UBC Theses and Dissertations

UBC Theses Logo

UBC Theses and Dissertations

The corporation is a social institution Cody, Michael David 2006

Your browser doesn't seem to have a PDF viewer, please download the PDF to view this item.

Item Metadata


831-ubc_2006-0413.pdf [ 20.41MB ]
JSON: 831-1.0077611.json
JSON-LD: 831-1.0077611-ld.json
RDF/XML (Pretty): 831-1.0077611-rdf.xml
RDF/JSON: 831-1.0077611-rdf.json
Turtle: 831-1.0077611-turtle.txt
N-Triples: 831-1.0077611-rdf-ntriples.txt
Original Record: 831-1.0077611-source.json
Full Text

Full Text

THE CORPOPvATION IS A SOCIAL INSTITUTION by MICHAEL DAVID CODY L L . B . , University of Western Ontario, 1997 B.A., University of Western Ontario, 1994  A THESIS SUBMITTED IN P A R T I A L F U L F I L L M E N T OF THE REQUIREMENTS FOR THE D E G R E E OF M A S T E R OF L A W S in THE F A C U L T Y OF G R A D U A T E STUDIES (LAW) THE UNIVERSITY OF BRITISH C O L U M B I A August 2006 © Michael David Cody, 2006  ABSTRACT Corporate law theory in Anglo-American countries has long been dominated by economic analysis. While significant efforts have been made to critique the economic theory of the corporation and a number of alternate "progressive" theories have been offered - there is still no single theory that stands in opposition to the Nexus of Contracts theory. This thesis utilizes historical analysis to show that before 1930 there were two dominant and opposing theories of the corporation: Contractual theory (or early economic theory), which conceptualized the corporation as merely a collection of freely contracting individuals; and Entity theory (or early sociological theory), which conceptualized the corporation as a real entity with an existence distinct from its members. The competition between these two contrasting theories created a balance in the corporate law debate between the economic and social aspects of corporations. But Entity theory fell out of favour in Anglo-American countries and the balance was lost. The effects of that loss are evident in modern Anglo-American societies with our disproportionate preference for private interests over public interests. Our fascination with short term profits, our readiness to make lay-offs and rampant mergers and acquisition activity are a few examples of this phenomenon. This thesis argues for the revival of the social theory of the corporation to restore balance to the corporate law debate. Using advances in sociology and in particular developments from organizational theory and institutional analysis, the building blocks of an updated social theory of the corporation are outlined.  11  TABLE OF CONTENTS  ABSTRACT  ii  T A B L E OF CONTENTS  iii  LIST OF T A B L E S LIST OF T A B L E S  v <.  vii  PREFACE  viii  ACKNOWLEDGEMENTS  xiv  DEDICATION  xv  C H A P T E R 1: INTRODUCTION 1.1 Corporate Theory 1.2 Themes of the Book 1.3 Chapter Outline  1 3 6 16  C H A P T E R 2: T H E CORPORATION IS A SOCIAL INSTITUTION 2.1 Introduction 2.2 Historical References to the Corporation as a Social Institution 2.3 Social Institutions - Sociology and Organizational Theory 2.4 The Corporation is a Social Institution: The Statistical Evidence 2.5 The Dominance of the Corporation - The Commentators 2.6 Implications of the Corporation as a Social Institution 2.7 Conclusion  19 19 20 22 26 28 30 39  C H A P T E R 3: THE HISTORICAL D E V E L O P M E N T OF C O R P O R A T E T H E O R Y . . . 45 3.1 Introduction 45 3.2 The Relevance Of Corporate Theory 46 3.3 Analytical Approach 57 3.4 The Historical Development Of Corporate Theory 71 3.5 Corporate Theories Are Normative 162 3.6 Conclusion 164 C H A P T E R 4: THE RISE OF ECONOMICS IN C O R P O R A T E L A W 4.1 Introduction 4.2 The Rise To Dominance O f The Economic Conception O f The Corporation 4.3 The Criticisms Of Economic Theory, Law And Economics And The Economic Conception Of The Corporation 4.4 Conclusion  iii  174 -. 174 175 211 233  C H A P T E R 5: T H E L I N K B E T W E E N O R G A N I Z A T I O N A L T H E O R Y A N D CORPORATE T H E O R Y 5.1 Introduction 5.2 Introduction To Organizational Theory 5.3 The Historical Development Of Organizational Theory 5.4 The Link Between Organizational Theory And Corporate Theory 5.5 Increasing Complexity Of Theory C H A P T E R 6: T H E SOCIAL T H E O R Y OF THE CORPORATION 6.1 Introduction 6.2 The Sociological View Of Markets, Organizations And Individual Actors 6.3 Summary Of Insights From The Historical Review Of Corporate Theories 6.4 The Social Theory O f The Corporation 6.5 Is The Social Theory Of The Corporation Better? 6.7 Summary and the Recipe for Change  235 235 240 258 271 274 285 285 286 328 329 346 354  C H A P T E R 7: A MULTI-DISCIPLINARY CORPORATE T H E O R Y C O M B I N I N G SOCIAL A N D ECONOMIC THEORIES OF THE CORPORATION 7.1 Introduction 7.2 The Social Theory Of The Corporation Is Important 7.3 The Multidisciplinary Theory Of The Corporation , 7.4 Combining The Social And Economic Theories O f The Corporation 7.5 The Layered Approach 7.6 Conclusion  364 364 365 365 368 372 373  C H A P T E R 8: C O N C L U S I O N 8.1 Themes Of The Book: Politics And Balance 8.2 The Process Of Change  376 380 386  BIBLIOGRAPHY  388  iv  LIST OF T A B L E S T A B L E 2-1: THE L A R G E S T COUNTRIES IN THE W O R L D I N 2006 O R G A N I Z E D B Y GROSS DOMESTIC PRODUCT  40  T A B L E 2-2: T H E 15 L A R G E S T CORPORATIONS O N THE 2006 F O R T U N E 500  41  T A B L E 2-3: CORPORATIONS A N D COUNTRIES C O M P A R E D  42  T A B L E 2-4: R E V E N U E S OF L A R G E S T C O M P A N Y O N F O R T U N E 500 S E L E C T E D Y E A R S 1955-2006  43  T A B L E 2-5: B O U L D I N G ' S S Y S T E M TYPES  44  T A B L E 3-1: E U R O P E A N A N D R U S S I A N CORPORATIONS O N T H E E V E OF W O R L D W A R 1  168  T A B L E 3-2: S U M M A R Y OF C O R P O R A T E THEORIES  172  T A B L E 3-3: SELECTION OF C H A R T F R O M D A L L A S (2005) T A B L E 5-1: O R G A N I Z A T I O N A L A N A L Y S I S DEFINITION OF O R G A N I Z A T I O N WITHIN R A T I O N A L , N A T U R A L A N D O P E N T H E O R E T I C A L PERSPECTIVES T A B L E 5-2: D O M I N A N T T H E O R E T I C A L M O D E L S A N D R E P R E S E N T A T I V E THEORISTS: A L A Y E R E D M O D E L  ...173  277 278  T A B L E 5-3: CLASSIFICATION OF C O R P O R A T E THOERIES USING SCOTT CLASSIFICATION S Y S T E M  279  T A B L E 5-4: SCOTT'S FOUR STAGES IN T H E D E V E L O P M E N T OF O R G A N I Z A T I O N A L T H E O R Y  280  T A B L E 5-5: THE " T H R E E " STAGES IN THE D E V E L O P M E N T OF C O R P O R A T E T H E O R Y  281  T A B L E 5-6: DIFFERENCE IN N O R M A T I V E ASSUMPTIONS B E T W E E N ECONOMICS A N D SOCIOLOGY  282  T A B L E 6-1: ECONOMIC SOCIOLOGY THEORISTS A N D S E L E C T E D WORKS  357  T A B L E 6-2: L E V E L S OF A N A L Y S I S IN O R G A N I Z A T I O N A L T H E O R Y AND CORPORATE THEORY  359  T A B L E 7-1: T H E DIFFERENCES B E T W E E N SOCIOLOGY A N D ECONOMICS  375  v i  LIST OF FIGURES  FIGURE 3-1: T H E T H R E E ASPECTS OF CORPORATE T H E O R Y  167  FIGURE 3-2: D E V E L O P M E N T OF SELECTED C O R P O R A T E THEORIES  169  FIGURE 3-3: GRAPHIC REPRESENTATION OF ASSUMPTIONS OF C O R P O R A T E THEORIES (PUBLIC/PRIVATE A N D JTTOIVIDUAL/GROUP)  170  FIGURE 3-4: GRAPHIC REPRESENTATION OF ASSUMPTIONS OF M O D E R N C O R P O R A T E THEORIES (PUBLIC/PRIVATE A N D INDIVIDUAL/GROUP)  171  FIGURE 5-1: T H E RELATIONSHIP A M O N G SOCIOLOGY, ECONOMICS E C O N O M I C SOCIOLOGY A N D O R G A N I Z A T I O N A L T H E O R Y  276  FIGURE 5-2: A HISTORY OF O R G A N I Z A T I O N A L T H E O R Y  283  FIGURE 5-3: A HISTORY OF THE L I N K B E T W E E N O R G A N I Z A T I O N A L THEORY A N D CORPORATE THEORY  284  FIGURE 6-1: INDIVIDUAL B E H A V I O R D E T E R M I N A N T S " R E A S O N A B L E NOT R A T I O N A L "  360  FIGURE 6-2: O R G A N I Z A T I O N A L B E H A V I O R D E T E R M I N A N T S "EFFECTIVE NOT EFFICIENT"  361  FIGURE 6-3: M A R K E T CHARACTERISTICS " S T A B L E NOT COMPETITIVE"  362  FIGURE 6-4: E M B E D D E D N E S S OF THE E C O N O M Y IN SOCIETY  363  vii  PREFACE THREE STRIKES AND YOU'RE OUT  This book was motivated by my experiences in the practice of corporate law. I graduated from law school in the late 1990's. Although I did not recognize it at the time, I was a well trained corporate lawyer from the law and economics school. I knew the 1  mantra: the corporation, at all times, was to be run in the best interest of shareholders. This idea is referred to as "shareholder primacy". Corporate transactions, such as hostile takeover bids, mergers, acquisitions and other shareholder maximization transactions (such as employee lay-offs) were all justifiable on the basis that focusing on returns to shareholders ensured that corporations were always operating efficiently. not, shareholders would replace ineffective corporate managers  If they were  and force the  redeployment of underperforming corporate assets to more productive uses. The theory made everything seem so simple. The problem was that the real world turned out to be a lot different than the theory described. The story of my career as a corporate lawyer is best described using the metaphor: three strikes and you're out. When I graduated law school, I was lucky enough to attain an articling position at a well respected Bay street corporate law firm. I practiced there for a very short period of time. But, it was long enough for me to realize that there was something wrong with what I had been taught in law school.  Two deficiencies, in  particular, became clear to me. First, most corporate transactions aimed at increasing the profits of a corporation were not successful. Ineffective corporate managers were not often replaced, and assets, though redeployed, rarely seemed to be put to more productive ' This is a particular approach to corporate law that is based on the Nexus of Contracts theory of the firm. It is described in more detail in Chapter 3 - "The Nexus of Contracts Theory of the Corporation."  viii  uses.  Second, in my mind, it was very hard to reconcile the fact that in the same  transaction, a senior manager could be paid ten of millions of dollars in "parachute" and stock option payments to leave the company, while at the same time, ten of thousands of employees who wanted to stay, were getting let go in "cost-cutting measures". Were they really getting let go to cut costs? To redeploy assets to more productive uses? Or were they being let go to fund the payments to the outgoing executives? I left the firm to join a Canadian software and technology company that was listed on the Toronto Stock Exchange. I became the General Counsel of the company shortly after I arrived. It was a wonderful company, full of community feeling, and a place that everyone would be happy to work at. Canadian from its inception it valued people and customers first and profits were a clear second. While its products may have fallen a little behind the times - it was a wonderful place to work. Unfortunately, about 18 months after I joined, the company was sold in what looked like a friendly transaction, but which was ostensibly a hostile takeover bid. Even though the company was not losing money, it was not generating enough returns for its major shareholder, and, so, it was sold to a larger Canadian information technology company. Unfortunately, the end results are all too familiar: large financial payments were made to exiting executives, employees were laid off and the integration of the companies was a failure. I left. I understand that the company was sold twice more in the ensuing years and that it was forced to shut down half of its business. I believe it is now owned by an American company. Strike one against the practice of corporate law. From there I became the corporate counsel for another Canadian technology company that was listed on the Toronto Stock Exchange. Again, I chose it because it was  ix  a wonderful place to work. It was founded by a Canadian entrepreneur, who had bought a patent from a larger corporation, and grown it, from a few people working in a garage, to a company with over 400 employees that made world class technology products. The sense of pride and community at the company was incredible and it had a real 'family' atmosphere. It was clearly the type of place that could choose people over profits and, unfortunately, it did.  