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 Seth Oranburg, who is an Associate Professor at the University of New Hampshire Franklin Pierce School of Law. Professor Oranburg also co-directs the Program on Business, Organization, and Markets at the Classical Liberal Institute at New York University School of Law. As always, the Federalist Society takes no position on particular legal or public policy issues; all expressions of opinion are those of the speaker. PUBLIUS: Professor Oranburg, where did corporations come from? Do they look or operate differently today than when they originated? SETH ORANBURG:Corporations have been around since at least the 1600s in one form or fashion. They weren't always called corporations. They didn't act in all the same ways modern corporations do. But the essential concept of a corporation is simply an association of people who get together to seek profit or for some common enterprise. And that's been happening since people needed to fund ships to go and get tea from the South China region and bring it back to Europe and or India. And so these tea companies, which were funded by an agglomeration or a group of people, were some of the first corporations. The difference between those corporations and the ones we see today are those corporations needed to be chartered by governments. You needed to be powerful to get the rights to form a corporation. And so these corporations were formed by the already rich and powerful who would then solicit their rich and powerful friends to get involved in, effectively, a state venture. In fact, early corporations were actually called patents. You may be familiar with patent law or intellectual property law. A patent gives you a monopolistic right, a unique right to exploit a technology. And a corporation was seen the same way. You had the unique right to do this particular business. Sort of the inverse of what we think about today in terms of competition. So these kind of corporations have existed since we've had industrial history. Since we've had a mercantile culture and divisions of labor. So this isn't new. What's new is that in the 1850s in America, we began allowing what we call free incorporation. Various states, and this is the beauty of federalism, because we can have experimentation among states. Various states began creating laws that allowed corporations to form in their state. And you didn't have to get permission from the legislature. So almost anyone could do it. And we saw in the 1850s as a result of these free corporation laws, or at least the mid 1800s, as a result of these free corporation laws, a huge increase in the number of American corporations that started to look like what we identify as modern corporations today. It was actually in that period that America surpassed the rest of the world in terms of number of corporations. And I think it's a big reason why after the First and Second World War, we were prepared to take the reins as the economic center of the world. Because we had the corporate presence here. Again, free corporate presence, as opposed to some of the older versions of corporations, which were really government granted monopolies to go and engage in business together. Now we're talking about a free market system where people can enter into, without having to give special favors to Congress. PUBLIUS: What is free incorporation? How does it work? Is that still the system we have today? SETH ORANBURG: Free incorporation is a state law that allows basically anyone to charter or form a corporation in that state automatically, without further permission from the state legislature. And the best way to understand this is in contrast to what came before. It used to be that you had to petition the legislature, meaning all the Congress people and get them to vote, that you should get the rights to start a corporation, to charter a corporation. Of course, this was hard to do and required being politically connected. The concept of free incorporation took the legislature out of that process. And if you simply filed the paperwork correctly and paid the fee, you would get a corporation, you would get permission from the state to form a corporation. And the result was a huge increase in the number of corporations that could be formed. It was much cheaper and it allowed people who otherwise wouldn't have been invited into this political system to become entrepreneurs and start businesses. And this free incorporation was a state law. So corporations are creatures of state law. There's not such a thing as a federal corporation. And at least for now, the federal government has stayed out of the corporate game for the most part. So the different states could compete with each other to offer the best corporate laws. There was an early competition between New Jersey and Delaware. Delaware apparently won out as most corporations, large ones, at least incorporate in Delaware today. So these states could actually offer the best or some people would say the worst, anyway, the ultimate set of rules. There's a concept called race to the top, race to the bottom. And there's certainly academic discourse about whether state-based free incorporation leads to the good or to the bad. But we do have a system now where any state can form a law that says you can create a business here. And if you comply with those minimum standards, which are very light, you can form a business. And that's the reason we have millions and millions of corporations in America today. PUBLIUS: What did this free incorporation process look like in early America? It’s easy to imagine a modern corporation operating in multiple states but incorporating in Delaware. But the first corporations must have been exclusive to their state rather than national entities? SETH ORANBURG: If you look back at early corporations in America, a lot of them were banks. Banks are a type of corporation and they're an important type of corporation because they actually fund other corporations. So they're in a way, a meta corporation. They actually can cause other corporations to come into existence by providing them with loans and money. The question is who can make banks? And this was a big struggle between the Federalists