The Natural Right to Form a Corporation

A Parable about Hobbits to Illustrate How Advanced Business Organization is Rooted in Basic Justice

The corporation. It is the most potent and beneficent institution of our age. My purpose here is to legitimize it, and also, to abolish it. 

No, just kidding! Or mostly kidding. What I advocate is not so crudely paradoxical as that. Still, it will probably strike many as rather schizophrenic. Let me explain…

Interruption: Thanks for the Money!

But actually, let me first mention a completely unexpected thing that happened: after my last post, people paid me. I didn't ask for any money and hadn't even set up a payment system. They pledged money spontaneously, and Substack prompted me to set up a way to accept payments, so I did.

It might be a one-off, but it's very encouraging. I pretty firmly plan to keep this blog completely free and public forever, but the benefit to subscribing, aside from the moral satisfaction you might get, is that I'm more likely to keep writing, and oftener, if people pay. At one level, a little more money for Chinese takeout means another hour or two to write instead of cooking. And the signal that other people value my writing makes it seem worthwhile.

I have a conjecture that the world would be a better place if everyone resolved to spontaneously pay at least half of the value they get from anything they buy, regardless of the stated price. I don't expect others to live by my eccentric theory, and anyway, there's so much writing around, much of it free to read, that the marginal value of most writing might be near zero, even if the writer is pretty good. But if you can afford it, and if something I've written changed your outlook about something, consider paying.

For my part, I'll make sure I write another post any time someone pays (unless I get famous and that becomes infeasible). I'll probably keep writing anyway, but I'll make double sure to do that if people make a lot of pledges. Let's say I'll treat anything readers pay me as an advanced payment for future writing.

Back to today's topic…

On Corporations

So, first, what I mean is that I will not only uphold the legitimacy of corporations, but show why corporations' legitimacy arises from natural law, not merely from positive law, and why corporations are more legitimate than any government. When governments recognize corporations and enforce their rights, they are not merely prudently adopting an instrumental policy to promote economic development, but respecting basic justice.

Second, however, I seek to abolish the shareholder value maximizing corporation, not through law and policy, which would be unjust, but through moral suasion. Corporations should not be narrowly selfish for more or less the same reasons that individuals should not be narrowly selfish. When corporations organize the efforts of lots of people for no higher end than to maximize profit or shareholder value, they corrupt us, and sell our moral potential short. And so I appeal to everyone, but especially to business leaders and aspiring business leaders, to deal a quiet death blow to the institution of the shareholder value maximizing corporation by refusing to run companies that way, and to a lesser extent by trying to avoid working for, investing in, or buying from companies which are run that way.

This appeal may sound very quixotic. Yet I think, on the contrary, that the change is already underway, though arguably it's happening in too clumsy, cowardly, and conformist a way. I want to make the transition more intelligent, deliberate, honest and teleologically sound by defending it at the level of principle. But I think the pivot away from profit maximization, far from being impossible, is probably more or less inevitable. It's more historically normal, because it's generally more prudent, for selfish people and institutions to be hypocritical than nakedly selfish. I think it's likely that the shareholder value maximizing corporation will only have been a phase, after all. Of course, hypocrisy is not what I'm advocating for. I want corporations to transition not from naked selfishness to hypocrisy, but from naked selfishness to virtue.

But that's for the next post. In this one, my business is to show why there is a natural right to form a corporation.

The Shire as a Laboratory of Natural Law (and a Digression About Tolkien)

I'm going to illustrate the nature and origins of the corporation by means of a parable set in the Middle Earth of JRR Tolkien, specifically the Shire, and I want first to explain why.

First is the familiarity of it. This means a little more than merely that lots of people have read Tolkien's books. There's something about Tolkien's world that speaks to the heart. Why do so many of us feel more at home in Hobbiton than in our hometowns? What is it about reality that Tolkien has captured so well in his fantasy world? The world has much more to learn by drinking deep from Tolkien. I won't do much of that here, but every little bit helps.

Second, the pleasant old Shire turns out to be an excellent Imaginative laboratory for the study of natural law because it's a land where people live in peace without, apparently, any government. Oh, I know there's a do-nothing mayor of some sort, and some sort of reeves who rove about, and in certain places, occasionally, some sort of boundary sentries employed by prominent families to ask questions of travelers. But there is no king, no legislature, and above all, no violence. There are customs, certainly. There are property rights, because property rights are not created by governments but arise from natural law. But nothing like a Weberian or Hobbesian state claiming sovereign authority and a monopoly of violence is remotely compatible with the Shire as it is depicted in Lord of the Rings. Casually, unassumingly, in the background of his great epic, Tolkien has sketched a wholesome anarcho-capitalist utopia.

I'll take advantage of that, and use it as a setting for a tale that illustrates the natural right to form a corporation.

