Modern Functions of the Corporate System

Author(s): Adolf A. Berle

Source: Columbia Law Review, Vol. 62, No. 3 (Mar., 1962), pp. 433-449
Published by: Columbia Law Review Association, Inc.
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MODERN FUNCTIONS OF THE CORPORATE SYSTEMt

ADOLF A. BERLE*

I. PERSONAL PRIVILEGE

Pioneer work usually does (and invariably should) come in for critical

rake-over a generation later. By that time, the author is usually dead. I am

not, and find the experience piquant.

Appreciating the subtle flattery implied in the title-and in being con-

sidered "folklore" in the text-something more than courteous passivity is

indicated. It is nice to be credited with having asked the right questions in
1932. But I can not escape the feeling that it is also incumbent on lawyers
and scholars to come up occasionally with the right, or at least with viable,
answers.

Folklore is commonly considered legend rather than description. Later

generations, criticizing, did not live through the period that produced the
original work. Professor Manne and his contemporaries did not live through
World War I and the decade of the twenties, and the crash of 1929, culminating in the breakdown of the American economic system in 1933. They have
not experienced a corporate and financial world without the safeguards of
the Securities and Exchange Commission, without systemization and en-

forced publicity of corporate accounting, without (more or less) consistent

application of antitrust laws, without discouragement of financial pyramiding,

and which tolerated conflicts of interest to a degree unthinkable now. They
have not experienced a banking, credit, and currency system unguided by the
reorganized Federal Reserve Board. Least of all have they lived in a politicaleconomic world in which great corporations were not consistently held by

active public opinion to public responsibility. Naturally, books reflecting the

conditions then prevailing seem "folklore" to them, as the tales of Marco
Polo and the travels of Herodotus seemed myths to their readers. Historical
research later usually verifies-and I think would verify in respect to my
own work-that what is later taken as folklore was a more or less accurate
account of existing historical conditions.

Prediction is another story. Some, at any rate, of the extrapolations

made in 1931 by Dr. Means and myself have not come true. It would, I
think, be fair to acknowledge that we had something to do with this. Some
of us went into that phase of active government known historically as the

"New Deal." We did our level best to prevent those predictions from being
realized. The "grandfather clause" embodying the death sentence for unduly
t This article is a reply to Manne, The "Higher Criticism" of the Modern Corpora-

tion, appearing in this issue, 62 COLUM. L. REV. 399 (1962).

* Professor of Law, Columbia University.

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434 COLUMBIA LAW REVIEW [Vol.62:433

pyramided holding companies in the public utilities field is only one illustration.'

In at least one respect the prediction, in modified phase, has come true.

The work of Professor M. A. Adelman, covering the years 1931 to 1947,2

more or less confirmed by Professor Lintner's later studies,3 does indicate
that the degree of concentration of the American industrial economy has
remained relatively constant; that is, 135 corporations control about fortyseven per cent of American industrial production now, as they did in 1932.

A fair estimate would be that 600 large corporations control between twothirds and three-fourths of that production today, and probably have done
so for the last thirty years. Yet, while this was happening, the country has
steadily shifted away from agriculture to industry. In 1930, agriculture
accounted for fourteen and four-tenths per cent, and industry for forty-four
and five-tenths per cent of the total gross national product privately produced.
In 1960, these figures had changed: agriculture accounted for four and sixtenths per cent, and industry for fifty and five-tenths per cent. Within the

industrial sphere the degree of concentration has remained about the same.
But the aggregate of industry, both in size and in relative importance, has

established undoubted dominance. Concentration within it is thus markedly

more powerful relative to total production and in the total economic scene
today than it was in 1932.

It is amusing to recall that, in 1932, The Modern Corporation and

Private Property4 was thought so dangerous as to be almost worth suppressing.

It was in fact first brought out by a law publishing house then affiliated with

the Corporation Trust Company. Discovering the viper they had nourished
in their corporate bosom, publication was promptly suspended after a few
copies had been sold. (Copies under that rubric are-modestly-collectors'
items now.) Shortly after, the book was reissued by Macmillan and has

circulated under their imprimatur ever since. This is somewhat more than a
romantic incident. Books questioning power systems-as did The Modern

Corporation-often do have initial rough handling by the power system whose

rationale and bases are analyzed. At that time, there was no question what-

ever where the chiefs of the American economic power system resided. They
were the dominant figures in the banks and banking houses clustered near the
corner of Broad and Wall Streets, and a few counterparts in Chicago. Their
rule was then nearly absolute. They had no respect at all for the "free

market." They could only be challenged by politics; they were, in the event,
1. Public Utility Holding Company Act of 1935, 49 Stat. 820, as amended, 15

U.S.C. ? 79k (1958) (especially subsections a and b).

