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When a corporation is created, its officers, directors, and shareholders usually are the same people. They
elect themselves or their nominees to the board of directors and then elect themselves as corporate officers.
When the corporation later goes public, the founders accept the possibility of a dilution of control because they
value the additional capital and because they expect to continue to control a majority of votes on the board and
thus to direct the company's future policy and growth.
That the board of directors is dominated by "insiders" makes sense. The founders are the first directors;
later, their places on the board are filled by the executives they groomed to succeed them. This arrangement
does not injure new shareholders. As outside investors they buy shares of common stock because they discover
corporations whose record of performance indicates a competent managerial system. They do not want to inter-
fere with it or dismantle it; on the contrary, they willingly entrust their savings to it. They know that the best
safeguard for their investments, if they become dissatisfied with the company's performance, is their ability to
sell instantly their shares of a publicly traded corporation.
Berle and Means challenged the legitimacy of giant corporations when they charged that corporate officers
had seized or usurped control from the owners – the shareholders. But their underlying premise was wrong. In
reality, investors make choices along a risk-reward continuum. Bondholders are the most risk-averse; then
come those who buy the intermediate-risk, non-voting securities (debentures, convertible bonds and preferred
shares); and then the least risk-averse investors, those who buy common shares and stand to gain (or lose) the
most.
Just as one may assume that investors know the difference between being a general partner and a limited
partner, so too they know that shareholders in a publicly traded corporation are the counterparts of limited part-
ners, trust beneficiaries, those who make passbook deposits in a bank, or those who buy shares in a mutual
fund. All hope to make money on their savings as a sideline to their regular sources of income.
To look askance at executives who supply little or none of the corporation's capital, as many of the corpo-
ration's critics do, is really to condemn the division of labor and specialization of function. Corporate officers
operate businesses whose capital requirements far exceed their personal saving or the amounts they would be
willing or able to borrow. Their distinctive contribution to the enterprise is knowledge of production, market-
ing, and finance, administrative ability in building and sustaining a business, in directing its growth, and in
leading its response to unforeseen problems and challenges. But specialization – capital supplied by investors
and management supplied by executives – should be unobjectionable as long as everyone's participation is vol-
untary.
Another technique used by critics to undermine the legitimacy of giant corporations is to equate them to
government institutions and then to find them woefully deficient in living up to democratic norms (voting rights
are based on number of shares owned, rather than one vote per person, for example). Thus shareholders are re-
named "citizens", the board of directors is "the legislature", and the officers are "the executive branch". They
call the articles of incorporation a "constitution", the by-laws – "private statutes" and merger agreements –
"treaties".
But the analogy, however ingenious, is defective. It cannot encompass all the major groups within the cor-
poration. If shareholders are called citizens or voters, what are other suppliers of capital called? Are bond-
holders "resident aliens" because they cannot vote? And are those who buy convertible debentures "citizens in
training" until they acquire voting rights? A belabored analogy cannot justify equating business and govern-
ment.
Those who cannot distinguish between a government and a giant corporation are also unable to appreciate
the significance of the fact that millions of people freely choose to invest their savings in the shares of publicly
traded corporations. It is farfetched to believe that shareholders are being victimized – denied the control over
corporate affairs that they expected to exercise, or being shortchanged on dividends – and yet still retain their
shares and buy new shares or bid up the price of existing shares. If shareholders were victims, corporations
could not possibly raise additional capital through new stock offerings. Yet they do so frequently.
Particular corporations can be mismanaged. They are sometimes too large or too diversified to operate effi-
ciently, too slow to innovate, overloaded with debt, top-heavy with high-salaried executives, or too slow to re-
spond to challenges from domestic or foreign competitors. But this does not invalidate corporations as a class.
Whatever the shortcomings of particular companies or whole industries, corporations are a superb matchmaking
mechanism to bring savers (investors) and borrowers (workers and managers) together for their mutual benefit.
To appreciate the achievement of corporations, one has only to consider what the state of technology would be
if workers or managers had to supply their own capital, or if industrialization was carried out under government
auspices, using capital that was taxed or expropriated.
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