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the trustee is aware of the factors which give rise to the supposed trust, there is nothing which can affect his conscience. Thus neither in the case of a subsequent failure of consideration nor in the case of a payment under a contract subsequently found to be void for mistake or failure of condition will there be circumstances, at the date of receipt, which can impinge on the conscience of the recipient, thereby making him a trustee.
Notes and Questions 8.1
Explain why, according to Lord Browne-Wilkinson, the consequences he notes under the headings ‘The breadth of the submission’ and ‘The practical consequences of the bank’s argument’ must follow if the local authority holds the money on trust for the bank (see further section 14.2 below on the enforceability and priority of property interests).
8.4. Fragmentation of management, control and benefit
In this section, we consider mechanisms for fragmenting the management, control and benefit aspects of ownership. These mechanisms can be put into three categories. The first is corporate property holding, where property is held by an artificial legal person such as a company. The second is managerial property holding, where property is held by a non-beneficial owner – in other words, held or controlled by one person for the benefit of another. Examples falling within this second category are where property is held by trustees, or by administrators of the estates of people who have died or gone bankrupt. The third category is group property holding, where property is held not by a single person but by a group of people for their own benefit, whether as co-owners or as communal owners (a distinction we will look at more closely later on).
These three categories are not exclusive: artificial persons can be co-owners and can also hold property on behalf of others as managerial owners. So, for example, it is quite common to have a trust where the trust property is jointly held by two companies on trust for (say) their employees. However, for the present we will consider each category in isolation.
8.4.1. Corporate property holding
A corporation is, in law, a person in its own right and as such it has many of the attributes of a real person – it can hold property, enter into contracts, commit torts and crimes, and sue and be sued in the courts. But of course it cannot itself make decisions to do any of these things, or take any action to implement those decisions – all this has to be done by human persons acting on its behalf. So, while it makes perfect sense to say that a corporation holds property for its own benefit, it is not quite the same thing as saying that a human person holds property for her own benefit. A human person who owns a book can be left to decide for herself what to do
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with it, whether to read it, sell it at a profit or a loss, give it away, or destroy it. If a corporation owns the book, none of these things can happen unless some human person decides that they shall happen. Who makes these decisions, and for whose benefit, and who controls the decision-maker?
There are different types of corporation, but by far the most important (numerically and economically) in this jurisdiction is the limited liability company. In a limited liability company, as Harold Demsetz explains in Extract 8.2 below, the company itself owns its assets and its shareholders own shares in the company. The company’s assets consist initially of money supplied by the shareholders in exchange for shares in the company issued to them. The shareholders’ liability is limited in that they cannot be called on to provide any more money to meet the liabilities of the company: once the company has been formed and the shareholders have paid the full price of their shares over to the company, the only assets available to meet claims by creditors of the company are those owned by the company. In other words, by joining in the formation of a company or buying shares subsequently issued by it, a shareholder chooses how much of his personal wealth to risk in the enterprise to be carried out by the company.
In traditional theory, ownership of the company’s assets is fragmented in the following way. Title to the assets is held by the company, but the assets themselves are managed by the board of directors, who are required to use the assets to carry out the purposes for which the company was formed, in order to provide a profit for the shareholders. This profit is distributed to the shareholders by way of dividends on their shares from time to time declared by the board. The board’s management of the assets is controlled by the shareholders, who have the power to appoint and dismiss the directors, and whose consent (given by voting at company meetings) is required for the exercise of various powers.
If this model provided an accurate description of the way in which companies operate in practice, then, according to classical economic theory, they ought not to work at all in a market economy. Indeed, Adam Smith (writing before the rise of the limited liability company) thought it was impossible for a company to function efficiently:
The directors of such companies . . . being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own . . . Negligence and profusion . . . must always prevail, more or less, in the management of such a company. It is upon this account that joint stock companies [the precursor of the modern limited liability company] . . . have seldom been able to maintain the competition against private adventurers. They have, accordingly, very seldom succeeded without an exclusive privilege, and frequently have not succeeded with one. Without an exclusive privilege they have commonly mismanaged the trade. With an exclusive privilege they have both mismanaged and confined it. (Smith, The Wealth of Nations, vol. II, p. 229)
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This objection to corporate ownership is more fundamental than might at first sight appear. The problem is not simply inadequate control over management: as we see below, there are many different ways in which controls can and have been built into the basic corporate mechanism. The real objection, as Berle and Means first pointed out in their classic analysis of corporate property holding in 1932, The Modern Corporation and Private Property (Extract 8.3 below), is that corporate ownership subverts the profit function which Adam Smith considered integral to the efficiency and social utility of private property.