and the Anti-Federalists in the early days of our Republic. The Federalists wanted there to be a strong central bank and that central bank would have the ability to raise funds for the army and do other things for the nation. The Anti-Federalists who were typically from the rural South and had some skepticism about those monied interests in the North, had a whole campaign over several periods. The first, and then the second national bank of America was formed by Federalists and then destroyed by Anti-Federalists. In the wake of the destruction of the second national bank, the country saw a great need for more banking. And a lot of states filled that void by allowing private individuals to form banks in the state. Not national banks, but state banks. So free banking is a period in American history. It's an era. The free banking era occurred from around 1837 to 1863. In 1837, there was a financial crisis called the panic of 1837. And it was prompted in large part because President Jackson had, the year prior, caused the dissolution of the national bank of the United States. Michigan was the first state to allow it with the Act to Reorganize and Regulate Banking of 1837. New York and Georgia follow suit in 1838. Alabama in 1849. New Jersey in 1850. Illinois, Massachusetts, Ohio, and Vermont passed similar laws in 1851, as did Connecticut, Indiana, Tennessee, and Wisconsin in 1852. Some states imposed various requirements like minimum or maximum interest rates or debt equity ratios. But the period was primarily categorized by very loose regulation. And as a result of this loose regulation, there was some funny money floating around. There was a distinction made between hard currency and what is called soft currency. Hard currency was things like gold coins, silver bullion that could be minted and had some inherent or at least agreed upon value. Soft money were bank notes. And they're not like the bank notes you have in your wallet, like those green ones from the United States that say, "In God, we trust." Those are bank notes, but those are federal bank notes. These banks began issuing their own currency known as Wildcat Currency. Some of them would say things on them that are actually kind of funny, in retrospect. Like it would be a $5 bank note and you could take it to the Cleveland bank and exchange it for either $5 or $5 in cords of wood or $5 in coonskin caps. The problem with these private bank notes was that they weren't very regulated, which isn't inherently a problem, but it became a problem when the government got itself into several other economic crises. And as the money supply began to dry up, and people went to banks to demand a return on their bank note and banks didn't have enough cash on hand to pay out the notes. People got more anxious. Bank runs began to proliferate. And this all tumbled down with a series of unfortunate events. There was a war in Europe from 1853 to 1856, which again, history repeats itself, had to do with Crimea, an area which is still contentious today. But as a result of the Crimean War from 1853 to 1856, which is the breadbasket of Europe, there was a food crisis. : Europe was sending boys to war instead of to the farms and they were fighting in the fields instead of harvesting them. And so Europe had a food crisis. Europeans purchased food from America and farms did well. And in fact, increased because they were able to sell internationally their grain produce. But when the war ended the next year, the demand on American wheat from Europe crashed suddenly. And this, among several other events, including a boat carrying 1.5 million in gold bullion... A boat carrying 1.5 million in gold bullion sunk off the coast of California, which further disrupted the money supply. Literally, there was hard money at the bottom of the ocean that was irretrievable. And there were other factors as well, including at that point, we're now talking about a few years before the Civil War, the Union, and the Confederacy are going to split the following year. And the Civil War began in 1861. Entire banks went bankrupt and it turned out those banks had lent to other banks. And the whole thing was a mix, a mess of an interconnected system. And one bank went down, took down another one. It's a lot like what happened by the way, in the 2007-'08 mortgage crisis, where we had these toxic assets that were interconnected. I guess, just a reminder that history repeats. But this free banking era ended in a crisis where these free banks turned out to be unsustainable, or at least, the regulatory response to a crisis is usually to change whatever was perceived to cause the crisis. And at that point, the crisis was blamed on free banking. So the free banking laws were rescinded and a national bank, the US Treasury was established around 1860. And in part, of course, as you might imagine, that was necessary for the Union to fund its effort and needed a central organization and it wanted power over the money supply because we were now entering into The Civil War conflict. So that may have politically motivated the end of the free banking era as well. So a huge amount of tension is happening in society all around this time. And the instability of a state banking system was simply untenable. The volatility created by this was untenable. And if you want to find the power, you follow the money. So creating a more rigorous central bank apparatus, like the one we know today, was a direct result of the exigencies of the immediate crisis before the Civil War. But after that point, you can't just form a bank in America anymore. You can form whatever corporation you want, but not a bank, not a university. There are certain types of corporations you can't form in America, even today. And you can't form a bank in America without going and asking for a specific charter. PUBLIUS: Let’s go back to something you mentioned a few minutes ago. Why was a national bank a flashpoint for the Federalists and Anti-Fedearalists? Did the Anti-Federalists distrust all corporate organizations? SETH ORANBURG: There really was throughout history, a sharp divide between the Federalists and the Anti-Federalists, and their trust for corporations and for banking. The Federalists were