In the past, and even today, the stock market has played an important financial role in the economy by enabling companies to access the large amounts of money which they need to grow and expand their operations, while it allows people to invest their savings in order to earn money and thereby finance their retirement years, their children’s education, and to achieve other socially beneficial goals. Those who first buy shares of the stock that are issued by a company do contribute money to the company; and the secondary sales of shares in the stock market provides liquidity by allowing these individuals to sell their shares to others, without which ability many people would not be willing to buy the company’s shares in the first place. Moreover, historically the important legal concession to shareholders of no liability for a company’s actions and debts was found necessary, or at least expedient, to encourage people to give money to companies in exchange for a part ownership in them, since many of these ventures were risky because of the high failure rate of new businesses in general. However, this model has had a number of harmful effects that have become more pronounced in this frenetic human age of mass consumption and massive corporate profits, when many people’s frequently irrational financial expectations exceed, sometimes by a wide margin, the economy’s ability to create wealth.[1] These unrealistic expectations have led many investors to seek speculative gains that can destabilize a country’s economy, or even the global economy.
Another insufficiently discussed factor in the ability of corporations to so freely do harm is that most forms of corporate structure are “limited liability corporations.” That is, if the company commits some public harm that the local or state or national government is able to sue about, it can sue only the corporation itself, not its owners, the shareholders. In most cases the government cannot even hold liable the high-level executives who may have personally initiated or managed the dangerous performances. Corporate structure is actually an insulation protecting its primary actors, and its owners, from the consequences of most negative acts they may commit. Without such insulation, many harmful acts might never be initiated in the first place, so the legal structure effectively helps create the harms, while also assisting profits and causing an additional effective transfer of wealth from ordinary taxpayers to corporate coffers.[2]
Even Adam Smith, the great champion of capitalism, whom free-market capitalists are fond of quoting whenever his views coincide with theirs, was not at all sanguine about the integrity, trustworthiness, and social responsibility of the owners of capital.
The violence and injustice of the rulers of mankind is an ancient evil, for which, I am afraid, the nature of human affairs can scarce admit of a remedy. But the mean rapacity, the monopolizing spirit, of merchants and manufacturers, who neither are, nor ought to be the rulers of mankind, though it cannot perhaps be corrected, may very easily be prevented from disturbing the tranquillity of anybody but themselves.[3]
In the story of Rumpelstiltskin, a misshapen gnome appears at a time when a young girl is distraught because she must perform an impossible task – to spin straw into gold – or else be put to death. In return for performing the task she has been set by her captor, no less a personage than the king, Rumpelstiltskin demands from the desperate girl the promise to hand over to him her first-born child. Greatly relieved, the girl makes this promise to the gnome, since the fear of death overwhelms any concern she may have about surrendering a child that has not yet been born and, moreover, not even conceived. However, following the child’s birth, when Rumpelstiltskin suddenly reappears to take possession of the child, the mother, like most mothers, suffers great anguish at the thought of having to give up her beloved first-born child, and so she tries to find a way to avoid keeping her promise.
The model of corporate ownership shares many similarities with the story of Rumpelstiltskin. A young company requires financial aid to pay off its creditors and expand its operations, without which funds it may die or fail to prosper. In exchange for this timely help, the founders of the company hand over ownership of their company, in whole or in part, to its benefactors, promising to pay some or all of the company’s future profits to them in perpetuity. Like the promise made by the young girl in the fairy tale to hand over her first-born child to her misshapen saviour, this promise is an exorbitant price to have to pay for the help that was given to the nascent company’s owners in their time of financial need.
The widely-adopted model of corporate ownership has a number of serious flaws and defects; and it is precisely this inherently flawed nature that is responsible for producing the harmful effects due to the increasing global dominance of corporations that are based on this dysfunctional model. Among these undesirable outcomes is corporate tyranny, which has become increasingly prevalent in many countries around the world, especially in the United States, a country that is becoming a totalitarian corporate state because of the harmful influence and control of free-market fanatics and their rigid ideological policies of deregulation, privatization, trade liberalization, which usually means the imposition of free-market policies on the rest of the world, and minimal government oversight and intervention in business affairs.
