Which of the following was not a feature of the modern corporation in the 1920s?

3.2.1 The modern corporation

Might the salient features of the modern corporation be explained in property rights terms? Harold Demsetz took this position. Upon observing that there are ‘significant economies of scale in the operation of large corporations … [and] that large requirements for equity capital can be satisfied more cheaply by acquiring the capital from many purchasers of equity shares’ (1967, p. 358), Demsetz described the modern corporation in the following property rights terms: (a) efficiency is realized by delegating effective ownership to the management; (b) shareholders are essentially lenders of equity capital; and (c) limited liability relieves shareholders of the need to carefully examine corporate liabilities and the assets of other shareholders (as they would need to under partnership law).

This property rights interpretation of the modern corporation over-reaches in the first two respects. First, to suggest that diffuse ownership is responsible for delegation, whereupon the ‘management group becomes the de facto owners’ and that ownership is ‘legally concentrated in management's hands’ (Demsetz 1967, p. 358) is incorrect. For one thing, delegation is observed in large corporations whether there are many or few owners of equity shares. For that matter, delegation is observed in every large organization—public, private, nonprofit. Well-known limits on the span of control (from organization theory) rather than the economics of property rights are responsible for that result. Additionally, of the three rights of ownership—the right to use, transform, and appropriate the income from an asset—the management is never delegated this last. Equity is the residual claimant.

Second, to describe shareholders as ‘lenders’ of equity capital is misleading. Debt and equity are not merely instruments of finance; they are also instruments of governance. If shareholders are merely lenders, why not just sell collateralized bonds? Or why not loans from the banks? It is not for naught that equity investors, who invest for the life of the firm and are residual claimants, are awarded control of the board of directors (Fama and Michael 1983). The efficiency logic of debt and equity is usefully viewed as a governance issue (Williamson 1988).

2.1 Limited Liability

Notwithstanding attempts to trace back the modern corporation to ancient forms of organization of business enterprises, ‘limited liability,’ as the term is understood today, was an invention of the seventeenth century, granted to legal entities established for the purpose of raising funds to finance colonial expansions. The increasing need for new capital, which could neither be found in the treasuries of western monarchies nor raised through taxes, made resort to private saving an imperative resource. In order to collect such a considerable amount of money it became necessary to involve also small and medium bourgeoisie classes. Because these groups were risk-averse with their money, it was necessary to ensure legally that if they invested, only the amount of the investment would have been at risk. Limited liability was considered a royal privilege, an exemption from the general principle of unlimited liability, and as a consequence, it was subject to the discretion of the sovereign. It was only later that the ‘power’ to grant limited liability to corporations became a nondiscretionary power and was entrusted, in continental Europe, to the judiciary.

Borne out of historic necessity, limited liability has remained critical to the development of the modern corporation, and consequently to the development of western capitalism. The predominant economic explanation for the modern importance of the corporate structure is that it reduces the costs generated by the separation and specialization of ownership and management functions (Easterbrook and Fischel 1985, Woodward 1985). A more detailed account of this economic effect involves several distinct but complementary considerations.

The first major consideration is that limited liability reduces the investor's need to incur monitoring costs. True to its name, ‘limited liability’ defines and restricts to the original investment the total amount of money an investor can lose. With the fear of unlimited liability gone, the investor no longer has a great incentive to interfere with the management of the corporation or to monitor the financial wellbeing of fellow shareholders.

Another important consequence of limited liability is that it makes freely transferable shares possible. In a setting with unlimited liability, shares would not be readily transferable because it would be highly relevant who is selling the shares and who composes the shareholders' group (they are not, in other words, ‘commodities’). Meanwhile, when shares are readily transferable, the investor's incentives to monitor management are further reduced because his shares can be sold if he is dissatisfied with the corporation's performance, which can be easy if there is an active market for the shares. Another consequence of the reduction in the need to monitor and the availability of ownership through shares is that they permit the investor to diversify his investments into several companies, which further attenuates the consequences of poor management or adverse external events in one particular company.

The free transferability of shares, in turn, makes it possible to create a market for corporate control, which can be a powerful mean of external governance of the corporation. In fact, if shareholders are dissatisfied with the management of the corporation, they can sell their shares, thus causing a decline in the price of the shares. The corporation can thus be exposed to hostile takeovers by newcomers that believe to be able to make a profit buying the shares at a low price, manage it efficiently and thus enjoy a capital gain in the value of the shares. Thus, the presence of a market for corporate control represents an incentive for managers and controlling shareholders to act efficiently and not oppress minorities because, as long as shares have a voting right attached, poorly managed companies are exposed to the risk that shareholders will sell their shares and cause a change in control.