B y chance, it chose to buy a beautiful new building for its  employees just before its business took an unexpected short term downturn. A temporary cash flow problem resulted and the company was unable to find funding. About 18 months after I arrived, the company was sold in an auction process to a large U.S. corporation. The results were the same: large financial payments were made to exiting executives, employees were laid off, and I am not really sure how well the integration went because, knowing what the outcome was likely to be, I left before it started. The most disappointing thing about this transaction was the effect that it had on the employees, at both the executive level and the non-executive level.  The community  feeling of the company evaporated overnight, trust disappeared, there were instances of marital breakdown, family stress, divorce, adultery, depression, drug abuse, alcoholism, greed etc. as people succumbed to the pressure and uncertainty that is involved in these types of transactions. Living through these situations with people that you know, or worse care for, is very difficult. Sometimes legal practitioners who do not have to live at the company that is being sold can be too removed from the actual consequences to understand the impact that these activities have on people. Anyone who has worked in a corporation knows that it is not just a 'legal fiction'. It is an organization made up of real people, each with their own motivations, hopes, aspirations, dreams, idiosyncrasies etc.  x  When a decision is made to 'maximize profit' - you are not just moving decimal places around - you are making an impact on the lives of real people. It is important not to forget that there are social and psychological consequences to the human beings involved in shareholder maximization transactions. Strike two. I then went to another great company as a corporate counsel. It was, and still is, Canada's largest health and life sciences company. I chose it because of its core values, the mentors that they offered me, and the fact that it was so large that it would be an unlikely target for a 'shareholder maximization' process - or, so I thought. Again, the story is eerily similar. This company was a Canadian success story. It had been founded by three entrepreneurs in the 1970's and had grown to a C$1.6 billion revenue company with about 10,000 employees and operations worldwide. Many of its employees had been with the company for the entire working careers and the culture was characterized by a strong community feeling. Unfortunately, it made a crucial mistake. During the late 1990's, it decided that it was a growth company and promised investors that it would return annually 15% on its equity. The problem was that historically it had only ever delivered 9-10% return on equity.  The result was that it attracted institutional  shareholders whose expectations that cold not be met. About two years after I arrived, the shareholders became dissatisfied with the financial performance of the company, even though the company continued to make money, albeit not the promised 15% return on equity. The founders were forced to leave, a new CEO was brought in from the U.S. with the sole purpose of focusing on return to shareholders, large layoffs ensued, and plans were developed to break the company up into at least two parts. community feeling of the company evaporated.  xi  Immediately the  Good people started to leave and the  standard results looked to be on the horizon. The fate of this company is still in the air as of the time of printing. Strike three and I was out. At that point, I came to a realization. Was it coincidence that I managed to choose three companies early in my career that were to be sold or affected by shareholder maximization transactions? Or, was there something more systematic going on here? The realization that I had was this: in the current economic system in North America, with its focus on generating profits for shareholders, it is impossible for any public company that values people over profits to exist for any significant period of time. Inevitably, the company will be forced to choose its people over profits, and its financial performance will suffer. If the company is publicly traded, a short term dip in financial performance is not permissible, even i f it is temporary, and the company will be subject to some sort of shareholder maximization process, to return the company to 'profitability'.  Therefore, in the current system, the existence of 'good' companies is  only temporary and all 'good' companies that are publicly traded are likely to be sold or torn apart at some point in the future. Personally, I realized that I could either continue to choose good companies and fight to protect them one at a time - or I could focus my efforts on trying to change the system - so that companies like the ones described above can not only exist in our society, but be treasured. The result is this book. I hope that it proves useful in helping people understand how the current economic system in North America came about, how our current corporate law and corporate theory are structured, and how extreme they all are in their politics. I hope it also provides a useful picture of what the alternatives are.  xii  The focus of the book is corporate law, but its implications are far wider. Society is about people - not profits. As a society, if we continue to value profits over people, we risk grave consequences. Karl Polanyi warned us of this in 1957 in his book: The Great Transformation. If Polanyi was right in his analysis, the stakes are high. We risk losing our society. As Canadians, we need to start making policy choices that are consistent with the preference of people over profits. How can we do that? This book offers some thoughts, theories and tools that might be helpful. Finally, I would be remiss i f I did not mention the indebtedness that I have to all the great thinkers that have gone before me whose work is cited in this book. There is nothing new in this book. It is really just a collection of great ideas that people need reminding about. Michael Cody August 31, 2006  xm  ACKNOWLEDGEMENTS I would like to take this opportunity to acknowledge some of those who assisted me in the completion of this thesis. I cannot say enough about Professor Janis Sarra. Not only was she my supervisor, but she was also a mentor and role model for me. She is the kind of person and academic that we all marvel at. The support and encouragement that she provided me was invaluable and the opportunities that she opened up for me, I can never repay her for. I am in her eternal gratitude. I am also fortunate to have had Professor Ron Davis as my second reader on this thesis. His incisive comments helped provide focus to a project that had a tendency to grow out of all proportion. I would also like to acknowledge Professor Wesley Pue for his encouragement throughout the year and his support of all ideas subversive. In addition, I would like to thank Joanne Chung who was our Graduate Secretary but who also was my mom away from home. Thanks go out to everyone else who at one point or another provided comments on drafts of this thesis including: Brandi Stocks, Jessica Fletcher and Rebecca Proctor. Finally, I would never have gotten this thesis done without the support of my good friend Rob Russo who helped to ensure that it was accepted by FOGS on the first try.  DEDICATION This thesis is dedicated to Jessica. Thank you for helping me find my passion.  x v  C H A P T E R 1: I N T R O D U C T I O N  The thesis of this book is that the corporation is a social institution. It is a simple insight, but it has profound implications for the way we think about corporations. Currently, in Anglo-American societies we think of the corporation only in economic terms.  2  The corporation is simply a vehicle to fulfill our economic requirements, and, we  treat it that way. From the way we conceive of it, to the way we structure it, to the way we operate it, to the way we regulate it, economic theory informs all of our opinions of corporations. But, economic theory is i l l suited to current reality, because it makes a series of simplifying assumptions that effectively eliminate human, cultural and social aspects from analysis. This is a dangerous thing to do with a social institution. The outcomes of this type of analysis are apparent all around us: Profit is more important than people, mergers and acquisitions are rampant, short term results are more important than stable long term sustainability, massive downsizing and lay-offs are common and the economy is in a constant state of instability. The economic conception of the corporation is wrong. If it ever was correct, its time of usefulness has passed.  Corporations are no longer simply economic vehicles.  They have attained enormous power in Anglo-American societies:  they make most  everything we use, many of us earn our living working for them, our communities are dependent on them, they control almost all of the financial capital in the economy, and they are involved in providing many of our basic services, including food, health care, education, defense etc. In this context, corporations have become an important social institution: a social structure that provides meaning and stability to our lives. A structure The term Anglo-American will be used throughout this book to refer to the United States, the United Kingdom, Canada, Australia and New Zealand. 2  1  similar, in kind, to the family, the church or the state. We need to re-conceptualize our views of corporations to account for this. We need to change how we conceive of them, how we structure them, how we operate them and how we regulate them. We need to reintroduce the missing human and social aspects of corporations - the aspects that are the most important when we recognize that the corporation is a social institution. This should not be too hard to accomplish. The economic conception of the corporation is relatively new. In corporate law, it did not become the accepted paradigm until the mid 1980's.  In the past, social conceptions of the corporation were quite  popular and influential. However, somewhere along the way, those social conceptions of the corporation fell out of favour in Anglo-American societies and the economic conception took over. This book explains what those earlier social conceptions of the corporation were, how the economic conception of the corporation became dominant, and argues for the revival of a social theory of the corporation. A theory based on sociological analysis and not economic analysis. A n approach that focuses primarily on understanding the human and social aspects of how corporations work and the role they play in our society. Beyond that, this book argues for balance. One of the insights of the social theory of the corporation is that society and human organizations, including corporations, are very, very complex phenomena, and no single theory, economics or sociology, is yet capable of completely explaining them. Therefore, going forward, the progress we make towards truly understanding society, organizations and corporations, will come from balancing  and  incorporating  the  insights  multidisciplinary theory of the corporation.  