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Although the managerial function arises out of organizational needs imposed by market competition and technological development, managers' professional status has come in large part from legal conceptions that perceive the managerially run firm as an institutional bulwark for modern democracy. This article examines how the law, through its doctrines of trust and contract, has made and unmade management as a semi-public profession. The article explores the history of tender-offer regulation as a case study of this process.
The effects of large managerial corporations on individual liberty and democratic rule constitute one of the most troubling subjects in American political history. At first glance, these effects should not seem problematic, because few in the American polity have doubted the compatibility, indeed the symbiosis, between liberty and democratic rule through a market economy. Yet the preeminent institution of the modern marketplace, the managerial corporation, has regularly incited debates over its benefits for democratic practices, the market, and liberty itself.
The concern is over a legitimate constitutional order in America, an order, regardless of historical period, founded on liberal premises: that a voluntary association exists to enhance liberty and that democracy and rule by law make for a well-ordered society.(1) In practice, of course, these premises have been variously interpreted. Americans have differed as to whether democracy only protects liberty by holding public officials electorally accountable, or whether democracy also cultivates liberty by developing enlightened citizens; but most have agreed that public life does not provide space ample enough for the exercise of freedom and that government has a penchant for abusive interference.
In response, American legal and political theorists have looked to the market, liberty's principal arena, for an important supplement to democratic rule. By delineating the private from the public sphere, the market allegedly created a social space in which individuals could determine their life stories free from public or government interference.(2) This was a constant of American political theory, at least before the rise of the large firm and while most citizens had access to productive property.
But the rise of the modern corporation in the late nineteenth century raised doubts about the market's service to politics.(3) By concentrating wealth, the corporation served the individual's direct relationship to productive property and thus invited dependent economic and political relationships. In fact, modern corporate society reduced the individual, America's basic element of constitutional logic, to apparent sociological irrelevance. These new business institutions, intent on monopolizing their markets, seemed resistant to the kind of economic well-being that an earlier, less concentrated market had promised. And, as the modern corporation grew to a scale that made investor oversight improbable, a new concern arose about whether management could be trusted to subordinate its narrow interests to the firm's economic health. Taken together, these two characteristics of the modern corporation, size and the separation of ownership from control, confused the market's ability to distinguish public from private spheres and therefore helped prompt government regulation.
Even after the Second World War, when the large firm's economic effectiveness and management's technical competence were evident, anxieties persisted. Because there was no legitimate basis for the firm's success, a sort of legitimation crisis--at least a legitimation angst--has informed much recent scholarly defense of the modern corporation. In this essay, we consider the issue of managerial authority.
Edward Mason gave a famous formulation of the problem for the post-Second World War generation in a 1959 essay. America, he wrote, is a "society of large corporations ... [whose] management is in the hands of a few thousand men. Who selected these men, if not to rule over us, at least to exercise vast authority, and to whom are they responsible?"(4) To private shareholders or to the American public? In Mason's formulation, the basis of managerial authority has two components: dedication to scientific standards of efficiency, which led to meritocratic career paths and bureaucratic hierarchies, and an apparent responsibility for social equity, because administrative hierarchies replaced the market as society's basic distributive mechanism.(5) An intellectually satisfactory accounting of these components, in Mason's judgment, would yield a definition of "professional" management that could ease misgivings about its privileged position.
Since Mason's eassy, scholars have tried to explain the technical and functional dimension of management--for example, how self-perpetuating hierarchies develop and why they are efficient.(6) The public dimension in Mason's definition of professional management has received little scholarly attention, however. Here were ask a legal, rather than an economic, question: how did the large firm controlled by a professional managerial staff become an institution constitutionally acceptable to public officials? The laws and administrative practices to which managers were forced to respond provided management with a quasi-public professional identity that helped the corporation to remain a private concern. Owen Young, chairman of General Electric (GE) during the turbulent 1920s and 1930s, had joined GE as an accomplished attorney specializing in utility regulation. He was among the first to explore how the law could invite management to create a coherent professional identity, acceptable to public officials.(7) When GE faced antitrust charges, Young developed his defense from the following principles: 1) by aggregating wealth, the modern corporation had taken on a public function that limited its owner's right of use; and 2) by divorcing control from ownership, the corporation had given management an unprecedented degree of autonomy.(8) He was boldly displacing the traditional logic of contract, whereby investors could maintain rights over management, with a fiduciary doctrine arguing that managers were the public's trustees, authorized to coordinate the firm's investors and employees into a socially responsive undertaking.