However, the fact is that most business enterprises do in practice choose to operate through the medium of a limited liability company, and, contrary to Adam Smith’s experience, there is no modern evidence that they do so less efficiently than individually owned businesses. How then can this apparent gap between theory and practice be explained?
One possible answer lies in the fact that the strict division between management, control and benefit described in the traditional analysis of corporate ownership rarely occurs in practice. This is particularly true of the smallest and the largest companies.
Take first the case of small companies, which numerically form the vast proportion of all companies. Most small companies are ‘closely held’ – i.e. the directors and shareholders are the same people: a study published in 1985 revealed that, in about 80 per cent of British small companies, the directors of the company held 90 per cent or more of the shares (Carsberg et al., Small Company Financial Reporting, p. 79). In these companies, the individual shareholder/directors have management and control of the assets and keep all the benefit for themselves, so the division of management, control and benefit is purely notional. Corporate ownership in these cases is therefore practically indistinguishable from individual ownership. Even limited liability is likely to be illusory: individuals trading through close companies will almost certainly be required to mortgage their personal assets and give personal guarantees to secure lending to the company.
In relation to very large companies, the traditional model of corporate ownership is a better match, but it is misleadingly simplistic. For these purposes, largeness can be equated with listing on a stock exchange. These companies of course vary enormously, but there are some typical characteristics that make them radically different from closely held companies. First, in many large companies the board of directors does not manage, but hires and fires others to manage for them. This transforms its function from management to control over management – the function performed in the traditional model by the shareholders. Secondly, control by the board is only part of a complex network of control over management of large companies. In particular, there is massive regulatory control exerted by the listing authorities, partly to protect the interests of the shareholders but mainly to preserve the integrity of the market.
Thirdly, the shareholders have only an attenuated connection with the assets of the company. They have no day-to-day control over management, except in those
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comparatively rare cases where a single individual or group of individuals controls a significant proportion of the shares. Leaving aside those exceptional cases, many of the shareholders have never and will never contribute towards the capital of the company. Most of them are not the original suppliers of capital to the enterprise, and although some of them subsequently supplied capital by buying new issues of shares from the company, many of them bought their shares on the stock market, paying the purchase price not to the company but to the shareholder seller. Indeed, many of them have no direct interest in the profitability of the enterprise. While some shareholders buy shares with the long-term aim of earning income in the form of dividends declared on those shares, others do so primarily in order to make a profit on resale of the shares in the market. Consequently, the correlation between the movement of share prices on the stock market and the profitability of the companies in question is not straightforward (see further Hadden, Company Law and Capitalism, pp. 71–5, and the review of current theories of correlation between the two by Cheffins, Company Law: Theory, Structure and Operation, pp. 54–8).
The allocation of management, control and benefit in these large companies is radically different from that which occurs in the traditional model. Nevertheless, Berle and Means argue that this merely exacerbates the problems of corporate property holding, and that the constraints that make private property efficient and socially beneficial are even less effective in this kind of company than they are in the traditional model.
The Berle and Means thesis was highly influential in its time, as Gregory S. Alexander explains in Commodity and Propriety (Extract 8.4 below), although mainstream modern economists concerned with corporate governance now largely reject its assumptions as to the nature of a corporation. On this modern view – the ‘nexus of contracts’ theory of the company – the artificial legal person, the corporation, is an irrelevance, and the company is more aptly viewed as a network of explicit and implicit bargains entered into voluntarily by individuals who interact on the basis of reciprocal expectations and behaviour. The classic exposition of the nexus of contracts theory is found in 0-Easterbrook and Fischel, The Economic Structure of Corporate Law, and see also Cheffins, Company Law: Theory, Structure and Operation, pp. 31–47. For a critical analysis rejecting the nexus of contracts approach, see Ireland, ‘Company Law and the Myth of Shareholder Ownership’: he describes it as ‘the company law equivalent of Mrs Thatcher’s ‘‘there is no such thing as society’’’.
