NARRATOR: Thanks for joining this episode of the No. 86 lecture series, where we discuss basic principles and applications of Corporate Law along with landmark cases. Today’s episode features M. Todd Henderson, who is the Michael J. Marks Professor of Law at the University of Chicago Law School. Professor Henderson’s research interests include corporations, securities regulation, and law and economics. As always, the Federalist Society takes no position on particular legal or public policy issues; all expressions of opinion are those of the speaker. Professor Henderson, what is corporate law? What is a corporation? Why should a lawyer know or care about corporate law if they intend to practice in a different area, like environmental law? Corporate law as a subject governs how companies or corporations are formed, the rules on how they're governed, what one might call corporate governance, and the rules about how they can be sued or sue to press rights of the corporate entity. At its base, corporations involve activities done by some people, we call these people managers, who are working on behalf of other people, typically we call these people shareholders. And those managers may act in ways that are not in the interests of the shareholders, giving rise to something that we call agency costs. And a lot of corporate law is about how to constrain or ensure that the agents of the corporation, the corporate managers, are acting in the best interests of the shareholders and other stakeholders of the corporation. A corporation is... I like to think that they're something that I would call a social technology. Everything that we do as humans, we by and large do cooperating with other people. And that cooperation now happens at a massive scale globally, hundreds of thousands or millions of people cooperating to do a particular thing. That thing might be make a product, produce a movie, ship something across the planet, fly people from here to Tokyo. All those things require enormous amounts of human cooperation. And a corporation is just a particular kind of technology, a social technology, that enables that. More specifically, a corporation is what we call a legal fiction. There is no such thing as Facebook or Amazon, it is just a label that we use to conveniently describe this underlying cooperation that's happening. In section one of the United States Code, so 1 USC section 1, a corporation is characterized as a legal person. And it's just a fiction. We just call this activity that's happening, Amazon or Boeing or Facebook, and then we organize a bunch of economic activity within that label. And that's what a corporation is. Corporations are ubiquitous in our society. They're not just the way that we do business, but things like the NAACP, the Sierra Club, the City of Chicago, all of these things are organized in the corporate form. So, one reason students would want to study corporate law is that a lot of the social organizations or political organizations that one might work for as a lawyer are corporations. Another reason is that corporations will be defendants in suits brought by interest groups of various kinds, whether they're environmental or other social organizations. So, corporations are predominant in our society, and understanding them is essential for lawyers, whether you're going to be a corporate general counsel, or a regulator, or someone who is potentially suing companies who you think are misbehaving. Can you explain what you mean by “corporations are a social technology?” So the idea of a social technology really comes if you think about the kind of history of corporate law or corporations generally. When we all started as human beings in cooperating, we did those things in our kin groups or our tribes. Eventually proto societies arose that tried to organize people. Maybe those things would've been city states or medieval guilds. They required people to be able to trust one another in their economic activities. Trust that you would do the work that you said you were going to do, you were going to fulfill the contract or obligation that you were supposed to do. And law has been primarily focused throughout all of human history in enabling and establishing trust and trying to get people to cooperate with other people. It wasn't really until the 20th century when the form that we now think of as the corporation developed in its modern style or modern incarnation that we see today. But it was just doing the work of cooperation that lots of other types of organization had done in the past. And what really precipitated this is the kinds of cooperation needed to build something like a railroad, to build a canal were unprecedented in human history. All the activity of the economy, say at the founding, could be done within the wealth of an individual or a family. You could build a factory to make sales or pins or clothing with just a thousand pounds at the founding. By the middle of the 19th century, the building of one mile of railroad cost 25,000 pounds. This is enormous change required, scaling up the level of human cooperation that could happen. You couldn't make railroads with the wealth of any individual or any family. And government was available to do that, but the corporation was a mechanism of trying to enable that cooperation. It was new and really revolutionized our ability to cooperate as humans. Let’s talk more about that. How old are corporations? Has their role in society changed over time? Corporations play a huge role in society. And that role has changed in interesting ways over time. The first corporations were creations of the state. In Europe, especially monarchs and other rulers, wanted to do particular activities, but didn't want those activities to be run by the government. So they might be building ships, they might be setting up business in India to exploit its natural resources, they might be building infrastructure projects, things that you would think of as typical government activities at least in the 18th and 19th century context. And for a variety of reasons, sometimes having to do with budget pressures, sometimes having to do with political constraints. Rulers and governments would set up separate entities that they called corporations to carry on those activities. So come fast forward to the United States at the time of the founding, we want to build a bridge over the Charles River in Boston. And how would you do that? Well, the government could tax people, and it could do that directly. Another idea is that it could create a separate company, a separate legal entity, that could raise money from people. And it could build the bridge and maybe in return get some kind of a monopoly on the tolls for