices for a constant set of goods, or from a set of goods of higher price, but of increasing variety and quality.

 

About Ken Parish

Ken Parish is a legal academic, with research areas in public law (constitutional and administrative law), civil procedure and teaching & learning theory and practice. He has been a legal academic for almost 20 years. Before that he ran a legal practice in Darwin for 15 years and was a Member of the NT Legislative Assembly for almost 4 years in the early 1990s.
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Paul Frijters
Paul Frijters
10 years ago

there is some intuitive merit to setting a limit on corporate life-spans, though I would say the real merit is not for creative destruction reasons, but rather for reasons of political economy: long-lived entities such as, say, Dysney, get very adept at getting politicians to do their bidding at the expense of the rest of society via, say, lengthier and lengthier IP rights. If you arrange for a timely death of the entity you will also reduce the rent-seeking activities that have such negative externalities on the rest of us. In order to acknowledge this fact as important one has to buy into a view of regulation as being as much driven by market forces as it is by paternalistic forces.

From within neo-classical economics you would expect such rules to have no effect: companies close to their execution would simply go into death-house constructions whereby new corporate entities looking identical to the old one take over all its assets. That is very hard to police (and why would politicians help you enforce the death of what seems to be a perfectly healthy and politically clouty company?), though I dont know about how this goes with trusts.

Hence, quirky idea with some intuitive merit but forget about it.

Andrew Norton
10 years ago

I’m not sure I see the intuitive merits, but it raises similar issues to the philosophical question of to what extent you are the same person at 70 as you were at 20 or 10? The bare fact of legal incorporation may be the only thing that is continuous over decades of corporate existence. Companies change industries, create completely new products, etc. Plus there is likely to be 100% staff turnover, so why should people who joined late lose their jobs?

Pedro
Pedro
10 years ago

Creative destruction occurs because business are out-competed, not because they are closed by fiat. I think you would get a fair bit of uncreative destruction happening. How many important and still useful companies are more than 80 years old? Paul’s anti-corruption justification would be better achieved through improving the quality of our elected public servants.

If I remember from law school, trusts are time limited to prevent the locking up of land, which is now an outdated public policy need.

whyisitso
whyisitso
10 years ago

what extent you are the same person at 70 as you were at 20 or 10?

As anyone in the 99% will tell you, wisdom is like testosterone. It reaches its peak at 16 and declines steadily thereafter; of course in some cases the pace is faster than others. For example Homer has completely exhausted his supply of the former already.

desipis
10 years ago

You could also make it more gradual. Have it start out young and healthy with the shareholders 100% in control of the corporation, but then every year transfer 1% of the control of the corporation over to the community/employees/etc (but not necessarily the dividend rights). Once the community gets enough voting power it can vote to liquidate the corporation, or even just modify it in a way that suits them. That way after a certain amount of time the corporation it needs to continually justify itself to the community in order to continue to exist.

Andrew Norton
10 years ago

Ken – Who might also have only been there a short time. There doesn’t seem much point in having a rule to achieve what natural turnover will generally do anyway, but more gradually and with stronger reasons than some arbitrary death date.

desipis
10 years ago

If the goal is renewal at the board level then you could just impose term limits on board members.

Alan
Alan
10 years ago

“That, if it had been my good fortune to come into the world a STRULDBRUG, as soon as I could discover my own happiness, by understanding the difference between life and death, I would first resolve, by all arts and methods, whatsoever, to procure myself riches. In the pursuit of which, by thrift and management, I might reasonably expect, in about two hundred years, to be the wealthiest man in the kingdom. In the second place, I would, from my earliest youth, apply myself to the study of arts and sciences, by which I should arrive in time to excel all others in learning. Lastly, I would carefully record every action and event of consequence, that happened in the public, impartially draw the characters of the several successions of princes and great ministers of state, with my own observations on every point. I would exactly set down the several changes in customs, language, fashions of dress, diet, and diversions. By all which acquirements, I should be a living treasure of knowledge and wisdom, and certainly become the oracle of the nation.

The clever Luggnagians, by Gulliver’s report, decided they did not want all the wealth in their kingdom held exclusively by struldbrugs so they legislated that a struldbrug would lose all property to their heirs at 80.

