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What Is A Corporation

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WHAT IS A CORPORATION?

In understanding the meaning of a corporation and their operations, we would be looking at the following with regards to how corporations have evolved over the years and their impacts on Environmental and Social Governance responsibilities (ESGR).

The topic will be discussed under the following headers

  1. The Meaning of a Corporation
  2. Evolution of the Corporate Structure
  3. The Purpose of Corporations
  4. Is the Corporation a Person?
  5. Are Corporate Decisions moral?
  6. Are Corporations Accountable?
  7. The Three Key External Mechanisms for Directing Corporate Behavior
  8. What does it mean for Corporations to Operate within the Limits of the Law
  9. Environment & Social Governance – A new way to analyze Investment Risk and Values
  10. Future Directions

The Meaning of a Corporation

To aid us in understanding the structure, purpose and powers of a corporation, it is important that we answer the question “WHAT IS A CORPORATION?”

A good way to define a corporation would be to say that “a corporation is a structure established by law to allow different parties to contribute capital, expertise and labor for the maximum benefit of all of them”

This way, the investors get the chance to participate in the profits of the enterprise without taking responsibility for the operations.

On the other hand, the management gets a chance to run the company without taking responsibility of personally providing the funds.

It is important to note here that sometimes both the providers of funds and the management of the enterprise are the same people.

Also worthy of note is the fact that in legal terms the corporation and the providers of funds to set up the corporation are defined as separate entities as such the providers of funds has a limited share holding in the event that the corporation is wound up. This means that they cannot be called upon to make up any excesses from the winding up of the corporation from their personal earnings asides to the amount of share holding in the corporation.

Due to the fact that a corporation is an entity on its own in the eyes of the law, it must relate with a wide variety of constituents – its directors, managers, employees, shareholders, customers, suppliers, creditors as well as members of the community and the government. Each of these relationships has a variety of constituents, sometimes inherently contradictory.

Evolution of the Corporate Structure

 The evolution of the current forms of corporation we have today can be traced back to the Anglo-Saxon form municipal and educational corporation. They were granted perpetual existence and control over their functions as a way of inspiring independence from the powers of the Kings during those times.

By the seventeenth century, corporation began to arise as creations of the state for specific purposes like the settlement of India and the American colonies. The effectiveness of this corporation was mainly credited for Europe’s half millennium domination of the world. These corporations limited investors liability to the amount they actually invested which became a critical factor in attracting funds towards the execution of this domination.

In 1932, a US Supreme Court Justice Louis Brandeis argued for making sure that states conferred the privilege of corporate structures only in cases where it was consistent with public policy and welfare.

He noted that the decision to remove strict requirements imposed on corporations was not based on the legislators’ “conviction that maintenance of these restrictions was undesirable in itself, but to the conviction that it was futile to insist on them; because local restriction would be circumvented by foreign incorporation”

What this decision clearly spelt out was the fact that legislators realized that the characteristics of corporate form were so important to people in person and they could not beat them, rather it was better to either join them or at least permit them and then tax them.

The corporation form of doing business became so appealing and essential as a result of four major characteristics –

  1. Limited liability for investors

2. Free transferability of investors interests

3. Legal personality (entity-attributable powers, life span and purpose)

3. Centralized management

There are three major developments which started in the nineteenth century that make these attributes particularly important; vis-à-vis

  1. The need for firms far larger than they had previously been. This was due to technology advances that led to new economies of scale

2. The second was the need for capital from a range of sources broader than in the past, when the only game in town was a small group of wealthy individuals who had previously invested in private negotiations

3. The third thing was that private ownership of investment property had to be accepted as a social norm.

Finally as corporations grew in size and age, their ownership became increasingly fractionated and markets started to develop to ensure almost total liquidity. This invariably increased their strength and scope, but it has however reduced their accountability.

In the early days of corporations, when the directors sat round for a meeting of the board they represented the shareholders because they were share holders.

As corporations grew in size and complexity, the law tried to develop a standard of performance for directors that would encourage the same sense of duty and care that they would normally use when representing themselves.

The Purpose of Corporations

Corporations are such an insidious part of our everyday life, that it can be difficult to step back far enough to see them clearly.