that bridge for a particular period of time. That was a common approach at the time of the founding that the state would charter, give its imprimatur to a particular separate legal entity to do some work. Those were the proto corporations. One of the first ones was called a society for useful manufacturers. Alexander Hamilton had this idea of boosting the industrial capacity of the early United States. He wanted Congress to establish an industrial park, a kind of corporation that would engage in a bunch of industrial activities along the Passaic River in New Jersey. Well, Thomas Jefferson and the Republicans didn't really see that in Article 1, Section 8 of the constitution enumerated powers. And they thought that's not something that's a proper role of government. So Hamilton decided to create a corporation, the society for useful manufacturers that would be not government but take on this role of what the government would otherwise be doing in encouraging industrial capacity. So those were the early corporations. They were quasi-governmental activities, but just done under a separate label. And all corporations in the early United States had to have one of these charters, a piece of paper that you went to the legislature and you said, "We would like to do this. Build this industrial park in Passaic. Build this bridge over the Charles River. Start this bank." And you had to get approval of the state legislature to do that. As a consequence of the political role that these played and the fact that corporations were not really necessary given the scale of economic activity, relatively small scale, sole proprietorships, partnerships, they were sufficient to engage in all the economic activity that was necessary. By the time of the first part of the 1800s. There were only a few hundred corporations in the United States. Most activity was done in sole proprietorships or partnerships. This really changed in 1811 when New York State passed a statute that allowed corporations to freely incorporate. No longer did you have to go to the state legislature and beg for permission to do a particular activity. Anybody could start a corporation. And importantly, this early move by New York State generated an important feature, which is corporate law in our country as state law. And the states all compete for writing what is the best law. They give free choice to companies. If you're an Illinois company or a California based corporation, you can choose to be governed by the state law of Delaware or New York or any other state. So, once New York passes this law that enables free incorporation, and as society is changing, and the demands for cooperation at scale are growing, and the economic activities are getting bigger and bigger and requiring more corporation, corporations change and evolve to that. Railroads is the first big use of this new kind of social technology. The cooperation needed to build railroads, given the costs and given the scale and scope of their activities was just massive. And it turned out that corporations were particularly good way of doing this. So the US builds out its enormous industrial capacity connecting all different parts of the country. The growth in the US economy as the industrial revolution booms is driven largely through a corporate activity. Up until the period after World War II, most businesses did not have large public shareholders like corporations do today. Think about the Ford motor company and companies like that. They were largely owned predominantly by the founders of the company. Carnegie Steel is owned by Andrew Carnegie until he sells it to J.P Morgan in the early teens, in the 20th century. The Vanderbilts and the Carnegie and Ford, the Rockefellers, all of these individuals owned most of the shares of corporations. And these people did what they wanted. The law permitted them to largely govern the corporations as they liked. And there weren't pesky shareholders to police their activities. The dawn of the 20th century and the rise of shareholders who would invest in corporations that weren't owners or didn't work there really changed the nature of the role that corporations played. Now, corporations really had to focus on delivering value for shareholders. If businesses didn't return value to shareholders, the businesses could be taken over by outsiders, so-called corporate raiders. And so from World War II until very recently, the idea of shareholder wealth maximization was the coin of the realm in corporate America. Businesses existed to serve the interests of shareholders. Milton Friedman in a famous New York Times magazine piece in the 1970 said the only purpose of the corporation is to maximize shareholder value. And every business school in America preached that to would be corporate titans. Your job is to return value to shareholders. As a consequence of this, the big fat American corporations that grew wealthy and complacent after World War II, because America was really the only economic force that hadn't been destroyed by the war, started to face pressure to perform better for shareholders. And we saw massive waves in the 1970s, 1980s, to break up big old corporations and make them more efficient and return value to shareholders. Recently, there's been a big change, and we're still in the midst of it, about what the role and purposes of corporations are. It started with churches, in the 1980s, who had money to invest. And didn't like the fact that they were investing in companies that they viewed as being maybe sinful in some way, maybe they were selling products or engaging in activities that the church didn't want to be associated with, and started a socially responsible investing movement. That seed has grown substantially in the past several decades to an entire focus of investors, shareholder activists, and others to pressure corporations to be more socially responsible in their activities. Corporations wield enormous power in our society, they touch every aspect of our lives. So I think it's quite natural that people will pressure them to change their role and their purpose as society changes and evolves. Thank you for listening to this episode of the No. 86 Lecture series on Corporate Law. The spirit of debate of our Founding Fathers animates all of the No. 86 content, encouraging discussion and critical reflection relative to how each subject is widely understood and taught in law schools and among law students. Subscribe to the No. 86 Lecture series on your favorite podcast platform to have each episode delivered the moment it’s released. You can also go to no86.fedsoc.org for lectures and videos on Federalism, Contracts, Jurisprudence and more. Thanks for listening. See you in class!