Regardless of which theory of the corporation provides the most fruitful approach to questions of corporate governance, for property theorists the Berle and Means thesis remains a useful analysis of the fragmentation of ownership that occurs in corporate property holding and the nature of corporate property holding (see, for example, Jeremy Waldron, The Right to Private Property, pp. 57–9, who describes the Berle and Means account as still the best discussion, while taking the
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view that corporate property is best seen as ‘a mutation of private property rather than as a distinct form of property in its own right’).
Extract 8.2 Harold Demsetz, ‘Towards a Theory of Property Rights’ (1967) 57
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The interplay of scale economies, negotiating cost, externalities, and the modification of property rights can be seen in the most notable ‘exception’ to the assertion that ownership tends to be an individual affair: the publicly held corporation. I assume that significant economies of scale in the operation of large corporations is a fact and, also, that large requirements for equity capital can be satisfied more cheaply by acquiring the capital from many purchasers of equity shares. While economies of scale in operating these enterprises exist, economies of scale in the provision of capital do not. Hence, it becomes desirable for many ‘owners’ to form a joint-stock company.
But if all owners participate in each decision that needs to be made by such a company, the scale economies of operating the company will be overcome quickly by high negotiating cost. Hence a delegation of authority for most decisions takes place and, for most of these, a small management group becomes the de facto owners. Effective ownership, i.e. effective control of property, is thus legally concentrated in management’s hands. This is the first legal modification, and it takes place in recognition of the high negotiating costs that would otherwise obtain.
The structure of ownership, however, creates some externality difficulties under the law of partnership. If the corporation should fail, partnership law commits each shareholder to meet the debts of the corporation up to the limits of his financial ability. Thus, managerial de facto ownership can have considerable external effects on shareholders. Should property rights remain unmodified, this externality would make it exceedingly difficult for entrepreneurs to acquire equity capital from wealthy individuals. (Although these individuals have recourse to reimbursements from other shareholders, litigation costs will be high.) A second legal modification, limited liability, has taken place to reduce the effect of this externality. De facto management ownership and limited liability combine to minimize the overall cost of operating large enterprises. Shareholders are essentially lenders of equity capital and not owners, although they do participate in such infrequent decisions as those involving mergers. What shareholders really own are their shares and not the corporation. Ownership in the sense of control again becomes a largely individual affair. The shareholders own their shares, and the president of the corporation and possibly a few other top executives control the corporation.
To further ease the impact of management decisions on shareholders, that is, to minimize the impact of externalities under this ownership form, a further legal modification of rights is required. Unlike partnership law, a shareholder may sell his interest without first obtaining the permission of fellow shareholders or without dissolving the corporation. It thus becomes easy for him to get out if his preferences and those of the management are no longer in harmony. This ‘escape hatch’ is extremely important and has given rise to the organized trading of securities. The
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increase in harmony between managers and shareholders brought about by exchange and by competing managerial groups helps to minimize the external effects associated with the corporate ownership structure. Finally, limited liability considerably reduces the cost of exchanging shares by making it unnecessary for a purchaser of shares to examine in great detail the liabilities of the corporation and the assets of other shareholders; these liabilities can adversely affect a purchaser only up to the extent of the price per share.
Extract 8.3 Adolf A. Berle and Gardiner C. Means, The Modern Corporation and Private Property (New York: Harcourt, Brace & World, 1932), pp. 299–301
[In this classic (and now hotly disputed) analysis of property holding by limited liability companies first published in 1932, Adolf A. Berle and Gardiner C. Means estimated that approximately 300,000 companies then registered in the United States controlled at least 78 per cent of business wealth in the country. This was not spread evenly between all companies: the 200 largest companies were estimated to control between 45 per cent and 53 per cent of all corporate wealth, between 35 per cent and 45 per cent of all business wealth, and between 15 per cent and 25 per cent of national wealth.]