2  from  all social sciences  into  one  This book explores these issues by focusing on corporate law and theory upon which it is based. It adopts a contextual approach and examines the rise of corporations, economic analysis, and corporate law from a broad social and historical perspective. This approach is a conscious effort to take a step back from the narrow field of corporate law and place the current issues in corporate law within societal context. The geographic focus of this book is primarily Canada and the United States although reference will be made to Anglo-American countries, and other countries, including Germany, China and Japan.  This book is also primarily focused on large publicly traded corporations,  although many of the insights will apply to all corporations.  1.1  3  Corporate Theory This book is about Anglo-American corporate law. More specifically, this book  is about the theory upon which Anglo-American corporate law is based. A l l Anglo-American corporate law theories are based on the answers to two related questions: 1.  What is a corporation?  2.  What is the purpose of corporate law?  4  Anglo-American jurisdictions are unique in the fact that they do not distinguish between privately held companies and large public companies within the corporate law. Although the latter is subjected to additional requirements through securities acts and stock exchange regulation. In contrast, in Germany and France, for example, they have different concepts for private and public companies.For a description of these differences see John Kay, The Business of Economics (Oxford: Oxford University Press, 1996). The view that corporate theory is concerned with providing an explanation for what corporations are is shared by David Millon. See David Mi lion, "Theories of the Corporation" [1990] Duke Law Journal 201 at 241, where he states: "Legal theories differ from legal rules because legal theories set forth a positive or descriptive assertion about the world - an assertion about what corporations are.'" Millon argues that these types of positive statements then lead to normative implications. This book makes the argument that the positive statements do not lead to normative implications because the statements themselves are normative. See Chapter 3 - "Politics and Normative Assumptions." 3  4  3  In this book, the term 'corporate theory' is used to describe theories that attempt to answer these two questions. The  5  first question is important to corporate law because the way that the  corporation is viewed is often the primary determinant of what the purpose of corporate law is deemed to be. For example, i f the corporation is conceived of as a contract among private individuals, then it is likely that the purpose of corporate law will be to act as a standard form contract among those individuals. The second question is important to corporate law because the view of the purpose of corporate law is the primary determinant of the form corporate law takes. For example, i f the purpose of corporate law is to act as a standard form contract among private individuals, then it is unlikely that the corporate law will contain terms that regulate the corporation's relationship with society. There is a strong link between the answers to these two questions, corporate theory, and the corporate law. Almost all proposals to reform corporate law are based, knowingly or not, on different answers to these questions, and consequently, different corporate theories. The best way to judge whether any given proposal to reform the current corporate law is an improvement, is to determine whether the answers that are provided by the new corporate theory being offered are better than the answers provided by the current corporate theory. 'Better' answers are: more descriptive of reality, better at predicting behavior, and/or more consistent with the normative views of society concerning corporations.  6  Historically, change in corporate theory has only occurred  Throughout this book when the term corporate theory is used it is referring to Anglo-American corporate theory. These three criteria are linked to the three aspects of corporate theory. The descriptive aspect describes how corporations and corporate law work in the real world. The illustrative aspect allows the behaviour of 5  6  4  when a new theory arises that offers better answers than the answers offered by the current theory.  7  Currently, the dominant theory in Anglo American corporate law, the 'nexus of contracts' theory, provides the following answers to the questions: 1.  The corporation is a "nexus of contracts" among inputs and outputs in the production process  2.  The purpose of corporate law is to act as a standard form contract among those inputs and outputs.  While these answers are not very descriptive of reality, it is alleged that they are relatively good at predicting behaviour, and they are (or were) extremely consistent with the normative view of Anglo-American societies concerning corporations.  9  The purpose of this book is to re-examine the two corporate theory questions and determine i f there are answers to those questions that are 'better' than the answers provided by the 'nexus of contracts' theory. Are there answers that are more descriptive of reality, better at predicting behavior and more consistent with society's normative views of corporations? If there are better answers, do those answers justify a change in corporate theory? Even more so, do they justify a change in the corporate law?  corporations and actors to be predicted. The normative aspect is the core of the theory that consists of value judgments about the way corporations and their relationship(s) to society "ought to be". For a more complete description of these aspects see Chapter 3 - "Politics and Assumptions". For example, Concession theory was replaced by Entity theory and Contractual theory when it became clear that corporations formed naturally and were not dependent on the the state for their existence. For a description of this see Chapter 2 - "Evolution Not Invention" and Chapter 3 - "Fiction/Concession Theory", "Entity Theory" and "Contractual Theory". This position argues that corporate law exists because it offers efficiency gains to the contracting parties. For a complete description of the nexus of contracts theory see Chapter 3 - "The Nexus of Contracts Theory of the Corporation". For a complete assessment of these criteria applied to the nexus of contracts theory see Chapter 4 - "The Rise of Economics in Corporate Law." 7  8  9  5  This reassessment of corporate theory is timely. The recent high profile corporate governance failures in both Canada and the United States have highlighted and reinforced existing concerns about the structure of the Anglo-American corporate governance system.  10  The timing of this inquiry is further heightened due to the ongoing corporate  governance convergence debate, in which a number of prominent U.S. corporate law scholars have argued that the Anglo-American corporate governance system, with its focus on shareholder primacy, should be adopted by all jurisdictions worldwide. This argument is based on the belief that the U.S. corporate governance system has proven itself to be the most efficient.  11  Before such convergence claims are made, Anglo-American scholars must be confident that the dominant Anglo-American corporate theory is the best that we can offer, and that the resulting corporate law structure to be exported is appropriate. This book argues that neither is the case.  1.2  Themes of the Book There are two main themes that run throughout this book: Politics and Balance.  1.2.1  Politics  The contention of this book is that the answers to the two corporate theory questions are largely political (or normative) and, therefore, corporate theories are  The corporate governance failure at Nortel Networks in Canada and Enron in the United States are examples. See Henry Hansmann and Reinier Kraakman, "The End of History for Corporate Law", (2001) 89 Geo. L.J. 439. 10  11  6  normative theories.  12  Normative theories are simply statements about the way we want  the world to 'be'. They are in contrast to positive theories, based on observation, that are scientific theories about the way the world 'is'. There is a big difference between the two. The answers to the two corporate theory questions are not universal truths that can be discovered through academic or theoretical analysis. The answers that are provided depend on the normative assumptions that are first made when the questions are approached. This normative aspect of corporate theory inevitably leads debates about corporate law into the political sphere because corporate theory has distributive effects in our society.  13  A reader cannot wade deeply into the corporate law literature without coming to the realization that the debate in corporate theory is really political. Lyman Johnson has argued that corporate law scholars need to admit to themselves when they approach corporate law problems that what they are struggling with is really the political, social and economic power in society: Why isn't corporate law flocked to, begged for by new law teachers the way the subject of constitutional law is? I think in part it is because constitutional law teachers are more honest in saying they are dealing with political, economic and social power, and how that power is exercised and controlled in a democracy. . . In corporate law, the sphere of which is, after, all, the governance of immensely The fact that corporate theories are normative has been pointed out by a number of legal scholars, especially feminist legal scholars. For example, Janis Sarra has written: "An important step in this exploration is to challenge the apparent neutrality of the shareholder wealth maximization norm of corporate governance and expose its normative content." See Janis Sarra, "The Gender Implications of Corporate Governance Change" (2002) 1 Seattle Journal for Social Justice 457 at 461. For an example of this type of argument see Lynn Dallas, "Working Towards a New Paradigm" in Lawrence Mitchell, eds. Progressive Corporate Law (Boulder: Westview Press, 1995) at 44, where she argues that corporate law is distributive regardless of the claims by law and economics scholars that corporate law is value free and non-distributive: "Economists offer both definitions of allocative efficiency [Kaldor Hicks and Pareto Optimality] as appropriate goals because they are considered to be value neutral: that is, they do not concern themselves with the distribution of wealth. But this assertion itself contains a value judgment: that wealth distribution can be ignored in measuring societal welfare. These concepts treat societal welfare as equally maximized where one percent of the population owns ninety-nine percent of the wealth, as where there is a more equal distribution of wealth, an assertion that has substantial normative implications." 12  13  7  influential business organizations, the power dimension of our subject is not confessed but submerged, and so our area is regarded by our own colleagues (wrongly) as being of a rather limited scope . . . Those within the legal academy . . . must rediscover corporate law and its central place not only in the law school curriculum but in our social lives. 