Corporate Law and Corporate Responsibility Quiz

PDF page 104: Corporate law, which enables businesses to take advantage of a legal structure that separates liability from ownership and control, was introduced in most states in the nineteenth century. The separation of ownership and liability means that, unlike sole proprietors and members of partnerships, owners of modern business corporations enjoy the advantage of limited liability for the corporation’s debts and other financial obligations, a concept at the heart of a U.S. economic system built on capitalism.

PDF page 104: The concept of limited liability means that the owners (shareholders or stockholders) of corporations, as well as directors and managers, are protected by laws stating that in most circumstances, their losses in case of business failure cannot exceed the amount they paid for their shares of ownership (Figure 4.2). The same protection applies to owners of some other business entities such as limited liability companies (LLCs). An LLC is similar to a corporation in that owners have limited liability; however, it is organized and managed more like a partnership. For purposes of granting owners the protection of limited liability, several types of entities are possible within each state, including a corporation, an LLC, a limited liability partnership, and a limited partnership.

PDF page 104: Corporate law, which enables businesses to take advantage of a legal structure that separates liability from ownership and control, was introduced in most states in the nineteenth century. The separation of ownership and liability means that, unlike sole proprietors and members of partnerships, owners of modern business corporations enjoy the advantage of limited liability for the corporation’s debts and other financial obligations, a concept at the heart of a U.S. economic system built on capitalism.

PDF page 104: The concept of limited liability means that the owners (shareholders or stockholders) of corporations, as well as directors and managers, are protected by laws stating that in most circumstances, their losses in case of business failure cannot exceed the amount they paid for their shares of ownership (Figure 4.2). The same protection applies to owners of some other business entities such as limited liability companies (LLCs). An LLC is similar to a corporation in that owners have limited liability; however, it is organized and managed more like a partnership. For purposes of granting owners the protection of limited liability, several types of entities are possible within each state, including a corporation, an LLC, a limited liability partnership, and a limited partnership.

PDF page 105: personal financial liability could limit the ability of businesses to raise capital by selling stock. Limited liability, by reducing the amount a shareholder can lose from investing in a corporation by buying its stock, increases the investment’s attractiveness to potential new shareholders. Ultimately, corporate status increases both the potential number of willing investors and the amount of capital they are likely to invest. After all, would you be willing to invest your money in a business if you knew not only that you could lose the capital you invested, but also that you could be sued personally for any and all debts of the business? Corporate status is conferred upon a business by state law (statute) when a state issues the business a charter of incorporation. The protective shield of corporate status enables businesses to socialize their losses in a way that traditional proprietorships and partnerships are not able to do. Socializing a loss is a means to amortize it or spread it out over society in general, so the owners do not absorb it individually. Amortization is similar to the idea behind insurance, in which many people bear a small share in a loss, rather than one or a few people bearing all of it. Therefore, it is accurate to say that society enables corporations to exist, both by passing laws that create them and by limiting the financial risk exposure of their owners. Since our society grants for-profit businesses the right to incorporate and make unlimited profits with limited liability, a reasonable person could conclude that corporations owe a debt to society in return. Corporations’ quid pro quo—a Latin term meaning this for that—is acceptance of corporate social responsibility, to benefit the many stakeholders to whom corporations may owe a duty, including customers, the community, the environment, employees, media, and the government (Figure 4.3).

PDF page 105: personal financial liability could limit the ability of businesses to raise capital by selling stock. Limited liability, by reducing the amount a shareholder can lose from investing in a corporation by buying its stock, increases the investment’s attractiveness to potential new shareholders. Ultimately, corporate status increases both the potential number of willing investors and the amount of capital they are likely to invest. After all, would you be willing to invest your money in a business if you knew not only that you could lose the capital you invested, but also that you could be sued personally for any and all debts of the business? Corporate status is conferred upon a business by state law (statute) when a state issues the business a charter of incorporation. The protective shield of corporate status enables businesses to socialize their losses in a way that traditional proprietorships and partnerships are not able to do. Socializing a loss is a means to amortize it or spread it out over society in general, so the owners do not absorb it individually. Amortization is similar to the idea behind insurance, in which many people bear a small share in a loss, rather than one or a few people bearing all of it. Therefore, it is accurate to say that society enables corporations to exist, both by passing laws that create them and by limiting the financial risk exposure of their owners. Since our society grants for-profit businesses the right to incorporate and make unlimited profits with limited liability, a reasonable person could conclude that corporations owe a debt to society in return. Corporations’ quid pro quo—a Latin term meaning this for that—is acceptance of corporate social responsibility, to benefit the many stakeholders to whom corporations may owe a duty, including customers, the community, the environment, employees, media, and the government (Figure 4.3).