Richard Tsukamasa Green
Richard Tsukamasa Green(@richard-green)
10 years ago

I think there is also a case wrt corporate governance and principal agent problems. New corporations may have less problems than old ones. They need to have either a dominant or majority shareholder (for instance the founder) who is either the CEO (and thus faces no principal agent problem) or owns enough that when they exercise their control over the board it is in the interests of shareholders in general. Alternately they need a corporate constitution and voting set up that cedes enough control to shareholders in order to attract them to the firm in the first place and obtain capital. However as time goes by, shareholdings become more disparate or held by passive and institutional investors and the ability to change voting set ups, create poison pills and gerrymanders and hold AGMs in obscure hard to reach places and rent seeking, suboptimal management and excessive remuneration becomes easier (see News Ltd, QANTAS etc.). Subsequently we can have large amounts of physical capital and going concerns that are not being operated efficienctly but the accumulated debris in the corporate structure prevents market discipline from operating via shareholder democracy or by the threat of takeover.

The hope would be that newly created corporations would be clear of the debris and perhaps even compete by offering things like electronic and binding votes on directors and remuneration and physical capital, going concerns and the like more efficiently allocated. Executives and directors in firms approaching death would be mindful that their future careers and remuneration rely on demonstrated virtue rather than networking on the director merry go round that appoints the same faces to each others boards or hiring the right remuneration consultant.

Tel
Tel
10 years ago

Me and that other ultra-libertarian, Adam Smith, who precisely identified the problem long before any of us were born.

But I’m open to suggestions. I dispute entirely that the Socialist Alliance type people have diametrically opposing reasons for disliking limited liability. Both the “Tea Party” style protesters, and the “OWS” style protesters recognise that there is a genuine problem with risk management in our society. Even people like Desipis (seems like a fairly mainstream SNAG) are willing to profess the problem is real, we merely disagree as to how to approach a fix.

It’s pretty easy to stick a hand up and go, “Waaa! There’s a problem!” but it’s damn difficult to be sure about the next step forward.

Now if government regulators actually did their job, then we would have a system where unsuccessful corporations would waste away to a natural death, but overly successful corporations would grow until the anti-monopoly squad cleaved them in twain with an axe (just like the broom in Sorcerer’s Apprentice)… and the remaining two halves (wholesale and retail I guess) off and go about their business in a healthy competitive manner. But P.J. has something to say:

When buying and selling are controlled by legislation, the first things to be bought and sold are legislators.

Oh yeah, I remember now, the government regulators never do their job. Rats! Need to find a different fix then…

fxh
fxh
10 years ago

I’m sure I’ve seen some research which shows that most companies don’t last very long at all – the figure for most was far, far less than three score and ten.

Your legislation would be redundant

Corin
Corin
10 years ago

This is governments taking a gun to a fight between third parties and shooting the elderly companies first so the young companies have less to worry about! I don’t see why you discount the value of institutional knowledge as well. I accept that there should be more vigorous competition in the economy, but really is the way to do that to set the clock to year zero for companies when they get to a certain age! I think you end up with less competition, not more, more often. I also take issue with the destruction of private wealth without a demonstrable need or legal wrong having committed to justify this.

Nicholas Gruen
Admin
Nicholas Gruen(@nicholas-gruen)
10 years ago

Ken, I’m not sure I see much sense in it. As companies aged the incentive to maintain them would fall away so they’d slowly decline into either deception (transferring their assets – which, remember, will often be intangible and so virtually impossible to keep an eye on) or would zombify themselves towards the end, which would be pretty bad for all concerned.

It’s a bit like saying that trademarks should be limited in tenure. They’re not there to reward innovation, they’re there to assist in identification. In this case a company is a structure to enable limited liability legal persons to be constructed. If it makes sense for them to exist for a while, I’m not sure why it makes sense for them to be euthanised.

Shann Turnbull has been hawking around the idea of naturally decaying equity – so that one loses a share of equity each year one holds it – with it reverting to others – stakeholders and/or the state. It’s quite interesting to think about, but at least from what I’ve seen, his work doesn’t really demonstrate why it’s a particularly good idea – or if it is why it is better than the equivalent tax on the company.

Peter Patton
Peter Patton
10 years ago

Ken

Just quickly O/T that CDU post of yours on the Bolt case was one of the best pieces I have ever read on the Australian blogosphere. It should be compulsory HSC reading, with the majority of Australia’s superior court judges would do well to read it many times, slowly, more urgently those legal personages who were closest of all to the action. And for god sake bloggers, study it for what makes a quick post, a great post, and why it takes so much longer to write a short post. Clearly, more fires have been lit, than they hoped to extinguish.