Except for corporate ownership, in all other forms of ownership, control or ownership is accompanied by the assumption of full responsibility over the object of ownership. But since stock market owners are exempted from this very important condition, they should not be allowed to exercise control over the company whose shares they own. The principle in this case should be “No ownership without responsibility,” just as, prior to the American War of Independence, the rallying cry of “No taxation without representation” was repeated throughout the thirteen colonies. The fact that the colonists who were taxed had no representation in the legislative body that imposed these taxes led, so the colonists argued, to arbitrary abuses of power. Similarly, the fact that the owners of corporations are not legally responsible either for the corporations’ actions or its debts has led to numerous abuses of corporate power.
We don’t have to look hard to notice the public harm of allowing corporations to have all of the freedoms of an individual without any of the responsibilities.[4]
The principle feature of stock companies that is the cause of all these problems is the concept of “limited liability.” This means that the owners of the company’s shares cannot lose more than the amount they paid for their shares. In other words, they cannot be sued for any mistakes or wrongdoings committed by the company, and, moreover, they are not responsible for paying any of the company’s debts. It is not at all surprising that this form of ownership, which has created a kind of ownership without responsibility, encourages the individuals who own the company to behave in a selfish and irresponsible manner, such as by demanding that the company pay dividends, or increase them, or use its profits from the most recent calendar year to buy back shares of its stock, even when it is burdened with debts.[5] In the way that it functions in the real world, the model of limited liability has produced a system of no-liability and no-responsibility ownership, which, by divorcing responsibility from ownership, is an extremely dangerous and foolish way of allowing businesses to operate.
This very peculiar form of ownership is completely at odds with all other kinds of ownership. If one buys a car or house, one is responsible for paying all the costs of repairing and maintaining it. Moreover, one is also responsible for any damage that its use or ownership may cause others, such as if one kills or injures someone while driving the car, or if a tree on one’s property falls and damages part of an adjacent property. Even in the case of animals, such as dogs, cats, chickens, and horses, the owner is responsible for the animal’s behaviour, such as if it bites or causes harm to another person, or causes damage to another person’s property. Except for publicly-owned companies, there is no other kind of ownership where the concept of “limited liability,” which in effect means no responsibility, applies.
This extraordinary concession was made to those who lent needed funds to the company during its infancy because of the difficulty of raising large amounts of money for capital-intensive ventures in the past, such as railway construction in the nineteenth century. But with the vast amounts of money that circulate around the world’s financial markets today, eagerly looking for opportunities to expand, like the hoarded treasure of a fire-breathing dragon, into even larger quantities of money, this difficulty no longer exists. Why, then, do we continue to employ this dysfunctional model when it produces so many harmful effects? The simple answer is that human beings are imitative creatures who continue to imitate and conform to the dominant model in a given situation, even when this model causes considerable harm, until someone presents an alternative model, which, hopefully, will be widely adopted and perhaps displace the old model.
From the time that a company’s shares are first issued and bought by investors, many of these shares will change hands numerous times over the course of the company’s existence. The prices at which they are bought and sold will vary, in some cases by considerable margins. Some of the company’s owners will make money by buying and selling its shares, while others will lose money.
Economists have the tendency to regard the individual participants in the economy as being more or less interchangeable components. Hence, according to them, the identity of the person who happens to own a certain number of shares of a corporation is not important – provided, of course, that the individual does not own so many shares that one can exert an influence on the corporation’s decisions and the manner in which it is operated. But the fact that the present owners of a corporation are not the original owners does make a difference, for, in the case of a successful corporation, whereas many of its original owners have made money from selling their shares and moved on to other things, the present owners may not have made any money and therefore have greater demands and expectations from their collective ownership of the company. In other words, each time a company’s shares change ownership, the new owner has not made any money from owning the shares, and so one will make constant demands that the company maintain or increase its profits, regardless of how this is done, since a company’s profitability has a significant influence on its stock price, which in turn results in speculative gains for the company’s owners.