Corporate law not only creates limited liability to promote these aims, it also regulates some potentially harmful side-effects of limited liability. One consequence of limited liability and ownership through shares is that ownership can become more and more separate from management: the typical shareholder is not knowledgeable about the firm and, because there are reduced incentives to monitor management, does not expect to participate in its management. This separation between management and control—as will be discussed below—brings with it some potential for problems.

While the basic economic feature of firms and the need to raise capital justify the legal concept of limited liability as a general matter, there are also scenarios experienced by all systems that counsel in favor of exceptions to limited liability. For example, if the corporate structure is used to mislead creditors or perpetrate fraud, or provides inappropriate incentives to corporate actors, the protection of limited liability is no longer justified and it is instead better policy to permit the creditors of the corporation to reach shareholders' personal assets. In light of these potential consequences, all European and North American legal systems provide a mechanism ‘to pierce the corporate veil’ or to eschew a corporation's limited liability.

In civil law systems, the circumstances in which this mechanism is available are usually strictly defined by law. For instance, under Italian law, article 2362 of the Civil Code permits the corporate veil to be pierced in the case of corporate insolvency if there is a single shareholder. In common law systems, by contrast, there is greater flexibility in determining when the corporate scheme can be disregarded. A general overview of US and British cases on this issue suggests that the most important situation in which courts pierce the veil is when separate incorporation misled creditors. There are also a range of other exceptions, such as when the debtor corporation acted as a mere alter ego of the shareholders, when the corporation is not adequately capitalized or when shareholders have deceived creditors on the financial solidity of the corporation. In addition, US courts have demonstrated a willingness to disregard corporate limited liability in tort cases reasoning that without the possibility of such liability, corporations have less incentive to avoid disastrous harm to victims who they will never be required to compensate beyond the limited value of the corporation. In that situation, instead of simply attracting capital, limited liability creates the potential for a ‘moral hazard’ (Hansmann and Kraakman 1991).

Conclusions

We opened our paper with a simple but fundamental question: Why is there a continuing development of information technologies whose use impinges on personal privacy in modern societies? Few analysts have tried to answer this question directly, although some answers are implicit. Laudon and Laudon (1994:702–703), for example, focus on rapid improvements in the absolute capabilities and the cost/performance ratio of information technologies. They also identify “advances in data mining techniques” used for precision marketing by firms like Wal-Mart and Hallmark.

Our answer concentrates not only on these environmental factors, but as well on the micropractices of those who manage such systems and their incentives, as well as the institutional structures in which they work (i.e., information capitalism). In short, we argued that the dynamics of expanding surveillance systems is systemic rather than the result of isolated practices. However, we know relatively little about the ways that informational entrepreneurs conceive and build internal alliances to develop information systems that collect and organize personally sensitive data.

Within modern corporations and organizations, there exists a set of social practices that encourage the use of data about individuals, data-intensive analysis, and computerization as key strategic resources. We called these practices “information entrepreneurialism.” Information entrepreneurialism thrives within an information capitalist social and political system. It has been stimulated by many social transformations in the past one hundred years in industrialized societies, especially North America: the increasing mobility of populations, the growth of nationwide organizations, and the increasing importance of indirect social relationships. The key link between information entrepreneurialism and the new technologies that support databases of personally sensitive data lies in the possibilities for enhanced information processing that it provides to analysts whose managerial strategies profit from significant advances in analyzing records of an organization's (potential) clients and operations.

We find it especially important to examine how managers and professionals develop surveillance technologies (Smith, 1993; Laudon, 1986) as well as changing technologies. The information entrepreneurial model argues that the growing importance of indirect social relationships in North American society leads many organizations to seek personal data about potential and actual clients. At the same time, managers and other organizational employees trained in analytical techniques and actively pursuing data-intensive strategies foster the use of personal data. Attempts to introduce products such as Lotus Marketplace: Household are difficult to understand without examining this organizational context.

The positive side of these informational strategies lies in improved organizational efficiencies, novel products, and interesting analytical jobs. However, as a collection, these strategies reduce the privacy of many citizens and can result in excruciating foul-ups when record keeping errors are propagated from one computer system to another, with little accountability to the person. David Lyon (1994) argues that a sound analysis of changes in technology and social control should be based on a vision of “the good society,” rather than simply on avoiding social orders that are horrifying or perverse.