2. Adelman, The Measurement of Industrial Concentration, 33 THE REV. OF Eco-

NOMICS & STATISTICs 269 (1951).

3. Lintner, Effects of a Shifted Corporate Income Tax on Real Investment, 8 NAT'L

TAX J. 229 (1955).

4. BERLE & MEANS, THE MODERN CORPORATION & PRIVATE PROPERTY (1932).

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1962] FUNCTIONS OF THE CORPORATE SYSTEM 435

challenged by Franklin Roosevelt. They could only be shaken by an earth-

quake; as it turned out, the earthquake occurred when the banking system

fell apart in 1932-1933. After reconstruction, the world as now known to

Professor Manne's generation emerged-a result not achieved without strug-

gle. As one of several examples, for two years the United States capital
market was closed (and the Reconstruction Finance Corporation, for which

I was of counsel, picked up the burden) because the investment banking

world refused to function under the requirements and policing of the Securities and Exchange Commission-elementary safeguards the financial community today takes for granted and, indeed, would not do without.

All this I saw, and a small part of it I was.5 Past struggles are indeed
the stuff of folklore. Without them, I think, some of our unhappier predic-

tions might well have been fulfilled. In that case, I think Professor Manne's

"Higher Criticism" probably would have been impossible.

So much for personal privilege. Individual prophecies, positions, and

debating points are unimportant when serious social theory is under discussion.
So let us leave them and get on with the main issue.
II. THE FUNDAMENTAL POSTULATE

Professor Manne and his academic supporters are, of course, accepting

and crusading for an academic theory of economics, and are trying to place
the modern corporation within it. The theory is the classic, nineteenth century
economic postulate that the free market under competitive conditions is the
best, and in ultimate account the final, allocator of economic effort, of wealth

devoted to capital use, and of capital application, as it is a like allocator of

the distribution of goods and services. In current account the fundamental
postulate has been forcefully stated by two brilliant economists of Austrian
training, Professor Ludwig von Mises and his disciple, Professor Friedrich
August Hayek, also a Viennese, now of the University of Chicago.6 The basic

philosophy is that of the great John Stuart M\ill; it is loosely termed the
doctrine of laissez-faire. The economic theory was first adumbrated by Adam

Smith in his history-making tract, The Wealth of Nations,7 as it contemplated

5. No one's opinion of his own part in history is worth much. I refer therefore to
ARTHUR M. SCHLESINGER, THE CRISIS OF THE OLD ORDER 190-93, 419-20 (1957) and
THE COMING OF THE NEW DEAL 430-33 (1958), for an account.
6. Ludwig von Mises, born in Austria in 1881, now living in the United States, was
professor of economics at the University of Vienna until displaced by Nazi seizure. His
theory was presented in HUMAN ACTION: A TREATISE IN ECONOMICS (1959), although
he had expounded this restated theory as far back as 1912.
Friedrich August Hayek, likewise born in Vienna, later professor of economic
science, is now professor of social and moral science at the University of Chicago. His
best known book is THE ROAD TO SERFDOM (1944), and, more lately, JOHN STUART
MILL AND HARRIET TAYLOR (1951).
These men have more than a theoretical attachment to laissez-faire. They saw the
nazi government reduce Germany to an autocracy partly through control of the economic
processes of the country.
7. (1776).

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436 COLUMBIA LAW REVIEW [Vol.62:433

free markets composed of a great many units competing in price. To this

work, perhaps, the United States owes its ingrained prejudice against
monopoly-although monopoly is itself likely to be a product of complete
laissez-faire.

I do not accept much of that theory. But, taking it as a framework, into

its free-market premise the huge modern corporation fits awkwardly. As will
be noted later, the type of "passive property" exhibited by some billions of

shares of stock, given liquid value (monetized) though at fluctuating rates

as demand may require through the New York and other stock exchanges,
fits even more awkwardly. Professor Manne in his "Higher Criticism" is
really struggling to place into that framework the phenomenon of a few

hundred large corporations and their managements, and particularly of the

three or four very large corporations that dominate each industrial sector.