In a 1927 address dedicating the new facilities at the Harvard Graduate School of Business Administration, Young expressed his hope that professional business schools would educate their students in the standards of trusteeship.(9) Such standards, he believed, would make management a profession, one that would be able to anticipate social needs before they became subject to coercive regulatory agencies. Implicitly, then, Young construed managers as modern liberals who, by administering private negotiations among the firm's constituent groups, promoted a spontaneous order that needed minimal public supervision. The business community would not fully live up to Young's expectations; but it did take advantage of Young's trustee argument. First in articles that appeared in Fortune magazine and then in policy statements by the preeminent managerial associations, the Committee for Economic Development and the Business Roundtable, managers represented themselves through Young's model.(10) In large part, this identity has developed alongside management's interaction with the administrative state over macroeconomic issues and stakeholder relationships (for example, with shareholders, employees, creditors, and consumers).(11)
Our contribution to the history of managerial identity will be to consider how the law--by reconciling management's dictatorial control with the nation's constitutional ideals--promoted a vocabulary for articulating management as a profession. This vocabulary came largely from fiduciary doctrines that held the responsibilities of trustees to be morally more arduous than conventional market relationships. Predictably, there were normative disagreements in defining the parties to whom management was accountable--to the shareholders alone or to the firm's constituents in general. Yet, for the most part, legal theorists and practitioners avoided this irksome issue and concentrated their attention on fashioning pragmatic strictures to guide regulators in their oversight duties.(12) The fiduciary creed that emerged lent itself to a broad public interpretation of the modern firm that acquiesced in managerial discretion, holding it up as a means for reconciling the various private interests of the firm's stakeholders and their collective interest with the public good. If management acted responsibly, it would sustain the liberal distinction between private and public, even though the modern corporation had substantively made economic life into a public affair.
Yet, as we will see, the law also outlined a contrary position, one that refused to vest any professional responsibilities in management beyond those set by contract and technical expertise. This vocabulary of contract, which has recently shone through the cracks of the language of trusteeship, warned against the dangers of granting vast discretionary powers to managers or to public administrators. Contractarians cautioned that, in seeking a public standard for private enterprise, the trustee position effectively gave up any tangible limits to public intervention and permitted public values alone to guide legislative actions.(13) They defended contract law because it plainly holds the protection of private rights (whether of the propertied or the propertyless, of owners, managers, or workers) to be the sole justification for government coercion. Legally and economically, it considers managers to be nothing more than contracting agents whose responsibilities and duties are no greater than those of any other citizen. Accordingly, contractarians turn to the market for safeguards against managerial discretion; these, they believe, are not only more efficient than fiduciary standards, but they are also more protective of liberty.
We divide the essay into two parts. In the first section, we examine the legal possibilities, trust and contract, open to the administrative state for carrying out its corporate oversight responsibilities.(14) Our analysis focuses on Adolf Berle and Gardiner Means's classic work, The Modern Corporation and Private Property (1932), because it more than any other study has summarized these two legal avenues. The second part of the essay focuses on a specific regulatory issue, tender-offer regulation and the market for corporate control. We have chosen this topic because it deals directly with the issue of corporate governance and the responsibilities inherent in the corporate control function. Through an examination of these debates, we trace the shifting public conception of managers from semi-public fiduciaries to contracting agents.
The Legal Vocabulary of Corporate Social Responsibility
By the end of the nineteenth century, the centralized authority of large business corporations intruded on the earlier visions of America's decentralized economy. The corporate boom triggered a constitutional debate on how to reconcile the new organizational realities with individual liberty.(15) Through the early twentieth century, the legal community considered this issue in the language of "corporate personality" and "entity" theory, terms that promised legal theorists broad means for deciding whether the modern corporation should be given constitutional status.(16) In a series of cases around the turn of the century, the Supreme Court held that 1) groups had personalities, separate from this individual constituents, and 2) the corporate personality, or "entity," like that of the individual, enshrined the values of private liberty in relationship to private property and to others.(17) Thus, the Court established constitutional barriers against state regulation of the corporation by replacing the "artificial entity" conception that had prevailed with a "natural entity" conception of the corporation.
Proponents of an artificial entity conception had held the corporation to be the creature of public policy, not the natural result of private liberty. When they attempted to draw conceptual boundaries to insulate the corporation from the state, they outlined the rights of shareholders. These rights were grounded in contract: the investors or owners had implicitly bargained with the state over charter terms, and so the state was prohibited under the Constitution's "contract clause" from impairing charter obligations.(18) Although this conception remained true to liberal dispositions about individual rights, it failed to comprehend the firm as an ongoing organizational entity.
In contrast, the natural and real entity conceptions reflected the conviction that groups had distinct personalities that warranted legal recognition. Recent historiography suggests that the "natural entity" conception was a particular subset of a more general "real entity" conception.(19) The "naturalists" differed from the larger body of "realists" by arguing that the law should not tamper with groups because they were the natural outcomes of social evolution. "Realists," meanwhile, believed that group formation and behavior were matters for social scientific study and control.