Social changes toward a society that prizes fair information practices could be influenced by the policies and routine actions of commercial firms and public agencies. They are not inevitable social trends, as shown by the differences between United States and European regulatory systems for managing personal data (Flaherty, 1989; Trubow, 1992). For instance, the North American public might insist on stronger fair information practices to reduce the risks of expanding records systems. Or Laudon's (Part VI, Chapter K) proposals for pricing personal data might be developed for some areas, such as marketing. The society could change some key rules, rights, and responsibilities that characterize the current practice of unfettered information entrepreneurialism. It is unfortunate, but broad systematic changes in United States information policies seem politically infeasible today, for reasons that we have sketched above.

Currently, relatively few restraints have been imposed on the exchange of personal information between organizations, both public and private, in North America. We are not sanguine about any substantial shifts toward more privacy protections during the next two decades. Without changes that are exogenous to the direct use of specific computer applications, the trends we have discussed are likely to continue. These trends can be the subject to systematic empirical inquiry, and merit such an investigation.

3 The Theoretical Legacy of the ‘Old’ Institutional Economics

Although it never provided a systematic theoretical legacy, the achievements and influence of the ‘old’ institutional economics have been considerable (Rutherford 1994, Yonay 1998).

For example, Veblen (1899, 1919) was the first social scientist to attempt to develop a theory of economic and institutional evolution along essentially Darwinian lines (Hodgson 1993). Veblen's work shares common features with the much later attempts by economists to use evolutionary metaphors from biology by Armen Alchian, Kenneth Boulding, Friedrich Hayek, and Richard Nelson and Sidney Winter. However, Veblen never regarded evolutionary processes as necessarily optimal or progressive. Although he did not use the term, his writings are replete with examples of path dependent evolution, almost a century before that concept became fashionable (Hodgson 1993).

Veblen's writings are brimming with ideas, many of which have subsequently been taken up by others. In the 1970s the Cambridge economist Joan Robinson recognized the importance of his theoretical contribution to the critique of standard capital theory. Veblen (1919, pp. 185–200) criticized the conflation of ‘capital goods’ with ‘capital.’ He rejected the ‘factors of production’ approach in its entirety, seeing production as much to do with ‘the accumulated, habitual knowledge of the ways and means involved … the outcome of long experience and experimentation’ (Veblen 1919, pp. 185–6). Veblen's emphasis on the role of knowledge and learning in economic growth is perhaps, simultaneously, his most important and most neglected theoretical contribution.

In his Theory of Business Enterprise (1904), Veblen discussed not only the conflict between a pecuniary and an industrial culture but also its manifestation in the separation of ownership and control, made famous later by Adolph Berle and Gardiner Means in their highly influential book on The Modern Corporation and Private Property (1932). Furthermore, in the same volume, Veblen (1904, pp. 46–8) hinted at the idea of transaction costs, long before Coase and Williamson.

A number of commentators have perceived similarities between the works of Veblen and John Maynard Keynes, and their joint parallels in President Roosevelt's New Deal policies. Writing after the Second World War, James Duesenberry in his Income, Saving and the Theory of Consumer Behavior (1949) accepted Veblen's influence in building a theory of the consumption function upon habitual behavior and Harvey Leibenstein also acknowledged the founder of institutionalism with his ‘Veblen effects’ in the theory of consumer behavior.

John Commons (1924, 1934) has been acknowledged as a major influence on the behavioral economics of Herbert Simon and the ‘new’ institutionalism of Oliver Williamson (1975, 1985). Overall, Commons made a major theoretical contribution, including the development of the concept of asymmetric information in contracts (Commons 1924). Indeed, Commons pioneered the whole modern research program in economics and law. Relevant modern ideas, such as the notion that the money supply is endogenous rather than exogenous, have also been credited to Commons. Commons and his students were also highly influential in the development of the subdiscipline of labor economics.

Nobel Laureate Herbert Simon's idea of bounded rationality was also prefigured in the writings of the ‘old’ institutionalist John Maurice Clark (Rutherford 1994). Clark influenced other leading economic theorists, notably Frank Knight. In fact, Clark supervised the production of Knight's classic work Risk, Uncertainty and Profit (1921).

Clark also shared responsibility for another important theoretical development. In a paper published in the Journal of Political Economy in 1917, he was one of the first to elaborate the idea of the interaction of the multiplier and the accelerator, seeing it as a driving mechanism in the generation of economic fluctuations. Paul Samuelsonand others later replicated this idea.

The Nobel Laureate Milton Friedman was a student of Mitchell. Friedman acknowledged the influence of both Veblen and Mitchell on business cycle theory, and even translated some of Mitchell's theoretical work into a mathematical model.