He has also to digest the phenomenon of their internal generation of the

capital they use, and to place the phenomenon of free-wheeling stock market
paper wealth into the free capital market theories of von Mises and Hayek.

To do this he must redescribe these phenomena, and the descriptions do not

fit the facts. I think it is a last-ditch stand of the nineteenth-century school.
Manne is doing the best he can, but is making heavy weather.
The industrial system implacably ground forward through the latter

nineteenth and early twentieth centuries. To achieve itself it was forced to

evolve vast organizational institutions-the modern large corporation, in
fact. In this process it definitively separated ownership from management.
The broad road of industrial organization of production and of property
forked visibly at a date somewhere near 1920. One branch-"management"is today readily identifiable as power. The other branch is equally identifiable
as paper or passive property or at least wealth-stock. We are obviously

moving forward on both fronts today. Divergence between the two branches
is daily becoming more marked. Let us pursue both. Both roads have

pushed out into that academic no-man's-land where economics, political

science, and law must be drawn on to account for present phenomena and,
if guidance is desired, to guide future developments.

Let it be noted that the comments hereafter made are analytic, not
"angry" criticism. The American industrial system, under guidance and
control, has done more for more people, has made possible a higher standard
of living for the vast majority of a huge population in a huge country, has
preserved more liberty for individual self-development, and now affords more

tools (however unused or badly used) from which a good society can be
forged so far as economics can do so, than any system in recorded history.
It is eons from perfection. It has, nevertheless, empirically arrived at results

that relegate both the communist economics of Karl Marx and the classic
economics of his contemporary, John Stuart Mill, and of the modern ex-

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1962] FUNCTIONS OF THE CORPORATE SYSTEM 437

positor, Ludwig von Mises, to a museum of nineteenth-century thought.
As with most museum exhibits, much can be learned from them; some of the
principles remain valid and are, as they should be, applied in the prevailing
American system.
III. THE ORGANIZATION OF POWER: MANAGEMENT

No one, including Professor Manne, now denies the essential separation

of ownership of the large corporation from its control. Thirty years have
markedly accentuated this separation. Mere growth in the number of shareholders and wider distribution of shares would have produced this result
in any case. Institutional holdings-by insurance companies, by pension trusts,
in the unexplored aggregates of personal trusts accumulating in a few great
banks, by mutual funds, and in foundation and charitable endowments-have
thus far operated to separate the ultimate beneficial "owners," or at least

beneficiaries, to astronomical distance from the industrial enterprises they

(in theory) collectively "own." Decision-making, the essence of any manage-

ment power, is increasingly removed from them; controls and qualifications

on decision-making come from quite different sources.

I gladly concede that the dishonest conflict of interest between management and shareholder ownership-that is, abuse by management of a position
in which it can divert a part of the profit and income stream to itself-has
not been accentuated. Again, it seems to me, our work may have been partly
responsible. By law and stock-exchange regulation, management is now

obliged to file and publish annual accounts of its trust, and quarterly interim
reports of its progress. It must make general disclosure of its operations
(a recommendation made in The Modern Corporation).8 In all respects the

businessmen-managers now operate under the glare of perpetual publicity.

Misconduct can give immediate rise to intervention by the state, intervention
far more practical than the classic stockholders' derivative action-although

that, in somewhat crippled form, continues as an active and potential restraint.

I have been accused of (and plead guilty to) believing that the businessmen
constituting managements in general are more trustworthy and that their
standards are higher, than was the case at the close of the twenties. While

human nature probably has not changed much, community standards do

develop, and they have. These have been implemented by institutions tending
to enforce them; the Securities and Exchange Commission, the various
regulatory commissions, elevation of securities exchange administrations to
8. BERLE & MEANS, op. cit. supra note 4, at 300-25. See the provisions of the
Securities Act of 1933, 48 Stat. 81, as amended, 15 U.S.C. ?? 77j-k (1958), and the
regulations of the Securities and Exchange Commission promulgated thereunder, 17
C.F.R. ?? 230-01 (1949 & Supp. 1961). Perhaps of more importance here are the provisions of laws applicable to the stock exchanges. See Securities Exchange Act of 1934,
48 Stat. 894, as amended, 15 U.S.C. ? 78m (1958).