I'll be assuming you've read The Lord of the Rings, and if you haven't, I strongly advise you to stop reading this post and go read Lord of the Rings immediately. It's an extremely enjoyable experience, but also, I see it as a kind of civic duty. It's good for a nation, or the world, to have a common cultural currency of books that we can assume that people have read. It helps to raise the level of conversations, and knits society together. School is supposed to do that, but the decline of the Western "canon" and general multiculturalism and ignorance have largely eviscerated the schools' ability and willingness to supply a common cultural currency of great books. School-assigned reading material is too diverse to be focal, and much of it is rubbish. Meanwhile, among the books the general popular culture has latched onto, none is greater than The Lord of the Rings. It seems to be especially popular among the Christian counterculture. So read it!

The phrase "natural law" will strike many people as odd, implausible, spooky, and vaguely medieval. A lot of people will think they don't believe in that. But such disbelief is only skin deep. Should people kill you? Should they beat you up? Should they steal your stuff? Everyone agrees: no. And they might add that it's against the law. But what if it weren't against the law? What if some wacky government declared murder or beating or theft, legal, either in general, or maybe against you in particular as a persona non grata? Should people kill you, or beat you, or steal from you, then? Surely everyone will agree: No, they still shouldn't. Why not? Natural law. It is mysterious and metaphysically difficult, but it's also indispensable, inescapable, common sense.

While the reality of natural law can't ultimately be denied without descent into a nihilistic moral relativism that most people will instinctively and wisely shun, the content of natural law takes a lot of difficult discernment. Stories can aid intuition. So follow me to the Shire, where the good hobbit comrades of the old fellowship of the Ring have returned home from their great adventures and are making their livings.

The Bag End Apple Company: A Case Study in the Nature and Emergence of Corporations

After Frodo departs, sailing west from the Grey Havens to Valinor, Sam Gamgee decides to plant an apple orchard at Bag End. He plant some trees in the first year, some more in the second, as time allows, and so on in the third, fourth, and fifth, until it has become quite large. In the sixth year, he starts getting a real harvest, and it grows rapidly thereafter. 

Sam finds he can't keep up with the work of harvesting and selling the fruit. He hires helpers, but that means paying their wages before he gets the proceeds from apple sales. His savings are limited. Also, he's not sure beforehand how many he'll sell, and at what price. One year, he loses money. The next, he's more cautious, fails to fully harvest the crop, and disappoints his customers by running out of stock, even as good fruit is left to spoil on the ground. He needs to do better.

So he turns for advice to his friend Pippin Took, who quickly offers to lend him the money to pay wages in advance. Sam's afraid of coming up short, and Pippin says not to worry about it, but Sam's still uncomfortable undertaking a debt that he's not sure he'll be able to pay. Meanwhile, Pippin has lots of other ideas. Why not get a press, and produce cider? Why not dig a root seller for winter storage? And some of his apple trees are of superior quality, and the fruits would be in demand in other towns. Why not export? Pippin would love to be able to buy Sam's delicious apples in his hometown of Tuckborough. Sam objects that he doesn't have enough apples to satisfy even his current customers. Then plant more trees, says Pippin. A lot more. But that takes more money, and again, Sam's afraid to go into debt.

But they soon settle on a solution. Pippin will provide Sam money to expand, not as a lender, but as an investor. Sam will also earn a wage as the manager. That's only fair, since he's expected to do most of the work. But Pippin will have a continuing say in how the business is run, how it uses its money, and what ventures it undertakes.

In short, Bag End Apple Orchard will become a partnership.

With this agreed, Sam gets a large dollop of money from Pippin, and goes home to put it to work. He plants more trees in the spring, and then, in the fall, hires workers to help him with the harvest. He buys a cider press, starts experimenting, and makes some delicious stuff to drink. He asks friends to get the word out to grocers, and some come for taste tests. The crop gets bigger every year, and demand more than keeps up with supply. Year after year, Sam hires more workers for the harvest, and he keeps some on staff year round, pressing cider, planting, pruning, and weeding. Pippin comes to visit sometimes. Once he gives more money, but in the fourth year of the partnership, Sam is so flush with cash that he tells Pippin to take some of it back. The Bag End Apple Company has paid its first dividend.

Sometime after this, Sam and Pippin go to visit their friend Barliman Butterbur, the innkeeper at Bree. After chatting for a while about old times and sharing news, Pippin opens his pack, and with a twinkle in his eye, pulls out a bottle full of rich, golden liquid.

"Try this!" he says.

Barliman takes a sip, trembles with excitement, then takes a long drink. Then he almost jumps in the air with glee as he declares:

"I must have this for my customers! What extraordinary flavor! Can I buy it?"

