On 23 November 2009, the family of a challenger to the incumbent governor of Maguindanao province in the Philippines were on their way to file his certificate of candidacy. They were accompanied by some 34 journalists, lawyers and aids. They were brutally massacred.
Blood feuds are not some medieval throwback. Modern vendettas continue in parts of Europe, the Middle East, and the Philippines.
In places such as this, one bad business experience will be avenged down the generations. This keeps people perpetually looking over their shoulders rather than investing and getting on with things.
Limited liability, as a concept, allows people to know in advance the full extent of their liability so that they can manage the degree of risk they are willing to take on. The purpose of limited liability is to allow an individual investor in a joint stock company to be held responsible for that company’s risks only up to the value of his financial contribution to that company.
Limited liability was created by an act of the UK parliament in 1855 (Limited Liability Act of 1855) which followed on from the Joint Stock Companies Act of 1844. The Companies Act of 1862 followed.
This was more revolutionary than you can imagine. While Britain was governed by a Parliament it was still headed by an unelected hereditary peer. Few countries in the world were parliamentary democracies and the US was heading in and out of civil war.
Up to that point creditors would hold individuals infinitely liable for debts both severally or individually. Poorer investors went to debtors gaol and the wealthier lost everything. Creditors were worried that companies would get away with debt through limited liability and so investors were held to “partly paid” shares which limited their liability up to a certain multiple of the share price they initially paid (partial but capped limited liability). That didn’t work too well and by the 1880s shares were fully-paid and liability capped to that.
The consequence of this new law was a little something known as the Industrial Revolution or, more rightly, the Second Industrial Revolution which saw the explosion of investment in rail, steam ships and the globalisation of trade.
Investment is more than money
Limited liability had lots of spin offs that go well beyond the context of investment and entrepreneurship.
Newspapers thrived as limited liability meant that they could report without fear of the owners being financially destroyed for the newspaper’s speaking truth to power. Millions of people who had never engaged in commerce joined into the excitement of investment through shares. Money that is free to move is free to move foolishly… bubbles followed, including on those new railroads.
However, limited liability allowed for diversified investment portfolios. You didn’t have to put all your wealth and effort in one place. Portfolio theory gave rise to better insurance and the potential for retirement planning through pension funds.
Let’s go back a bit. Limited liability is a short-hand, a way of simplifying transactions. Up to the creation of a limited liability company doing business with business was unnecessarily complicated.
Any business with more than one investor was a partnership. If a business wished to buy something on a contract then every owner would have to sign that contract. If one partner wanted to cash out his investment (or died) then the business would have to dissolve itself, pay out, and then be reconstituted. If the owners wanted to leave as a block then the business would just end. Succession planning and continuity was unnecessarily complicated.
Lots of stuff was just difficult, unpleasant or horribly expensive. Any economist or investor will tell you that true wealth is set on the margin. When you reduce complexity then lots of new and exciting things happen. Including railroads.
Oh, and democracy.
Wars of succession erupt in many countries, and throughout history, where a strong leader dies and leaves no clear heir. In a democracy all citizens are shareholders in their own nation. As shareholders the executives have to ask the owners to set the agenda and nominate a chief executive.
You may not think of countries as really just a big corporation but that is what they are: sovereign corporations.
The idea of limited liability and incorporation allows for sophisticated labour and investment collaboration. A contract can be drawn up which binds all shareholders uniformly. You no longer need to create a new contract for each person or handle each case separately.
Consistency of law and consistency of risk and liability ensure that each participant knows both the upside and downside of engagement.
Where an individual acts against the interests of the corporation then that individual can be punished without the liability extending to others. Where a corporation acts against the interests of other corporations and against the laws that govern the interactions of all corporations then that corporation can be dealt with as an entity.
It’s a short-hand. It has implications.
The sovereign individual and the sovereign organisation
Prior to the acceptance of incorporation a business could not get very big. Partnerships would be limited to people who knew each other and would be willing to stand personal surety for all debts.
These sorts of relationships have their modern counterparts in impoverished parts of the world in lending clubs and savings circles. Much research has been conducted on optimum sizes for such groups and 50 people seems to be about the maximum size.
A modern corporation can have tens of thousands of individual investors.
The problem with a society where individuals are limited by personal bonds from forming cooperative societies is that their world will be dominated by the entitled and hereditary wealthy.
If a group of people could not from a legally recognised body that can negotiate on their behalf, and sign a contract on behalf of the collective without having each person within that contract negotiating their own terms, then what? Unionisation was a natural consequence of incorporation, not the other way round.
Of course, once you recognise that a corporation can sign contracts then a lot of other things follow. Ownership of property is just a contract between the state and the title holder in which the state agrees to recognise and protect that property right. Where the property is expensive and requires numerous owners then passing ownership via a corporation is the best approach.
Farmers often pass the family estate down to their children via such a vehicle. If a farm had to be wound up every time the patriarch wanted to retire then children would rapidly lose access to the family property.
Such recognition also enabled corporations to transact with each other. Whether those corporations be your local municipality purchasing water in bulk on your behalf, or whether it be a pension fund buying shares in an energy company.
The benefit of this is the democratisation of wealth.
Concluded in Part 3