CORPORATE GOVERNANCE:
CROWN CHARTERS TO DOTCOMS

By Irene Macauley

“Merchants have no country.” So asserted Thomas Jefferson in writing about his concerns over corporate accountability in 1814. He subsequently warned the country to not create “immortal persons” in the form of corporations. Decades later, the courts would ignore that warning.

Sound corporate governance—how a public company fulfills its responsibilities to its investors and other stakeholders—is not merely being responsible for making profits, it should also ensure accountability, fairness, and transparency in the conduct of business.

But to whom are corporations accountable? Today, government works with independent, private organizations to encourage self-regulation. It was not always so. In earlier times, there were no federal laws to regulate governance. States, on behalf of public citizens, did the regulating.

THE CROWN CHARTERS
America was actually settled by early corporations. In 17th century England, companies were chartered by the Crown to help colonize the New World. Investors pooled capital and launched massive trading ventures. These joint stock companies created colonies in America that served as sources of raw material and as markets for exports from England. The Massachusetts Bay Company and the East India Company were two examples of these trade monopolies.

Early citizens of the colonies, burdened by increasingly onerous taxes and import duties imposed by the Crown, had no say in how they were governed and taxed. The Boston Tea Party in 1774 epitomized the growing wrath of the citizenry and presaged the American Revolution. The War of Independence, which began the following year, was not merely a revolt against the Crown; it was a fight for independence from royal-chartered corporations.

America’s founding fathers purposefully “created a new nation in which government could not interfere in the individual wealth-creating activities of its citizens.” The result, according to Professor Paul Tiffany of the Wharton School, is “a long history of abuses.”

In 1787, the year the Constitution was framed, there were fewer than 40 corporations in the United States. Except for a general suspicion of corporate power, the public gave them little thought. It had full confidence that it, the citizen public, controlled proper regulation through their elected state legislators; citizen oversight, it believed, would keep corporations honest in serving the public interest.

Typically, corporations were chartered by the state to perform specific public functions, mostly infrastructure building—bridges, canals, turnpikes, railroads—or financial services such as banking. Each corporation was granted a charter by the state in which it did business. And they and their officers were held to stringent regulatory standards. Typical controls included: full liability, limited life span, service to the public, full disclosure of documents, and prohibition from making political contributions. When transgressions occurred, directors could be summarily removed by shareholders.

When Thomas Jefferson embargoed trade with Britain and France in the early 1800s, Americans formed new companies to supply products previously imported. These new companies amassed capital for building factories. Their mission, however, differed from that of earlier corporations in one important aspect: To create private wealth rather than merely serving a public service.

These new bodies needed new laws under which to operate. But they were slow in coming.

INALIENABLE RIGHTS
Until 1880, the American people were still in control of corporations. But the democratic traditions of corporate governance that had previously prevailed were beginning to falter. The shift in power began in the aftermath of the Civil War as corporations gained political clout and power.

With the end of the Civil War, America was ripe for economic expansion. Land, resources, and cheap labor were plentiful. Opportunities for mobilizing large capital and for building large businesses were unparalleled. The so-called “robber barons” grabbed those opportunities.

Congress passed legislation to help govern economic development and to thwart monopoly building: the National Banking Act, Tariff Act, Homestead Pacific Railroad Act, and more. With fortitude and creativity, corporations soon found ways to circumvent anti-monopoly regulation.

They formed cartels in which competitors in an industry came together to control prices, a move not then illegal. The next step was a form of interlocking directors and shareholdings, the trust. John D. Rockefeller’s Standard Oil of Ohio became the first trust in the nation in 1882. Instead of issuing stock, as a trust Standard Oil issued “trust certificates” and was overseen by a board of “trustees.” Thus anti-monopoly laws were not broken and expansion was assured. Other industries followed suit. By 1890, 300 trusts were parents to more than 5,000 companies. These trusts earned massive profits by using one formula: high prices, low wages, and anti-competitive strategies.

In a landmark case decided in 1886, the Supreme Court defined a corporation as a “natural person” sheltered by the 14th Amendment (ratified in 1868 to protect the rights of freed slaves). Under this definition, courts struck down myriad state regulations. In that year alone, the Supreme Court struck down 230 laws that regulated corporations.

SHERMAN TO THE RESCUE?
There continued to be much public opposition to trusts. Citizen concern led to passage of the first antitrust law, the Sherman Antitrust Act enacted in 1890. It was meant to curtail the power of big monopolies: “Every contract, combination in the form of trust or otherwise, or conspiracy in restraint of trade or commerce among the several States or with foreign nations, is hereby declared illegal.” There was no initial effect. New state law legalized holding companies and newer business forms evolved in the form of mergers.

In 1899 alone, Andrew Carnegie consolidated various steel properties to form Carnegie Steel. Copper producers merged to create the American Smelting and Refining Company (Asarco) trust; Guggenheim refused to join the copper trust and formed an alliance with mine owners in order to compete with Asarco. International Paper was created by the merger of 30 U.S. and Canadian companies. Union Bag, a 30-year-old patent pool, reorganized to create a trust to squeeze out competition, mainly International Paper. Rockefeller-controlled light and gas companies merged to form Consolidated Edison.

Another trend was emerging. Big companies were passing from the hands of owner-capitalists into the hands of a new group of “managers” who ran the corporations by virtue of their know-how. The entrepreneurial, production-oriented industrialists of the early 19th century had, by the end of the century, become the sales and strategy-oriented “captains of industry”—Carnegie, duPont, Mellon, Morgan, and Rockefeller among them. They directly controlled their investments and their corporations were accountable only to them.