14  D.P. Derham went a step further and argued that corporate theories have been used as political tools in the past to achieve desired social and political ends: It must be observed at this stage that all four theories, and their variations, have been used for social and political ends - particularly on the continent of Europe. [Emphasis added] 15  The outcome of the realization that corporate theories are normative is that the devotion in Anglo-American corporate law to the Nexus of Contracts theory is not based on the theory's intellectual superiority, but more because of a broader normative allegiance in society to economic theory. This allegiance is the result of a partnership between politics and economics in Anglo-American countries that is best exemplified by the neo-liberal movement. It is not possible to evaluate the Nexus of Contracts theory in any meaningful way without keeping this broader political context in mind. The political nature of the debate in corporate law is evidenced by the fact that labels are used to describe proponents of both sides of the debate including: 'right wing', 'leftist', 'conservative' and 'communitarian'.  16  The purpose of using labels is to invoke 17  an emotional response that will make people overlook ideas.  For example, when  Lyman Johnson, "New Approaches to Corporate Law" (1993) 50 Washington & Lee Law Review 1713 at 1721. David Derham, "Theories of Legal Personality" in Leicester Webb, Legal Personality and Political Pluralism (Melbourne: Melbourne University Press, 1958) 1 at 11. For examples of the use of the terms see Stephen Bainbridge, "Community and Statism: A Conservative Contractarian Critique of Progressive Corporate Law Scholarship" (January 1997). Available at SSRN: http://ssm.com/abstract= 10335. Bainbridge uses the terms "leftist" and "communitarian" on page 23. The term "conservative" is used on page 24 and the term "right-wing" is used on page 22. See John Ralston Saul, The Unconscious Civilization (Concord, Ont: House of Anansi Press, 1995) at 176, where he uses an historical analysis to show how language can affect the analysis of a problem: "Before Benjamin Franklin began to think about lightning, the received wisdom had it identified as a super 14  15  16  17  8  approaching the corporate law debate how would you feel about reading the ideas of a 'progressive' corporate law scholar? Chances are it would depend on your politics - but most of us would feel excited about the possibilities of 'progress'.  What i f the same  scholar and the same ideas had been labeled by someone else as 'communitarian'? Are you as excited? Less excited? What emotional response does that label bring to you? This second label is obviously associated with words that are generally viewed negatively in Anglo-American countries, words like: 'communism'. The best example of how these labeling tactics have been used in the corporate law debate is Stephen Bainbridge's 1997 book review of Larry Mitchell's collection of essays: Progressive Corporate Law.  In the book review, Bainbridge, after having  admitted that his basic criticism with the essays was political and not intellectual, went on to systematically label each author in the collection of essays as 'communitarian.' He did this even though each of the authors referred to themselves as progressive corporate law scholars and only David Millon referred to himself as communitarian: Although Progressive Corporate Law's scholars are united in their rejection of the contractarian model and of Economic Man, they have achieved less unity in offering an alternative theory of the firm. To the extent a common theme can be identified it is the tendency toward a leftist version of communitarianism. David Millon's chapter most explicitly embraces communitarianism as an alternative to contractarianism. . .Several of Progressive Corporate Law's other authors write from a perspective that is communitarian in all but name. Lynne Dallas, for example, offers a so-called power coalition model whose rhetoric is essentially communitarian. Larry Mitchell denies being a communitarian, although he 18  admits to sympathy towards that view. [Emphasis added] natural phenomenon. For that reason, gunpowder was often stored in churches, to give it divine protection. Church bells were rung during thunderstorms to ward off the bad spirits. Between 1750 and 1784, lightning struck 385 German churches killing 103 bell-ringers. In 1767 lightning struck a Venetian church whose vaults were filled with gunpowder. The explosion killed 3,000 people. In other words, there was ample proof that divine protection did not ward off lightning. But so long as there was no language to destroy the received wisdom, it remained in place. Our experiences today with the invisible hand of the marketplace are similar. What we require is the language to demonstrate its comical nature." Supra note 16 at 21-22. 18  9  In order to make the reader aware of the politics of corporate theory, this book provides a framework for analyzing the normative assumptions behind each corporate theory and categorizes each Anglo-American corporate theory according to that framework.  Balance  1.2.2  The conclusions offered in this book largely conform to one major theme: Balance. In particular, the argument is made for a restoration of the balance between the social and economic aspects of corporate theory. It is part of a larger argument that is being made for the restoration of the balance between the social and economics aspects of our society.  Currently, Anglo-American societies have become dominated by their  economic aspects through their devotion to the neo-liberal ideal of the 'self-regulating market'. This is not the first time in history that this has happened. It happened during the 19 century with the movement by market liberals to create a self-regulating market. th  That movement had disastrous consequences. In 1944, Karl Polanyi wrote about the dangers that lurk when balance is lost and the social aspects of society become subordinate to its economic aspects. This had never occurred before the 19 century market liberalism movement. Prior to that time, the th  economy and the market were always subordinate to the social aspects of society. Politics and religion were always more important and the market was 'embedded' in society.  19  Polanyi argued that very bad things occur when the market becomes  See Karl Polanyi, The Great Transformation: The Political and Economic Origins of Our Time (Boston: Beacon Press, 2001). Originally published in 1944. On page 71 he wrote: "This cursory outline of the economic system and markets, taken separately, shows that never before our own time were markets more 19  10  disembedded from society and society becomes subordinate to it.  For example, the  results of the last attempt by the market liberals to create a self regulating economy were the First World War, the great depression and the rise of fascism and communism. Polanyi argued that no attempt to create a self-regulating market can ever be successful because the consequences to society are so grave that the government and/or citizens always intervene.  21  The socially disruptive consequences of the 'self-regulating  market' are the commodification of everything, including things that should not be 22  commodified:  like  people  (labor)  and  the  environment  (resources).  The  commodification of these items almost assures the destruction of society and the environment. Polanyi summarizes his thesis in the following way: Our thesis is that the idea of the self-adjusting market implied a stark Utopia. Such an institution could not exist for any length of time without annihilating the human and natural substance of society; it would have physically destroyed man and transformed his surroundings into a wilderness. 23  He described the effects of the self-regulating market on people and the environment as a 'satanic mill': To allow the market mechanism to be the sole director of the fate of human beings and their natural environment indeed, even of the amount and use of purchasing power, would result in the demolition of society. For the alleged commodity 'labor power' cannot be shoved about, used indiscriminately, or even left unused, without affecting also the human individual who happens to be the bearer of this peculiar commodity. In disposing of man's labor power the system would, incidentally, dispose of the physical, psychological, and moral entity than accessories of economic life. As a rule, the economic system was absorbed in the social system, and whatever principle of behaviour predominated in the economy, the presence of the market pattern was found to be compatible with it." Ibid at 60, where he writes about the disembedding of the market: "Ultimately that is why the control of the economic system by the market is of overwhelming importance to the whole organization of society: it means no less than the running of society as an adjunct to the market. Instead of economy being embedded in social relations, social relations are embedded in the economic system." Ibid at 80. For Polanyi, a commodity is something that is produced for sale on a market. Labor, land etc. are ficititious commodities because they were not originally produced for sale on a market, see Ibid. Ibid at 3. 20  21  2 2  23  11  'man' attached to that tag. Robbed of the protective covering of cultural institutions, human beings would perish from the effects of social exposure; they would die as the victims of acute social dislocation trough vice, perversion, crime, and starvation. Nature would be reduced to its elements, neighbourhoods and landscapes defiled, rivers polluted, military safety jeopardized, the power to produce food and raw materials destroyed. Finally, the market administration of purchasing power would periodically liquidate business enterprise, for shortages and surfeits of money would prove as disastrous to business as floods and droughts to primitive society. Undoubtedly, labor, land , and money markets are essential to a market economy. But no society could stand the effects of such a system of crude fictions even for the shortest of time unless its human and natural substance as well as its business organization was protected against the ravages of this satanic mill. [emphasis added] 24  Polanyi described the reaction against the self-regulating economy as the 'double movement': The laissez-faire movement to create the self-regulating market and the countermovement to protect society.  Polanyi argued that the welfare state was the  outcome of the last counter movement. One of the errors in Polanyi's theory was that he had assumed that the counter-movement had been successful and that the idea of the selfregulating market was dead. The truth is that the idea of the self-regulating market is alive and well in AngloAmerican societies and it is the dominant political ideology. This fact has been pointed out by many social commentators including John Ralston Saul.  25  Saul's diagnosis is  similar to Polanyi's - i f no counter movement soon develops - we are headed for a wave of negative nationalism that inevitably will end in war. The difference between Polanyi's approach and John Ralston Saul's approach, is that Saul has called for a balanced countermovement this time.  26  Polanyi supra note 19 at 76-77. For the argument that the modern neoliberal movement is just another attempt by market liberals to create a self-regulating market see John Ralston Saul, The Collapse of Globalism and the Reinventing of the World (Toronto: Viking Canada, 2005); see also Mark Blyth, Great Transformations: Economic Ideas and Institutional Change in the Twentieth Century (Cambridge: Cambridge University Press, 2002). See Saul Ibid at 245 where he talks about the two potential responses to globalization and the self regulating market: negative nationalism and positive nationalism. He advocates a positive nationalism that 2 5  2 6  12  As a result of the political alliance between politics and economics, Western capitalism, together with its shareholder oriented corporation, has lost its balance and Anglo-American societies have become subordinated to the market. For example, most Anglo-American societies now measure their success based almost exclusively by economic measures.  