The socially beneficent results to be derived from the protection of property are supposed to arise, not from the wealth itself, but from the efforts to acquire wealth. A long line of economists have developed what might be called the traditional logic of profits. They have held that, in striving to acquire wealth, that is, in seeking profits, the individual would, perhaps unconsciously, satisfy the wants of others. By carrying on enterprise he would employ his energy and wealth in such a way as to obtain more wealth. In this effort, he would tend to make for profit those things which were in most demand. Competition among countless producers could be relied upon in general to maintain profits within reasonable limits while temporarily excessive profits in any one line of production would induce an increase of activity in that line with a consequent drop of profits to more reasonable levels. At the same time, it was supposed that the business man’s effort to increase his profits would, in general, result in more economical use of the factors of production, each enterprise having to compete with others for the available economic resources. Therefore, it has been argued that, by protecting each man in the possession of his wealth and in the possession of any profits he could make from its use, society would encourage enterprise and thereby facilitate the production and distribution of goods desired by the community at reasonable prices with economic use of labor, capital, and business enterprise. By protecting property rights in the instruments of production, the acquisitive interests of man could thus be more effectively harnessed to the benefit of the community.
It must be seen that, under the condition just described, profits act as a return for the performance of two separate functions. First, they act as an inducement to the individual to risk his wealth in enterprise, and, second, they act as a spur, driving him to exercise his utmost skill in making his enterprise profitable. In the case of a private enterprise the distinction between these two functions does not assume importance. The owner of a
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private business receives any profits made and performs the functions not only of risktaking but of ultimate management as well. It may be that in the past when industry was in the main carried on by a multitude of small private enterprises the community, through protecting property, has induced a large volume of risk-taking and a vigorous conduct of industry in exchange for the profits derived therefrom.
In the modern corporation, with its separation of ownership and control, these two functions of risk and control are, in the main, performed by two different groups of people. Where such a separation is complete one group of individuals, the security holders [here meaning the shareholders and those who provide loan finance for the company] . . . perform the function of risk-takers and suppliers of capital, while a separate group exercises control and ultimate management. In such a case, if profits are to be received only by the security holders, as the traditional logic of property would require, how can they perform both of their traditional economic roles? Are no profits to go to those who exercise control and in whose hands the efficient operation of enterprise ultimately rests?
It is clear that the function of capital supplying and risk-taking must be performed and that the security holder must be compensated if an enterprise is to raise new capital and expand its activity just as the workers must be paid enough to insure the continued supplying of labor and the taking of the risks involved in that labor and in the life based on it. But what if profits can be made more than sufficient to keep the security holders satisfied, more than sufficient to induce new capital to come into the enterprise? Where is the social advantage in setting aside for the security holder, profits in an amount greater than is sufficient to insure the continued supplying of capital and taking of risk? The prospect of additional profits cannot act as a spur on the security holder to make him operate the enterprise with more vigour in a way to serve the wants of the community, since he is no longer in control. Such extra profits if given to the security holders would seem to perform no useful economic function.
Furthermore, if all profits are earmarked for the security holder, where is the inducement for those in control to manage the enterprise efficiently? When none of the profits are to be received by them, why should they exert themselves beyond the amount necessary to maintain a reasonably satisfied group of stockholders? If the profit motive is the powerful incentive to action which it is supposed to be, and if the community is best served when each enterprise is operated with the aim of making the maximum profit, would there not be great social advantage in encouraging the control to seize for themselves any profits over and above the amount necessary as a satisfactory return to capital?
Extract 8.4 Gregory S. Alexander, Commodity and Propriety: Competing Visions of Property in American Legal Thought 1776–1970 (Chicago: University of Chicago Press, 1997), pp. 342–50
B E R L E A N D M E A N S A N D T H E P R O B L E M O F C O R P O R A T E P R O P E R T Y
By the time of the Great Crash of 1929, it was abundantly clear to anyone who cared to look that the shift to the large corporation as the dominant mode of doing business
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and with it, corporate equity and debt instruments as the dominant form of property, was now completed and irreversible. Attacks on the modern industrial corporation by critics like Edward Bellamy and Thorstein Veblen had utterly failed to slow the rapid growth of the business corporation or to weaken its enormous economic power.