The recognition of group personality moved constitutional thought in significant ways. Appraisals of democracy rooted in earlier forms of individualism, property ownership, and contract gave way to a pluralist conception of democracy.(20) Previously, the individual's citizenship had been defined by productive participation in the market and in local politics. As the nineteenth century wore on, many were excluded from property ownership and, in that light, citizenship was reduced largely to formalistic but unreal conceptions of private property and contract rights.(21) In this situation, a pluralist vision of democracy emerged, in which the individual's political meaning took the form of group membership, and the Constitution evolved to guarantee individuals process rather than economic rights, the freedom to associate and disassociate, to hear and to be heard.(22)
The modern corporation stood at the center of this transformation, as legal scholars and social scientists tried to define in what respects the firm was public, in what respects private. Between 1900 and 1930, several fields gradually converged, both on the advisability of regulating corporations and on the legal forms available for regulation. After 1910 lawyers began to withdraw from the formalism of "entity" theory, specifically from the supposition that understanding the corporate entity's "true" personality would conclusively determine the corporation's constitutional status--that is, whether it should be public or private, subject to regulation or not. By the 1920s legal scholars acknowledged that the legal conception of the firm should depend on a functional understanding of the transactions among the participants and of the processes that could conform the participants' relative powers to social advantage. In this regard, lawyers resorted increasingly to the work of economists and students of public administration.(23)
Legal realists such as John Commons and, perhaps most influentially, Karl Llewellyn were at the center of this convergence of social science, pragmatic lawyering, and group--as opposed to individualistic or class--analysis.(24) Llewellyn did not directly address corporate regulation, but he did convert the Progressive period's functional analyses of pluralism into prescriptions for regulation that would eventually work into corporate law. Essentially, Llewellyn focused on an organization's transactions or ongoing relationships among groups--for instance, consumer purchases of goods from mass producers and distributors or labor contracts between unions and large employers.(25) He attempted to discover in these transactions an underlying body of "working rules." To the extent that the working rules revealed particular imperfections in modern pluralist society, particularly disparities in bargaining power, their modification would be appropriate public-sector interventions.
Whereas Progressive reformers had focused on the modern corporation's size, the idea of working rules played itself out in two related areas. One had to do with the social costs of corporate concentration and the responsibility of corporations to those not directly involved in governing the firm--to workers, customers, suppliers, and the community at large.(26) The other concern centered on the majority of shareholders and their apparent dependency on corporate insiders. Perceptions of this new shareholder dependency followed the effective dispersal of ownership by mass financial markets.(27) A lack of ownership, Progressive reformers feared, would undermine the corporation's accumulation of capital and with it America's prosperity. In general, these alleged dependencies of the firm's constituents on their control group--the corporate managers--raised fears that the modern corporation had introduced a potentially despotic social force within the polity.
Louis Brandeis, for example, warned about the corporation's subversive effects on the nation's older, less-concentrated market economy, transforming the producer from an independent farmer or mechanic into a dependent wage earner.(28) He feared that the productivity that industrial consolidation promised would be undercut by the apathy and impotence of investors, who had surrendered their control over corporate property to managers. "Can any man be really free, asked Brandeis, "who is constantly in danger of becoming dependent upon somebody and something else than his own exertion and conduct?" No, he concluded; the loss of economic freedom and the enlargement of power among financial control groups or managers promised social inefficiency and class warefare.(29)
By the 1920s the debates over social costs and corporate control had adapted the earlier abstract pronouncements about corporate personality and private property to the language of legal realism.(30) In addressing the problems, no one was more insightful than Adolf Berle, in whose view "this dissolution of the atom of property destroys the very foundation on which economic order of the past three centuries has rested."(31)
Adolf Berle and the Reconciliation of Corporate Form and Function Following several modest inquiries into the legal problems raised by the modern corporation during the late 1920s and a well-known debate with E. Merrick Dodd over managerial responsibility in 1932, Berle published The Modern Corporation and Private Property with Gardiner Means. The book redefined the debate over the costs of social dependency and corporate responsibility.(32) Berle argued from observation. Ownership was separate from control in the nation's two hundred largest firms, a group that by 1930 represented over 50 percent of the nation's corporate wealth.(33) These firms drew their capital from dispersed investors while centering economic power in the hands of their control groups, typically composed of managers.(34) Over time, "control" had freed itself from the oversight of ordinary shareholders, both practically and as a matter of law--that is, through the erosion of statutory restrictions on managers' power to dilute shareholders' property rights and through managers' ultimate influence on corporate policy.(35)
Berle did not worry about this division between financial risk-bearing and operational management or about the associated concentration of industrial wealth. On the contrary, he supposed that the separation contributed to economic efficiency. He did, howver, insist that mechanisms to control managers were essential to ensure the corporation's social ultility; Berle assumed that if managers acted as rational maximizers, they would use the corporate property to benefit themselves rather than the shareholders generally or the other corporate participants. Consequently, Berle focused his analysis on the relationship between managers and shareowners-investors and asked what sorts of legal rules should be relied on to render managers accountable.
Answers came from two approaches that U.S. law had developed to prescribe the obligations of agents to the legal beneficiareis of an enterprise: fiduciary or "trust" relations based on "fairness" and the arms-length contractual logic of market expectations. Austin Wakeman Scott, a leading writer on trusts at the time, sccintly noted the difference between agents acting under a deed of trust and under contract. The trustee, Scott wrote, owes the trust beneficiaries a "duty of loyalty"; even when beneficiaries consent to the trustee's dealings with their property, a court may void transactions "if the trustee failed to disclose to the beneficicaries the material facts which he knew or should have known, or if the transaction in question was not in all respects fair and reasonable." "In contrast, Scott continued, when "presons deal with each other at arm's length [that is, in contract]," courts will set aside the transactions only on grounds of "fraud or duress or undue influence or mistake."(36)
Berle noted that the …