Many years ago a British judge commented that “men are not hanged for stealing horses but rather that horses not be stolen.”
Qwest Communications may be glad that the Minnesota Public Utilities Commission apparently does not share that harsh judicial philosophy. But Minnesota citizens and taxpayers may come to rue the PUC’s apparent lenience.
In all fairness, the difficult choices and the political pressures facing the PUC render the commissioners’ task daunting. Punishing crimes committed by corporations is inherently more difficult than dealing with similar crimes committed by individuals. It is difficult to do fairly or well. But when it’s not done, it creates incentives for further illegalities by the same firm or by others.
The modern joint-stock corporation represents a key institutional innovation for mobilizing societies’ resources to produce goods and services.
With the dawn of the industrial age, it became clear that in certain industries, an efficiently sized company was too large or too risky to be funded by one individual or even a set of partners. Separating ownership from day-to-day control gave entrepreneurs access to capital if they sold part of a business to passive investors. Investors could participate in profit-making ventures even if they were not in a position to actively manage them on their own. Moreover, owning shares in a number of different ventures was less risky than putting all of one’s assets into one business.
But a corporation posed legal problems. Existing legal systems recognized rights and responsibilities of people. A corporation represented something new, a “juridical person” as opposed to a “physical person.”
When a physical person committed a crime, it was clear whom the law should punish. But what should happen if a corporation committed a similar crime? Who should be punished: the stockholders? the board of directors? their hired managers? Who ultimately was responsible for a misdeed committed by an artificial legal entity; who should be punished, and how?
The answers are never simple. Willingly and knowingly breaking certain laws exposes corporate managers to fines or imprisonment. Eventually, some former Enron executives are going to do time. But not all illegal acts by corporations expose their managers to such personal punishment.
Current Qwest management is eager to blame departed CEO Joseph Nacchio and his lieutenants for illegalities the firm committed. They, and their advocates, are quick to point out that “these individuals are no longer with the firm.” This is true, but not complete.
If a corporation can slough off the legal consequences of actions taken by its agents by simply dismissing them, it creates the set of asymmetric incentives known as “heads I win, tails you lose.” If managers increase profits for the firm by breaking the law and get away with it, everyone — including managers, directors and shareholders — is happy and takes the money to the bank. If their misdeeds are found out, the managers involved can quickly be given healthy severance packages and dropped over the side. The directors and owners then proclaim, “Don’t punish us — the individuals who did this are no longer with the firm.”
This is far too convenient. As the English judge harshly pointed out, one purpose of punishing crime is to deter other possible lawbreakers. If letting hired managers break laws never hurts directors or stockholders, the latter have no incentive to ensure that management obeys the law.
We cannot send people who own Qwest stock to jail, but we can fine the company harshly enough so that shareholders see a significant drop in the worth of their holdings. They can then take out any resulting ire on the directors who let Nacchio and others repeatedly break the law.
We are in the middle of a severe crisis of confidence in corporate governance in this country. It will end only when directors and stockowners again recognize that they are responsible for the businesses they own. The buck has to stop somewhere, and it is best if it returns to the true owners and their elected representatives — the corporate directors.
Limited liability is a prominent feature of the modern corporation. It means that the firm’s owners are liable for its misdeeds or errors only up to the value of their stock. Once that is gone, shareholders cannot be forced to cough up additional money from their other wealth.
But there is no reason why shareholders should not be exposed to losing some or all of their investment if the firm breaks the law. Like hanging horse thieves in 17th century England, this sounds harsh. Investors see themselves as victims rather than as principals in corporate misdeeds.
The paradox is that if investors never suffer when corporations commit crimes, more crimes inevitably will be committed. A sound overhaul of corporate governance must include a return to the principle that owning shares of stock entails responsibilities as well as the right to a stream of profits.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.