It is this peculiarity about the stock market – that the monetary gains which the ownership of a company allows some of its fortunate owners to acquire are not evenly distributed – that is one of the main causes of the frequently irrational, callous, tyrannic, and selfish behaviour exhibited by many corporations today in the pursuit of greater and greater profits. Even conscientious corporate executives find themselves subjected to the constant pressure of having to maintain or increase their company’s profits in order to satisfy their insatiable owners, regardless of how this is achieved.
The present model of corporate ownership unduly favours those who lend money to new businesses. It transfers ownership of the company to them, while it absolves them of any responsibility for the company’s actions, including the obligation to pay back the debts it incurs during its operations, which operations are the source of the profits that the owners expect to be paid for their investment. Thus, the stock owners provide no labour, no ideas, and no initiative, they assume absolutely no responsibility for the company’s operations and debts, and yet they expect a part of the company’s profits to be paid to them in perpetuity. What is more, in cases where a company’s stock is bought and sold at levels that are much higher than the price at which the stock was originally issued, none of the money that is paid for those shares, or the speculative gains that are realized by the individual investors who buy and sell them, goes to the company. Clearly this is an extraordinarily one-sided deal that is reminiscent of the deal made by the distraught girl with Rumpelstiltskin to hand over to him her first-born child in exchange for helping her in her moment of need.
Surely, given our species’ much-bruited capacity for innovation and change, we should be able to come up with a model that is better than this inherently flawed, irrational, harmful, irresponsible, and occasionally dangerous method of financing new companies.
I will call the alternative that I wish to propose to the dominant stock market model of raising funds the “investment mortgage bond” (IMB). As its name suggests, the lenders will not receive any part of the ownership of the company, which will remain with the company’s original owner(s) or founder(s). However, unlike a bond, which obliges its issuer to make regular interest payments and then repay the principal at the end of its term, the investment mortgage bond will require the issuer to pay both interest and a part of the principal until the principal is paid back in full, just as in the case of a home mortgage or other kinds of bank loans. Since companies that need loans are usually not profitable initially, there can be a “fallow period” when no payments are made, perhaps from one to five years, based on how long the owner estimates it will take the company to become profitable. Fallow periods of longer than five years should not be allowed, as this is a sign that either the investee does not intend to pay the money back, or one’s company or business idea has little chance of ever becoming profitable.
There will be a number of variables in each case: the amount of the loan, the length of the fallow period, the bond’s termination date, when it (hopefully) will be paid back in full, the interest rate offered, and the repayment schedule. Given the other variables, the latter can be calculated by using standard annuity formulas.
In my opinion, the return on investment mortgage bonds should be higher than the returns that are paid on investment-grade corporate bonds, which are issued by large, established companies that have little chance of going out of business because they have survived the high mortality rate of new companies. This is to compensate for the fact that a significant number of these bonds will become worthless in cases where the company that issued them goes bankrupt. But this return will be a fixed amount, unlike the extravagant promise to pay dividends in perpetuity, in the case of stock ownership.
It is important for people to understand that this alternative model of funding new businesses will not lessen the risks involved in starting or investing in new businesses. Were this model to become widely adopted, the failure rate of new businesses will probably be similar to what it is presently. The primary purpose of this model is to make corporate behaviour more responsible, by preserving the important link between ownership of a company and responsibility for all of its actions, which link has been severed by the present dominant model of limited-liability stock corporations. Along with unbridled competition, it is this severance that has caused so much harm to large numbers of people, while it has transformed some corporations into tyrannical powers that threaten the democratic integrity of many countries, by the widespread corporate practice of unjustly expropriating control over government laws and policies to favour their very narrow ends.
It would be very easy for this proposed financial model to be misused by unscrupulous individuals to obtain money on false pretenses, which they will spend on things that are not related to the business they are attempting to develop. The most obvious scam is that there is no business, or the business is merely a front for criminal activities. Hence, it is important that various safeguards be put in place to protect investors from such unscrupulous individuals. In other words, this new model of financing companies must be strictly regulated in order to protect both investors and owners, and settle the disputes that will inevitably arise between some of them.