Gross domestic product (GDP) has become the measurement of  progress, as opposed to some other more meaningful measures, like lower crime rates, poverty levels, levels of drug abuse, addiction, suicide etc.  27  One example of this loss in balance can be found in Anglo-American corporate law. In the past, corporate law was balanced by a debate between competing corporate theories formed using opposite normative assumptions: social theories on the one side and economic theories on the other. That is no longer the case. Anglo-American theory has become dominated by economic analysis.  The most widely accepted economic  theory of the corporation is the Nexus of Contracts theory. It is a normative theory that is based on at least three key normative assumptions: 1.  Individuals act only in their own self-interest - the "rational choice theory",  will more likely avert outright warfare among nation states as they reassert themselves against the negative effects of the global market. 2 7  In fact, there are many other potential balanced measures of progress that we are capable of using that  take into account societal factors other than just economics. The measures include: The Index of Sustainable Economic Welfare, which is described at <http://www.foe.co.uk/campaigns/sustainable development/progress/> ; The Genuine Progress Index, which is described at <http://www.rprogress.org/projects/gpi/>; Wellbeing Index, which is described at <http://www.australianunity.com.au/au/info/wellbeingindex/>; The UN's Human Development Index, which is described at< http://hdr.undp.org/reports/global/2005/pdf/HDR05_HDI.pdf>;  The World Bank's  Wealth of Nations <http://web.worldbaruc.org/WBSITE/EXTERNAL/NEWS/0,,contentMDK:20648103~pagePK:34370~piP K:34424~theSitePK:4607,00.html>; UN's System of Integrated Environmental and Economic Accounts, which is described at < http://unstats.un.org/unsd/envAccounting/seea.htm>; and Dashboard of Sustainability, which is described at < http://www.iisd.org/cgsdi/dashboard.asp>. For a description of the process by which corporate theory became dominated by economic analysis see Chapter 4 - "The Rise of Economics in Corporate Law".  2 8  13  2. The individual is the correct political, social, economic or legal unit of analysis in society and not the group, and 3. The corporation is a private entity that should be free from public regulation. While significant efforts have been made to critique the economic Nexus of Contracts theory of the corporation, and a number of alternate progressive theories have been offered, there is still no single theory that stands in opposition to it. That was not always the case. Before 1930, there were two dominant and opposing theories of the corporation: Contractual Theory (or early economic theory), which conceptualized the corporation as a collection of freely contracting individuals ; and Entity theory (or early 30  sociological theory), which conceptualized the corporation as a real entity with an existence distinct from its members.  The competition between these two contrasting  theories created a balance in the corporate law debate between the economic and social aspects of the corporation.  But, Entity theory fell out of favour in Anglo-American 31  countries and that balance was lost.  The effects of that loss are evident in modern  Anglo-American society, with our disproportionate preference for the individual over the group, private interests over public interests and economic concerns over social concerns. This book argues for the revival of the social theory of the corporation to restore balance to the corporate law debate. Using early sociological theories as a base and updating them using the latest advances in sociology and, in particular, developments from organizational theory, the building blocks of an updated social theory of the  For a complete description of the assumption underlying the nexus of contracts theory see Chapter 3 "Nexus of Contracts Theory" and Chapter 4 - "The Critique of Economics, Law and Economics and the Economic Conception of the Corporation." For a description of Contractual theory see Chapter 2 - "Contractual Theory". Another way to characterize this problem is that in Anglo-American countries Contractual theory appropriated the benefits of Entity theory without also adopting the corresponding obligations. 2 9  3 0 31  14  corporation are outlined. The social theory of the corporation provides the following answers to the two questions of corporate theory: 1.  The corporation is a social institution. It is an organization of human beings that has become so important as an organizational type that it has become institutionalized and now provides meaning and stability to social life.  2.  The purpose of corporate law is twofold: •  To facilitate the formation, survival and evolution of corporations, and  •  To provide stability to society, markets and corporations by managing the relationships amongst the corporate participants in a way that is consistent with the normative views of the society in question.  The social theory of the corporation is a normative theory and it is based on normative assumptions that are opposite to the assumptions of the Nexus of Contracts theory: 1.  Humans are social beings whose behaviour is affected by their social circumstances,  2.  Groups are a valid and natural political, social, economic or legal unit of analysis in society, and  3.  Corporations are public institutions that can rightly be subjected to government regulation.  The argument in this book relating to corporate law is but a small portion of the larger arguments that Polanyi and Saul were making about society. The argument is simply that the economic system in Anglo-American societies, and with it the corporate law, has gone out of balance and balance needs to be restored.  This can be done by  reintroducing the human and social characteristics of organizations and markets into corporate theory.  On the larger scale, it can be done by ensuring that the market is  subordinated to society. However, in so doing, we need to be careful not to react too far.  15  Replacing neo-liberalism's rejection of any legitimate concerns about others or society with a theory or system that only takes into account social relationships and groups would just be creating a whole new problem. They key is that society and corporations are about individuals and groups; private interests and public interests; and social and economic aspects. We just have to find the right balance. There is nothing in this book that is anti-capitalist, anti-democratic, anti-market or anti-corporate.  It is not a rejection of market economies. It supports properly regulated  economies. This book is simply an attempt to remind us that society is about people not profits.  1.3  Chapter Outline  The fact that the corporation is a social institution, the need for the revival of the social theory of the corporation and the superiority of a multi-disciplinary approach to corporate theory is illustrated in this book using a seven-part analysis. Chapter 2 shows that the corporation is a social institution. It is a social structure that provides stability and meaning to social life. The most important insight of this finding is that the corporation should be analyzed using social theories, including sociology and organizational theory etc. and not just economic theories. Chapter 3 provides a historical survey of corporate theories to show that the idea that the corporation is a social institution is not new.  In the past, corporations were  viewed as social institutions and earlier corporate theories that acknowledged this were built on insights from sociology. Examples of these theories include Entity theory and  16  Early Sociological theory.  However, for some reason, during the course of the 20  tn  century, these social theories of the corporation lost their prominence in Anglo-American societies and economic theories of the corporation became dominant. Chapter 3 also shows that corporate theories are normative. It does this by offering a framework by which the normative assumptions behind each corporate theory can be understood and by classifying each Anglo-American corporate theory using the framework. Chapter 4 explores two insights from Chapter 3 in more detail. First, the process by which economic theories rose to dominance in Anglo-American societies is explained by showing that the Nexus of Contracts theory of the corporation came to dominate Anglo-American corporate law largely because of its normative assumptions and not because of its intellectual superiority. Second, the normative basis of the Nexus of Contracts theory of the corporation is exposed by examining the attributes of the theory that were supposedly value neutral and which made allegedly made the theory intellectually superior. Chapter 5 begins to introduce the relevance of sociology and organizational theory to corporate theory - starting with organizational theory. The chapter shows that there has always been a strong link between organizational theory and corporate theory. In also shows that most of the advances in corporate theory in the last half-century came first as advances in organizational theory.  More recently, organizational theory has  advanced to a new perspective on organizations called the "natural open systems" perspective. Unfortunately, corporate theory has not kept pace and it is still using the previously popular "rational open systems" perspective.  The natural open systems  perspective is an improvement over the rational open systems perspective because it is  17  more descriptive of reality and is able to account for more of the complexity of social phenomena. The need for a new "natural systems" theory of the corporation in corporate theory is highlighted. Chapter 6 continues the process of showing the relevance of social theories to corporate theory by focusing on economic sociology. This chapter outlines the building blocks of an updated version of the social theory of the corporation. The updated theory is built on the foundations of the early sociological corporate theories, the natural open systems view of organizations, and the latest developments from economic sociology regarding the sociological view of actors, organizations and markets. It is illustrated that the social theory of the corporation has the potential to be better than the current Nexus of Contracts theory of the corporation. Chapter 7 explains the need for a multidisciplinary theory of the corporation. One of the most important insights of the social theory of the corporation is that social life is very, very complex and no single theory can completely explain it. The need to incorporate insights from all of the social sciences in order to explain as much of this complexity as possible is highlighted and the difficulties of this incorporation exercise are discussed. A 'Layered Approach' is offered to overcome these difficulties. Finally, a conclusion is offered that explains that the time is right for renewed interest in a law and society approach to corporate law that draws on insights from sociology and organizational theory as the first step away from a strictly economic analysis of the corporation and toward a multidisciplinary theory of the corporation.  