The Corporation as Time Machine

Lynn Stout is the Distinguished Professor of Corporate and Business Law at Cornell Law School.

My article, The Corporation as Time Machine: Intergenerational Equity, Intergenerational Efficiency, and the Corporate Form, advances an explanation for the rise of the corporate form and an alternative perspective on its economic function. The article argues that the board-controlled corporate entity is a legal innovation that can transfer wealth forward and sometimes backward through time, for the benefit of both present and future generations. The article was written for a symposium organized around the author’s prior work with Margaret Blair.

The corporate form allows natural persons to aggregate and transfer resources to a legal person with the capacity to hold assets in its own name in perpetuity. When the corporate entity is controlled by a board subject to the fiduciary duty of loyalty, corporate assets can be “locked in” and insulated from the demands of natural persons (e.g., the current generation of shareholders) who want to extract and consume them. Asset lock-in thus permits board-controlled corporate entities with perpetual life to invest in and pursue projects that may generate wealth only in later time periods, possibly even after the current cohort of human beings has ceased to exist.

As a historical matter, preserving and investing resources in very long-term projects was exactly what many of the earliest corporate entities (monasteries, universities, and townships) were created for. The Veneranda Fabbrica del Duomo di Milano, created in 1387, has been building and maintaining the Cathedral of Milan for more than 30 human generations. As the Veneranda illustrates, the corporate form can serve and historically has served as a mechanism through which present generations can altruistically preserve and invest resources for the benefit of multiple future generations. Put differently, board-controlled corporations shift wealth forward into the future. This forward wealth-shifting can serve not only intergenerational equity, but also intergenerational efficiency when present-day investments produce larger benefits for multiple future generations.

Nevertheless, because human altruism is limited, even when the corporate form is available we can expect present generations to preserve and invest resources for future generations at a suboptimal level. This problem of suboptimal future investment can be ameliorated through the use of a special type of corporate entity: the publicly traded business corporation. This is because under certain conditions, publicly-traded business corporations can transfer wealth backward as well as forward in time, allowing future generations to “compensate” present generations for investing in the future.

Publicly-traded business corporations can transfer wealth backwards in time when their shares are traded in a “fundamental value efficient” market where prices capture expected future returns to share ownership. In such a market, present-day investment that is expected to generate future returns produces an immediate gain in share price. As result, present-day shareholders become wealthier, even if those shareholders do not expect to hold the corporation’s shares when the future profits from today’s corporate investments finally appear. For example, Google’s current investments in developing autonomous vehicles may raise Google’s share price today, although it may be decades before self-driving cars become commercially profitable.

Public corporations accordingly can play a critical role in spurring long-term investment and secular economic growth—if stock markets are fundamental value efficient. This raises the question: how well can publicly-listed business companies shift wealth through time in an imperfectly efficient market?

The article argues that, even when markets are imperfectly efficient, public companies can still promote intergenerational equity and efficiency by shifting wealth through time—as long as they are board-controlled and not shareholder-controlled. Without board control, public corporations become delicate creatures. All it takes is a stock market that temporarily undervalues the company’s shares, and some short-term shareholders may pressure the board to abandon its long-term plans and instead pursue strategies calculated to produce immediate share price gains. Short-term investors, like activist hedge funds, may even target the company and acquire its shares in order to push for such strategies. If the company’s board is not insulated from such pressures, it is likely to abandon its long-term plans. Indeed, anticipating short-term shareholders’ demands, boards that are too vulnerable to shareholder influence will not attempt long-term investments in the first place.

This perspective warns against the unthinking assumption that “good” corporate governance involves making corporate boards more responsive to present-day shareholders’ demands (e.g., by de-staggering boards, tying executive or director pay to shareholder returns, and so forth). So long as markets are imperfectly efficient and shareholders are free to hold shares for only short periods of time, “shareholder democracy” threatens the public business corporation’s economic value as a vehicle for preserving and investing resources for the future. The article concludes by reviewing some of the evidence indicating we may be already seeing the signs of declining corporate investment in the future. This pattern threatens both intergenerational equity and intergenerational efficiency.

The full article is available for download here.

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