Locking in Capital: What Corporate Law Achieved for Business Organizers in the Nineteenth Century

Abstract

This Article argues that corporate status became popular in the nineteenth century as a way to organize production because of the unique manner in which incorporation permitted organizers to lock in financial capital. Unlike participants in a partnership, shareholders in an incorporated enterprise could not extract capital from the firm without explicit approval of a board of directors charged with representing the interests of the incorporated entity, even when that interest might sometimes conflict with the interests of individual shareholders. While this ability to lock in capital has occasionally led to abuses, the ability to commit capital generally helped promote and protect the interests of shareholders as a group by making it possible for the entity to invest in long-term, highly specific investments. It also helped protect a wide range of enterprise participants who made specialized investments in reliance on the continued existence and financial viability of the corporation. The ability to lock in capital grew out of the fact that a corporate charter created a separate legal entity, whose existence and governance were separate from any of its participants. Although the idea that the law creates a separate legal person when a corporation is formed has been played down in the legal scholarship of the last two decades in favor of the view that a corporation is simply a nexus through which natural persons interact, recent legal scholarship has begun to reconsider the importance of entity status. Entity status under the law, and the associated separation of governance from contribution of financial capital through the formation of a corporation, allowed corporate participants to do something more than engage in a series of business transactions, or relationships, or even projects. It made it possible to build lasting institutions. Investments could be made in long-lived and specialized physical assets, in information and control systems, in specialized knowledge and routines, and in reputation and relationships, all of which could be sustained even as individual participants in the enterprise came and went. And these business institutions, in turn, could accomplish more toward the improvement of the wealth and standard of living of their participants in the long run than the same individuals could by holding separate property claims on business assets and engaging in a series of separate contracts with each other.