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>> 47 2 The Corrupted Corporation [W]hat went wrong in corporate America . . . was a pathological mutation in capitalism—from traditional owners’ capitalism, where the rewards of investing went primarily to those who put up the capital and took the risks—to a new and virulent managers’ capitalism , where an excessive share of the rewards of capital investment went to corporate managers and financial intermediaries. John C. Bogle (2006)1 Legal infrastructure created the corporation, and it qualifies as one of the most economically powerful legal innovations in history. Yet governance issues plague the modern publicly held corporation, and sophisticated investors like John Bogle (founder of one of the largest mutual fund families—the Vanguard family of mutual funds) see the dementia.2 Increasingly, corporations exist to serve the interests of managers instead of shareholders. One study found, for example, that between 1993 and 2003 the compensation paid to senior executives doubled as a percentage of profits.3 The publicly held corporation in America today fails to operate in accordance with its economic policy basis. In the course of the subprime debacle, firm managers took in billions in compensation payments based upon illusory profits generated through excessive risk while their firms crashed.4 This reality imposes massive costs upon society, and the subprime debacle constitutes the latest and greatest multi-trillion-dollar catastrophe attributed to deeply suboptimal corporate governance. This time CEOs manipulated risk for more 48 > 49 The Promise of the Modern Public Corporation Corporations function to facilitate the flow of passive capital to productive investment and entrepreneurial uses. Small pockets of capital that otherwise would require expensive intermediation through financial institutions may instead directly fund economic growth through the purchase of shares of stock issued by publicly traded firms. Facilitating this flow of capital fuels investment, entrepreneurship, and innovation.14 If public share markets are well developed, then investors can enjoy the benefits of risk diversification, which further lowers the cost of capital.15 Nations with more developed financial markets naturally enjoy more growth in capital-intensive industries .16 Today, a broad economic consensus holds that well-developed capital markets with widely dispersed share ownership consistently appear in successful modern economies and enjoy a close association with superior economic growth.17 The modern public corporation appears essential to macroeconomic growth because it holds the promise of lowering the cost of capital. Five key legal elements undergird this function. First, limited liability protects passive investors from any liability for corporate obligations, shielding them from unnecessary risks. Second, shareholder claims on the corporation , including its assets, are transferred to freely trading shares, meaning that the firm need not concern itself with the possibility that its owners (or their creditors) could disrupt operations by calling back capital.18 Third, centralized management means that shareholders are legally stripped of all control over the firm (save electing directors) and cannot bind the corporation improvidently; instead, managers control the firm through their expert business judgment.19 Fourth, shareholder primacy (which at least rhetorically means that the corporation should be operated with the primary goal of expanding shareholder wealth) gives shareholders confidence that they will benefit from the fruits of their investment.20 Fifth, perpetual existence gives the corporation a very long investment horizon, making it the ideal means of holding long-lived assets.21 Each of these elements gives the corporation a capital-raising advantage, by eliminating risks or creating potential economic benefits. Shareholder primacy lies at the core of the corporation because the point is to attract capital at a lower cost, and any move away from shareholder primacy likely would defeat this purpose. All of this allows the corporation to operate as the perfect capital aggregator under law.22 None of these elements imposes costs upon society because shareholders do not have power over the firm, and the duty to manage the firm rests with a board of directors that, at least theoretically, owes a duty of care to the corporation. If a shareholder cannot control a corporation—which the law 50 > 51 The corporation stands as a powerful example of legal infrastructure. The legal innovations associated with the corporation lower the cost of capital throughout the economy. These innovations create an institution every modern capitalistic society needs: an entity that can soak up the passive savings generated by individuals with neither the interest in managing nor the expertise to manage a business venture. The creation of a centrally managed firm with the ability to hold long-lived assets proves critical to macroeconomic...

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