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Pass Corporate Chartering Power to Washington

Historically, it’s states that charter corporations. Shifting that to the feds could democratize our economy.

By Daniel A. Hanley

Tagged AntitrustchartersCorporate GovernanceCorporationsequalitystates

Federal and state regulators have recently taken significant action to curb concentrated corporate power in our economy. Some notable steps include state enforcers filing new antitrust cases against Google, and President Joe Biden signing a sweeping executive order in July that commands America’s gamut of federal administrative agencies to use their congressionally delegated authority to deconcentrate the U.S. economy and appointing progressive antitrust enforcers like Lina Khan, Jonathan Kanter, and Tim Wu to prominent regulatory positions. These actions are an important step toward fundamentally changing the public’s relationship with corporations.

Though antitrust is an essential tool to tame and extinguish concentrated corporate power, it is just one component of a comprehensive policy prescription to democratize the economy and transfer power from dominant corporations, financiers, and shareholders to small businesses, workers, and the public at large.

Politicians and policymakers with an interest in truly curbing out-of-control corporate power in the United States should take advantage of this new paradigm of increased antitrust litigation and enforcement, along with Democratic control of the White House and both houses of Congress. They should use all relevant areas of law to fundamentally transform the relationship citizens have with corporations. Corporate law is one area in particular that Congress should consider.

For a corporation to exist, it must enter into a contract with the government (formally known as a “charter”). Almost all corporations obtain their charters exclusively from state governments. This poses a problem because states are required to allow corporations chartered from other states to do business within their borders. Therefore, corporations can simply choose the state that is willing to grant them the most favorable terms for their charter—state governments enacting strict requirements for a corporation to obtain a charter and tightly regulating corporations through their charter’s terms, therefore, effectively does not exist.

But Congress has the power to significantly modify how corporations are created and prevent corporations from using our country’s loose state-oriented corporate landscape to their advantage. Congress can require firms that desire to engage in national commerce to obtain authorization from the federal government, likely from an administrative agency such as the Federal Trade Commission. Federal charters could impose additional regulations that state governments are unable to implement and significantly modify how corporations are governed. For example, federal charters could require firms to adhere to additional requirements like appointing more diverse members on the board of directors or more stringent disclosures, which would increase the legal firepower of regulatory agencies. Such changes could also democratize a corporation: Congress could require them to incorporate labor into the decision-making process and consider the effect their operations have on the communities they serve as well as on their workers.

Requiring all national firms to obtain a charter from the federal government would fundamentally change the public’s relationship with them. Federal corporate chartering must therefore constitute, like antitrust, a part of Congress’s broader antimonopoly agenda. Lasting change to reducing the power of corporations cannot be complete without it.

What Are Corporations, and What Is a Charter?

The nature of the charter is fundamental to a corporation, as a corporation is in fact defined as a legal entity constructed from a charter with the state (or federal) government. In exchange for adhering to a set of rules, which can include financial disclosures and the appointment of a board of directors to oversee its operations, a corporation is allowed to exist. A corporation typically also receives a liability shield that protects the members of the firm from personal liability, as well as favorable tax benefits from the state designed to promote investment in the corporation’s activities. The contract with the state governs and structures exactly what powers a corporation has at its disposal, including what investments it is allowed to make, its maximum market capitalization, and even its duration. Most importantly, the charter structures what is known as the “internal affairs” of a corporation, which include the election and appointment of directors to the board, rights to examine records, shareholder meeting requirements, and processes to amend the charter or bylaws of the corporation. The state legislature can ultimately determine what terms and conditions charters have. In the words of the Supreme Court in 1892, “A corporation being the mere creature of the legislature, its rights, privileges, and powers are dependent solely upon the terms of its charter.”

As territorially sovereign entities, state governments within the United States were and still are the central figures in American corporate law. In the early nineteenth century, state legislatures gave out individual charters only sparingly (fewer than 350 existed before 1801). The corporations created during that time were also significantly different from their modern counterparts. Almost all of them were restricted to serving local communities, had narrowly defined objectives and purposes, such as building a canal or road, and were required to serve a broad public purpose.

In effect, a corporation was an extension of the state government itself and a delegation of some of its powers for private investment to perform some specified service. Primarily because of the still nascent administrative capacities of the various state governments at the time, the charter was deployed when needed as a regulatory weapon to ensure corporations adhered to the rule of law and served the public interest: Any deviation of the terms of its charter, could result in the charter being revoked and end the corporation’s existence.