First, a detailed description of the business venture will be made by the investee so that prospective investors can inform themselves about the nature of the business. The investee should also provide a sort of business resume listing one’s skills, accomplishments, credit history, previous relevant experiences, etc., so that investors can appraise one’s chances of success.
Second, investees must put up some sort of collateral in case their business fails or they are unable to pay back the loan. The purpose of this measure is to discourage individuals whose ideas are of dubious merit or who are not serious about doing the necessary work to make their business succeed. If the investee were to obtain a loan from a bank, one would have to put up collateral equivalent to or greater than the value of the loan, in case of default. The requirement need not be as strict in this case, but a ratio of the collateral value to the amount of the requested loan (C/L) can be calculated. Obviously, the lower this ratio, the higher is the risk of the investment in case of default.[6]
Third, it may be prudent to put a limit on the amount that can be raised by a new investee. Since the investors probably will not know the investee, they will have no way of knowing whether one is trustworthy or has the skills, knowledge, judgment, resolve, and good work habits to make one’s business succeed. Similarly, it may also be prudent to put a limit on the amount that each investor can invest in a given scheme in order to limit one’s losses in case the business fails. Because human beings are imitative and emotional creatures, it can easily happen that the IMBs issued by a company that never actually becomes profitable nevertheless become highly desired by investors, in which case they will vie with each other to gain as much of them as possible. The purpose of this limit is to protect investors from themselves, in this case their penchant for developing an irrational exuberance for certain investments.[7]
There is another reason for this second restriction: limiting the total that one investor can invest in any single IMB will prevent that investor from gaining too much power or control over the investee, such as if there are repayment difficulties. With a new model like the one that I am proposing, there will be a tendency to revert to the current model of behaviour, just as most people tend to revert to old or established habits or behavioural patterns. There will probably be some purchasers of IMBs who will seek, by hook or by crook, to gain control over the company’s daily operations, as is allowed by the present corporate ownership model, where ownership, and thus control over the company, is granted to the investors, provided they hold a majority share of the company.
Fourth, a record should be kept of each investee’s loan history, which information will be readily available to all prospective investors, detailing the amounts that were borrowed, whether they were paid back on time or not, and so on. The aim of this feature is to prevent lazy, fraudulent, unscrupulous, and unsuccessful investees from raising funds in the future, or at least make it more difficult for them to do so. Of course, any investee that attempts to mask this history by using a different name or by getting someone else to borrow money on one’s behalf should be subject to various sanctions, including criminal prosecution if warranted, in order to prevent this kind of chicanery.
Fifth, the investee must submit regular financial reports to the investors until the bond is paid off in full. If, for whatever reason, one or more of the investors suspects fraud or dishonesty on the investee’s part, one can request an audit to be performed, which will be paid by the investor(s) who wishes the audit to be performed. There should be a limit of such audits, say to one per year, in order not to inconvenience the investee unduly.
Sixth, an investee should not be allowed to borrow funds in order to pay the mortgage payments that are due to previous investors, since this would create the possibility of a Ponzi scheme.[8] If a second loan is sought by the investee before the first one is paid off in full, a majority of the initial investors must approve the loan, since this new loan may affect the investee’s ability to pay them back. In addition, this information about any outstanding loans must also be made available to any prospective investors. If an investee cannot meet the repayment schedule and has to suspend payments temporarily, a small penalty or fine should be imposed to compensate the investors.
Seventh, since these financial transactions may involve significant amounts of money, they should fall under the laws against fraud, including financial fraud, that exist in the country where the investee lives and operates one’s business. For instance, if one makes false declarations about the nature of the company, misreports its costs and revenues, or declares other falsehoods related to the business, one should be liable to criminal prosecution. Since it can happen that the investor and investee live in different countries, it is incumbent on the investor to familiarize oneself with the laws against financial crimes in the country where the investee lives and operates one’s business.
A contract with all these stipulations will be signed by the investee and one’s investors guaranteeing the latter their rights in case of legal disputes. The purpose of these conditions is to ensure responsible behaviour on the part of both parties to the contract, unlike the present situation in stock markets around the world, which encourages irresponsible behaviour on the part of both investors and investees, or the company’s executives, primarily because legal responsibility for the company’s actions and debts is separated from ownership of the company.