The phenomenal growth of corporate power, together with the stock market’s crash and the ensuing economic depression, engendered in the 1930s an intellectual milieu of skepticism about the validity of the classical theory of economic behavior. That theory posited that the natural forces of market competition by themselves would force firms to supply the best products that consumers wanted at the lowest possible prices. Those that did not would decline and eventually shut down through a process of natural economic selection. The upshot of this theory was that, since market equilibrium was self-maintaining, government intervention in the workings of the market was unjustified.
A central assumption of this theory was that the same person or group of persons would both supply and manage capital for a business venture. Since they would reap the gains or suffer the losses of their own decisions, self-interest would lead these persons to operate the firm as efficiently as they could. The emergence of the modern industrial corporation undermined that assumption and with it, at least in the view of critics, the coherence of the classical theory itself. Among all of the critiques of that theory and of corporate capitalism generally that appeared between 1890 and 1930, no work was more influential than A. A. Berle and G. C. Means’s famous book, The Modern Corporation and Private Property.
Berle initiated the project under a grant to Columbia University from the Social Science Research Council and was the book’s principal author. Means, who was a member of Columbia’s economics faculty, contributed to the study primarily by collecting a substantial body of statistical data documenting the concentration of corporate ownership and the diffused distribution of stockholdings. Berle had joined the Columbia law faculty shortly after a split on that faculty had led several prominent Realists to leave. Despite the departure of important figures like William O. Douglas, Herman Oliphant, and Underhill Moore, however, Legal Realism still exerted considerable influence at Columbia, largely through the presence of Karl Llewellyn and Edwin Patterson. Institutional economics, championed by Robert L. Hale, also remained an important intellectual force at Columbia during the time of the Berle study. The book reflected the influence of both strands of thought.
Berle and Means developed two related claims: first, the central characteristic of the modern corporation is the separation of the control of property from its beneficial ownership; second, corporate managers and beneficial owners (i.e. shareholders) do not share the same incentives, undermining the key assumption of the classical model of the market. Berle and Means connected the two claims together in this central passage:
It has been assumed that, if the individual is protected in the right both to use his property as he sees fit and to receive the full fruits of its use, his desire for personal
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gain, for profits, can be relied on as an effective incentive to his efficient use of any industrial property he may possess.
In the quasi-public corporation, such an assumption no longer holds. [I]t is no longer the individual himself who uses his wealth. Those in control of that wealth, and therefore in a position to secure industrial efficiency and produce profits, are no longer, as owners, entitled to the bulk of such profits. Those who control the destinies of the typical modern corporation own so insignificant a fraction of the company’s stock that the returns from running the corporation profitably accrue to them in only a very minor degree. The stockholders, on the other hand, to whom the profits of the corporation go, cannot be motivated by those profits to a more efficient use of the property, since they have surrendered all disposition of it to those in control of the enterprise.
The implication of these claims for the economic function of property was, they thought, profound. At least in the industrial context, the role of property had fundamentally changed. Property no longer performed the economic function that classical economic theory traditionally ascribed to it. ‘Must we not’, they asked rhetorically, ‘recognize that we are no longer dealing with property in the old sense? Does the traditional logic of property still apply? Because an owner who also exercises control over his wealth is protected in the full receipt of the advantages derived from it, must it necessarily follow that an owner who has surrendered control of his wealth should likewise be protected to the full?’
For Berle and Means, the upshot of these changes in the nature of the business corporation and its concomitant effect on the function of property in the business sector was clear: ‘The explosion of the atom of property destroys the basis of the old assumption that the quest for profits will spur the owner of industrial property to its effective [i.e. efficient] use.’ Large corporations could not be counted on to serve either the interests of shareholders, as the corporation’s owners, or of the public generally. Since self-interest alone was inadequate, the only alternative mechanism for assuring that corporations were governed in the public interest was government regulation. Government had ‘to strip itself of the illusion that it might recreate the classical society of small competitors and proceed with the structural reforms needed to stabilize the economy’.
