Adam Smith and the Corporation

12 July 2007 at 10:22 am 4 comments

| Peter Klein |

Larry Elliott writes in the Guardian that Adam Smith would oppose the modern shareholder model of the corporation. Smith, he argues, “would have looked askance at an economy gripped by speculative fever, with the emphasis not on making things but on buying and selling, making a turn, churning, taking a punt, sweating an asset.” Leaving aside for the moment that the distinction between “making” and “buying and selling,” as used here, is entirely specious, is this a fair interpretation of Smith? Elliott continues:

Smith, indeed, predicted what might happen in the Wealth of Nations, when he supported the idea of private companies (or copartneries) against joint stock companies, the equivalent of today’s limited liability firm. In the former, Smith said, each partner was “bound for the debts contracted by the company to the whole extent of his fortune”, a potential liability that tended to concentrate the mind. In joint stock companies, Smith said, shareholders tended to know little about the running of the company, raked off a half-yearly dividend and, if things went wrong, stood only to lose the value of their shares.

“This total exemption from trouble and from risk, beyond a limited sum, encourages many people to become adventurers in joint stock companies who would, upon no account, hazard their own fortunes in any private copartnery. The directors of such companies, however, being the managers rather of other people’s money than their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own.”

As Gavin Kennedy points out, however, what Smith meant by joint-stock companies was the state-chartered monopolies like the East India Company, not the shareholder model per se. “[I]t was the monopoly status, sanctioned by law that gave the ‘parcel of rogues’ who represented The Company in India and elsewhere in the region a virtual free hand to act as despots, and to plunder on a scale that made even lowly clerks into millionaires, who ‘traded on their own account,’ and committed crimes to match.”

Some have argued that the limited-liability corporation is inherently a creature of the state regardless of any monopoly privilege in the product market, but I don’t find those arguments convincing.

Entry filed under: - Klein -, Myths and Realities, Theory of the Firm.

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