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438 COLUMBIA LAW REVIEW [Vol.62:433

disciplinary agencies with the Securities and Exchange Commission looking
over their shoulders, more active state inspection, a better educated financial

press, more widespread use of congressional investigations, and the now lively
administration of the antitrust division of the Department of Justice. Even

so, there are times and areas when sentinels sleep and public apathy allows
slackness or crookedness to creep in.

Whereas in the past public opinion had little influence on the conduct

of corporate managements, today it is crucial, and every management knows

it. Whether this results from the wiles of public relations men or from other
forces is immaterial. Within the past few years the heads of two of the

nation's largest life insurance companies resigned because they were thought
to have transgressed, albeit without breach of law, standards of ethics to
which public opinion held them accountable. The executive head of the
country's largest electronics corporation demoted himself from direct execu-

tive power because some of his associates had indulged in criminal bid-

rigging and pleaded guilty thereto; as he was commanding officer, public

opinion held him accountable. The preventive effect of a public consensus on

standards of conduct can not be precisely measured. Undeniably it is great.9

In legal account, a lively interest in the attribution of value to power has

already begun. It is illustrated by the case of Perlman v. Feldmann,io in

which the Court of Appeals for the Second Circuit held the sellers, at a price
over the market, of a controlling block of stock in a corporation liable to
turn over the excess to the corporation or (as the remedy was molded in
this case) to divide it pro rata with their fellow but noncontrolling shareholders. Some day we shall probably have a case determining whether the
shares of a corporation whose money is made by managing investment trusts

(other people's money) on a year-to-year basis, and whose chief "value"

arises from that power, can be transferred from hand to hand or validly be
the subject of market operations."
Theory aside, we have Professor Manne's really surprising argument

that a proxy fight is in essence an economic mechanism affording economic

competition for the management prize in the management market or industry.
This describes a wholly imaginary picture. To begin, such fights in large
9. The three instances given-affecting the Equitable Life Assurance Society, Prudential Insurance Company of America, and General Electric Corporation-are spectacular and, happily, rare. There are many other illustrations of less prominence. See
Watkins, Electrical Equipment Antitrust Cases-Their Implications for Government
and for Business, 29 U. CHm. L. REV. 97 (1961).
10. 219 F.2d 173 (2d Cir.), cert. deified, 349 U.S. 952 (1955).
11. Such a case may be presently in the making. The Securities and Exchange
Commission is presently considering the application by Investors Diversified Service
(which sells and manages the investments of a number of mutual funds) for permission
to split its stock ten for one. Part of the stock has voting rights; part under an old
decree does not; the problem has arisen whether or not the holder of the voting stock
should be compensated because of the power he possesses. See SEC Investment Company Act Releases Nos. 3346, Nov. 2, 1961 & 3388, Dec. 19, 1961.

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1962] FUNCTIONS OF THE CORPORATE SYSTEM 439

corporations are extremely rare. J. A. Livingston in The American Stock-

holder'2 observed that proxy fights in corporations occur on an average once

in thirty-three years; even this average is misleading. In most really large
corporations they never occur at all. And when they do, they certainly are
not "competition" for a place in the "management industry." Proxy fights

are singularly uninspiring as a rule; the last important one (Alleghany Corporation), like most such contests, was quite obviously a sheer struggle
between two tycoons for power. In the Alleghany case the power related
to administration of several billions of large assets (mutual funds) and
railroads controlled, though not owned, by Alleghany stockholdings and
contract relationships. It is not wholly without significance that Alleghany
is almost the only remaining example of the unlimitedly pyramided holding
companies so popular in the era ending in 1933. It is, in fact, the top holding corporation of the old Van Sweringen railroad empire, now considerably
trimmed by time from its greatest extent.

Professor Manne himself is not wholly satisfied with proxy fights as a

variety of "free market" mechanism for management, conceding that this "is
not the most efficient scheme that can be devised for allowing a competitive

market for managers to operate."'13 This is a glistening addition to anyone's

masterpiece-of-understatement collection. A greater difficulty is that it does
not describe the phenomenon. You can not put a proxy fight for power like

that in Alleghany, or the proxy fight when Mr. Nelson Rockefeller recaptured
control of the management of Standard Oil of Indiana (to correct what he

considered substandard activity on the part of its President, Colonel Stewart)

into the "market" framework of Hayek, von Mises, or Professor Manne.
To do so is mere misdescription. The "market" for managerial talent of
course does exist. Corporations do bid for the services of able men at all
levels. They compete in hiring promising graduates of business schools and

in persuading executive vice presidents to leave the service of one corpora-

tion and enter another. Stockholders have nothing at all to do with this,
and proxy fights still less.

