CORPORATIONS

CORPORATIONS. A corporation is an independent entity: it exists separately from its owners, the shareholders. Most corporations are businesses for profit that raise capital for corporate activities by selling shares of stock, which represent ownership and are transferable. There are also charitable, cooperative, municipal, and religious corporations, all of which have distinctive features. A corporation's shareholders elect the board of directors that hires the corporation's officers, who run the day-to-day business. For many purposes, the corporation is treated as if it were a person. The corporation can sue or be sued, enter into legally binding agreements, and own property.

One important element of the corporate form is that it allows for limited liability. The liability of individual shareholders is limited to the amount they actually invested, even if the corporation runs up large debts. However, there are extreme cases in which shareholders can be held liable for the acts of a corporation—a situation called "piercing the corporate veil." American courts have developed several criteria in determining whether or not to pierce the corporate veil. One factor the courts consider is whether the corporate action involves a contract or personal injury–type action, in which case the person affected normally has no choice but to deal with the corporation. The courts may also hold shareholders liable for corporate actions when the shareholders are involved in fraud or some other wrongdoing, such as siphoning off company profits. This occurs most often in closely held corporations, with very few shareholders and in which the majority shareholder plays a substantial role in company management. Other occasions on which courts have held shareholders liable are when the corporation was knowingly undercapitalized and when it failed to follow normal corporate formalities, such as issuing stock or keeping corporate meeting minutes.

One benefit that corporations provide is that they are freely transferable, with ownership interests in the corporation represented by shares that can be sold quickly and easily, without many limitations.

Origins of the Modern Corporation

The modern corporate form is a combination of two historical types of companies: the joint-stock company, actually a partnership between shareholders, and the traditional corporations that had originally been developed for medieval guilds, municipalities, monasteries, and universities in England. The first American corporations were monopolies chartered by the English Crown in the sixteenth century, with the intent of pursuing profit in the New World. Before the American Revolution, the London and Plymouth companies, Massachusetts Bay Company, and Hudson's Bay Company played a large role in establishing and supporting the European colonies. The royal charter of these companies allowed them to control governmental functions like customs regulation and terms of trade, as well as the formulation of foreign policy within their jurisdictions.

In the eighteenth century, corporations' exercise of essential government functions was curtailed and courts began to hold that the trade monopolies excluded fair competition from other incorporated companies. However, since companies who were incorporated at that time could lawfully compete with the monopolies, a great deal of economic activity was organized by single proprietors or partnerships under existing contract and property common law.

State Control of Incorporation

After 1776, the power to grant incorporation moved from the Crown to individual state legislatures. The interstate commerce clause in the U.S. Constitution granted incorporators the freedom to incorporate in one state without limiting their ability to transact business in other states. States eventually began to compete, liberalizing their laws to attract more requests for incorporation.

At first states passed a special act for each incorporation, but in 1811 New York enacted a general incorporation law that enabled the secretary of state to grant charters. The general incorporating statute enacted by New York was of limited application. The Connecticut incorporating act of 1837 was broader and more flexible, and New Jersey went on to create an incorporating act in 1875 that included a number of the provisions businesses had long sought from other states. But the privileges granted by corporate charters remained insufficient to facilitate the centralization of manufacturing that some businesses desired. In response, New Jersey enacted laws greatly liberalizing its 1875 act.

In the Dartmouth College Case of 1819 (Trustees of Dartmouth College v. Woodward), the Supreme Court held that an incorporation charter was a binding contract between a state and a corporation. Thus, the charter could not be altered without the corporation's consent. Since that decision, however, few perpetual charters have been granted and states have specifically reserved the right to alter or annul incorporation charters.

Individuals wishing to incorporate a business, or incorporators, must file an official document—called the articles of incorporation—with the secretary of state and pay a filing fee. The articles of incorporation must contain the corporation's name, a purposes clause, and form of capitalization (the number of shares the company plans to issue). Until the late 1880s, corporations were created for very limited and well-defined purposes, and the articles of incorporation would explain their corporate structure in great detail. In addition, the incorporators were forced to prove to the legislature that the corporation would serve a public purpose, should the state grant them the right to incorporate. In the twentieth century, though, corporations were allowed to provide a very broad purpose, and most companies used the phrase "to engage in any lawful business" or something similar.