They do not just determine what goods and services are available in the market place, but more than any other institution, they determine the quality of the air we breathe and the water we drink, to some large extent they also determine where and how we live. This enduring appeal stems from the wide range of purposes that corporations serve. These include;

  1. Satisfying the human need for ambition, creativity and meaning – as we all know, businesses provide an outlet for the satisfaction of essential human drives – quest for fulfillment, success and security, for creative expression and for the competitive spirit

2. Social Structure – man has created social structures since their days in the caves in order to foster cooperation and specialization. However with advent of corporations and their ability to create wealth through goods and services desired by the population willing to pay, they became the foremost lasting and resilient social structures.

3. Efficiency and efficacy – they enable people to get things done. The words “businesslike,” professional,” and enterprise are synonymous with beneficial efficiency and efficacy. Their ability to translate an idea into a product, human ingenuity into bricks etc., and savings into growth stocks has literally enhanced the lives of many people in society.

4. Ubiquity and flexibility – an individual may decide to refrain from certain risky actions for several reasons. He may be afraid of shame, liability, prison etc., but corporations, though may be fined cannot be jailed. This makes the corporate form a way of transferring enterprise liability to society as a whole.

5. Identity – corporations have a life, and even citizenship, of their own, with attendant rights and powers. Corporations are persons within the meaning of the law and are entitled to protection against taking their property without due process.

Is the Corporation a Person?

The great project of corporate lawyers especially in Europe and America, over many generations, has been to establish full citizenship for their business organizations. They have argued that their companies are entitled to the same political rights, except voting, the laws of the land guarantees to the people.

One of the first cases to herald this was in the 1886 United States Supreme court declaring without hearing arguments, that corporations would henceforth be considered “persons” for the purpose of the 14th amendment, which was the due process law passed to protect the newly emancipated black slaves after their civil war.

Following the review by Justice Hugo Black 50 years after the decision, it was observed that the pronouncement was used more to the benefit of corporations than the black race.

Are Corporate Decisions Moral?

One of the most perennial questions in business circles is “can business do well by doing good”? Almost every business today proudly points to some evidence of good citizenship, from the participation by employees in extracurricular activities to efforts to minimize environmental degradation.

A lot of companies have made social responsibility (at least in their own views of social responsibility) part of their marketing strategy. In the business world of today, it is important that in as much as businesses have to make decisions that would increase the wealth of the business, there must be a fair level of morality in order to ensure sustainable development of the business and the community in which the carryout their business.

Are Corporations Accountable?

In terms of policy, we try to make corporate operations to be consistent with public good. However in economic terms, we do not want them to externalize their costs on to the community. To make this happen, we must establish a system of accountability.

In business theory, corporations are held accountable by the invisible hands of the market and the government. Sometimes, these realities are not often the case. Today in theory, the legitimacy and authority of corporate power is also based on accountability. The need therefore, for corporations to adopt effective and efficient corporate governance to act as checks and balances.

As such to maintain legitimacy and credibility, corporate management needs to be effectively accountable to some independent, competent and motivated representative. This is what is expected of the board of directors of corporations.

With the continued increase in the number of corporate scandals since the beginning of the 21st century, we continually grapple to find answers to the following questions;

  • How do we make sure that corporate power is exercised in the best interest of society?
  • How do we measure corporate performance?
  • How should society measure corporate performance?

These questions are so closely related, however their answers are miles apart. As such it is important that we either manage corporations or monitor corporations we would continue to research in order to find the relevant answers to these questions.

The Three Key External Mechanisms for Directing Corporate Behavior

There are three key external mechanisms for directing corporate behavior. We however will be looking at two of the three vis-a-vis;

  1. The Law – Civil and Criminal law – which includes the executive, legislative and judicial branches of the central, state and local government regulations, legislation and enforcement
  2. Performance measurement – this deals most significantly with the accounting rules which are intended to make it possible for government and other insiders and outsiders understand a company’s priorities, progress, effectiveness and impact

However, to evaluate the impact of the major players in corporate governance, we have to decide what we are trying to achieve in the largest, most long-term sense.

  • The Law: Government – legislation, regulation, enforcement

Without government there can be no corporations. It is government that grants a corporation a license to operate, as long as it can stay in business, and limits the liability of its investors and employees.

Laws also restrict corporate operations. The security and exchange commission have several rules and regulations about how companies must operate, and the level of disclosure to the public and government.