On the substantive side, there is more formidable objection to the Manne

12. 46-47 (1958). The relatively few proxy fights occurring each year will, on
examination, be found to be among the smaller corporations. The proxy fight between
the Murchison and Kirby interests for control of Alleghany is scarcely even an excep-

tion. Alleghany, through stock ownership, controls several hundred enterprises; but

the corporation itself holds (as a rule) minority interest and is so capitalized that, in
comparison with most large corporations, it has a relatively small amount of stock
outstanding. The real exception, which may prove the rule, was the proxy fight for
the New York Central won by Mr. Robert Young, who had obtained control of Alleghany.
The New York Central stockholders were later asked to approve reimbursement by the
New York Central of the very large campaign expenses.
The victor in a proxy fight not infrequently does arrange to have the corporation
whose control he has just won pay the expenses of the campaign. Courts allow this.
Just how this can be reconciled with Professor Manne's theory that a proxy fight reflects
competition in the corporate management market, I do not understand.
13. 62 COLUM. L. REV. at 420.

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440 COLUMBIA LAW REVIEW [Vol.62:433

theory. He believes managements are substantially bound by the capital
market-that is, that they must seek money and, to get it, must turn in a
brand of perforniance acceptable to the "market," by which he means to those

who merchandise or buy corporate securities. There is some truth in thisbut not much. We have now (as we did not in 1932) figures showing
where capital comes from. They arose because fifteen years ago Mr. Nelson
Rockefeller, then in private life, became interested in that simple but elemental

fact of American capitalism. The rough studies made for him by this writer

at that time were later done and done better by the Bureau of Business
Statistics of the United States Department of Commerce, which now maintains them in sequence. These studies show that, for the past decade (and
probably as far back as 1919, previous to which I have seen no really good

data), sixty per cent of all capital entering industry was "internally gener-

ated."'14 This was composed of undistributed profits and accumulations for

depreciation and depletion, these last being of course free of income tax.

They piled up primarily in the treasuries of corporations, especially the large

ones. An additional twenty per cent of the capital invested in industry came
from bank credit-largely in anticipation of such accumulation.

The "capital market"-investors' savings-thus accounted, and now accounts, for only twenty per cent of the capital annually invested in industry.

The greatest advantage seems to fall to the largest corporations, at least in

part because those having assets of $250,000,000 and over report a consistently
higher profit ratio than their smaller brethren. In this group of corporations
-except for public utility companies, whose regulation does not permit
internal generation at so great a rate-examples are many of concerns whose
growth is almost entirely a result of their internal capital accumulation.
Public utilities aside, the large corporations do not seek substantial capital
either by floating bonds or new stock issues, save on very rare occasions.15
14. A ten-year summary, covering the years 1947-1956, was made by the United
States Department of Commerce, Office of Business Economics. 37 SURVEY OF CURRENT
BUSINESS 8-13 (1957). The annual calculations made thereafter by the same office

indicate that the ratio has remained roughly constant.

A breakdown shows that public utilities went into long-term capital markets for

more than 50%o of their new capital. The next largest group-manufacturing and
mining-asked the market for something less than 20%. The trading and commerce

group asked for very little.

If purely open market forces prevail in the capital markets, their effect is severely
limited, in any case, and still more severely limited in the non-public utility field. Public
utilities are not free market enterprises; they are in the main regulated monopolies.
15. Professor Joseph L. Weiner, in an address before the Practicing Law Institute
in New York City, Jan. 13, 1962, quotes the current Securities and Exchange figures for

common stock flotations:

In 1960: 1.46 billion;

In 1961: Probably around 3 billion (1961: a record year).

These figures would appear to be not more than 10% of the estimated actual additional investment by industry in its plant, equipment, and capital facilities. Figures for
1960 and preliminary figures for 1961 indicate that, of new securities issues, communications and public utilities accounted for 39% of all new issues in 1960, and 37% of such

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1962] FUNCTIONS OF THE CORPORATE SYSTEM 441

More important yet, these internally generated capital accumulations

constitute the most active, decisive, and determinative of all capital funds.

