Corporate Federalism (Historical Development)

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CORPORATE FEDERALISM (Historical Development)

Perhaps the most conspicuous aspect of the American federal system of government, aside from the continuing robustness of state government itself, is that corporations in America are chartered overwhelmingly by the states and almost never by the national government. Despite the modern displacement and augmentation of state power by federal power in realms as diverse as criminal law and the regulation of morals, the power of states to create the corporations and other entities that conduct America's business affairs has steadfastly resisted federal encroachment. The United States is essentially alone among the commercialized industrial powers of the world in not allocating that power to the central governmental authority.

This allocation of power has long been controversial. Overwhelmingly, until the last quarter of the twentieth century, this allocation of governmental power has been regarded with hostility by those concerned with the parochialism of American state governments, with suspicion by historians explicating American political and institutional development, and with concern by economists committed to a planned economy. In these perspectives, the state power to charter corporations and control the existence of other business entities looked to be a "race to the bottom" in which states seeking the revenue provided by corporate chartering fees were the witting and unwitting pawns of businesses and those who controlled them. The states became pawns because corporations may freely do business in all states even though chartered by only one, and because they are also free to change their state of incorporation at will. Thus, businesses both covertly and overtly evaded or overcame regulations framed in the interest of shareholders and the larger public by pitting one state against another. Recently, however, scholars in economics and scholars in law influenced by them have posited a radical new interpretation of the allocation of the power to charter businesses. Congruent with the competitive principles of neoclassical economics, these scholars have reinterpreted the regime of state chartering as beneficial, not detrimental, both economically and politically. These scholars view the allocation of the power to charter businesses and its evolution not so much as evidence of the corruption of local politics, but as wealth-producing competition. This competitive process, these scholars suggest, is not necessarily corrupt but rather one that requires state governments to be attentive to the actual needs of successful businesses in a fluid and dynamic economy, balancing the necessary shareholder protection from incompetent and self-interested managers with managerial desire to obtain capital (from shareholders) cheaply, thus helping to maximize a business's production of wealth.

Proponents of each theory have propounded an admixture of history, economics, and political theory to make their claims. The story of federalism and the corporation thus has two components, one of which concerns the legal and economic nature of business entities and the other of which concerns the nature of the legal regime, constitutional, statutory, and common law, relevant to the existence and status of those entities.

When the Constitution was adopted business was still largely a local phenomenon. Save for a handful of trading companies, few businesses reached beyond their local environment. The costs of communication and transportation, the uncertainties of the politics and the cultures of foreign environments, and the difficulties of controlling an organization over expanses of both time and space, made cosmopolitan enterprise expensive and problematic when possible, and more often impossible. Consequently, of necessity and habit, business enterprises were regarded as local.

At the time of the adoption of the Constitution, moreover, the corporation was not principally a business utility. Rather, it was a vehicle for the creation of entities more generally, such as municipal corporations and charitable corporations, as well as business corporations. Contemporary corporate law reflected that understanding. Each corporate entity, whether business or not, was a product of the energies of the local citizenry and the sanction of the sovereign body legislating the entity into existence. These creations came to be seen as products of the agreement of a sovereign body and a group of individuals who agreed to create a legal entity for certain purposes. Only occasionally were those purposes economic. Because business enterprise was local and severely limited in scale and scope, most businesses existed without being chartered by the sovereign.

In a federal constitutional system of dual sovereignty, however, which sovereign had the power to create business entities quickly became controversial as the physical, temporal, and spatial boundaries for economic activity began very gradually to melt away. Entrepreneurial choice, however, was also legally limited.

States not only chartered corporations but also regulated them, usually through the charter itself. Entrepreneurs who sought the advantages of the corporate form, such as monopoly rights and limited liability (although there is today an important debate about whether these advantages, especially limited liability, were as prevalent or as advantageous as historians have long assumed), submitted to certain regulations as a condition of incorporation. Because state legislatures granted the charters—creation of subordinate legal entities being the prerogative of the sovereign, and sovereignty residing ultimately in the legislature—corporations were legislative creations. Their creation thus occasioned, especially in times of antibusiness sentiment, stringent limits on corporate behavior and even outright denials of charters.

State legislative sovereignty was not, however, absolute. The courts, especially the Supreme Court, spent much effort, especially in the early nineteenth century, to create the preconditions for cosmopolitan, even national, businesses and to limit parochial control of those businesses by the states. In its early decisions it noted that corporations were creatures of common law as well as charter, thus claiming for itself a role in defining corporate existence. It laid this claim in dartmouth college v. woodward (1816) by defining corporations as contracts between the sovereign and the individual corporators, and then using the contracts clause to prohibit states from changing the terms of such contracts after the charter was granted. It legimated congressional charters by validating the charter of the Bank of the United States in mcculloch v. maryland (1819) though Congress did not take advantage of this power often. The Court used its own power to create the presumption that a corporation might operate across state lines unless excluded from doing so, and then limited the terms on which a state might exclude. In these, and many other ways, the Court helped to create the legal regime that allowed corporations to reincorporate at will, and thus to take advantage of the economic and political conditions that made both the "race to the bottom" and the "climb to the top" plausible interpretations of the history of corporate federalism.

Gregory A. Mark
(2000)