Over the years especially in Europe and America, and the new trend in Africa with the PPP (Public-Private Partnership) initiatives, the executive and legislative branches of government are now being dominated by corporations. They have also made substantial inroads into the decisions of the judicial branch. This is clearly evident in the underlying rationale for many of the decisions of the Delaware Chancery and Supreme Courts in the USA. As more countries and states within countries are making it easier to do business thereby providing huge revenue generation capabilities from the various fees and charges for incorporation and tax incentives.

  • Performance measurement

To establish a context for the evaluation of a company’s performance, it is important to define the purpose of a corporation as a long-term value creation. This will create the frame work for defining the rights and responsibilities of the shareholders and directors and therefore determine how they should be organized.

One of the basic problems is that management has no way to judge by what criteria outside shareholders value and appraise performance. Performance measurement must be a flexible and changing concept. What is suitable for one time or company may be wrong for another. Therefore, the single most important structural requirement is that the standard is set by someone other than the management.

Some of the criteria to be used in setting these standards for performance measurement include but is not limited to the following

  • Long-term versus short-term goals
  • Corporate decision making – whose interest does this person or adaptive creation serve?
  • What does each of the value proposition contribute to the ability of good corporate governance of the corporation
  • Who is in the best position to decide when to apply which measures

What does it mean for Corporations to Operate within the Limits of the Law?

Did you ever expect a corporation to have a conscience, when it does not have a soul to be damned and no body to be kicked? These are the words Edward, first Baron Thurlow, Lord Chancellor of England.

The American Law Institute says that the objective of a corporation is “the conduct of business activities with a view to enhancing corporate profits and shareholders gain”, but that even if doing so would contravene those goals, the corporation has the same obligation as a natural person to act within the law.

The corporation must also take into account ethical considerations that are reasonably regarded as appropriate to the responsible conduct of business and devote a reasonable amount of resources to public welfare, humanitarian, educational and philanthropic purposes.

Environment & Social Governance – A new way to analyze Investment Risk and Values

The nearly 400 signatories to the Principle for Responsible Investments (PRI) include some of the largest investors in the world, as part of the United Nations Environment Program Finance Initiative and the UN Global Compact. The principles they have adopted to promote better disclosure and management of environmental, social responsibility and governance policies in portfolio companies provide that;

As institutional investors, we have a duty to act in the best long-term interest of our beneficiaries. In this fiduciary role, we believe that environmental, social and corporate governance (ESG) issues can affect the performance of investment portfolios (to varying degrees across companies, sectors, regions, asset classes and through time). We also recognize that applying these Principles may better align investors with broader objectives of society. Therefore, where consistent with our fiduciary responsibilities, we commit to the following:

  1. Incorporating ESG issues into investment analysis and decision making process
  2. Being active owners to promote ESG policies internally and at portfolio companies
  3. Pushing companies for better disclosure
  4. Seeking additional support from the investor community
  5. Disclosing our efforts and the result of the expectations

In attempting to design a social responsibility accounting structure, they have proposed the following characteristics of a social report:

  1. Each report should include a statement of objectives which allow the assessment of the grounds for data selection and the reason for the form of presentation chosen
  2. The objective of the social report should be to discharge accountability in the spirit of improved democracy

3. The information should be directly related to the objectives held for the particular groups to whom it is addressed

4. The information should be unmanipulated and readable by a non-expert.

5. It must be audited

Future Directions

As corporations expand their operations and markets into virtually all parts of the world, we must begin to develop a more consistent and coherent approach. To do that, we must, whenever possible integrate the most important legislated standards with the realities of the economic laws, so that all incentives promote priorities we agree on, without perverse incentives or unanticipated consequences. Some of these future directions include that:

  1. The law should be process oriented, not substantive.

2. It should be focused on results not structures.

3. The focus should be on relationships between the corporation and its constituents to reduce conflicts of interest (agency cost) and make sure that the right people are making the decisions.

4. Corporations must have their primary and overriding goal; the generation of long-term value.

5. A commitment to satisfaction of employees, suppliers, customers and the community must be the essential for achieving this goal

In conclusion, this text has tried to shed some light on the following;

  • How we make sure that corporations add the maximum value to society.
  • How we measure corporate performance.
  • What we want and how we determine how far we have achieved it.

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