traditionally from states like Massachusetts and engaged in banking, commerce and mercantilism.The Anti-Federalists like Jefferson, were from rural states like Virginia, and as an anecdote or maybe as an exclamation point, were slave owners. Famously Hamilton, who is the star of a very popular Broadway movie and was an anti-slave politician, during his tenure he was the first secretary of the treasury and he also created the Bank of New York. So he was very heavily invested in banking. He was a Federalist and he helped create the first bank of the United States in 1791. And it was the Anti-Federalists that made campaigns to take that bank down. And it was to their detriment really. Multiple times Anti-Federalists sought to disrupt the banker's power in New York in an effort to accumulate power in the Southern rural states and move it from the free North to the slave South at their peril. A number of times where for example, 1832, President Jackson, a notable Southern Democrat who was pro slave vetoed the second bank of United States' charter renewal, causing the bank to disappear. His goal was to take the money away from the wealthy North and their influence. In fact, it was a direct effect to enhance slavery. The Democrats wanted to perpetuate slavery by destroying federal banks. It's not a question. It's a fact. Nathaniel Macon, a Democrat from North Carolina said, "If Congress can make banks, roads and canals under the Constitution, they can free any slave in the states." In his argument against the bank, John Tyler, a Democrat from Virginia, concurred and said, "If Congress can incorporate a bank, it might emancipate a slave." There's a direct connection with banking and freedom that caused many of these Southern Democrats to significantly oppose any sort of free banking or central banking system. But ironically, it didn't help the Southerners. In fact, it crushed them. By getting rid of a central bank, what you're really getting rid of is liquidity, the ability of that bank to lend money, especially in times of crisis. Well, crises happened from time to time. There was a panic in 1837, a financial crisis. And as the money supply dried up, who was harmed the most? Well, it turned out it was farmers who sold luxury goods, at that point, cotton. Cotton was fairly luxurious. It was also very labor intensive. It was a slave crop. It was almost exclusively made by slave power. And that is the industry which was probably harmed the most by the Democrat anti-banking practices because that industry needed liquidity and the ability of others to borrow money to buy cotton, because merchants don't have so much money on hand. In order for them to buy cotton and then turn that cotton into shirts and blankets and to sell goods, they need capital. And that comes from banks and trying to cut the banks out of the picture meant that you were then cutting the merchants out of the picture, which meant you were cutting the factories out of the picture and suddenly cotton that you can't turn into anything looks a lot less valuable. So these policies were absolutely driven by Southern Democrats who wanted to keep the South slave and hated bankers, but it really ended up hurting their constituents. Of course, that put pressure on them that showed the failures and inadequacies of an immoral system, slavery, which led to the Civil War. Although tragic, it did lead to the at least legal abolition of that disgusting institution. So I guess it's a good thing they didn't really understand economics very well. They might have talked about freedom, but freedom for wealthy male landowners, who were them. Whereas, when you move to the Federalists, I think what the Federalists understood was a much broader concept of freedom and freedom through opportunity, social mobility. The Anti-Federalists didn't seem to view social mobility as a preeminent concern. They effectively had a feudal society where people had their roles. Whereas under a system of banking, you take chances, you take risks, and you have opportunities to rise and fall in society. It's a different view about opportunity in America and who deserves to have it. PUBLIUS: This is a bit tangential but when you mentioned risks and opportunities, I thought of the stock market. When did that get started here in America? SETH ORANBURG: The New York Stock Exchange originated very soon after the Constitution came into effect. On May 17th, 1792, 24 brokers and merchants met under a tall tree, a Buttonwood tree on Wall Street in Lower Manhattan, New York. And they signed a short document, which today would be an antitrust violation by the way, because it was effectively an agreement for them to set prices and to maintain controls over the brokerage industry. But at that time, we didn't have laws against that sort of thing. And they ended up creating what we now know as the New York Stock Exchange. They wrote, "We, the subscribers, brokers for the purchase and sale of public stock, do hereby solemnly promise and pledge ourselves to each other that we will not buy or sell from this day for any person whatsoever, any kind of public stock at a less rate than one quarter percent commission on the specie value. And that we'll give a preference to each other in our negotiations and testimony. Whereof we have set our hands the 17th day of May at New York, 1792." So in addition to this being an agreement to set prices and collude, it is also the beginning of self-regulation. It's one of our first self-regulatory organizations. A self-regulatory organization is one that sets its own rules for how it does business in order to preclude the government from telling it how to do business. And this feature allowed the New York Stock Exchange to declare itself as either more or less safe or efficacious than other markets. And in the end, it won out. The New York Stock Exchange today is one of the most prolific exchanges in the world. And it all began under a Buttonwood tree in 1792. PUBLIUS: Talking about the Stock Exchange naturally brings modern corporations into my mind. There is a lot of discussion now about whether we need corporations and what they should or shouldn’t do. What purpose do they serve? The corporation is the greatest vehicle for the