Worry about cops now, corps later

Anti-corporate types often seem to miss the ways in which government agencies are just as bad or worse than large private corporations. And anti-government types often seem to miss the ways in which large private corporations share some of the same problems as government. Arnold Kling lampoons both nicely:

Large organizations, in the private sector and the public sector alike, are inherently dehumanizing to employees, clumsy, inflexible, and unable to handle sudden new challenges. In addition, public sector organizations are hampered by political constraints and the stultification that comes from the absence of competition. In the private sector, the pressure of competition means that the surviving large organizations tend to be slightly less dysfunctional than those that go out of business.

"Slightly less dysfunctional" - now there's some pleasantly non-pie-in-the-sky libertarianism! Read the rest of his piece too, its good stuff.

I sometimes use a different version of this to argue with liberal friends who are fans of decentralization: If you're going to hate and fear big power structures, shouldn't you hate and fear the biggest and most powerful ones the most? Microsoft and Nike just determine what OS and shoes I wear - the BATF, DEA, cops, etc determine whether I live or die, whether or not I'm in jail, whether or not I'm allowed to keep my property...

I'm willing to start worrying about corps instead of cops as soon as the former are the biggest threat.

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I've tried to talk about

I've tried to talk about public choice theory with liberals. It seems like such a great way to break through to them: I too worry about the power of large corporations, but regulating industry just guarantees that those corporations that can afford to lobby the government have the legal power to dominate their small and less politically connected rivals.

Unfortunately, it induces cognitives dissonance and gets ignored.

Patri-- Nike determines what

Patri--

Nike determines what shoes you wear? I doubt it! It's pretty fucking hard to even find a place that ONLY sells nikes. Unless you're a college basketball player, you have a choice, killa!

Microsoft may be a slightly more plausible case of coercions. W'evs.

Next time you're in the southland, you and me can go shopping for some $14-$25 shoes at ye olde Wal-Mart. Oh no, those big corporations are soooo coercive.

I think it’s appropriate

I think it’s appropriate to hold management and/or workers personally liable—either civilly or criminally, depending on the severity of the misconduct—for negligence or for taking on inappropriate risks (i.e., those exposing the corporation to liability greater than its assets).

I'm just not convinced that the negative consequences of certain types of misconduct represented by state sanction of a responsible individual are nearly as effective as the market-based positive consequences of certain types of misconduct. All this is further clouded by the centralization of corporate decision making, which allows the fate of a large, potentially dangerous corporate entity to be concentrated in one falliable person's hands. So much of the misdeeds occur behind closed doors between the few and powerful.

It just all seems unbalanced.

I am not by the way arguing

I am not by the way arguing that the current system of law is fine whereby people are able to successfully sue companies for hundreds of millions of dollars for no better reason than that ignorant juries who don't understand the topic (e.g., the science of drugs) make wrong decisions. If those who propose limited liability do so as a kind of band-aid on the current deeply malformed system of law which makes outright robbery a profitable business model, then I understand where you're coming from, but I'm talking about best law, not about what band-aids to place on current law.

And again, why should

And again, why should investors, specifically, be responsible?

I don't know - you tell me why law supporting limited liability is needed to protect the investors. I am not, and never did, mean to say investors definitely should be held responsible. I am saying that the law should be free to hold them accountable or not in accordance with the principles of law, without special protection. As I suggested earlier, I proposed that there be conducted a kind of efficiency analysis of law as Coase did to decide where responsibility should lie. I pointed out why when a third party is harmed and the third party is not made whole by the managers and workers, then the the economically efficient solution may be to shift that harm to the investor - i.e., to internalize the harm - rather than leave it with the absolutely, completely innocent victim. You are so worried about the poor investor who may be harmed that you forgot to worry about the victim who may be harmed and not fully compensated. On average, that is shifting costs of doing business (i.e. risks) from the investor to unrelated outsiders. You did not as far as I can see respond in any way shape or form to my argument, but rather said something like, I didn't get it, and then proceeded to make an argument which did not respond to my economic point about efficiency but which restated stuff that I already understood (e.g. that there is more to a company than an investor).