Of course, a secondary market where IMBs are bought and sold will develop, just as exists presently in the case of stocks and bonds. However, because the promised annual payments are explicitly stated and remain fixed, the price volatility of these bonds should be much less than the price volatility that exists in the stock market. The main kind of volatility would be a sudden drop in the bond’s price if it is believed that the company is insolvent and will go out of business. By making a clear separation between corporate ownership and a limited, precisely-defined share in the corporation’s future profits, there will be less reason for speculation in the IMB market. Because the stock market combines these two elements – ownership of the company and a potentially unlimited share of its future profits – it greatly increases the speculation that takes place in the buying and selling of stocks. Moreover, it leads to certain kinds of coercive behaviours, such as mass layoffs, the relocation of plants to poor countries where workers are paid much less than in wealthy countries, and increased automation, whose aim is to extract as much as possible of the corporation’s profits for its no-responsibility owners and executives, since many executives receive stock shares or options, whose value depends on the corporation’s stock price, which in turn depends on its profitability.
Another important restriction is that no derivative of any kind of these IMBs should be allowed, such as by combining a variety of IMBs into a new financial “product” which is then bought and sold like the original bonds.[9] This kind of development contributed significantly to the global financial crisis of 2008. Such dubious financial “products” or “services” fulfill no social need, and they should therefore be considered as primarily speculative products that can reduce the stability of financial markets. After all, there are few people who would consider gambling and betting to be socially beneficial services, even though they are activities that many human beings regularly participate in.
As many potential investors will have neither the time nor the expertise to evaluate different IMBs, while they sift through their uniformly promising and professional-looking prospectuses, there will probably arise ratings agencies that seek to provide such useful guidance to investors. However, it is important that investees be prohibited from paying, whether directly in fees or indirectly in material benefits or a promise to pay a share of future profits, anything of value to these ratings agencies. Rather, these should be funded by potential investors. This restriction is necessary to prevent the absurd situation that exists in the financial world today – another example of the harmful effects of lax regulation – where companies pay large sums to ratings agencies for stellar ratings, a system that is so obviously corrupt that it is hard to believe that it was allowed to flourish to its present extent.
There is another important consideration, namely, the ultimate fate of the companies that are developed from the funds that are loaned through this new method of financing businesses. Ideally, these companies should remain under private ownership because, in my opinion, companies that are privately owned by one or a small group of individuals are less likely to behave in the tyrannical manner in which many corporations presently behave, since these new companies will not be subjected to the often unreasonable demands and expectations of their greedy, no-responsibility owners, and they will not be subjected to the constant pressures to make more and more sales and profits in each quarter in order to maintain their stock price and, while trying to placate their insatiable owners, keep from being bought by another company, which may restructure the company to make it conform to current corporate practices. If many of these businesses end up being sold to companies that operate according to the dominant stock-market model of corporate ownership, then they will not have made much difference in the long run. This outcome is certainly possible, since large corporations will probably be able to offer the highest amounts for those newly-developed companies that turn out to be profitable. Those investees whose main goal is to cash in on their success will probably turn to this option after a number of years of operating their business.
In order to discourage this kind of behaviour, a record can be kept of what each investee does with the business or businesses one has developed. Perhaps those investees who have sold their businesses to stock-market corporations could be barred from raising funds in this new market in the future, since they are not contributing to developing companies that operate according to a different model that combines ownership and full responsibility, in contrast to the present dominant model, which divorces ownership from responsibility. Another option that I would favour is to make every investee sign a legal agreement stating that one will not sell one’s company to a stock market company, and that, furthermore, one will make any person to whom one sells one’s business sign the same document.[10]
This new investment model is based on the important principle of “No ownership without responsibility,” for it is precisely the violation of this principle by the stock market model of corporate ownership that has caused so much harm around the world. The owners will retain full ownership of the company, meaning they will also assume full responsibility for everything that is done by the company, including the obligation to pay back its debts. It is not at all surprising that the very strange nature of corporate ownership, where ownership is divorced from responsibility, has produced numerous instances of irresponsible and harmful behaviour around the world.
