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Corporations: A Contractual Paradigm

Robert Hessen

• Hoover Institution and Graduate School of Business, Stanford University

“A New Concept of Corporations: A Contractual and Private Property Model.” Hastings Law Journal 30 (May 1979): 1327–1350.

Current thinking about corporations rests upon dubious assumptions that are inconsistent with the principles of a free society. Specifically, it is often argued that corporations are created by the state and hence are fit subjects for state regulation. This contention in practice is associated with the view that large corporations lack legitimacy and should be dissolved. Known as the “concession theory,” this contention is explicitly advanced in the Supreme Court's dictum in Hale v. Henkel (1906): “The corporation is a creature of the State.”

The claim that a corporation rests upon state privilege and does not arise naturally in the free market rests upon its status as an entity, its perpetual character, and its limited liability. The first of these, however, is simply a legal convenience, and the law recognizes other types of organization, such as partnerships, as entities. Its existence in perpetuity means only that the articles defining its form of organization need not be renewed at stated intervals. Limited liability, furthermore, may simply be regarded as an implicit contract between the corporation as debtor and its creditors.

To this some might object that this cannot apply to tort liability, since the victim may recognize no contract implicitly limiting the liability of the tortfeasor. In answer to this, liability of a master for his agent's actions rests upon the doctrine of respondeat superior. The extent to which this doctrine applies in a particular case is a matter of convenience, and limited liability in this regard cannot be taken simply as a special privilege for corporations alone.

Supporters of government regulation such as Ralph Nader point to the fact that a corporation must be chartered by the state in order to function legally. In the United States, however, the custom beginning in the nineteenth century was for automatic incorporation, turning the process into one in which the state had no independent role for action. Legal theory has not caught up yet with this development.

The claim that modern corporations separate ownership and control (the famous Berle-Means thesis) reverses cause and effect. It is because corporations can be legally organized in a fashion which allows the executive officers scope for independent action that the separation can occur. But there is nothing inevitable about this, and corporations can be organized so that this separation does not take place. In any case, the stockholders' power to sell their shares is an effective means of control.