Daily Archives: September 7, 2018

Social Justice and the Corporate Form

The other day I was having lunch with my good friend Seth Rosenblatt, whom I met years ago when we both served on the San Carlos Elementary School Board. Among many other things, Seth is my go-to guy on economics.

At one point during lunch we ended up talking about how each of us thinks allowing corporations to play a role in politics causes significant distortions of our society. That’s been a difficult problem for lawmakers to address, even though it’s a widely understood problem. Why? Because of the choice we made as a society to grant corporations many of the legal rights associated with flesh-and-blood individuals.

But why was such a choice made? It’s certainly not an obvious one. Whatever else it might be, a corporation is clearly not a living, breathing entity.

The answer lies in an aspect of human nature often overlooked in discussions of economics by lay people: humans are risk averse. We will reject, say, a $1 dollar bet that gives us a 50% chance of winning $2…even though, arguably, we are, on average, no better or worse off by placing the bet, and so shouldn’t care one way or the other. In fact, we instinctively demand much more than a better-than-breakeven return before we’ll place any bet.

Overcoming risk aversion is precisely the reason the corporate form was developed centuries ago. By law, a corporation shields its investors from bad economic bets: they can lose their investment, but irate customers, victims, etc., cannot come after the investors’ wealth or income that has not been invested in the corporation.

But why did we put that risk shielding in place? It clearly isn’t in the interest of people whose interests are, or could be, harmed by corporate failures.

The answer is simple: because it made us, individually and collectively, enormously wealthier than we used to be. Whatever problems they cause, there’s no denying corporations have dramatically increased collective and individual wealth and income. That’s why every human culture I’m familiar with has allowed the use of some kind of corporate form.

Risk aversion, by keeping us from placing reasonable bets, denies us the benefits reasonable bets produce. Those tantalizing benefits encouraged us to figure out a workaround for the limitations of our nature. If we had to squint past treating an artificial construct as a something similar to a living, breathing entity…well, humans are very pragmatic. We don’t argue with success, however much rationalization we need to do to justify it.

Besides, it was an easy step to take. Most people would reject as immoral and unethical punishing someone because their friend, without their knowledge or consent, injured someone economically. Once you accept a corporation as an entity in its own right, granting investors a risk shield follows naturally from that same perspective*.

But here’s the thing: despite how it’s sometimes described by business people lost in rapture, the corporate form is really just a dodge, a convenient fiction. It’s purpose is to let us, collectively and individually, create wealth and income that would otherwise be unavailable because of the limitations imposed by human risk aversion.

Why haven’t we thought about using the exact same logic in the realm of healthcare? Or having a decent place to live?

We all know talented and capable people who are kept from living up to their potential — and thereby benefiting all of us, not just themselves — because of the accidents of fate. A seriously ill family member, preventing someone from using their talents and abilities in a new, more demanding role at a different company, when pre-existing conditions keep people from getting health insurance. A child who has to “play it safe”, or drop out of school, because of the loss of a family member, or because he or she is an orphan.

People who worry about having a roof over the heads of their family rarely have the bandwidth to launch new economic enterprises, no matter how smart or talented they are. If you have to worry about starving, you’re not going to be able to use whatever creative talents and abilities you have, except in the pursuit of food.

These kinds of risks clearly limit what we are willing and able to do as individuals. Even more so than how the risk of losing one’s wealth limits one’s interest in investing it in new, valuable ventures.

So it’s not surprising that most advanced societies have taken some steps to mitigate the impact of such risks. Things like Social Security and Medicare were enacted, at least in part, to do so. Another example is public education. In addition to everything else it does, being better educated makes you better able to assess and manage risk.

Let me close with the following question: if giving people more peace of mind, and some kind of backstop to life’s vagaries, frees them to be more creative and economically active — which benefits all of us — why aren’t we doing more to insure against such risks? After all, based on the wealth (pun intended) of experience we have with the corporate form, we already know the payoff is there!

Something to think about.

* To keep things simple, I’m ignoring cases where investors knowingly participate in causing economic harm through a corporation. The law contains provisions for “piercing the corporate veil” for that, and other situations, when the facts justify it.