They are "risk capital," in the hands of and applied by competent men-the
corporate managers in fact. A degree of influence over large corporations

by capital markets probably still exists, but it has become minimal except in
the utility industry. Public utilities, as Professor Manne rightly observes,
are regulated monopolies, and in large measure are outside the scope of the

assumed "free market system." These enterprises, indeed, take up the largest
share of the twenty per cent of outside capital (personal savings) entering the
industrial system.
Probably the greatest single power inherent in corporate managements is

their allocation of the risk capital they thus accumulate. In doing this they

unquestionably attempt, but within limits, to seek the highest return. To that
extent they follow the market mechanism so dear to the classicists. Yet the
limits are substantial. First claim on allocation is the expansion of those

varieties of production for which the corporation has assumed responsibility

-"our own business," in the board-room cliche. Second claim goes to activities and enterprises readily capable of being related to the corporation's

central business and to its area of technical competence and knowledge. An

oil company having a reserve of risk capital may learn that immense profits
can be made, let us say, in mining diamonds or manufacturing women's
dresses. But they will pass up these opportunities. If they do not develop
new oil production, they will tackle petro-chemicals, because these are re-

lated to their central activity.

I do not believe that the resulting system badly allocates capital resources,

although not infrequently the allocation is lopsided. Corporations that have

accumulated large amounts of risk capital allocate it to those enterprises most
convenient and profitable in connection with their own enterprises, not where
issues in 1961 (the telephone industry is obviously the major factor in communications).
These figures include both stocks and bonds.
Market considerations undoubtedly do affect the bond market. There is substantial
competition for long-term, interest-bearing securities (of which nearly $10,000,000,000
were issued in 1961). The market unquestionably does exercise some influence in "allocating" bond capital. Industrial corporations are minor takers of bond capital. After

communications and public utilities industries issues (39% in 1961), the next largest
capital seekers are finance and real estate companies (16% of new issues in 1961).

Flotations of common stock, even including the utilities and communications companies (both severely regulated), are secondary in amount.
On January 21, 1962, the Securities and Exchange Commission reported that the
total of new securities offered in 1961 was just under $13,000,000,000. But the total

stock issues were only $3,300,000,000-though 1961 was almost a record year (in 1960

stock issues amounted only to $1,700,000,000). Of this amount, the lion's share again
was taken by the communications and public utilities industries-the regulated, not the
free market companies. And with respect to the regulated companies, it is fairly arguable
that the regulation under which they work as licensed monopolies "allocates" capital far

more drastically than the securities markets. As to the purely industrial corporations,
as noted in the text, it is difficult to see how the stock market allocates capital at all.
In its unpredictable fashion, the stock market "allocates" the distribution of existing
shares of stock in established companies, and with them, the increase or decrease of
value assigned to the operations of the issuing corporations as these grow or diminish.

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442 COLUMBIA LAW REVIEW [Vol. 62: 433

it is most needed. Their capital accumulations do not rove the market seeking the highest profit or the most useful allocation available on the economic

scene. My point here is that a powerful modifier has been introduced. It may
well be that the modification is beneficial, better planned, contributes more

to stability, and produces, over the long run, better results. But it is scarcely
in accord with the full free-market theory of capital allocation.

I note, without here elaborating, the fact that far more American indus-

tries are in the "planned" category than is commonly realized. The so-called

"defense" industries (including aircraft) are in effect dominated by the planning operations of the Department of Defense. The oil industry is governed
by a highly developed external planning system (the Interstate Oil Compact,'6
plus consumption estimates of the Bureau of Mines, plus regulation of produc-

tion enforced by the Connally Hot Oil Act).17 Sugar is "planned" by government adjustment of import quotas. Copper, lead, and zinc production and
markets are modified if not controlled by the power of the United States

Government to restrict imports. Free market theorists do not approve. Yet

it is scarcely accident that almost nowhere in the world, and certainly not
in the United States, has the classic free-market system remained free from

control, a result effected either by over-all national economic planning or by

ad hoc national planning affecting key industries.'8 The United States

combines elements of both methods, which affect many of the major sectors

of her "private" industry.