As corporations grew in size, owners replaced themselves with professional managers. These managers were adherents of Frederick Taylor’s “scientific management” (automation) philosophy, the result of Taylor’s time and motion studies. They were hired based on their expertise, ability to produce performance reports, and aptitude at P&L accounting.

PRESIDENTS AS TRUSTBUSTERS
Concerns about monopolies heightened. Theodore Roosevelt’s “Square Deal,” balancing the rights of both companies and average citizens, strengthened the effectiveness of antitrust legislation. His goal was to regulate big business. In 1902, Congress formed the Bureau of Corporations to do the regulating and the Supreme Court ruled that the Sherman Act could be applied to holding companies.

The Department of Justice established its Antitrust Division in 1903. That same year, the Elkins Act was passed by Congress to strengthen the Interstate Commerce Commission, which had been created in 1887 to regulate railroads.

William Howard Taft succeeded Roosevelt as president in 1909—he, too, took on the role of trustbuster. Two years later, the Supreme Court ordered trusts and combinations to be dissolved for exercising monopoly power in violation of the Sherman Act.

The Standard Oil trust was broken into five separate corporations comprising 33 companies. American Tobacco and the railroad combine Northern Securities were declared illegal monopolies and were broken into separate companies. The next year, 1912, DuPont was ordered to divest itself of some of its explosives factories. Thirty offices of National Cash Register were indicted for criminal conspiracy in restraint of trade.

Woodrow Wilson ushered in the “New Freedom” era in 1914. An early act of his administration was passage of the Clayton Antitrust Act and creation of the Federal Trade Commission. He wanted to abolish price discrimination, linking of multiple products, corporate mergers, and interlocking directorates.

The following decade was a period of flagrant politico/business alliances and cutthroat competition.

MERGER MANIA
On January 17, 1925, President Calvin Coolidge told an audience of newspaper editors: “The business of America is business.” Although Congress passed the Corrupt Practices Act that year, for the rest of the Twenties, antitrust prosecution waned and merger mania continued.

Adolph Berle and Gardiner Means compiled their classic study of the American marketplace in 1932 . They discovered that one-half of all corporate wealth was in the hands of just 200 companies. If these companies continued to grow at their 1932 rate, they predicted that by 1950 these 200 companies would control three-quarters of the country’s incorporated wealth. They also found that 90 percent of large firms were controlled by managers rather than by shareholder owners.

Franklin Roosevelt took over the helm of a Depression-weary country in 1933. During his “New Deal,” trust-busting actions lessened; in fact, big companies were encouraged to combine to boost prices and heighten productivity. But there was new legislation, to forbid holding companies.
The Glass-Steagall Act became law in 1933; it barred banks from dealing in stocks and bonds. The National Industrial Recovery Act was passed to ensure “codes of fair competition.” The next year, the Securities and Exchange Commission was created to police the securities industry.

THE CONGLOMERATES
The 1950 Amendment to the Clayton Act, meant to curb mergers, prevented companies from buying up stock in other companies, but large corporations found other ways to achieve mergers. There were more that 200 in 1950, more would follow. Textron, the world’s first business conglomerate, moved out of textiles into diversified businesses thus setting a model for other conglomerates to follow, and follow they did.

Antitrust legislation forced corporations away from direct “concentration-affecting” mergers to diversified acquisitions. By the 1960s, conglomerates were gobbling up unrelated businesses at a rapid pace. There were 844 corporate mergers in 1960. In 1967, there were almost 3,000.

Throughout the 1970s, the price value of conglomerates began to lag. Chief executive officers were held to blame as diversification for the sake of diversification came to be seen as a faulty concept. There were outcries for tougher oversight.

CORPORATE RAIDERS
Large antitrust actions in the early 1980s, including IBM and AT&T, were followed by relaxation of rules and regulations. This was the decade of junk bonds. Corporate raiders, using junk bonds, took companies private, broke them up, and resold them to the public as separate entities. The outcome was often devastating to shareholders and employees alike. By the end of the decade, there was a backlash against leveraged buyouts. The junk bond market imploded amid public outcry for more active corporate governance in the face of high profile business scandals: Lincoln Savings & Loan, Drexel Burnham Lambert, Wedtech; Boesky, Milliken, Keating, Levine.

By 1992 Republican presidents had appointed two-thirds of U.S. federal judges. As the courts became more conservative, antitrust prosecutions dwindled. During the Clinton administration, one of tremendous economic growth and technology innovations, there was renewed antitrust activity and new forms of corporations … the dotcoms.

The new millennium began with a slew of business scandals—Adelphia, Enron, Global Crossing, ImClone, Tyco, and Worldcom. The new “robber barons” included Ebbers, Fastow, Kozlowski, Lay, and Wuksal.

As a result, the need to rebuild public trust, to prevent corrupt business practices, and to ensure effective corporate governance and oversight will spur “a lot of changes coming out of Congress and the regulatory agencies.” The speaker is turnaround strategist and interim chief executive of Enron Corp., Stephen Cooper.

And new regulation is coming. Proposed SEC rules would require the majority of a board’s directors to be independent. NYSE and Nasdaq plan to tighten the definition of an independent director. Amex is revamping its rules. And there will be more from government agencies.

Why? In the words of Cooper, “We continue to prove we can’t govern ourselves effectively.”