Imagine the following scenario to dramatize the point about how investors can shift costs (risks) onto an unsuspecting public. Suppose there is some amazing new technology would be extremely profitable but there's a good chance something will go wrong and a laboratory explosion will take out ten city blocks. Here's an idea: let's form a corporation, put some penniless doofus at the head of it to take the blame. If things go well, we profit! If things go badly, the doofus, I mean the CEO takes the blame, and since he's penniless the victims get no compensation, bwahahaha. Or how about this: let's form a corporation without any such nefarious plan but let's consider candidate CEOs from the point of view of profitability. OK, we have two applicants, Mr. Careful, and Mr. Doofus. Huh, Mr. Careful's proposal looks safe to third parties and not very profitable. Mr. Doofus's proposal looks dangerous to third parties but very profitable. Let's go with the more profitable guy, Mr. Doofus, because it's more profitable and we're not liable. Or how about this: I am a simple investor looking at a lot of different corporations. I am considering investing in, and therefore increasing any inherent capacity for catastrophe of, one of two corporation: Careful Inc., and Doofus Inc. I notice that Doofus Inc. is doing more profitable stuff. I neglect to take into account that Doofus Inc. is doing more dangerous stuff that might wipe out a city, since I am not liable for that. Not being liable, I simply don't bother to inform myself. So, I invest in the more profitable company, Doofus Inc., thus increasing the risk of catastrophe. Thus, market forces combined with limited liability lead me to invest in a way that creates more than optimal risk, because the burden is shifted.

This is merely a dramatization. Any limitation of liability seems to me to have the effect, nay, the *intended* effect, of shifting some costs (risks) of doing business to innocent unsuspecting third parties by shielding the investors from a re-shifting back to them. And, by shielding the investors, it creates a bad incentive, i.e., it creates an incentive to invest in business with higher risk to third parties than investors would invest in were they themselves liable for those risks. Now, to some extent, cost shifting is unavoidable. For example, when you sneeze, there are slight costs to others which they're not going to recuperate from you. Courts aren't usually going to hold you responsible for sneezing and getting someone sick. When people get sick they usually don't seek out the person who got them sick to sue them. Nevertheless, when you sneeze you do impose some slight costs on others. So, to some extent cost shifting is unavoidable and it would be a waste of the court's time to track them all down. Maybe that's the case for investors. It may depend. Stuff like this should be up to courts to decide, because that's what courts are for. They are for deciding this stuff.

The problem is that the courts might decide to hold investors liable anyway.

I cannot accept that argument at all. The courts are there to decide law. Common law, lex mercatoria: that's the kind of law I advocate. What you seem to be advocating is some kind of legislation. It might help to point out that I'm an anarcho-capitalist, not in any particular mold but persuaded mainly by David Friedman's ideas, and a legislative body that sits there and second-guesses the courts isn't any part of the idea that I'm familiar with. In any case, I'm of the opinion that legislators produce worse law than what I find in the common law.

Maybe you're arguing that Natural Law dictates that investors should not be held accountable. I do buy the idea of natural law as a kind of evolutionarily stable strategy so I don't poo poo the very idea. However, I think natural law tends to be efficient, i.e., I see a convergence with the efficiency idea, and I tried to point out why the efficient solution may hold investors responsible. I've already made this argument a couple times and as far as I can see you did not respond to it at all. To me, that's the key issue.

If common law has not so far produced the idea that investors are ipso facto innocent then that may suggest that your feeling that they should be ipso facto innocent is mistaken. I'm no lawyer but it seems to be agreed among the various people commenting that in any case people who loan money are ipso facto innocent in law. That seems to be taken as an unquestioned given. Giving is loaning and not requesting money back is giving, so it would seem to follow that a giver is ipso facto innocent. So the people who fund terrorist groups are ipso facto innocent. That may be. I am somewhat surprised, I must admit. In any case, whatever the result, I would rather leave things to the courts to decide than create a legal shield for a particular group of people.

Since the investors have

Since the investors have limited liability, they are happy to set things up so that they have little control and little knowledge. But if they had more liability, they might insist on more control and knowledge.