As the Industrial Revolution heated up in the mid- to late nineteenth century, fundamental changesin the law facilitated the growth of the infrastructure for critical communications technologies such as the post office, the telegraph, and telephone, along with the rapid spread of transportation infrastructure like railroads. These technologies, along with changes in law, freed corporations from a state’s geographic borders and vastly enhanced the ability of corporations to conduct their operations on a national level. It also expanded their legal capability; they could now modify their legal rights by obtaining a charter from a more favorable state venue.

Corporations continued to grow in both size and number throughout the latter half of the nineteenth century. Between 1860 and 1915, the number of corporations increased by a factor of ten, growing from 30,000 to 300,000 in 1915. But many Americans at the time saw the growth of these colossal enterprises as posing a threat to both their livelihoods and to the vitality of our nation’s democracy. In the words of one commentator in 1887, “Modern Feudalism is most apparent in the erection of great and irresponsible rulers of industry, whose power, like that of the feudal barons, burdens the people, and even overshadows the government which gave it existence[.]”

Congress was therefore required to confront these new forms of aggregated capital. Eventually, the public backlash against growing corporate power would culminate into congressional efforts to wrangle these corporate entities by enacting the Sherman Act, the Clayton Act, and the Federal Trade Commission Act, the primary set of antitrust laws enacted between 1890 and 1914.

But Congress’s response was limited to addressing the conduct of corporations rather than their construction. As such, the states remained the primary vehicles for the creation of corporations and the predominant deciders as to the rights corporations should be granted. The federal government’s role was relegated to being the primary regulator of a corporation’s business operations.

Toward the end of the nineteenth century, some states realized they could modify the terms for distributing charters to attract more corporations to their state. This open, state-oriented legal landscape created what has come to be known as a “race to the bottom.”

States quickly began to repeal many of the rules that restricted the powers corporations had historically been prohibited from having. States justified these changes as a necessary means to enhance their internal revenues, via the taxes and filing fees they obtained from issuing corporate charters. In other words, states placed profits above the need to restrict a corporation from operating in the public interest. However, the choice of certain states to weaken their corporate laws soon was no longer much of a choice at all. It took only one state to lead the way before others followed.

New Jersey was the leader in this race to the bottom that began in the 1890s when it removed practically every restriction on a firm’s operations, becoming known shortly after as the “Mecca for Corporations.” The state allowed corporations to buy and hold stocks and bonds in other firms, abolished market capitalization restrictions, and permitted corporations to exist for an indefinite period, as well as to merge and consolidate at will; many more restrictions were loosened or discarded. This meant that once a corporation obtained a charter from New Jersey, it had free reign to operate and structure its operations regardless of the effect on its workers or the public. The Sherman Act at this time was also not being enforced against the goliath monopolies, but, after being given a blessing by the Supreme Court, instead specifically targeted labor unions—despite this being contrary to the original purpose of the act.

Not only did corporations flock to become incorporated in New Jersey, but the state also provided the legal protections necessary to facilitate the rise of many new corporate behemoths, including the infamous Standard Oil. At the end of the nineteenth century, Standard Oil was about to have its charter revoked by the state of Ohio for violating the terms of its charter. To avoid such liability, Standard Oil, in 1899, simply reincorporated in New Jersey and continued existing as it was until it was finally broken up by the federal government in 1911.

New Jersey’s “chartermongering” had a significant effect, and other dominant corporations like U.S. Steel also flocked to the state. New Jersey went from chartering only 15 corporations between 1880 and 1896 to chartering over 2,000 in 1906. So much money flowed into the state, it was able to pay off all its debts and abolish its property taxby 1902. While New Jersey, under the leadership of then-Governor Woodrow Wilson, would reverse its decision in 1913 just before assuming the presidency and retighten corporate restrictions, the state’s actions provided a blueprint for Delaware, which has been since the early twentieth century the leading and primary state for corporate charters.

Federal Chartering Is a Necessary Part of the Solution to Rein in Corporate Power

With the construction of corporations (and their legal rights) being a predominantly state-oriented operation and the regulation of corporations being a predominantly federally one, corporations are able to have their proverbial cake and eat it too.

Under the current system, corporations can abuse the geographic landscape to obtain a new charter in a favorable state that grants them the most amount of power and legal capabilities possible to structure their internal governance as they wish. If Delaware decided to abandon its extremely corporate-friendly laws (as New Jersey once did), corporations would just incorporate in another state willing to provide the same power and control.