What made The Modern Corporation and Private Property so influential was not originality: virtually nothing in the book, certainly none of its major arguments, was completely new. Well-known books by Harvard economists Thomas Nixon Carver and William Z. Ripley had earlier argued that shareholders of large corporations had little, if any, meaningful power over corporate policy. Before them, Thorstein Veblen had developed a similar theory of the evolution of corporate structure. Still earlier, the great English economist Alfred Marshall had pointed out in 1890 that large corporations were ‘hampered by . . . conflicts of interest between shareholders and . . . the directors’.
Three factors explain the book’s phenomenal success. First, unlike Veblen, Carver and other critics of the corporation, Berle and Means (primarily Means) backed up their criticisms with a substantial body of statistical data. These data were intended to
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prove two points: that corporate wealth was concentrated in a few corporations and that ownership of corporate stock was broadly dispersed. The data effectively created the impression that a relatively small group of managers now dominated the nation’s economy.
The second factor was the book’s timing. The date of its first publication (1933) was ideal. After the stock market crash, the general public was quite receptive to a critical treatment of corporate power. As George Stigler and Claire Friedland have pointed out, ‘[t]he 1930s was a period of accelerating movement away from a competitive, unregulated market. Reasons for distrusting such a system . . . were in demand for the new rhetoric of public policy, and Berle and Means nicely met that need.’ Policyoriented lawyers and social scientists were no less ready than John Q. American to hear an analysis of corporate governance that emphasized the need for external control. The crash had seemed to validate Carver’s and Ripley’s earlier predictions of the disastrous consequences of leaving the modern corporation unregulated. The time could not have been more ripe for a study of the modern corporation that focused on its enormous power.
The third factor was the book’s functional and institutionalist approach to the study of corporations. Between 1920 and 1930 a debate raged among legal scholars over the ‘true’ nature of the corporation. The law reviews were filled with articles, most of which were aridly conceptualist, debating whether the corporation is a ‘real entity’ or merely an aggregation of contractual relationships. By 1930, this debate had run out of intellectual steam. The philosopher John Dewey, who had considerable contact with both the law school and the economics faculties at Columbia and whose work both influenced and was influenced by them, wrote in 1926 that legal writers and courts should disconnect specific issues concerning corporations from disputes over the appropriate conceptual theory of the corporation: how law and society treat the corporation, and what powers the corporation was given, depended on political and economic choices, not on formal analysis.
Heeding Dewey’s advice, Berle and Means simply ignored the whole ‘real entity’ debate. Instead, they focused on how the modern business corporation actually functioned in American society. The functional approach was perfectly suited to Berle and Means’s intended audience, for the book was not directed at professional economists, or at least not the academic economic establishment. Its real target was lawyers, especially those academic lawyers who were most interested in and involved with the making of public policy – Legal Realists and their economic allies. Berle and Means’s methodology effectively synthesized the institutional perspective of institutional economics and the functionalist outlook of the Legal Realists. Substantively, their analysis echoed the two dominant themes of Progressive and Realist legaleconomic writers that the market was a realm of power and that economic institutions were not wholly private in character. In particular, Berle and Means’s argument that large corporations were not really private institutions but were actually ‘quasipublic’ strongly reiterated and bolstered earlier arguments by Hohfeld, Hale, Ely, Commons, and others that there was no categorical distinction between the public and private in market transactions. While the economic profession was not especially
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interested in this line of criticism, the academic legal profession, especially its elite stratum, certainly was.
P U B L I C L Y C O N T R O L L I N G T H E P R I V A T E C O R P O R A T I O N
Berle and Means’s most significant contribution was to sketch a theory that would provide an alternative to the affectation doctrine of Munn v. Illinois as the theoretical foundation for government regulation of corporate activities. As we have already seen, that doctrine provided that there was no constitutional obstacle to legislative regulation of, for example, the rates that businesses charged their customers when the corporation was of the type that was ‘affected with a public interest’. In effect, the affectation doctrine denied that such corporations were solely private. While the US Supreme Court did not formally abandon that doctrine until the 1934 decision in Nebbia v. New York, it lost virtually all intellectual credibility among lawyers well before then. It was, as the Yale Legal Realist Walton Hamilton put it, the product of the view of a generation for whom the then-new fourteenth amendment was part of ‘the old constitution’. To a different generation, it sounded (if one was inclined to value liberty of contract above all) suspiciously hostile to property rights or (if one had taken the Realist turn) meaningless, since all businesses were in some sense affected with a public interest. By 1930, its demise as a justification for legal control of corporate activities in general to insure that corporations act for the common welfare was a foregone conclusion.