PDF page 105: personal financial liability could limit the ability of businesses to raise capital by selling stock. Limited liability, by reducing the amount a shareholder can lose from investing in a corporation by buying its stock, increases the investment’s attractiveness to potential new shareholders. Ultimately, corporate status increases both the potential number of willing investors and the amount of capital they are likely to invest. After all, would you be willing to invest your money in a business if you knew not only that you could lose the capital you invested, but also that you could be sued personally for any and all debts of the business? Corporate status is conferred upon a business by state law (statute) when a state issues the business a charter of incorporation. The protective shield of corporate status enables businesses to socialize their losses in a way that traditional proprietorships and partnerships are not able to do. Socializing a loss is a means to amortize it or spread it out over society in general, so the owners do not absorb it individually. Amortization is similar to the idea behind insurance, in which many people bear a small share in a loss, rather than one or a few people bearing all of it. Therefore, it is accurate to say that society enables corporations to exist, both by passing laws that create them and by limiting the financial risk exposure of their owners. Since our society grants for-profit businesses the right to incorporate and make unlimited profits with limited liability, a reasonable person could conclude that corporations owe a debt to society in return. Corporations’ quid pro quo—a Latin term meaning this for that—is acceptance of corporate social responsibility, to benefit the many stakeholders to whom corporations may owe a duty, including customers, the community, the environment, employees, media, and the government (Figure 4.3).

PDF page 106: A longstanding ethical debate about corporate social responsibility asks whether, in fact, a corporation owes a duty to society or only to its shareholders. The line of important court cases shaping this issue spans almost a century and includes a series of landmark cases involving the Ford Motor Company, the Wrigley Company, and Hobby Lobby. In Dodge v. Ford Motor Company (1919), the Michigan Supreme Court ruled in favor of shareholder primacy, saying that founder Henry Ford must operate the Ford Motor Company primarily in the profit-maximizing

PDF page 106: interests of its shareholders. In the traditional corporate model, a corporation earns revenue and, after deducting expenses, distributes the profits to shareholders in the form of dividends. Ford had announced that his company would stop paying big dividends to shareholders and instead would use its profits to achieve several other goals, including improving product quality, expanding company facilities, and perhaps most surprisingly, lowering prices. Shareholders then sued Ford, asking the court to order Ford Motor Company to continue allocating the lion’s share of profits to high dividend payments. (It is ironic that the named shareholders who sued Ford were the Dodge brothers, former Ford suppliers who had recently started their own car company.) At the trial, Ford (Figure 4.4) testified that he believed his company was sufficiently profitable to consider its broader obligation and engage in activities to benefit the public, including its workers and customers. This was a unique position for the founder and primary owner of a large corporation to take in the early twentieth century. During the rise of capitalism in the United States, most owners sought only to maximize profits, because that was the primary basis of their ability to attract capital and to reinvest in the company. Most investors were interested in a healthy return on their investment, rather than any type of social good. Shareholders contended that the concern Ford expressed for his workers and customers was both improper and illegal. The court agreed, and Ford was forced to abandon his managerial goal of balancing profits and

PDF page 107: corporate management latitude in deciding how to run the company. Essentially, the business judgment rule holds that a court will not second-guess the decisions of a company’s managers or directors. The legality and appropriateness of social responsibility as a business policy have followed a long and winding road since 1919. In the 1950s and 1960s, for example, some state courts rejected the shareholder primacy doctrine, instead ruling that a broad interpretation of the business judgment rule allowed managers discretion when it came to allocating company assets, including using them for programs demonstrating social awareness. In 1968, in a highly publicized case, the court ruled that the board of directors of the Wrigley Company, of baseball and chewing gum fame, had a significant amount of discretion in determining how to balance the

PDF page 107: interests of stakeholders. The case of Shlensky v. Wrigley (1968) revolved around William Wrigley Jr.’s ownership of the Chicago Cubs. The baseball team had steadfastly refused to install the lights necessary for playing night games at Wrigley Field, even though every other stadium in major league baseball had lights. Instead, the Cubs had respected the local community’s belief that night baseball games and their associated lights would negatively affect the surrounding neighborhood, creating more opportunities for crime. In the view of some investors, however, the Cubs’ decision was depressing profits for shareholders. The shareholders brought a challenge against the Wrigley Company, but the Cubs’ owners won the case. The Wrigley case represented a shift from the idea that corporations should pursue only the maximization of

PDF page 108: Hobby Lobby (2014), demonstrated what some may consider the double-edged sword of this latitude. In a 5–4 decision in favor of Hobby Lobby, the Supreme Court ruled that some corporations (those that are closely held by a few shareholders) can object on ethical, moral, or religious grounds to the Affordable Care Act’s rule that health insurance policies must cover various forms of contraception; such companies can elect not to offer such coverage. The majority opinion in the case was written by Justice Samuel Alito, joined by Chief Justice John Roberts and Justices Antonin Scalia, Clarence Thomas, and Anthony Kennedy. In essence, the Court ruled that business owners could place their personal values first and follow their own agenda. The case received a great deal of publicity, some of it quite negative. Essentially, the Court held in this case that “corporate law does not require