This would be horribly impractical. It's not reasonable to expect investors to keep tabs on everything every company in which they've invested is doing. It's insane to expect those investing through mutual and index funds to do so. To say nothing of the logistics of suing investors.

And again, why should investors, specifically, be responsible? Why not creditors? Why not customers? Why not the parents of the guilty parties? Why not businesses which the guilty parties patronize?

You must agree that there are important differences between limited liability investing and lending money.

There are, but they're not relevant to the point at hand. The main difference is that loans are not a feasible means of financing promising but risky ventures. But they both perform the same basic function: providing capital to fund a business venture. Can you think of any reason why an equity investor should be held responsible for the misdeeds of management, that does not also apply to a creditor?

The very existence of law recognizing limited liability corporations argues against the claim that one can cook up something very like a limited liability corporation just with a system of contracts.

The problem is that the courts might decide to hold investors liable anyway. Limited liability is, as I see it, simply a codification of the principle that investors shouldn't be held personally responsible for things they didn't do. Without this codification, there's no guarantee that plaintiffs won't try to sue investors and, finding a sympathetic judge and jury, win.

If one of the two parties harms a third party who is not party to the contract, then the third party, the victim, is not bound by that contract between the first two parties.

Correct. But the plaintiff still has to have some valid basis on which to sue the investor. My argument is not that the contract absolves the investor of any responsibility. It's that the contract, which is the only connection the investor has to any wrong done to the plaintiff, doesn't create a valid basis for a lawsuit against him. Why do you think it does?

Other than electing

Other than electing management, investors have little control over the operations of corporations

Since the investors have limited liability, they are happy to set things up so that they have little control and little knowledge. But if they had more liability, they might insist on more control and knowledge. Consequently I don't think that the current state of affairs (ignorance and lack of control) can be used as an argument for limited liability. After all, one of the points of the people who argue against limited liability is that the current state of affairs is bad and should be fixed.

Again, if you and I have an agreement such that I pay you a certain sum for a certain percentage of all future earnings, on what basis can I be held responsible for your wrongdoing, negligence, or incompetence? If stockholders should have unlimited liability, should creditors also have unlimited liability?

You must agree that there are important differences between limited liability investing and lending money. Were that not the case, then you would not be bothered by the idea of eliminating limited liability corporations; you would be happy that they be eliminated and replaced by mere loans.

Right, this is the classic anarcho-capitalist argument about corporations: as long as you have freedom of contract, you can have limited liability. We can always write a contract that gives the benefits of stock ownership (right to vote, share of profits) w/o being “owners".

If that were the case then why have limited liability corporations? Why have special law? The very existence of law recognizing limited liability corporations argues against the claim that one can cook up something very like a limited liability corporation just with a system of contracts. The existence of limited liability argues that it fills a void and therefore would not be quite replaced if eliminated.

Specifically, though, contracts are between two (or rather, a certain number, but let's say two) parties. If one of the two parties harms a third party who is not party to the contract, then the third party, the victim, is not bound by that contract between the first two parties. The contract cannot say, for example, that only one of the two parties is liable for harms to third parties. Or rather, if it says it, then the third party, the victim, can say, "I didn't sign that contract, and I'm going to sue both of you".

Nike determines what shoes

Nike determines what shoes you wear?

In the sense that they can limit by range of choice by refusing to sell me any of their shoes. This was meant merely as a generic example of the power a business has over its customers: the power to withhold its product. Don't get too carried away over my specific choice (I don't wear Nike's).

Brandon - Yes, I only meant liability for torts, I agree with you about debt not being an issue (hey, is that a pun?).

Patri: Regarding "lost

Patri:
Regarding "lost liability," do you mean liability for debts, or liability for tort? In the case of the former, of course, the creditor can control his risk by deciding not to lend. In the case of the latter, I think it's appropriate to hold management and/or workers personally liable---either civilly or criminally, depending on the severity of the misconduct---for negligence or for taking on inappropriate risks (i.e., those exposing the corporation to liability greater than its assets).

Again, if you and I have an

Again, if you and I have an agreement such that I pay you a certain sum for a certain percentage of all future earnings, on what basis can I be held responsible for your wrongdoing, negligence, or incompetence?