Berle and Means attempted to fill the gap by advancing a novel theory. They argued that the ‘traditional logic of property’ did not apply to the modern large corporation. Corporate power should not be exercised for the exclusive benefit of the shareholders but for the benefit of society as a whole. Shareholders are, they argued, passive property owners who have ‘released the community from the obligation to protect them to the full extent implied in the doctrine of strict property rights’. This leaves the community in a position to demand that the relationship between corporate property and the community be reconfigured in a way that recognizes that in the context of the modern industrial corporation the public/private distinction had lost much of its credibility:
Neither the claims of ownership nor those of control can stand against the paramount interests of the community . . . Rigid enforcement of property rights as a temporary protection against plundering by control would not stand in the way of modification of these rights in the interest of other groups. When a convincing system of community obligations is worked out and is generally accepted, in that moment the passive property right of today must yield before the larger interests of society . . . It is conceivable – indeed it seems almost essential if the corporate system is to survive – that the ‘control’ of the great corporations should develop into a purely neutral technocracy, balancing a variety of claims by various groups in the community and assigning to each a portion of the income stream on the basis of public policy rather than private cupidity.
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The precise content of the obligation that the corporation owes to the community remained obscure. Berle and Means never explained what the specific features of that obligation were or which constituencies are included in the notion of the ‘community’. Rather, they vaguely called for something resembling what late twentieth-century corporate lawyers call ‘corporate social responsibility’. But it is not entirely clear just how the Berle and Means analysis relates to the modern discourse of corporate social responsibility.
The phrase ‘corporate social responsibility’ today may mean either of two different ideas. The first is that the officers of large, publicly held corporations should focus exclusively on the shareholders’ dominant preference, which is presumed to be profitmaximization, rather than serving their own personal interests. The second meaning grows out of a quite different concern. It advocates what is sometimes called ‘corporate voluntarism’, that is, corporate actions that sacrifice profit-maximization to pursue other social objectives.
These two ideas have inconsistent implications for legal control over corporate managers. The first idea requires tighter legal control over corporate officers and directors. Corporate voluntarism, on the other hand, requires relaxing legal controls over managers, giving them greater discretion so that they can fulfill their responsibilities to the community.
These two meanings were the subject of a famous debate between Berle and the noted Harvard professor of corporate law, E. Merrick Dodd. Dodd supported the idea of corporate voluntarism, and he was unconcerned that corporate managers would exercise greater discretion in their own interests rather than the interests of social groups in addition to shareholders. He based his confidence on the theory that
[p]ower over the lives of others tends to create on the part of those most worthy to exercise it a sense of responsibility. The managers, who along with the subordinate employees are part of the group which is contributing to the success of the enterprise by day-to-day efforts, may easily come to feel as strong a community of interest with their fellow workers as with a group of investors whose only connection with the enterprise is that they or their predecessors in interest invested money in it.
Berle regarded this view as wildly naive. He simply did not think that corporate managers could be trusted to act in the interest of anyone other than themselves if they were given discretion to do so. Because of the separation of control from ownership, private property no longer performed, in the industrial setting, its disciplining role. Therefore, management powers had to be subjected to some form of legal control. One possible form is the requirement that managers act exclusively in the interest of shareholders. That approach, which Berle analogized to the controls that equity places on trustees, adopted the profit-maximization version of corporate responsibility.
Berle considered strict, trustee-like controls over corporate managers to be clearly preferable to open-ended managerial discretion, if those two were the only available options. His reluctance to abandon profit-maximization as the sole objective of corporate officers and directors was rooted in social welfare considerations.