The Corporation as Social Contract

The Corporation as Social Contract

This is a follow up post to an earlier piece, Anarchism and The Firm. A re-summarization of that piece:

If we accept the institution of the market, then we must accept the concept of economic rent–if we wish to engage in economic reasoning. Markets will then have rent-seeking participants/actors1. Economic rent is simply earnings or income for use of a resource in excess of that resource’s opportunity costs. In a world of perfect competition equilibrium, there is no economic rent(or firms). But we don’t live in that world(that is, a world where every resource/asset is traded at opportunity cost). We have (i) economic inefficiencies or (ii) relatively inelastic supply curves for specialized labor2 or (iii) product heterogeneity and/or shifts in demand and supply curves3, etc,etc.

Competition in these types of economic rents is a good thing and improves the human condition, at least from an economic standpoint. A dynamic perspective views the entrepreneur as rent-seeking agent that both “creates quasi-rent” and dynamically enforces economic rent as quasi-rent, that is, long-term earnings for asset usage that approach opportunity cost.

Economic inefficiencies explain why we might expect “firms” in a complex economy. For one explanation of this, we can turn to the work of Oliver Williamson regarding the Firm. In a complex economy, you will end up with assets that are specific to one another that may have a trade value much greater than opportunity cost. If these assets are owned by different entities or agents, these mutually dependent trading partners, absent long-term contracts, will have substantial quasi-rents to bargain over in actual returns. This creates the following bargaining dynamic: (1) trading partners have an incentive to “haggle” to maximize their share of the available quasi-rents; this is a type of transaction cost (2) when it is difficult to switch trading partners, the defection state–that is, a failure in negotiations–represents large surplus losses.

The “Williamson Firm” then is a type of DRO, a form of economic governance that arises as means to minimize the bargaining costs of quasi-rents and the costs of defection.4,5

The “Williamson Firm” provides a plausible bargaining foundation for “the Firm” in a free market. A number of qualifiers, however.

(i) the “Williamson Firm” is not necessarily equivalent to the legal construct of the “Limited Liability Corporation”
(ii) the “Williamson Firm” would only be specific to certain economic sectors and would not be universal across all sectors. It arises out of the quasi-rents of asset specificity. Vertical integration is explained in terms of efficiency, and not “market power.”
(iii) The bounds of the “Williamson Firm” are an important consideration

To succinctly rephrase the qualifying remarks: If the Williamson framework is defined in terms of rent-seeking and adaptation, we should give important consideration to bounds of the firm, given that, in a sense, the vertical integration is explained by the inefficiency of completeness in contracting(for certain sectors). In short, the rent-seeking can very easily become a matter of contrived rents and not quasi-rents.

As I pointed out in my original piece, Stephan Kinsella’s claim of a contractual foundation of “shareholder limited liability,” which he implied had been substantiated by the likes of Robert Hessen, was not an accurate claim. Hessen actually denied the possibility of any strong contractual foundation of shareholder limited liability. Hessen instead appealed to the legal principle of respondeat superior backed by a claim of investor passivity.

My response was that in the absence of a strong contractual foundation, to avoid “the Corporation as Social Contract,” you had to provide an economic or bargaining rationale for the thing you are claiming. In particular, I was referring to limited liability in torts. There is no economic bargaining foundation for this legal protection aspect of the Firm.

I then noted that “investor passivity” was a myth, that it was actually a quite active institutional agent on its own. In fact, I identified this institutional agency as the foundation of “too big to fail.”

Interestingly, over the weekend, I read this summary post at Global Guerrillas that linked to this complexity analysis, The Network of Global Corporate Control, authored by a trio of theorists from Swiss Federal Institute of Technology in Zurich. The technical paper employs a complex graph analysis(a standard tool in complex network analysis) to model the global capitalist network, a network the researchers found to form a giant bow-tie arrangement knotted by a small, interconnected core of financial institutions.

For non-technical summary, refer to this informative New Scientist article.

What we empirically see is that the knot is controlled by a “super-entity” of 147 firms, almost all financial institutions. If you study the paper, what you will see, in plain startling form, is the empirical proof(or a highly compelling proof) that demonstrates the incompatibility of limited liability torts and investor passivity with the free market. Of course, we are defining the free market as a mechanism of competitive dissipation of economic rents. And we are reminded why we should never consider the free market as serving any moral ends–in this case, as means to an ends of a moral claim of ownership liability.

Complex network analysis has no need of conspiracy theories or “bad actors.” It simply models the complex order that emerges from the rules of the system. And what we find is not necessarily collusion of over economic rents, or a violation of the Williamson bound vertically for monopoly rents, but rather a complex entanglement-which violates the Williamson bound–naturally geared toward network preservation. In other words, not “public choice,” but “ruling class.”

What appears to have been empirically verified is the Corporation as Social Contract…

1 The term “rent-seeking” is usually reserved for contrived/artificial rents that are typically a product of government action. But we can generalize it to include profit seeking that includes quasi-rents. The generalization then includes the entrepreneur as a rent-seeking agent. Of course, competition in quasi-rents results in the dissipation of such rent.

2 Easy examples are highly skilled professional athletes, entertainers, or technical personnel. Most, if not all of their compensation(or income), is economic rent, meaning that they would earn much less in an alternative profession or endeavor.

3 Steve Jobs/Apple is an excellent example. Jobs perfected “taste” as a basis for product heterogeneity in consumer computing/electronics, allowing for Apple to enjoy the benefit of economic rent(in this case, profits above “normal profits). There is nothing wrong this type of economic rent-seeking, unless the rent-seeker also seeks to use the patent/copyright regime to prevent competition in product heterogeneity, which is the case with Jobs/Apple. Thus Steve Jobs attempted to use protectionism to protect Apple’s quasi-rent as permanent rent, thus disqualifying him as an “entrepreneurial ideal.” It’s amazing how many libertarians apparently miss the boat on this.

4 For a more detailed account, refer to the 2009 summary compiled by the Economic Sciences Prize Committee

5It is easy to see that the concept of economic rent is a primary dividing line between social anarchism and “free market anarchism.” Social anarchism holds hierarchy mechanisms of governance to be immoral whereas the “free market” variety, in its acceptance of economic rent, cannot make such blanket moral judgements regarding hierarchical forms of governance.

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