The state in which a company incorporates is important, since the law of that state will control most matters, including acquisitions, mergers, and powers of the board of directors. At the end of the twentieth century, many businesses chose to incorporate in Delaware because of the state's extensive history of corporate formation and its finely tuned statutes and accompanying case law.

Growth of Corporations

The U.S. Constitution gives Congress the power to regulate commerce between the states and with foreign nations, a power that Congress used to charter national banks and transcontinental railroads in the nineteenth century. Congress has used its power solely to regulate state-chartered corporations through various federal rules, including extensive antitrust laws, rather than engaging in federal incorporation.

The end of the nineteenth century saw an unprecedented expansion and dominance of the corporate form. Large companies like the Standard Oil Company and United States Steel began to exercise monopolistic powers in their respective markets. Public concern over the abuses exercised by these behemoth corporations led to antitrust legislation, laws restricting business practices considered unfair or monopolistic and aimed at preserving competition. In 1890, Congress enacted the Sherman Antitrust Act to prevent interference with interstate trade and to promote a freely competitive market.

Between 1875 and 1893, the New Jersey legislature enacted a series of statutes intended to liberalize its 1875 incorporation laws. Previous legislation designated the geographical region in which a corporation incorporated in New Jersey could hold property and do business. In 1887, the state amended the law to allow foreign corporations to own real estate in New Jersey. Five years later, the state removed all restrictions on companies incorporated in New Jersey that were doing business outside the state. While earlier laws had restricted growth in other ways, the new revised laws greatly facilitated corporate growth and mergers. The revisions granted corporations the power to merge, increase amounts of capital stock, exchange newly issued stock for property, and purchase stock in other corporations.

In 1895 the Supreme Court declared that the federal government did not have the power to prevent a state-charted corporation from acquiring control of manufacturing plants producing 98 percent of the refined sugar in the nation (United States v. E. C. Knight Company). Combined with the liberal incorporation laws of New Jersey, corporate combinations that would have otherwise been considered restraints on trade were declared legal. A relatively few large corporations now controlled American industry, and with the simultaneous relative decline of agriculture, the American economy shifted from one organized primarily around small businesses to an industrial nation.

Antitrust Measures

In 1903 Congress reacted to the movement toward mergers and oligopolies by creating the Antitrust Division of the Department of Justice. The government also established the Bureau of Corporations, with the mission of investigating and publicizing the control of industries by corporations.

Largely based on the work of the Bureau of Corporations, the Supreme Court ordered both the Standard Oil Company and American Tobacco Company to be dissolved in 1911. Woodrow Wilson became governor of New Jersey that same year, and began mounting an effort to return to a more restrictive approach to incorporations. In response, companies began leaving New Jersey and incorporating in Delaware, which had liberal statutes very much like those of New Jersey prior to the restrictive measures. When New Jersey later amended its statutes to undo the Wilson-era reforms, many of the corporations that had moved to Delaware could find no reason to move back.

In 1914 Congress passed the Clayton Antitrust Act to supplement the Sherman Act. This new federal law included specific provisions prohibiting the contract tying, exclusive dealing contracts, mergers, interlocking directorates, and price discrimination that tended to lessen competition or create a monopoly. But in 1920, in the United States Steel case, the Supreme Court sanctioned a corporate structure in which one company controlled about half of the steel industry. Thirty years later, the federal government again strengthened the law on corporate mergers and acquisitions with the creation of the Celler-Kefauver Act.

The federal government continued strengthening corporate regulations with the creation of the Securities Exchange Act, regulating the use of manipulative or deceptive methods in the purchase or sale of securities (the stocks, bonds, notes, convertible debentures, warrants, or other documents that represent a share in a corporation). The Act's original intent was to prevent company insiders from making false statements about a company's health, so that they could buy shares of stock at lower prices. It was not until later in the century that the practice of receiving inside information to buy and sell stocks for the largest gain became common.

