A Short Account of the History of the Corporation: PART 5 (The Rise of the American Business Corporation)

It has been awhile, but in the last examination of the early developments of the corporate structure in America, we saw how a Marshall Court decision allowed businesses to pursue its own ends removed from the threat of federal intrusion. I also noted, however, that states largely ignored much of the court ruling because at the time the only way to curb corporate behavior was through manipulation of the corporate charter; no federal-based corporate regulatory framework existed at the time. We will see later on how this libertarian model of corporate regulation was massively flawed. As corporations expanded across not only state borders, but also across national borders, it would require the eventual development of a federal-based regulatory framework to better check the corporation and its newfound freedom against misguided business practices. These requirements would not surface until the 20th century immediately following the Great Depression.

Beyond a federal-based legal framework to properly guide the behavior of early chartered enterprises, another significant weakness was that the corporation was framed around partnership, which limited the “firm’s ability to raise capital” due to unlimited liability. Some early 19th century incorporation practices did use “limited liability” but it was only granted as a “favor” to those who had the “leverage to obtain it from state legislatures.” In 1824, a federal circuit court decision in Wood v. Drummer aided in moving common law toward accepting limited liability as “the default rule governing businesses.” By 1832, common law had fully adopted the principle of limited liability of corporate shareholders. This change of the corporate form was being mirrored in England with the passage of the Companies Act of 1862. The Act made it legal to form limited-liability joint-stock corporations (akin to publicly traded corporations today), which meant that the max that shareholders could lose was only the amount invested, and nothing more.

While the capital constraints that previously hampered corporations were now removed with the general acceptance of limited liability principles, the mid-19th century American corporation still faced geographic restrictions. To ward off competition from surrounding jurisdictions, states often legislated that corporate operations “be geographically limited to its chartering state.” A Supreme Court decision in 1868, Paul v. Virginia, changed that. The Court held that states could not prohibit a foreign corporate entity from pursuing commerce and commodity transactions in the state’s own jurisdiction. The Court’s opinion aptly captures the importance of corporate enterprise in the development of the Western world, taking the reader back to the annals of merchant empires, even noting that Massachusetts and Plymouth found their “origin, and settlement, and growth under the charters of trading corporations.”

These legal developments provided the catalyst for the emergence of big business in America. The first of these “super” corporations came from the railroad industry and its unprecedented demand for massive sums of capital. By 1910, 240,000 miles of railroad track had been laid. This was only made possible with vast sums of capital. And the most efficient means to bring that capital to the market was the corporation and the stock exchange. Such were the capital requirements of the railroad industry that in 1898, railroads “accounted for 60% of publicly issued stock” on the New York Stock Exchange. In 1891, The Pennsylvania Railroad employed over 110,000, almost triple the total size of the United States’ armed forces at the time. The company’s market capitalization of $842 million was nearly equivalent to the total national debt. And along with big business came extremely wealthy individuals: By 1900 the railroad industry was largely controlled by just seven investor groups: the Vanderbilts, E.H. Harriman, George J. Gould, James J. Hill, J.P. Morgan, Andrew Carnegie, and W.H. Moore.

The significance of the railroad corporation extends beyond its reliance on the stock market to meet heavy capital requirements. Perhaps an even greater development that further distinguished the railroad corporation from the mercantile partnerships that preceded it was on an infrastructure level and the operational efficiencies gained. The scale of railroad projects required a new way of doing business that could measure performance and make rapid and responsive changes, both of which required a steady flow of reliable information. The combined effect of the enormous sums of capital obtained through equity exchanges and the efficiencies of its business operations make railroads the first true corporations in the modern sense.

Other industries would model the success of the railroads. Henry Ford’s operation is particularly noteworthy as his company built upon the organizational efficiency of the railroad industry by applying similar concepts to his manufacturing facilities. Through these developments he was able to cut the production time of a Model T from 12 hours down to 1.5 hours by 1914. Such was the success of his mass production and mass distribution system that the process soon was copied by nearly every other successful corporation – the process became known as Fordism.

Now freed up legally, financially and geographically to pursue organic growth (natural growth within a business entity), another change would pave the way to corporate growth through acquisitions. Up until this time corporations for the most part were not given the ability to acquire shares of other corporations. This changed in 1890 when New Jersey policymakers enacted liberal legislation giving corporations for the first time the authorization to purchase shares of other companies. A new structure of parent- and subsidiary-corporations was realized, and soon powerful corporations like Standard Oil and United States Steel began organizing into super-massive corporate groups.

The cumulative effects of these legal developments on the corporate form were radical, transforming it from a simple partnership into a super structure with tremendous organizational complexity to match its vast operational scale. Modeling themselves after the railroads and utilizing the newly constructed railroad lines for the distribution of manufactured goods, soon other “super” corporations emerged. Identifying niches in the market and developing new products, corporations like Procter & Gamble, DuPont, General Electric, Ford and many others rose to power.

A glimpse at Proctor & Gamble’s corporate history portrays just how much of an impact these legal developments had on the corporation in America. Proctor & Gamble started in 1837 as partnership between William Proctor and James Gamble to sell candles. After operating as a simple partnership for 53 years, P&G incorporated in 1890 in order to raise additional capital for expansion purposes. With the ability to raise levels of capital that was previously impossible, and with the ability to acquire other businesses as well as expand across state borders, P&G experienced enormous growth over a 100 year period. Today the company has operations in over 80 countries and owns numerous brands like Pampers, Gillette, Braun, Iams, Folgers, Wella, Duracell, most of which acquired through the purchase of other companies.

In our next look at the history of the American business corporation, we will see that the concentration of capital, which led to abuses by tycoons, was met with collectives of labor. Much like English consumers were required to organize in the 1700s to counter business practices that relied on slave trade, workers similarly organized to combat unjust labor practices. The history of capitalism has this theme played out over and over again: the concentration of capital leads to injustices - the concentration of consumers, laborers, shareholders, and stakeholders to counter these injustices.

Peace

Jeremy