Business and Governance

HISTORY

The governance of American business has evolved over several major periods. From colonial times to the Civil War, most Americans were self-employed, and most American enterprises were small, single units owned by a single proprietor or partnership. Many Americans owned and worked their own farms; a small percentage were independent merchants, craftsmen, and artisans who owned their owned trade and tools; another small percentage owned their own shops. Some Americans were employed as hired hands or they worked someone else' s land by choice, as a tenant farmer or indentured servant, or without choice, as a slave. The great majority of Americans, however, ran their own farms and trades. Even American tycoons such as John Jacob Astor “ran their own businesses as private partnerships, as did American slavers, such as the Browns, and early industrialists such as Eli Whitney” ( Micklethwait and Wooldridge 2003, 45 ).

There were also joint stock companies, such as the Virginia Company and the Dutch West India Company, that colonized parts of America. Later in the eighteenth century, colonial assemblies and state legislatures chartered companies, such as universities, banks, and canal and road companies as monopolies providing a public benefit. Few business companies were founded, however, until the nineteenth century. Governments saw companies as public entities serving public goods, not as private enterprises created for the personal commercial gain of their owners. It was simply too difficult to persuade state legislatures to issue business charters or to restrain them from changing or withdrawing charters they had assigned. In 1800, America had less than 350 business corporations, most of which had been established in New England, mainly for building canals and roads.

Classical liberalism—with its beliefs in the power of the market, free enterprise, and rights of property and contract—inspired a second, gradually evolving period over much of the nineteenth century, in which government came to see the prospects of private business companies operating in free markets as an engine of economic growth and a source of revenue. With time, and occasional prodding by the courts, state governments eased their control over business and its incorporation. In Dartmouth College v. Woodward, 17 U.S. 518 ( 1819 ), the United States Supreme Court enforced the constitutional provision against state impairment of contracts. Ever so gradually, states allowed businesses to incorporate for general purposes without special legislation, and to do so as “artificial persons” for personal gain and with the protection of property and contract rights. These legal liberalizations were gradual, and setbacks occurred, but they allowed an expansion of business opportunity and an explosion in new businesses.

At about the same time, beginning with a New York State law in 1811, states gradually recognized the concept of limited liability by which stockholders were held liable only for the amount they invested. If someone invested $100 in a company and that company folded, the stockholder would lose his $100 but no more. Creditors could not pursue stockholders for the creditors' losses. This legal development democratized investment by making it a real possibility for the risk-averse middle class. The number of stockholders increased dramatically.

According to management consultant Peter Drucker, business companies became “the first autonomous institution in hundreds of years, the first to create a power center that was within society yet independent of the central government of the national state” ( Micklethwait and Wooldridge 2003, 54 ). In the United States these companies were hardly the first autonomous institutions; they joined civic associations, congregations, and communities. But they were the first autonomous institutions in the economic realm. Nonetheless, throughout much of the nineteenth century, business companies remained small and single units. Where there were choices between economic governance by governments, markets, or firms, the cumulative decisions of this period tended to look less favorably than the past on government and more favorably on markets. The rise of the firm as a governing structure lay ahead ( Chandler 1977; Williamson 2002 ).

The rise of the limited liability business corporation provided the organizational framework for the third great period in business governance, from the late nineteenth century to the late twentieth century. This period witnessed the rise and decline of the modern business corporation. The classic distinction of this institution remains Alfred Chandler' s: “Modern multiunit business enterprise replaced small traditional enterprise when administrative coordination permitted greater productivity, lower costs, and higher profits than coordination by market mechanisms” ( 1977, 6 ). This modern form is characterized in its organization and governance by several iconic features.

see also Williams 2002 ). Successful corporations acquired competing firms (horizontal integration) and firms in their supply chain (vertical integration).