Sam and Pippin put Barliman off at first, but when he presses them, a long conversation begins about how it could be done. They would need increased volume. More presses. More workers. Regular wagon loads of bottles traveling east. It would be nice to have a backhaul for the wagons, to split the cost. Was anybody running regular trade over the main road these days? Etc. They can't work out all the details immediately, but it's fun to think about, and seems promising. 

One thing is clear anyway, though. It will take a lot of money. Barliman has a lot of cash, and is glad to help, but Sam and Pippin don't see why Barliman should give them money for free. And yet they don't want to be debtors, either. Since Barliman's main interest in the business is to get the cider, a pre-order arrangement suggests itself. But Sam and Pippin are even less comfortable with that, since they're far from sure that they'll ever succeed in setting up a manufacturer and export business that can deliver to Bree. So in the end, Barliman, too, comes in as an investor, giving money in return for a share of the profits, if any, as well as a loose first claim on the company's hoped-for apple cider exports.

But will Barliman have a say in the Bag End Apple Company's decisions? That's a bit delicate. Sam and Pippin think he should, in principle. But it's not practical to include him much, since Bree is far away, and Barliman is busy. So the friends decide that Sam and Pippin will make their own decisions, keeping Barliman reasonably informed and trying to consult him occasionally. Pippin promises to strive to represent Barliman's interests when he consults with Sam.

At this stage, the Bag End Apple Company is, in effect, a joint stock company, with Sam as the manager or CEO, Pippin as the board of directors, and Barliman as a voting shareholder.

Sam and Pippin go home and start to execute their new expansion plans, but they soon discover that they didn't anticipate all the expenses involved, and they need more money. All the prospects are good, and they're not worried. They're sure Barliman would give them more money, but a trip to Bree is inconvenient. Meanwhile, their friend Merry Brandybuck has just come back from some profitable adventures with his friend King Eomer of Rohan, and is visiting to see if any of his cousins or nephews want to join him in the life adventurous before he returns to Rohan. He'd also like to unload some extra cash that he doesn't want to carry. And a loan to the Bag End Apple Company sounds like just the thing. But he's not interested in ownership or dividends. That's too complicated.

This time, Sam and Pippin are okay with borrowing. Their plans are far enough along that they're confident of having good cash flows in the near future, amply sufficient to pay back the loan in a reasonably short time. However, one thing must be made clear first.

Sam and Pippin know that business is risky. Fire, insects, or an invasion could ruin their business. They think Barliman is aware of that, and that he wouldn't hold it against them if they lost his money through misfortune. But he wouldn't understand it if, in addition to losing his investment, someone went to him and asked him to pay additional money to cover the Bag End Apple Company's unpaid debts. So they want to make sure that Merry's claims in return for the loan extend at most to the entire assets of the company, and that they can reassure Barliman that his personal assets won't be jeopardized. Merry says that of course he would never demand repayment from his friends if misfortune ruined their company, and insists that the same protection extend to Sam and Pippin as well as Barliman. 

At this point, the Bag End Apple Company has become a limited liability corporation.

More years pass, and the apple company continues to thrive. Now there are acres and acres of trees, dozens of harvesters in the fall, warehouses of apples and warehouses of cider, large cider mills with a production line that stays busy until deep in the winter processing the fall crop, wagons carrying apples and cider to half the towns in the Shire, and a continual stream of wagons full of bottled cider rolling eastward to Bree, to fill Barliman's sellers with a favorite drink of thirsty travelers at the Prancing Pony. People come from miles around to ask Sam's advice about growing apple trees, and he's started selling apple saplings to them as well. Merry has long since been paid back, and Barliman gets regular dividends for the investment he made long ago. Other people envy Barliman for those returns, which have long since paid back multiples of what he invested, and will apparently keep on coming forever, without any work on his side. Pippin keeps busy, too, acting as an agent, salesman thought leader, recruiting workers, making deals, and keeping in touch with investors. Sam pays him various commissions and consulting fees, but mostly, as part owner of the company, he's working to keep the company on the right track so that his own dividends will keep flowing, aside from friendship and the fun of the thing.

Then big news breaks. King Aragorn of Gondor, far away in the south, is undertaking a war to liberate the Haradrim of the east from their evil sorcerer-king, and he needs the help of all his knights. One of those knights is Pippin, who swore fealty to the steward of Gondor during his great adventures long ago. So Pippin must ride to the aid of his friend King Aragorn, and that takes money, especially since Pippin has a fancy to bring with him a troop of hobbit warriors and win glory for the Shire. But Pippin doesn't have nearly enough free cash to live up to his big dreams. So he thinks hard, and consults with Sam, about what the Bag End Apple Company can do for him.