Right, this is the classic anarcho-capitalist argument about corporations: as long as you have freedom of contract, you can have limited liability. We can always write a contract that gives the benefits of stock ownership (right to vote, share of profits) w/o being "owners".

On the other hand, I think its an important point that liability should not get "lost", otherwise incentives are wrong. If a corporation can take on risks greater than its assets, it does not have the proper incentives to manage those risks.

In talking about "A" and

In talking about "A" and "B", you're missing the point entirely. There are generally four distinct classes of agents in a lawsuit against a corporation:

1. Investors
2. Management
3. Workers
4. Plaintifs (or creditors)

Only management and workers act directly on behalf of the corporation. They are the parties most responsible for any crimes or torts committed or debts rung up "by the corporation." Other than electing management, investors have little control over the operations of corporations, and many investors may know little to nothing about the day-to-day operations. Those who own the stock through mutual funds may not even know that they own it. In short, they have little or nothing to do with any wrongdoing or negligence on the part of management.

Again, if you and I have an agreement such that I pay you a certain sum for a certain percentage of all future earnings, on what basis can I be held responsible for your wrongdoing, negligence, or incompetence? If stockholders should have unlimited liability, should creditors also have unlimited liability? Should someone who buys a CD from a bank have unlimited liability? What about someone with a savings account? If a shareholder voted in the last election against the management responsible for the tort or debts, should he be held responsible, too?

why should I be held

why should I be held personally responsible?

One question to ask is, should benefits and harms be internalized or not? Does the economy work better if benefits are internalized? If harms are internalized? I'm going to assume it does. Or more generally: I'm going assume that it is a legitimate question to ask, when a harm occurs, who should bear the cost of that harm, e.g., either the person directly harmed, or someone else through compensation of the harmed person.

Then we can ask the question, should the rule be (i.e. is the more efficient rule) that in the event of a catastrophe, the investors (who stood to benefit if things went well) should bear the cost, or should the rule be that the unlucky unsuspecting victims of the catastrophe (who did not stand to benefit if things went well) should bear the cost?

It seems to me that the answer is likely that harms should be internalized, and that therefore the investors should be held responsible.

One possible response is to point out that when A harms B, it is not clear that the fault is A's; sometimes the fault is B's, for being in A's way. Or in other words, sometimes the cost should be borne by B in order to discourage B from getting in the way. That may be. However I suspect that in the general case it would not turn out to be B's fault. So I think in the general case investors should be held responsible. The alternative is in effect to hold the victims responsible - in the sense that they effectively have to compensate themselves, i.e., suck it up.

Microsoft is probably big in

Microsoft is probably big in part because of state protection of intellectual property.

Drug companies are probably big for a variety of reasons, such as the high expense of FDA regulation, state protection of patents, and close relations between the company and the state (which a large company can manage more easily than a small company).

But it's not really bigness per se that we should look out for, but bad behavior. In addition, it's worth distinguishing between the different reasons people have for attacking big companies. Some big companies sometimes are attacked apparently because they symbolize something (McDonald's) or because they have deep pockets (various lawsuits) or because the attackers are misguided by a harmful ideology (Walmart), rather than because they have actually done something bad.

Finally a big company that is merely dysfunctional internally isn't the same sort of problem to society as a company that is hurting third parties.

Great post. Do you think

Great post. Do you think state-granted limitations on liability are the reason corporations even grow so big in the first place?

That seems backwards. Small corporations probably benefit the most from limited liability. A one-million-dollar corporation might get hit with, say, a two-million-dollar wrongful death verdict, bankrupting the corporation and leaving the investors liable for an additional million dollars. But how often do hundred-billion-dollar corporations end up on the hook for more than the full value of their assets?

Anyway, limited liability isn't really the privilege that a lot of people make it out to be. If I give you a million dollars in exchange for, say, the right to receive 20% of your company's future earnings, and then you go out and do something negligent that results in a huge settlement against the company, why should I be held personally responsible? It just doesn't make sense, either economically or morally, for investors, particularly minority investors, to be held responsible for the actions of the corporations in which they hold stock.

Great post. Do you think

Great post. Do you think state-granted limitations on liability are the reason corporations even grow so big in the first place?