Second, growth and acquisitions created a span-ofcontrol problem that was addressed by hierarchical organization for management, assembly lines for mass production and distribution, and the latest management theories to lead and operate such organizations. Third, as the founding generation of corporate leaders died off, and the number of passive stockholders increased, owners were replaced by professional corporate managers who controlled the leadership structure at all levels ( Chandler 1977; Berle and Means 1932 ). Fourth, after World War II, new technological developments increased efficiency but gradually led to automation, which reduced the workforce at a time when globalization resulted in the outsourcing of jobs overseas and eventually in the rise of multinational corporations.

None of these features were completely unbridled. Labor unions, government policy, court decisions, regulatory agency monitoring, and ambivalent public opinion have set outer borders of corporate power. But, in the final analysis, corporate power has been the source if its own decline, and this characterizes the period of business governance and organization that began in the late twentieth century and continues into the twenty-first century.

DEVELOPMENTS SINCE THE LATE TWENTIETH CENTURY

The twentieth-century business model of expansion, consolidation, and centralization has been increasingly subject to internal organizational limits and external market limits. Internally, large corporations encountered diseconomies of scale, such as unnecessary duplication of services, bloated management and rigid bureaucratic costs, widening span of control, and increased communication and transportation costs.

Externally, new technologies fostered new “high-tech” information industries to which “knowledge workers” fled in droves. New technologies also made it easier for small businesses to conduct business anywhere in the world. Computers replaced the need for secretaries, answering machines replaced receptionists, and personal digital assistants replaced human assistants. Smartphones made it possible for any small businessperson from Cairo, Illinois, to Cairo, Egypt, to negotiate, network, and market on the go. Consumer markets for information products and services exploded. Entrepreneurship became fashionable, flexible, and productive.

Many of these developments favor a hybrid model of governance combining the benefits of market preservation, credible contracting, and maximum coordinated adaptability ( Williamson 2002, 15 ). In some industries, following the lead of Jack Welch, the former chief executive officer at General Electric, large, highly centralized corporations have downsized, flattened their organizational pyramids, and sold off functions acquired in the interest of vertical integration. In a few industries it remains profitable to acquire firms, grow bigger, and consolidate. For example, in the early twenty-first century, only six corporations (CBS, Comcast, Disney, Newscorp, Time Warner, and Viacom) controlled 90 percent of mass media (broadcast and print media). At the same time, the governance mantra is “small is beautiful.”

The federal Small Business Administration (SBA) defines small business as an independent business employing less than five hundred employees and maintains statistics on this large sector of the economy ( United States Small Business Administration 2012 ). As of 2010 the SBA counted nearly thirty million small businesses in America. Of this number, 23 percent are minority-owned, and 46 percent are owned by women or equally by a man and woman. Over half are home-based, roughly three-fourths are sole proprietorships or partnerships, and nearly 80 percent have no employees. Still, because of their magnitude relative to only 18,500 medium and large businesses, the SBA notes that small businesses constitute roughly 50 percent of privatesector employment, 64 percent of new private-sector employment, 43 percent of high-tech employment, and 33 of the value of exports ( USSBA 2012, 1 ). Small businesses are easily adapted to new business trends, and new small businesses quickly start up in response to new consumer needs and demands. They are also incubators for innovation. Of the firms that secure a large number of patents, the SBA reports that small businesses file sixteen times more patents per employee than large firms ( USSBA 2012, 3 ).

Bornstein 2004 ).

One of the main features of Chandler' s description of large corporations of the twentieth century is the divide between the passive stockholders who owned them and the active corporate managers who ran them. This and other divisions persist into the twenty-first century. Corporations are typically divided among three internal stakeholders: (1) shareholders who own shares of the corporation but have little information and control over corporation policies and practices; (2) a board of directors that is responsible for monitoring and overseeing management' s financial and performance reports but may lack of the capacity to do so; and (3) a chief executive officer (CEO) and other senior officers who manage the corporation and accumulate considerable information and control in the process.