The company has almost enough cash to satisfy Pippin, and could easily raise enough by selling a wagon or two, and a bit of land it's not using. Or it could borrow. But Pippin doesn't have any straightforward right to take cash out of the company for his personal use. That wouldn't be fair to Sam or Barliman. If Pippin also relinquished his claim to future dividends, in favor of his partners, that might secure their interests well enough. But how will the company do without his help? Yet of course, Pippin's own person and labor are his to dispose of, so the company will have to deal with the loss of them somehow. Meanwhile, while Pippin now wants out, there are plenty of others who want in, either as investors or managers, and some of them have a lot of money and or/talent to offer. Can that help? How? How should they sort all this out?

Eventually they decide that Pippin's ownership stake in the company should be put up for sale, and sold, more or less, to the highest bidder. They figure the new owner ought to have a vote in how the company is run, so they decide to set up a board of directors, tasked with overseeing the business and making sure that shareholders' interests are properly accounted for. After all, Sam won't always know what shareholders want, and he might make mistakes. When they let Barliman know the new arrangements, he says he'll probably sell his shares too, since he never especially wanted to be an investor, just to buy cider. So they organize a share auction, also known as an "initial public offering" or IPO, Pippin and Barliman cash out, and Sam now has a new set of investors to answer to. 

Sam is now a minority shareholder in the company he founded, and investors could choose to oust him, which is both discombobulating and comforting. After all, a lot of people depend on the company now, and he would hurt a lot of people if he ruined it by unknowingly making some bad decisions. It's a good thing if the new investors will prevent that by firing him as CEO if he screws up. And since Sam owns quite a few shares of the company himself, and there is now a market for the company's shares, Sam has more liquidity, and his financial interests are pretty well aligned with those of the new investors. If he gets ousted in favor of a smarter manager who increases profits, he'll be all the richer.

At this stage, the Bag End Apple Company has matured into a public limited liability corporation.

Takeaways 

What's the point of the parable? First of all, simply to educate. This is an example of how businesses grow. They need to diversify their financing, to expand their scale of operations, and to plan long-term. Different forms of business organization or adapted to different stages in company growth. The Bag End Apple Company could be making shoes, furniture, farm tools, haircuts, or whatever. It could be in America or England or Germany, Japan or India or ancient Rome. Some adaptation would be needed, but many principles  would cross-apply.

But second, of course, placing the tale in the Shire underscored the lack of any inherent need for the government to play a role in this process. Licenses and charters and courts to enforce contracts may be necessary in some jurisdictions, and may be helpful even where not necessary, but the whole thing can be done, in principle, with nothing more than private promises, and doesn't need any special interventions of the lawmaker to make it possible. The Bag End Apple Company is a proof of concept for that. And if a government does serve as a third-party enforcer for a company's contracts and property rights, it's not doing any special social engineering, but just basic protection of natural rights.

That said, third, it may be a bit implausible that a bunch of hobbits could think all this up and then spontaneously stick to their agreements enough to make it work, with no government protection. We know perfectly well by conscience and common sense that you shouldn't steal and rob and you should keep promises, but not everybody does that, so we're glad there's a police force in town to intervene when they don't. Companies, too, are glad to have a good government around to keep them safe in a world prone to violence and injustice. The difference is that ordinary conscience and common sense aren't quite enough to support the elaborate arrangements of joint stock companies and public limited liability corporations. For that, we want moral reasoning to be codified in law, and legislatures and governments need to get pretty sophisticated to deal with it all. 

And that's why there's some wisdom in the ugly oxymoron "state capacity libertarianism." Even the basic governmental business of enforcing property and contracts starts to require a lot of sophistication and skill in an advanced capitalist economy where specialization, trade, and investment are managed by sophisticated commercial firms.

But fourth, there's a larger point here. Not only are corporations legitimate. Not only can they emerge and thrive, in principle, at least, in a pre-political state of nature. But they're legitimacy is superior to that of even the most democratic regimes. Remember what Thomas Jefferson wrote in the Declaration of Independence:

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.--That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed… (my emphasis)

It's the foundation of liberal democracy, the first tenet of the American creed, channeling the ideas of Locke that also undergirded the liberal constitution of modern Britain, which along with America has won the world wars and been the model, bastion, and champion of liberty for three centuries, inspiring emulation all over the place. What else could the legitimacy of governments be based on? Divine right of kings? Pagan gods? Nobody believes that anymore.

But consent is a myth, or at best an aspiration. The governed didn't really consent. I didn't sign a social contract, did you? And yet these corporations, these wonderful republics that produce most of our stuff and are the key to the prosperity of wealthy democracies, really are based on consent. Nobody works for them, invests in them, or buys from them without agreeing to do so. Anyone who wants to can exit them at any time.

That's why corporations are not only legitimate and grounded in natural law, but are superior to governments, even the most democratic, in their legitimacy. But as I'll explain in the next post, they are vitiated by an unfortunate creed of collective selfishness, which sadly reduces the good they can do.