Why Markets Chose the Corporate Form: Entity Status and the Separation of Asset Ownership from Control

Abstract

This essay draws on the experience of business people in the early 19th century U.S. to provide insights into the problems of creating effective institutions of capitalism in emerging market and transition economy countries. The essay argues that the unique contribution of the corporate legal form in the 19th century was that it allowed business people to create separate legal entities with potentially unlimited life to own the assets used in production, which, among other things, separated asset ownership from control over those assets. These features together enabled business organizers to commit capital almost irrevocably to an enterprise, and helped to make the enterprises more financially stable. Using the corporate form, rather than partnership or so-called joint stock companies (which were a type of partnership), business organizers could more easily accumulate organizational and other intangible capital, along with the specialized physical capital necessary to carry out complex business activities over an extended period of time. Scholars who have studied the problems of creating effective corporate law and governance institutions in developing and transition countries have emphasized the importance of protections for minority shareholders. But the need for legal and organizational mechanisms for locking capital into the enterprise, for preventing investors from stripping assets or otherwise pulling out prematurely, is even more basic, yet largely neglected in the literature so far. An appreciation of our own history of how business people tried to find organizational forms that would enable them to build substantial and lasting business enterprises in the absence of strong legal, cultural and institutional supports sheds light on the important role played in this country of entity status and separation of control from financial contribution.