18  CHAPTER 2: T H E CORPORATION IS A SOCIAL INSTITUTION  2.1  Introduction The corporation is a social institution. It is not just an economic institution.  It never was a person. It never was a  metaphysical entity with a will of its own, and it definitely never was a "nexus of contracts". A l l of these abstract theories were just creations of well intentioned jurists who were trying to fit the complexity of human organizations into existing legal systems built on individual rights. not an abstraction at all. beings.  33  32  Forgotten, in that process, was the fact that the corporation is It exists in the real world.  It always has been.  It is an organization of human  34  As an organizational form the corporation has become so important in AngloAmerican societies that it has become a social institution. The corporation is one of the primary ways that we organize ourselves and find meaning and stability in society. It is  Anglo-American countries have legal systems that are built on individual rights. This is a legacy from Roman law. The systems themselves are not capable of assigning rights to groups - so the natural solution was to turn groups into people. This has been pointed out by Morton Horwitz: "In a legal system whose categories were built around individual activity, it was not at all easy to assimilate the behaviour of groups". See Morton J. Horwitz, "Santa Clara Revisited: The Development of Corporate Theory," (198586) 88 W. Virginia Law Review 173 at 183. See also Meir Dan-Cohen, Rights, Persons and Organizations: A Legal Theory for Bureaucratic Society (Berkeley: University of California Press, 1986). The view that the corporation is an organization is shared by many sociologists and organizational theories. For a sociological argument that corporations are different than other organizations see Richard Swedberg, The Principles of Economic Sociology (Princeton: Princeton University Press, 2003) at 98 where he argues there are four differences between corporations and other organizations: 1) their main goal is to make a profit, 2) they are treated differently in law, 3) they have their own institutional features, and 4) economic interests play a crucial role in firm behaviour. This arguments in this book directly contradict each of these assertions. Corporations are no different than other social organizations: 1) Their main goal is survival not profit, 2) they should not be treated differently in law, 3) they have similar institutional features to other organizations, and 4) Anglo-American societies have systematically overvalued the effects that economics has on firm behavior. David Millon makes the argument that the actual social reality of corporations has not changed over time but that what has changed is our interpretation of them. See Millon supra note 4 at 249: "Corporations had not changed, but their meaning did." 3 3  3 4  19  not alone in this status. In fact, it is the latest in a long line of such social institutions that have included, throughout history, the family, the town, the guild, the church and the state.  2.2  Historical References to the Corporation as a Social Institution The contention that the corporation is a social institution is not a new one:  commentators have long recognized this reality. References to the corporation as a social institution can be found in the corporate law, economics and management literature.  35  For example, in the first paragraph of their 1932 classic The Modern Corporation and Private Property Adolph Berle and Gardiner Means wrote the following: Corporations have ceased to be merely legal devices through which the private business transactions of individuals may be carried on. . . The corporation has, in fact, become both a method of property tenure and a means of organizing economic life. Grown to tremendous proportions, there may be said to have evolved a 'corporate system' - as there was once a feudal system - which has attracted to itself a combination of attributes and powers, and has attained a degree of prominence entitling it to be dealt with as a major social institution? [emphasis added] 6  Examples from the corporate law literature include: Adolph Berle and Gardiner Means, The Modern Corporation and Private Property (New York: Harcourt Brace & World, Inc, 1968) (originally published in 1932). Examples from Berle and Means are included in the text; Kellye Testy also has made an argument that the corporation may be the dominant institution in modern society: " . . .have paved the way for corporations to rival the state, and certainly the church, in institutional power and influence." Kellye Testy "Linking Progressive Corporate Law with Progressive Social Movements" (2002) 76 Tulane L. Rev. 1227 at 1228; and Mary Stokes: "Firstly, it is accepted that the modern public company has become an organization whose significance rivals that of the state. It is the primary institution for organizing and employing much of capital and labour resources and the primary supplier of goods and services in our community." Mark Stokes, "Company Law and Legal Theory" in Twining, ed., Legal Theory and Common Law (New York: Basil Blackwell, 1986) at 176. Examples from the economic literature include: John Kay: "The corporation is therefore, naturally perceived as a social institution, with public responsibilities, and a proper public interest in defining the ways in which it is run and governed. ". Kay supra note 3 and Alfred Eichner, Toward a New Economics: Essays in Post-Keynesian and Institutionalist Theory (New York: M.E. Sharpe, Inc. 1985) at 10-28. Examples from the Management literature include Peter Drucker, The Concept of the Corporation (New York: John Day Co., 1972) (originally published in 1946). Examples of references from Drucker are included in the text. Berle and Means supra note 35. 3 5  3 6  20  In concluding the book they take their assumptions one step further: "In still larger view, the modern corporation may be regarded not simply as one form of social organization, but potentially (if not yet actually) as the dominant institution of the modern world. . . . The future may see the economic organism, now typified by the corporation not only on an equal plane with the state, but possibly even superseding it as the dominant form of social organization," [Emphasis added] 37  Similarly Peter Drucker wrote about the corporation as a social institution in his famous 1946 book The Concept of the Corporation: To understand that the modern large corporation is the representative social institution of our society; that it is above all an institution that is a mere human organization and not just a complex of inanimate machines; that is based upon a concept of order rather than upon gadgets; and that all of us as consumers, as workers, as savers, and as citizens have an equal stake in its prosperity, these are the important lessons that we have to learn. To make it possible for this new social institution to function efficiently and productively, to realize its economic and social potential, and to resolve its economic and social problems is our most 38  urgent task and our most challenging opportunity.  [Emphasis added]  More recently, commentator Joel Bakan has re-iterated this view of the corporation as an institution: A key premise is that the corporation is an institution - a unique structure and set of imperatives that direct the actions of people within it. It is also a legal institution, one whose existence and capacity to operate depends on the law. 39  One of the key insights in this last quote is that institutions can have different characters. This is important to remember. While the argument of this book is that the corporation is a social institution, it does not deny that the corporation is also an economic institution. In fact, corporations are social institutions, economic institutions and legal institutions all  Ibid at 309. Peter Drucker, The Concept of the Corporation (New York: John Day Co., 1972) (originally published in 1946) at 208. Joel Bakan, The Corporation: The Pathological Pursuit of Profit and Power (Toronto: Viking Canada, 2004) at 1. 37  3 8  3 9  21  at the same time. The problem is that our current dominant corporate theory views the corporation as an economic institution alone.  2.3  Social Institutions - Sociology and Organizational Theory The recognition of the corporation as a social institution is significant because the  term "social institution" has a very specific meaning in sociology and organizational theory. Sociologists have long recognized that the corporation is a social institution and have analyzed it in an appropriate way with sociological analysis. Richard emphasized this: Sociologists, as opposed to economists, have tried from early on to analyze firms as social institutions or social organizations, and there exists today a long tradition of sophisticated sociological analysis of this type. 40  Early sociologists who treated the corporation as an institution included all three of the founding theorists of sociology Max Weber, Karl Marx and Emile Durkheim  4 1  Sociology defines a social institution in the following way: Institutions are social structures that have attained a high degree of resilience. Institutions are composed of cultural-cognitive, normative, and regulative elements that, together with associated activities and resources, provide stability and meaning to social life. [emphasis added] 42  Swedberg supra note 33 at 88. For a description of the early treatment of firms as social institutions by these sociologists, with a specific emphasis on Weber see Ibid at 88-93. W. Richard Scott, Institutions and Organizations (2 ed.) (Thousand Oaks: Sage, 2001) at 48. Another sociological definition of institution was provided by Richard Swedberg: "[Institutions can be understood as distinct configurations of interests and social relations, which are typically of such importance that they are enforced by law." Swedberg, supra note 33 at 1. Yet another useful definition is provided by Carlo Trigilia: Institutions are "a set of social norms which orient and regulate behavior and which are based on sanctions which seek to guarantee compliance on the part of individuals." See Carlo Trigilia, Economic Sociology: State, Market and Society in Modern Capitalism (Oxford: Balckwell Publishing, 2002) at 4. 4 1  4 2  22  As the emphasis in the quote indicate the purpose of social institutions is to maintain stability in society.  43  Society consists of sets of interrelated social institutions, including  the family, religion, the education system, the political system etc. Institutions are sets of formal stable relations. They are rules that define individual roles in specific areas of society and they normally have built in mechanisms of enforcement. Collectively, they define who we are and what we do.  44  Gore describes the importance of social institutions  in the following way: We are born and socialized into the existing institutions, such as family, church, school, and workplace. These are the basis of our identity formation and perception of self-interests. Our rule-following or institutionalized behaviour (which represents the bulk of the routine choices we make in a day) requires a shared back-ground knowledge so taken for granted that it becomes part of our collective identity. This is the cultural reinforcement of existing institutions, which explains why even strategically oriented individuals chronically reproduce or acquiesce to social structures that are not in their best interests. 