Economics, Capitalism, and Corporations

Contradictions of Corporate Law, Economics, and the Theory of the Firm

Wm. Dennis Huber

• Publisher: Routledge
• Year: 2020
• ISBN:
  9781000291278
• Edition: 1
• Topic: Business
• Subtopic: Business Law
• Index: Business

This book is a continuation of Corporate Law and the Theory of the Firm: Reconstructing Corporations, Shareholders, Directors, Owners, and Investors. The author extends his analysis of contract law, property law, agency law, trust law, and corporate statutory law and applies that analysis to defy conventional concepts and theories in economics, finance, investment, and accounting and expose the artificial boundaries established by decades of research founded on indefensible assumptions and fallacious conclusions.

Using the Humpty Dumpty principle, where words mean what the authors want them to mean, economists have created "strange new worlds" where contract law, property law, agency law, and corporate statutory law no longer apply.

The author dismantles the theory of the firm by proving the theory of the firm wilfully and intentionally ignores fundamental contract law, property law, agency law, and corporate statutory law. Contrary to the theory of the firm, shareholders do not own corporations, directors are not agents of shareholders, and shareholders are not investors in corporations.

The author proves that by property law and corporate law, capital is not privately owned by capitalists but by corporations. Entire economic and social systems have been constructed that have no basis in law. With the advent of publicly traded corporations, the capital is there, but both capitalists and capitalism have been rendered extinct.

This book will appeal to researchers and graduate and upper-level undergraduate students in economics, finance, accounting, law, and sociology, as well as legal scholars, attorneys and accountants.

1 Review of corporations and corporate law, contract law, propertylaw, agency law, and trust law¹

Introduction

Economics, as defined by every introductory economics textbook, is the science of the allocation of scarce resources. Property in its various forms constitutes resources to the owner of those resources. The legal structure of society determines who owns the resources (e.g., private persons, government, or “the people”), which resources are allocated and controlled (e.g., labor or capital), and how the resources are allocated and controlled (by the market or centrally planned by the government).

Corporations are powerful economic forces in the global economy. Under-standing corporate law is therefore important since corporate law determines the ownership and legal structure of corporations, and the ownership and legal structure of the corporation determines the economics of the corporation and consequently the allocation of scarce resources.

In this chapter I review corporations and corporate law and how contract law, property law, agency law, and trust law apply to corporations and shareholders in order to establish the foundation for the analysis of Economics, Capitalism, and Corporations: Contradictions of Corporate Law, Economics, and the Theory of the Firm. While this chapter is not intended to be as comprehensive a review of corporations and corporate law as presented in Corporate Law and the Theory of the Firm: Reconstructing Corporations, Shareholders, Directors, Owners, and Investors, it is sufficient to sustain my argument that shareholders do not own corporations, that shareholders are not investors in corporations, and directors are not agents of shareholders thus obliterating any validity for the theory of the firm. Readers who are interested in learning more about contract law, property law, agency law, trust law, and corporate law in greater depth are referred to that work.

Economists either downplay or reject outright the role of the law in defining the firm (Masten, 1993). But understanding contract law, property law, agency law, trust law, and corporate law and their contradictions is important since the allocation of scarce resources is a function of the legal structure of society (Banner, 2011). Corporate law determines the ownership and legal structure of the corporation, and the legal structure of the corporation determines the economics of the corporation and therefore the allocation of scarce resources. Understanding the ownership of a corporation is necessary for a proper understanding of the nature of the corporation and an important consideration in the allocation of resources and rights in the corporation (Velasco, 2010).

The economic theory of the firm is founded primarily on the theory of separation of ownership and control of corporations. According to the theory, since there is a separation of ownership and control shareholders hire directors as their agents creating, as a result, agency costs.

Proponents of the theory of the firm make a distinction between the “corporation” as a legal entity and the “firm” as an economic entity and therefore between legal agents and economic agents. But that is a false dichotomy. The fact that one person, a principal, hires another person to be an “economic agent,” i.e., to represent her in an economic transaction, necessarily and automatically makes the economic agent a legal agent. An agent cannot be an economic agent unless they are first a legal agent: i.e., that complies with the laws of agency.

Corporations: creation, governance and operations, and ownership and control

Creation of corporations

Corporations can only be created by state corporation statutes. Corporate governance and operations are also controlled by state corporation statutes.