construction of wealth in America today. And perhaps ever. The corporation is a wealth creation vehicle. It's a place for people to put money for a common enterprise without taking on certain risks that they would otherwise incur. If you put money into a corporation, you get a share of the profits and that corporation can organize itself or can be organized by professional managers to use that money more efficiently than any one person could. I mean, think about an assembly line, right? You have a bunch of people on assembly line making a chair. Instead of one person doing every step in the process, there's one person who's creating dowel rods and another person that's sanding and another person that's chopping wood and another person that's painting. And it's just more efficient if you go out there and you do one job all day. You bring all the pieces together, you can start making more chairs. If you can make more chairs with the same number of hours, you can sell that chair for less money. And now that chair, which is every bit as good as the chair made by a single person, if it's just as good and it costs you less money, you can make a profit selling it for less. And now there's cheaper chairs to sit on. Now, people can buy a chair and still have enough money for soup for dinner. That's value, that creates value, right? That now we have more value in society because we were able to have this collective enterprise. And corporations can do this because one, they exist separately from the people who own them. They're their own thing. So you put money into a corporation and now that corporation has resources with which it can engage in commerce and construction and manufacture, et cetera. The second thing is that if you put money into a corporation, you are not at risk of losing more in general than you put in. And this is called limited liability. That will encourage you to invest in the first place. I mean, imagine this, imagine that if you put in $100 to Microsoft, a trillion dollar corporation, so you own making the numbers up but 0.0001% of Microsoft or whatever. So yes, you have a share of the profits, but clearly at that kind of levels, you have no say in what happens, you have no particular rights to, you don't know what their next processor's going to look like. So let's say that someone in Microsoft goes to China and needs to get a shipment off a boat and gives the guy $10,000 to get a permit to make it happen. These sort of things happen, right? It's called bribery. It's illegal, but it happens. Well, that's a violation of the Foreign Corrupt Practices Act. And it could result in millions of dollars of penalties to the company. If you, having put a hundred dollars into the company, now were personally liable for that manager's violation of the FCPA. That would discourage you from investing in the first place. It's a huge amount of personal liability that you can't oversee. So the imposition of limited liability is a requirement, otherwise we simply wouldn't have people passively invest in corporations. You would only invest in things you could monitor. And again, monitoring is very expensive. There's still risks of course, in investing in corporations. But the risks are primarily around losing the money you've invested. No one's going to come and take your house. And that really encourages investment because that allows us to invest an amount that we're comfortable with. We have certainty, and hopefully that's an amount you can afford to lose. But then of course, if things go well, you get a share of the gain. PUBLIUS: Wealth creation is, of course, good for individuals and society. Do corporations help us achieve any loftier goals? Corporations promote freedom by giving people new ways to earn a livelihood. So if you go back to the Declaration of Independence, it talked about life, liberty, and the pursuit of happiness. And this has generally been interpreted to mean the right to earn a living. So how do you earn a living? Well, you can go out into the world and offer to do work. That's one means, but that's a limited means because you can't really leverage a large organizational structure. And it may be that you are very strong and you have great capacity to chop wood quickly, for example, and people pay you highly to simply chop wood and you don't need a corporation for that, right? That's great if you have that capacity. But what if your capacity is you have ideas? Or what if you're good at organizing people? What if you're good at fundraising or planning? What if your skills are more in management? In that case, a corporation can be a vehicle for you to take those ideas and build an organization that can produce even more value than any one chopping trees. Maybe you realize that there needs to be an integrated operation, where there is someone who is cutting down on the trees, another person who is dragging them with a machine to another person operating a forklift, another person taking them to a mill, another person operating that mill, another person going out and about selling that wood as a salesperson, another person making final deliveries using a flatbed truck. And all of these different parts. You see all these parts and you're not a truck driver. You're not a mill operator. You're not Paul Bunyan out there cutting down trees. But you have this vision and this capacity to see a whole organization. And corporate laws give you the freedom to do that without taking on personal liability that could cost you your house or everything you own. And that allows you a certain level of freedom to engage in large scale ways in the economy. Without corporations, we could only really do very small barter tasks. If we don't have corporations, maybe I'll raise goats and I'll sell you a goat for some money, or I'll trade you a goat for some oranges or what have you. But aside from family relationships, we don't really have the ability to create large scale organizations because there's no structure for that. There's unlimited liability for that. So corporations promote the type of economic freedom that I think our founders intended when they wrote life, liberty and the pursuit of happiness. NARRATOR: 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!