45  This definition is wider than the way in which the term "institution" is used in common language. Normally, the term "institution" is used to refer to an organization like the government, hospitals, schools etc. This definition is also very different from the way that institutions are defined in economics.  Economics has a very narrow and  western centric definition of institution that defines institutions as the structures that contribute to economic growth. For example, Douglass North has defined an institution as:  See Lynne Zucker, "Organizations as Institutions" in Samuel B. Bacharach, ed., Research in the Sociology of Organizations: A Research Annual Vol. 2 (London: Jai Press Inc., 1983) at 21 where the author argues that the major consequence of institutionalization is maintenance of the institution over time and resistence to change. For a discussion of institutional theory in sociology see Lance Gore, Market Communism: The Institutional Foundation of China's Post-Mao Hyper-Growth (New York: Oxford University Press, 1998) at 24; Paul DiMaggio and Walter Powell eds., The New Institutionalism in Organizational Analysis (Chicago: University of Chicago Press, 1991); and Lynne Zucker ed., Institutional Patterns and Organizations: Culture and Environment (Cambridge, Mass: Ballinger Publishing Company, 1988). Gore/tod at 25. 4 4  4 5  23  [A] set of rules, compliance procedures, and moral and ethical behavioral norms designed to constrain the behavior of individuals in the interests of maximizing the wealth or utility of principals. 46  The sociological definition of an institution is broader and is not limited only to rules that promote economic growth. Lynne Zucker was one of the first organizational theorists to argue that organizations themselves are institutions: Organizations are the preeminent institutional form in modern society. They organize and structure the daily lives of most people. . . Organizations are everywhere, involved in almost every possible sphere of human action. 47  In the context of sociological analysis, an organization is simply a group of people who are acting together for some common purpose - whether it is a specified goal, survival of  Douglass North, Structure and Change in Economic History (New York: Norton, 1981) at 201. This definition is associated with the new institutional approach in economics (NIE). It is based on a number of economic assumptions. The main assumptions that are implicit in that approach are that: (1) the construction of a market economy is the primary desired goal for a society, 2) economic growth is a desirable social goal, and 3) political liberalization is a desired social goal. These assumptions are very common law centric assumptions about the goals of society and, in effect, they predetermine the outcome of the analysis that economic legal scholars conduct. Examples of NIE institutions are enforceable contract rights and private property rights. The goal of NIE analysis is to argue that domestic institutions that are different from western institutions should be replaced by western institutions in order to stimulate economic growth. By definition, the advantage of identifying the domestic institution, in the first place, is lost because of the inability of the theoretical framework to understand the institution in its own local and cultural context. In effect, the NIE definition of institution predetermines the outcome of NIE analysis. In a simplistic way it is like conducting an analysis to determine who is more American: the Chinese, the Japanese or the Americans? Or even more to the point, having acknowledged the importance of 'institutional analysis' - or the 'cultural differences' between the Chinese, the Japanese, and the Americans, the researcher still runs a competition to determine who is most American? What if, instead of the primacy of economic goals, those other societies also have social goals that they take into account when deciding how to structure their societies? Such as the health of their people in terms of life expectancy, suicides rates, rates of drug abuse, violence etc.? How are the differing social goals of the societies studied factored into this economic analysis? They can not be. Therefore, in order for institutional analysis to be useful, it needs to be used outside of the economic paradigm, so that the institutions identified in the analysis can be understood from the cultural perspective of the society that created them and not through the lens of AngloAmerican economic analysis. 4 6  Zucker supra note 43. For a more detailed description of the institutionalization of the modern corporation see Chapter 5 - "Why do Organizations Exist?"..  4 7  24  the organization or furthering the interests of its members within the organization's environment.  48  In describing organizations as institutions Zucker points out the dual nature of the term "institutionalization".  4 9  She argued that it was both a process by which actions  become taken for granted, and also a structure in society that sets limits to what is possible. She described this dual meaning in the following way: [Institutionalization is both a process and a property variable: it is a phenomenological process by which certain social relationships and actions come to be taken for granted, that is part of the "objective situation", while at the same time it is the structure of reality defining what has meaning and what actions are possible. 50  Another way to describe this phenomenon is that organizations, that have become institutions, are not simply constrained by their institutional environment, but are often able to define their own position in it: Despite widespread recognition of the central position and role of organizations in modern life, scant attention has been paid to the power that organizations have to alter the forces, which affect them, whether internal or environmental. 51  For example, in Japan, lifetime employment and cross-shareholding patterns affect the structure of the corporation. However, the corporation as a social institution is also able to affect society at large, including changing the institutions of lifetime employment and the cross-shareholding structures.  52  See Chapter 5 - "Definition of Organization" and Scott supra note 42 at 27-30 where three definitions of organizations are offered, each depending on the perspective adopted by the theorist: Rational, Natural and Open. The definition offered here represents each of the three different perspectives. This premise is not accepted by all sociologists. For the opposite argument that organizations are not institutions see Trigilia supra note 42 at 2. Zucker supra note 43 at 2. Ibid. For a discussion of this process see Michael Cody. "The Arrival of Hostile Takeover Bids in Japan: Convergence or Selective Adaptation?" (forthcoming).  48  4 9  5 0  51  5 2  25  The view that the corporation is a social institution is starting to receive more widespread acceptance outside of sociology. For example, in 2003, The Social Science Research Council sponsored a program called "The Corporation is a Social Institution" at Berkeley.  The goal of which was to develop a stronger, conceptually richer and  potentially more interdisciplinary approach to the study of the nature of firms and other business institutions.  2.4  53  The Corporation is a Social Institution: The Statistical Evidence How do we know that the corporation has become a social institution? Because it  has clearly become one of the primary ways that we find "stability and meaning" in modern Anglo-American societies. The corporation provides stability and meaning in Anglo-American societies by virtue of the size and power it has attained. When Berle and Means wrote their book back in 1932 they commented on the dominance of the corporate form at that time: In conclusion, then, the huge corporation, the corporation with $90,000,000 of assets or more, has come to dominate most major industries i f not all industry in the United States. A rapidly increasing portion of industry is carried on under this form of organization. There is apparently no immediate limit to its increase. It is coming more and more to be the industrial unit with which American economic, social, and political life must deal. 54  Things have changed dramatically since then. 1932 was just the tip of the iceberg. Since then, the size and power of the largest corporations have grown at an astounding rate. A s a result, instead of analyzing the dominance of the corporate form in relation to a particular industry, as Berle and Means did in 1932, we now have to analyze the  5 3  5 4  For more information on this program go to <http://www.ssrc.org/fellowships/cotporation> Berle and Means supra note 35 at 44.  26  dominance of the corporation as compared to nation states. For example, Lynn Dallas has commented that the most powerful corporations are now bigger than countries: [Transnational corporations account for 50% of the world's largest economies and the total income of the ten largest transnational corporations exceeds that of one hundred of the world's poorest economies. 55  To provide a better representation of just how large modern corporations have become, the revenue of the largest corporations can be compared with the gross domestic product of the world's countries. Table 2-1 contains the 2006 GDP of the 55 largest IMF member countries. Table 2-2 contains the 2006 revenue data for the top 15 companies on the Fortune 500. Table 2-3 shows the area where the two lists overlap. The data is shocking. Exxon-Mobil and Wal-Mart, the two largest companies on the 2006 Fortune 500 list with revenues of $339 billion and $315 billion respectively, are the 22 economies in the world.  nd  and 23  rd  largest  They are larger than the developed nations of Norway,  Denmark, Greece, Ireland and Finland. The largest corporations also continue to grow at an alarming pace. When Berle and Means were talking about the "enormous" size of corporations back in 1932, they were talking about corporations that had 'more than $90 million' in assets - corporations that were about l/1000 the size of the corporations that we have now. Table 2-4 th  provides the revenue data for the largest company on the Fortune 500 list at five year intervals between 1955 to 2006. It shows that the largest company on the Fortune 500 list has doubled in size approximately every ten years. It also shows that corporations started to rival the state in terms of size and power in the 1980's when the largest corporations revenues grew to around $80 or $90 billion dollars or about the size of  Lynn Dallas, Law and Public Policy: A Socioeconomic Approach (Durham: Carolina Academic Press, 2005) at 479. 5 5  27  modern day Egypt or the Philippines. These large corporations also show no signs of slowing their pace of growth. At the present rate, we would expect the largest of them to th  reach about the same size as the world's 16 biggest economy, the Netherlands, by 2015 and about the size of the world's 8  th  or 9 biggest economies, Canada and Spain, by th  about 2025. Obviously this projection is not very scientific. But, it illustrates just how dominant corporations are becoming in the modern world.  It also illustrates that the  corporation has to be viewed as a social institution because it really has started to rival the state as the dominant institution in modern society. For example, it is hard to argue that Wal-Mart with revenues of $315 billion dollars and 166,000 employees is not a social institution. Alan Hutchinson has also done a similar analysis for companies in Canada. He showed that in 2003 the revenues of the largest 500 private and public corporations in Canada was equivalent to approximately 81.8% of Canada's G D P .  