The primary purpose of this proposed funding model is to create a new class of businesses that, hopefully, will behave more responsibly and conscientiously, and less selfishly, than many stock corporations presently do, which increasingly are being operated to maximize short-term profits, a model that has many harmful social consequences, whether on workers, consumers, ordinary people who live in places where these corporations operate, and the natural environment. In order for this to happen, they must remain distinct from, while being able to compete with, the dominant corporations that increasingly wield more and more power over the way that human societies function. Because of their outdated and, in my opinion, completely absurd no-liability form of ownership, these corporations are causing a great deal of harm to both the human and the non-human world in which we all live, and on which we depend for the long-term survival of our species.
[1] I am referring to the fact that the annual rate of speculative gains, such as in stock market indexes, often exceeds by several percentage points or more the annual growth rate of a country’s GDP. Hence, when this unsustainable model is perpetuated, as it has been perpetuated for many decades, then it can only be by expropriating a greater and greater portion of the wealth that is created by the economy. In general, this means that those who have power are able to amass more of this wealth than those who don’t have power, who are often the lower and middle classes of society.
[2] The Capitalism Papers: Fatal Flaws of an Obsolete System by Jerry Mander, p. 66. Counterpoint, Berkeley, California, 2012.
[3] The Wealth of Nations, book 4, chapter 3, part 2.
[4] Small is Beautiful: Economics as if People Mattered by E.F. Schumacher, p. 224. Hartley & Marks, Point Roberts, Washington, 1999.
[5] Many publicly-owned companies have found it necessary to issue bonds in order to acquire additional financing in addition to the one-time financing that results from issuing stock shares. But unlike stocks, bonds do not concede any control over the company to the bond holders. A company that issues bonds only promises to pay a certain amount of interest each year along with the principal at the end of the bond’s term.
There are many large stock corporations that have a sizeable amount of debt, in some cases amounting to many billions of dollars, which they finance in part by issuing bonds. This very curious situation, at least considered from a financial or accounting perspective, whereby a profitable company does not use its annual profits to pay off its debts, which is the sensible course of action, but instead pays them out to its shareholders in dividends, or uses them to buy back some of the company’s shares, has begotten a sort of corporate slavery, where the corporation, no matter how long or how hard it toils, and no matter how much profit it is able to generate throughout its lifetime, is never able to free itself from its state of servitude to the callous and greedy shareholders, who make constant demands for the company to make more money, such as by firing a large number of the workers whose labour enables the company to earn revenue and thus make a profit.
This absurd situation is due to the terms of incorporation, which oblige the corporation to pay in perpetuity a part of its profits to the shareholders for as long as it continues to exist and earn money. In a very real sense, this deal results in the selling of the company’s soul to the shareholders for a one-time monetary injection to the company or to its founders and original owners. This very peculiar situation is due to the nature of corporate ownership, a model that was developed in Britain, the Netherlands, the United States, and in other industrialized countries, and was widely imitated in the nineteenth and twentieth centuries by foolish human beings who, motivated primarily by greed, didn’t bother to ask whether it was a good or even sensible model to imitate.
[6] This ratio could also be stated as the L/C ratio, in which case the higher the ratio, then the greater is the risk for the investor in case of default on the bond.
[7] This phenomenon was clearly visible during the tech stock bubble, when the shares of many new companies that never made a profit were nevertheless bought and sold at extravagantly high prices.
[8] The possibility of these and other kinds of fraud already exist in the case of the present stock market model of investment, and yet, this has not deterred many investors from continuing to buy and sell the shares of new companies.
[9] However, this is not to say that I would be opposed to a mutual-fund company that purchased many different IMBs and then sold shares to customers in order to reduce the risk of investing in them, which would also exempt investors from having to evaluate the merits of investees themselves.
[10] I realize that, given the present dominant models of behaviour in capitalist economies, this proposal will be considered by many people to be quixotic, but I will make it nevertheless.
Homo Stupidus 