There are several important links between institutionalism and the development of Keynesianism. One was the innovation of national income accounting, in which the work of Mitchell played a vital part. Inheriting the German historical school view of the economy as an organic whole, institutionalism thereby developed and sanctioned the conceptualization and measurement of economic aggregates. The theoretical and empirical work involved here was of major importance in the development of twentieth-century economics.

Mitchell was thus one of the fathers of modern macroeconomics. His work is notable for its implicit antireductionist thrust and its consequent contribution to the development of Keynesianism. In the 1920s and 1930s, Mitchell and his colleagues in the National Bureau for Economic Research played a vital role in the development of national income accounting, suggesting that aggregate, macroeconomic phenomena have an ontological and empirical legitimacy. Through the development of national income accounting, the work of Mitchell and his colleagues influenced and inspired the macroeconomics of Keynes.

The ‘old’ institutionalists also developed a number of theories of pricing behavior in imperfectly competitive markets (Tool 1991). Traces of the surviving influence of ‘old’ institutionalist ideas are found in many other areas of theoretical and applied economics.

Sign up Here for Privacy Violation

We’re all familiar with retail loyalty cards. You sign up once, then every time you make a purchase from that brand, you swipe your card and earn points, receive a discount, or get some other sort of benefit. In many instances customers receive a financial reward for making purchases they were intending to make anyway. Why not sign up to a scheme at your local store if it means you get money back for your weekly shop, when the alternative is simply doing the weekly shop at the same place anyway, but without the incentive? It’s a compelling argument, and is one posed by many of the largest retail chains around the world. In the US some of the biggest chains to offer such programs include Smith’s, Kroger and Safeway, and in the UK two of the oldest and largest schemes are run by Sainsbury’s and Tesco. Whilst the supermarkets pioneered the concept at scale, it has now spread to many other retail verticals, including pharmaceuticals, books, hardware, fashion, hotel chains and airline carriers, to name a few.

At first glance, it’s not just harmless, but actively beneficial, and the public has rushed in its droves to sign up.

These schemes are complex beasts, requiring sophisticated technology and significant investment to implement and run. UK-based pharmaceutical chain Boots has spent upwards of £30 million ($46 million) on its loyalty card program since its inception nearly 20 years ago. Since modern corporations are not prone to wasting cash, at least not firms who intend to survive, these schemes must generate significant value for the organizations who run them. In the case of Boots, its program has presumably generated considerably more than £30 million worth of value, otherwise it would be considered a failure. So what’s in it for the supermarkets, and should it trouble the ordinary consumer?

The answers, as we’re about to see, are ‘a lot’, and ‘yes’.

For every penny / cent / loyalty point or coupon that supermarkets hand out to their customers, they harvest a wealth of data around consumers’ purchasing habits. There’s a Latin phrase often invoked when consumers complain, having inadequately understood the terms of their purchase: caveat emptor. It translates as ‘let the buyer beware’. Basically, don’t buy a chocolate telephone then complain that your ear is sticky.

You could argue the same point with loyalty schemes. You don’t have to read the small print to guess that retailers are monitoring your shopping habits when you sign up. But what if you don’t sign up, effectively opting out of the entire deal? That’s also fine, right? You don’t get the discounts, and they don’t track you.

Wrong. Here’s where it gets shady. Supermarkets also track their customers via their credit and debit cards – almost always without the consumers’ knowledge.

This works in exactly the same way as the loyalty system. Every purchase made with a certain card is tracked and stored, with a profile of that individual’s shopping habits slowly built up over time, and used to assess the effectiveness of things like in-store promotions, placement of certain brands of produce, and customer loyalty. The difference is that the retailer is unable to send material directly to the customers in this case because it doesn’t know their home address. Although widely believed to be common practise, this form of non-consensual tracking has been expressly admitted by UK supermarket chains Morrisons, Waitrose and Asda, whilst Sainsbury’s and Tesco have made statements denying that it goes on at their organizations.

And for those chains that do employ this form of customer analysis – or at least are open about it – it doesn’t stop there. Not only do they track payment cards used in their stores, they pay data analytics firms, or sometimes data aggregators, to find out how certain customers spend their cash outside their stores. Waitrose, for one, has admitted to paying data analytics firm Beyond Analysis for anonymized information on customer spending patterns at rival chains.

How many members of the public are aware that detailed information on what they purchase with their credit and debit cards is available to anyone who wants to pay for it? Where is the opt-out button?

The answer of course is that there simply isn’t one, how could there be when most people are totally unaware that this is going on? Or at least there isn’t an opt out button that anyone concerned over retail data snooping is likely to find. Some credit card companies do offer an opt out from this sort of activity, if you’re prepared to look hard enough. Mastercard offers a ‘Data Analytics Opt-Out’ under the global privacy notice on its website.