One of the dangers in this system is the “principalagent problem,” in which the interests of the shareholders (the principal) and their agents (senior management) widen along with the power gap between them ( Fama and Jensen 1983 ). The power gap widens as senior management acquires more information; the gap widens further when there is no dominant shareholder, and when the CEO is also the chairman of the board of directors. Additional problems in accountability arise when the board of directors has diminished capacity or interest to seriously monitor and double-check the performance and financial accounts of senior management. Following the disclosure of major corporate fraud at Enron and other firms between 2000 and 2002, the federal government intervened and adopted the Sarbanes-Oxley Act of 2002. This act put in place a regulatory system to increase corporate accounting oversight, auditor independence, board of directors' responsibilities, and conflict-of-interest disclosures.

Many corporations refuse to go public and remain controlled by their founders and their founders' heirs. Many new corporations simply refuse to separate leadership and ownership. Research is needed to explore the full implications of this development in business governance, but one finding is clear: this new brand of corporate leader includes many who are passionate not only about political causes but about civic causes. Unlike the more established corporations that play it safe by funding the political campaigns of incumbents, many new corporate leaders are throwing their support to the candidates with whom they share ideological commitments, partly because they do not have to answer to shareholder concerns.

Business enterprises of the twenty-first century operate in an age of innovation and change. In times like these, there is little room for the old orthodoxies of markets or firms, choice or contracts, autonomous adaptation or coordinated adaptation. Businesses make individual choices as they seek to maximize profits, but they also enter into voluntary exchanges (e.g., by contracting) to achieve the three goals of creating order, reducing conflict, and maximizing mutual gain ( Commons 1932 ). Once perceived as transaction costs that could be overcome by consolidation and hierarchies, contracting and other exchange mechanisms have become important features of governance ( Buchanan 1975, 1987; Simon 1991 ). Over the near future, business governance is likely to be a subject of innovation and change as much as the times in which it operates.

SEE ALSO Campaign Finance Laws ; Campaign Finance Practices ; Charters ; Contract ; Entrepreneurship and Innovation ; Governance ; Government ; Politics ; Polity ; Property ; Self-Governance .

BIBLIOGRAPHY

Berle, Adolf A., Jr., and Gardiner C. Means. The Modern Corporation and Private Property. New York: Macmillan, 1933.

Bornstein, David. How to Change the World: Social Entrepreneurs and the Power of New Ideas. Updated ed. Oxford and New York: Oxford University Press, 2004.

Buchanan, James M., Jr. “A Contractarian Paradigm for Applying Economic Theory.” American Economic Review 65, no. 2 (1975): 225–30.

Buchanan, James M., Jr. “The Constitution of Economic Policy.” Nobel Prize Lecture. December 8, 1986. Nobelprize.org . http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1986/buchanan-lecture.html .

Chandler, Alfred D., Jr. Strategy and Structure: Chapters in the History of the American Industrial Enterprise. Cambridge, MA: MIT Press, 1962.

Chandler, Alfred D., Jr. The Visible Hand: The Managerial Revolution in American Business. Cambridge, MA: Harvard University Press, 1977.

Coase, Ronald H. “The Nature of the Firm.” Economica 4, no. 16 (1937): 386–405.

Commons, John R. “The Problem of Correlating Law, Economics, and Ethics.” Wisconsin Law Review 8 (1932): 3–26.

Drucker, Peter F. Concept of the Corporation. (1946). New Brunswick, NJ: Transaction, 1993.

Fama, Eugene F., and Michael C. Jensen. “Separation of Ownership and Control.” Journal of Law and Economics 26, no. 2 (1983): 301–25.

Micklethwait, John, and Adrian Wooldridge. The Company: A Short History of a Revolutionary Idea. New York: Modern Library, 2003.

Simon, Herbert. “Organizations and Markets.” Journal of Economic Perspectives 5, no. 2 (1991): 25–44.

United States Small Business Administration. “Frequently Asked Questions: Advocacy—The Voice of Small Business in Government.” September 2012. https://www.sba.gov/sites/default/files/FAQ_Sept_2012.pdf .

Williamson, Oliver E. “The Theory of the Firm as Governance Structure: From Choice to Contract.” Journal of Economic Perspectives 16, no. 3 (2002): 171–95. http://pubs.aeaweb.org/doi/pdfplus/10.1257/089533002760278776 .

Stephen Schechter
Russell Sage College