The Delaware General Corporation Law sets forth the requirements for creating a corporation:

Any person, partnership, association or corporation, singly or jointly with others, and without regard to such person’s or entity’s residence, domicile or state of incorporation, may incorporate or organize a corporation under this chapter by filing with the Division of Corporations in the Department of State a certificate of incorporation which shall be executed, acknowledged and filed in accordance with § 103 of this title.²

The New York Business Corporation Law, on the other hand, limits the formation of a corporation to natural, not artificial, legal, or fictitious persons: “Incorporators. One or more natural persons of the age of eighteen years or over may act as incorporators of a corporation to be formed under this chapter.”³

In all jurisdictions, corporations begin their existence and operation when the articles of incorporation are filed with the secretary (or department) of state, not when shares are issued or assets transferred to the corporation.

In Delaware, once the certificate of incorporation is filed in accordance with the Delaware General Corporation Law, the corporation begins its existence:

Upon the filing with the Secretary of State of the certificate of incorporation, executed and acknowledged in accordance with § 103 of this title, the incorporator or incorporators who signed the certificate, and such incorporator’s or incorporators’ successors and assigns, shall, from the date of such filing, be and constitute a body corporate, by the name set forth in the certificate, subject to § 103(d) of this title and subject to dissolution or other termination of its existence as provided in this chapter.⁴

The New York Business Corporation Law is more emphatic: “Upon the filing of the certificate of incorporation by the department of state, the corporate existence shall begin ….”⁵

It is important to note that upon creation the corporation exists without assets, without shares, and without shareholders. Significantly, the corporation begins its existence and the governance structure is in place prior to the election of the directors by the shareholders. There are in fact no shares outstanding at this time so there are no shareholders to elect the directors.⁶ The duties of directors to the corporation begin at the time the directors are named in the articles of incorporation and filed or when they are appointed by the incorporators.

Governance and operations of corporations

Corporate governance must first be in accordance with corporate statutory law. Common law only enters into the interpretation of corporate governance when statutory law is ambiguous or silent.

Corporate governance is the foundation of the economic “theory of the firm” since corporate governance addresses the theory of “separation of ownership and control” and “agency theory.” As a prelude to the corporate governance and theory of the firm, the statutory and common law requirements of corporate governance must be examined.

Corporate governance in statutory law

The Delaware General Corporation Law provides that “The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors.”⁷ “Managed by or under the direction of a board of directors” necessarily includes decisions on how to allocate corporate resources.

In New York, “the business of a corporation shall be managed under the direction of its board of directors ….”⁸

In Delaware, if shareholders’ voting rights are not denied, after incorporation and the directors are either named in the articles of incorporation or elected by the incorporators, “Directors shall be elected by a plurality of the votes” present at an annual meeting.⁹

In New York, initial directors are not named in the certificate of incorporation. If shareholders’ voting rights are not denied, after the articles of incorporation are filed, “an organization meeting of the incorporator or incorporators shall be held within or without this state, for the purpose of … electing directors to hold office until the first annual meeting of shareholders ….”¹⁰

Note that under the Delaware General Corporation Law¹¹ and the New York Business Corporation Law¹² after the certificate of incorporation is filed, if directors are not named in the certificate of incorporation, the incorporators must hold an organizational meeting to elect directors until the first annual meeting of shareholders is held at which time the shareholders elect directors. Either way, the corporation has begun its existence and operations, and it is important to understand at this point that whether the directors are named in the articles of incorporation or are appointed by the incorporators, it is the unelected directors who are in control of, and govern and manage, the corporation, prior to the existence of shareholders. For example, in Delaware,

If the persons who are to serve as directors until the first annual meeting of stockholders have not been named in the certificate of incorporation, the incorporator or incorporators, until the directors are elected, shall manage the affairs of the corporation and may do whatever is necessary and proper to perfect the organization of the corporation, including the adoption of the original bylaws of the corporation and the election of directors.¹³

That undeniably demonstrates that the corporation is operational and corporate governance is in place prior to shareholders owning shares, and therefore directors are not agents of shareholders since there are no shareholders.

In order for there to be shareholders, the initial directors must issue shares, Shareholders must pay for the shares the price determined by the directors in an arm’s length transaction. When shareholders purchase shares in an IPO (“initial public offering”), they are not purchasing x/n% of the corporation or x/n% of the assets of the corporation. They are purchasing x/n% of the shares issued by the corporation w...