56  Even more  disturbing is his finding that the revenues for the 10 largest corporations in Canada are now larger than the combined incomes of all the provincial and territorial governments.  2.5  57  The Dominance of the Corporation - The Commentators What effect does the dominance of corporations have on our lives? If you live in  North America chances are almost everything you do is related to corporations in one way or another. They are omnipresent in your day-to-day life,. They make your food, drink and clothes, they provide your communications and your transportation. Chances  See Alan Hutchinson, The Companies We Keep: Corporate Governance for a Democratic Society (Toronto: Irwin Law, Inc. 2005) at 86. Ibid at 87. 56  57  28  are that you work for a corporation, and some, if not most, of your friends work there too. If you are really unlucky, you may see your colleagues at work more than you see your family. The classic quote of the intrusive nature of the corporation into everyday life in North America was written by Lawrence Mitchell in the introduction to his 1995 book Progressive Corporate Law: It has become a significant social and to some extent, political institution as well. It is fair to say, I think, that no institution other than the state so dominates our public discourse and our private lives. In our world, corporations make most everything we consume. Their advertising products fill almost every waking moment of our lives. They give us jobs, and sometimes a sense of identity. They define communities, and enhance both our popular and serious culture. They present investment opportunities that send our children to college, and provide for our old age. They fund our research. This awesome collective power also leads to the problems created by corporations. They pollute our environments. They impoverish our spirits with the never-ending messages of the virtues of consumerism. They provide a living, but often not a meaning. And sometimes they destroy us; our retirement expectations are unfunded, our investment hopes are dashed, our communities are left impoverished. The very power that corporations have over our lives means that, intentionally or not, they profoundly affect our lives. 58  Joel Bakan has also described the power of corporations in our lives: Over the last 150 years the corporation has risen from relative obscurity to become the world's dominant economic institution. Today corporations govern our lives. They determine what we eat, what we watch, what we wear, where we work, and what we do. We are inescapably surrounded by their culture, iconography, and ideology. . . Increasingly, corporations dictate the decisions of their supposed overseers in government and control domains of society once firmly embedded within the public sphere. 59  Lawrence Mitchell, ed., Progressive Corporate Law (Boulder: Westview Press, 1995) at xiii.. For another classic quote with similar tones from 1932 see Berle and Means supra note 35 at 17-18. Bakan supra note 39 at 5. 5 9  29  2.6  Implications of the Corporation as a Social Institution There are a number of important implications that result from the finding that the  corporation is a social institution.  60  Firstly, the corporation should be analyzed using  social theories and not just economic theories. Secondly, social institutions are complex phenomena and, therefore, they require complex theories to explain them. Thirdly, social institutions evolve from previous forms of social institution and they cannot be 'created', 'designed' or 'invented'. Finally, social institutions cannot be owned in the traditional sense of property ownership.  2.6.1  Sociology and Organizational Theory If the corporation is a social institution, then it needs to be analyzed as one.  61  It  can no longer be analyzed as simply an economic institution. That means leaving the field of economic analysis and drawing on the incredible amount of theory and data that has been generated about organizations and social institutions in sociology and, in particular, economic sociology and organizational theory. To date, most of this literature has been vastly underrepresented in modern corporate law literature. It is a curious fact that modern Anglo-American corporate law- that is in essence the law of a particular type of organization - has thus far been so uninterested in the broader developments in the social sciences that relate to how organizations are created, maintained and change.  62  In  Viewing the corporation as a social institution is consistent with the Natural and Open perspective in organizational theory. For a description of this perspective see Chapter 5 - "The Link Between Organizational Theory and Corporate Theory". For example, see Berle and Means supra note 35 at 309 where they state: "The institution here envisaged calls for analysis, not in terms of business enterprise but in terms of social organization". Notwithstanding this statement, there is no doubt that portions of organizational theory have made their way into corporate theory. The most notable examples are transaction cost theory and agency theory that became the basis for the Nexus of Contracts model of the corporation and resource dependence theory that became the basis for the power coalition theory of the corporation. For a description of the link between 6 0  6 1  6 2  30  fact, using the analytical tools of these organizational theories it is possible to construct an updated social theory of the corporation. This theory is outlined in Chapter 6.  2.6.2  Complexity Over Simplicity Social organizations and the social world are very, very complex. Policy makers  in modern society have become addicted to economic analysis because they want to 'know' the answers, and economic analysis, with its simplifying assumptions, purports to know those answers. Policy makers have developed the bad habit of not being able to admit that they do not completely understand what is going on.  63  The truth is that we  really do not fully understand what is going on, either in society, in the market, or within organizations or corporations - regardless of what one hears otherwise. That is because the social world, socially constructed markets and social organizations are very, very complicated places. To illustrate the complexity of social systems it is useful to examine the systems classification scheme that was developed by Boulden during the 1950's.  64  Systems  theory was developed after World War II. It was based on the observation that the sciences and social sciences were increasingly becoming compartmentalized and that key concepts in any one science could have relevance across a number of other disciplines. In particular, systems theorists pointed out that: [M]ost important entities studied by scientists - nuclear particles, atoms, molecules, cells, organisms, ecological communities, groups, organizations, societies, solar systems- are all subsumable under the general rubric of system. 65  corporate theory and organizational theory see Chapter 5 - "The Link between Organizational Theory and Corporate Theory." See John Ralston Saul, The Unconscious Civilization (Toronto: Anansi, 1995) at 62 where he states: "Who among our leaders does not fear living with the conscious realization that they do not know?" Scott uses Boulden's chart to illustrate the complexity of organizations see Scott supra note 42 at 82. Ibid at 82. 63  6 4  6S  31  A system is simply a combination of parts that are interrelated.  00  Boulden's systems  classification chart (Table 2-5) identifies nine levels of systems in increasing complexity divided into three general types: physical systems, organic systems and human and social systems.  Progressing from level 1 to 8 the systems become more complex and the  relationships among the various parts become more loosely coupled, or in other words, there is more free choice or random variation in the system.  As system complexity  increases the system ceases to act mechanically. Level 7 is a human being or a system capable of free choice. Level 8 is the most complicated system that we are aware of. It is level 7 systems with free choice interacting with each other. Obviously, it becomes very difficult to predict behavior or outcomes in a level 8 system. Level 9 is simply systems we have not yet identified. Scott explains the increasing complexity of the systems and the characteristics of each general type in the following way: The parts of which all systems are composed vary from simple to complex, from stable to variable, and from nonreactive to reactive to the changes in the system to which they belong. As we move from mechanical through organic to social systems, the parts of which systems are composed become more complex and variable. In addition, relations among the parts vary from one type of system to another. . .In mechanistic systems, the interdependence among parts is such that their behaviour is highly constrained and limited. The structure is relatively rigid, and the system of relations determinant. In organic systems, the connections among the interdependent parts are somewhat less constrained, allowing for more flexibility of response. In social systems, such as groups and organizations, the connections among the interacting parts are relatively loose; less constraint is placed on the behaviour of one element by the condition of others. Social organizations, in contrast with physical or mechanical structures are complex and loosely coupled systems [Emphasis added] 61  This systems chart offers an important insight into corporations and corporate law. The corporation is a social institution: an organization of human beings that are interacting with each other. That makes it a level 8 system. A very complex system. As such, we Ibid at 83.  32  should be skeptical of simple theories that attempt to explain all of the behaviour in a corporation with one concept. For example: the rational choice theory of economics. As we progress our general understanding of our social world, we should expect our theories and conceptions of organizations (and corporations) to become more complex as well. They should 'move up' the systems chart. In this regard, complexity is a good thing. Constantly striving for simplicity of analysis when dealing with complex systems is a recipe for misunderstanding what is going on. Currently, we have theories that are able to explain social systems with level 4 understanding.  Therefore, we truly do not  completely understand how social organizations function yet. But, it does not mean that our theories are not useful. We just have to use them only for the purposes for which they are useful (explaining small portions of the more complex system) and not accept them as universal theories of understanding.  For example, neoclassical economics, with its  simplifying assumptions, is really a level 2 or 3 system because it attempts to turn human beings and social organizations into mechanical systems. The theory of rational choice assumes that every individual with the same choice will always make the same decision. Economics is full of these kinds of closely coupled mechanistic predictions.  For  example, i f a producer produces more goods then the price of those goods will fall. That kind of direct cause and effect relationship is characteristic of a simple system. The problem is that social phenomena like corporations, the market and society do not function that way. Can a simple theory like economic theory really accurately predict human or social behaviour? Part of the argument in this book is that it cannot. Therefore, our corporate law, the law which governs