America’s state-oriented chartering system makes it effectively impossible to regulate the internal structure of a corporation. No state can act individually because, as the situation currently stands, a corporation can simply obtain a charter from another state. Should any one state be able to determine corporate law and regulation for everyone else?

Compounding the problem further is that current Supreme Court interpretation of relevant clauses of the Constitution, including the Dormant Commerce Clauseand the Privileges and Immunities Clause, drastically limits the ability of an individual state to restrict and regulate out-of-state businesses in their operations within their borders. This situation effectively means that the federal government is the only entity allowed to regulate broad aspects of a corporation’s activities.

So, while corporations have many options from which to obtain their legal rights, the public has a limited number of governing entities capable of regulating their operations. Unless the states were to come together and act collectively, which they have little incentive to do, only federal action will solve the problem of corporate abuse in America.

In the early twentieth century, a movement came together to attack this very problem and to rein in corporate operations by shifting the balance of power away from states and toward the federal government. Various reformers of the time proposed that if a corporation desired to engage in interstate commerce, it should first have to obtain a charter from the federal government and thus subject itself to enhanced regulatory requirements and public oversight in addition to a given state’s requirements. For a variety of reasons, including the rise of antitrust law and the broader growth of the federal administrative apparatus, such as the creation of the Federal Trade Commission, federal chartering lost most of its luster. These alternative regulatory measures were seen as sufficient to regulate corporations in the public interest.

Yet these measures have fallen short. The deficiency stems in part from inadequate, ineffective, and misguided enforcement, radical changesin judicial interpretation of various statutes that weaken and stymie their enforcement capability, and the general spread of a false narrative about the role and ability of regulation, and antitrust more broadly, to operate in the public interest. Additionally, these regulatory avenues are incapable of implementing broader social policies that govern the internal operations of a corporation.

Federal chartering is an idea that should be revived as a necessary component to adequately regulate large corporations. Politicians, namely Senator Elizabeth Warren, promoted federal chartering during the 2020 presidential campaign, indicating some potential viability for this idea within Congress.

Under a federal chartering requirement, before a corporation can exist and engage in interstate commerce, it must also obtain a charter from the federal government. A federal charter could mandate several important policy objectives that would seek to ensure a demonopolized and democratized economy and thus radically change the public’s relationship with corporations.

For one, a federal charter could mandate that its board of directors have members from specific minority or underrepresented groups. For example, it could require that at least 40 percent be Black, Indigenous, or other persons of color, or that a certain percentage of the board be members of labor and elected by labor rather than shareholders. A federal charter could transform the board of directors from one simply controlled by a chief executive who considers only shareholder welfare to one that must also serve as a true check on a company’s operations and mandate considerations including the environment, workers, consumers, or even local communities.

Federal charters could also, like their historical state counterparts, strictly limit the size of a company and restrict its operations to select industries. It could restrict the conditions under which a company proposes mergers, creates shell companies, and changes its corporate disclosure practices. Thus, federal chartering can serve as a critical means to enhance the regulatory firepower of administrative agencies, as well as other federal and state law enforcers, including those charged with enforcing antitrust and securities law. Federal chartering could in fact ease the entire enforcement apparatus of the federal government.

On admittedly unclear constitutional grounds, given the current composition and jurisprudence of the Supreme Court, federal charters could also be used to circumvent other constitutional authorizations approved by the Supreme Court, such as the ability to make unlimited financial expenditures to political action committees as detailed in Citizens United v. FEC. Lastly, similar to preventing acts like that of Standard Oil from merely moving to New Jersey, federal corporate chartering can also assist with preventing national corporations from avoiding certain types of liability or tax obligations merely by moving their operations (if only on paper) to another more favorable geographic venue. Increased public oversight provided by federal charters would also create a deterrent effect against more nefarious corporate conduct—as corporate executives would understand that a revocation of a charter would cause the corporation to terminate all its operations.

Restructuring how businesses operate is critical to promoting economic equity in our society. By modifying a corporation’s internal governance and the processes that occur beyond the public’s immediate oversight, federal chartering democratizes a corporation from the inside out. In addition to ongoing efforts in the realm of antitrust, Congress should take this opportunity to pursue this formidable regulatory weapon against undue corporate power.

Read more about AntitrustchartersCorporate GovernanceCorporationsequalitystates

Daniel A. Hanley is a senior legal analyst at the Open Markets Institute. Follow him on Twitter at @danielahanley.

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