Despite the original requirement for corporations to serve the public interest, the public's confidence in corporations began to wane in the 1960s. Labor unions and collective bargaining grew in response to public wariness around corporations. In the 1960s and 1970s, the power of corporations over the lives of consumers also elicited the growth of public interest law firms, class-action suits, and organized political and educational activities by groups of consumers and environmentalists.

The Rise of Conglomerates

Eventually, another form of corporation would emerge. Conglomerates are corporations that consist of a number of different companies operating in diversified fields, often only indirectly (or not at all) related to other corporate divisions. Conglomerates became increasingly popular during the late 1950s and early 1960s because such entities could make acquisitions and grow, yet maintain immunity from the antitrust prosecution that companies faced when making acquisitions in the same line of business. Thus businesses that were constrained within their own industry were able to freely expand into different markets.

Some of the traditionally powerful American corporations began to lose their influence in the late 1960s. The government continued strengthening its antitrust efforts, launching attacks on various conglomerates that misstated earnings. The federal government turned its attacks on IBM in 1969 and AT&T in 1974. In addition, the increasing ease of travel for business contributed to a global economy with increased market competition. As industry internationalized, American business transformed. Competition for American dollars moved from a national to a multinational stage. In fact, almost all of the largest American corporations at the beginning of the twenty-first century operated in world markets directly or through subsidiary corporations.

Modern Corporations

By the 1970s, a handful of communications media, education, research and development, computing machines, and financial and real estate companies accounted for as much as 40 percent of the country's gross national product. Microsoft, a developer of personal computer software systems and applications, was formed in 1975. The corporation moved to the front of the software market in the 1980s when its operating system became the standard for personal computers across the country. By 1993, its newest operating system release was selling more than one million copies per month. Three years later, its net income topped $2.1 billion, and it could be argued that Microsoft is the corporation that had the largest impact on American history in the twentieth century. However, the company faced charges of unfair competition and a Department of Justice investigation in 1994. In 1996, the Department of Justice reopened its investigation and, following a 30-month trial, found the corporation guilty of antitrust violations and ordered its breakup. An appeals court overturned the breakup order, but found the company guilty of trying to maintain a monopoly.

Enron Corporation, formed from the merger of natural gas pipeline companies Houston Natural Gas and InterNorth, was exposed for inflating profits in 2001. A Wall Street Journal report disclosed that Enron took a __BODY__.2 billion charge against shareholder equity. Shortly thereafter, Enron announced that it had overstated earnings by almost $600 million, dating back four years. The Department of Justice opened a criminal investigation and found that the company actually inflated profits by __BODY__ billion. The government also indicted Enron's accounting firm, Arthur Andersen LLP, for obstructing justice, based on evidence that the company in appropriately shredded documents related to the Enron bankruptcy.

Not long after Enron's questionable accounting practices were revealed, WorldCom, Incorporated, disclosed that it had hidden __BODY__.2 billion in losses by failing to report $3.85 billion in expenses. The Securities and Exchange Commission (SEC) charged the long-distance telephone and data services company with fraud. The company's cofounder and chief executive officer resigned amid an SEC investigation that included questions about $366 million in personal loans from the company. Shares of WorldCom, which had flown to $64 in 1999, dropped to $.09 by July of 2002. Under the weight of both $30 billion in debt and the federal investigations, the company filed for bankruptcy, becoming the nation's largest company to ever declare insolvency.

In July 2002, as the American public voiced concern around corporations and their apparent disdain for the public interest, the U.S. stock market tumbled and the government again pledged to investigate corporate activities. The SEC began investigations of Qwest Communications International, Inc., Global Crossing Ltd., and other corporations. As more scandals of spurious accounting practices emerged across the country, some experts marveled at the irony that the increased competition resulting from antitrust legislation may have encouraged certain companies to cross the line of legality in order to remain viable.