It also explains, in typically dense legalese, with whom it may deign to share your personal information.

“We may share the personal information we collect with our affiliates, financial institutions that issue payment cards or process electronic payment transactions, entities that assist with payment card fraud prevention, and merchants.”

That final word is the key: ‘merchants’. That means anyone capable of taking payment via a credit card. It’s a deep pool.

It continues, in a presumably unintentionally comic moment, to suggest that the best way to stop the firm harvesting your data, is not to use its card:

“You can choose not to provide personal information to MasterCard by refraining from conducting electronic payment card transactions.”

Presumably MasterCard believes that its customers take out its card purely for the pleasure of filling in forms and receiving endless junk mail.

The supermarkets of course would prefer not to have to pay to find out how you spend your money when you’re not in the store, which is why the major (and plenty of not so major) brands offer even more loyalty points and discounts once you agree to take out one of their own credit cards.

But does any of this actually matter? If someone somewhere is having a blast counting how many kumquats you bought last week, isn’t the best thing to do just to walk away shaking your head?

The problem is that the data tracking doesn’t stop at the vegetable aisle. Think about the breadth of products sold by the modern supermarket. It includes ranges like hygiene products, pharmaceuticals, and alcohol. Most people might very reasonably find it hard to work up much of a sweat over the implications of their regular turnip consumption being tracked, but do you want your supermarket to hold what essentially amounts to your secondary medical record? To track and potentially sell on details of how much you’re drinking? And retailers haven’t proven themselves to be safe custodians of our data either. One of the most dramatic data breaches in recent years was when US retail chain Target was hacked in December 2013, with over 110 million customer details – including credit card data, names, email address and phone numbers – stolen. We’ll discuss the security angle in more depth in chapter 6.

If you’re still not feeling in some way violated, imagine a stranger coming into your home and rooting through your fridge. Then moving on to your kitchen cupboards, bathroom and wardrobes, all the while making notes on every purchase you’ve made. Once they’ve finished, they then approach you and show you a host of adverts based on what you’ve previously bought. Maybe they’re trying to get you to switch brands, maybe they’re trying to reinforce your loyalty to a particular product line. Whatever the strategy, ultimately they want your cash.

So your data is tracked, analysed, potentially sold on, and potentially lost in a hack whether or not you sign up to the loyalty scheme. But what if you give them what they’re ultimately looking for and just pay with cash? Surely then you’re safe?

In a sense you are (although your face could be captured by till-side cameras, as we’ll come to in chapter 10), but your purchases are still being analysed and logged. Most large supermarkets use a system at the till which builds up a profile of you literally as you’re standing there waiting to pay. They pinpoint your demographic, and target you with coupons and offers – either in-store or often in an attempt to entice you to their online presence where they can really grab your data. One of the most commonly used till-side systems in both the UK and the US is Catalina. As it declares on its website: “…Catalina knows the evolving purchase history and individual needs of more than three-quarters of American shoppers. We use that insight to create personalized, measurable campaigns that motivate high-value consumers to try new products, increase consumption, and stay loyal to CPG Brands and Retailers.”

So even paying cash, you still can’t escape the relentless attempts to convince you to spend more and stay loyal, although at least your name, address and credit card details won’t be attached in any way to your profile.

Another way the supermarkets profit is by allowing brands to target loyal customers of its rivals with special offers for its own products. So ShinyWhite toothpaste might pay a supermarket chain for access to regular purchasers of its big rival NoPlaque, in an effort to tempt them to swap brands. According to industry insiders, this form of targeted advertising causes coupon redemption rates to soar from the one per cent at which many languish, to as much as fifty.

You might think you’re making your own decisions as you wheel your trolley around the aisles, or your mouse around the site, but the supermarkets, brands and even payment firms are doing their damnedest to make your mind up for you.

Faced with the dizzying array of produce today’s supermarkets offer, some may like the idea of having decisions made for them. But Gartner’s Frank Buytendijk points out that it can be restrictive to customers.

“This sort of profiling keeps you where you are. If I’m down on a database as liking Chinese food, I’ll keep seeing offers for that. So how will I find out if I like Mexican?”

Target, a chain you could either view as lax in its security efforts or simply unlucky, is one of the worst offenders when it comes to what it does with its customers’ data. A good example to back this up happened in 2012, when a father found out that his teenage child – a schoolgirl - was pregnant. For many fathers that’s already bad enough news for one day, but what made it worse was the way he found out. His supermarket told him.