"Business statesmanship" and the assumption of social responsibility by

management comes in for a salvo of courteous attack by Professor Manne

and his friends. So indeed it must, from their point of view. In assuming
responsibility for certain aspects of community life, in making gifts to charity,
in playing any role in economic statesmanship not dictated by market con-

siderations, the corporate management traitorously departs from the discipline

of seeking the highest possible profit, regarded by classicists as the motive
driving all into the court of the "free market"-the supreme and beneficent

arbitrator. When these recreant managements depart somewhat from their

devotion to making the last market-dollar for their stockholders, they denigrate
the market mechanism and are thus faithless to their profit-seeking trust.
The discussion I had with the late Professor E. Merrick Dodd of Harvard
was just such a debate.19 I there took the same side that Professor Manne
16. An Interstate Compact to Conserve Oil and Gas, 57 Stat. 383 (1943).
17. 49 Stat. 30 (1935), as amended, 15 U.S.C. ?? 715-715n (1958).
18. See, e.g., report of "Economic Planning in France," the record of a conference

held by the National Institute of Economic and Social Research, London, April 20-22,

1961, in 27 POLITICAL & ECONOMIC PLANNING, No. 454 (1961). Or, on the other side

of the world, India's THIRD FIVE YEAR PLAN: SUMMARY (Government of India Planning
Commission, Publications Division, New Delhi 1961).

19. Dodd, For Whomii Are Corporate Managements Trustees?, 45 HARV. L. REV.
1145 (1932); Berle, For Whom Corporate Maianagers Are Trustees: A Note, 45 HARV.

L. REV. 1365 (1932).

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1962] FUNCTIONS OF THE CORPORATE SYSTEM 443

does now, though for rather different reasons. I was afraid of corporate
managements as social statesmen, or possibly as controlling fund-donors for
universities and other philanthropies, not because I objected to the job being
done, but because I thought corporate managements were not especially
qualified to do it. In doing it they might revert to their classic profit-making

function, and in that case would do the job badly-or worse. Events and the
corporate world pragmatically settled the argument in favor of Professor
Dodd. Legal sanction was duly given in the case of A. P. Smith Mfg. Co. v.
Barlow.20 The New Jersey Supreme Court held that a statute authorizing
corporations to make gifts from the corporate treasury was constitutional,
even though the managements were thus empowered to give away money
"belonging" to their stockholders. The Supreme Court of the United States
in negative fashion sanctified the decision, denying appeal on the ground that

no federal question was involved.2' Statutes of this kind have now been
enacted in practically every state in the Union. Corporation gifts directly to
philanthropy, or to philanthropic foundations of their own creation for later

distribution to charity, are now standard practice. Several billions of such

gifts are annually counted on by universities, hospitals, and other institutions.

On the "social statesmanship" side, perhaps the greatest exercises of

function have been in establishing pension trusts (now aggregating roughly
forty-five billions of dollars in toto) ; in dealing with labor negotiations, some
of which set industry-wide frameworks for wages, conditions of work, and
attendant matters; in determining whether operations shall be centralized
or decentralized; in channeling corporate activities between cities and regions;
and in laying out the general direction of an immense amount of primarily
theoretical scientific research. Obviously, many other matters are dealt with
as well. These functions were assumed by the managements because they

had to be. Failure to do so might have led to explosion, especially where

conditions that were considered intolerable existed.
Perhaps the United States Steel Corporation should have fought to a

finish against unionization of big steel and to maintain the twelve-hour day;
the late Myron Taylor, then its head, thought not, and induced its competitors
not to do so either. In these and like matters, company managements really act

as absorbers of the first wave of social shock. Should they not do something

in these fields, I believe (and so do they) that the impact would be such as
to force the government to intervene. I rather doubt that Professor Manne
would consider that more desirable than assumption of these tasks by the
corporate managements. This is not to suggest that we have reached first-

rate solutions. Planning, stabilization, continuity, and provision for the future
undoubtedly can be better taken care of than they are now. In many areas
20. 13 N.J. 145, 98 A.2d 581, affirming 26 N.J. Super. 106, 97 A.2d 186 (Ch. 1953).

21. 346 U.S. 861 (1953).

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444 COLUMBIA LAW REVIEW [Vol.62:433

where corporations did not or could not undertake social responsibility-for
example, ending race discrimination in employment and in giving serviceappeal has to be and now is being made to the state. But profit-making in
the free market is not the controlling factor.
I anticipate-and do not agree with-the probable observation that these

assumptions of statesmanlike function have in some roundabout fashion resulted from a purely economic, profit-seeking choice. Obviously, having

assumed one of these burdens a corporation will put the best commercial
face it can on the action in question. Conceivably, corporate charity can be
tortured into a form of possibly profitable advertising. Gifts to the local

community chest may be explained as a method of avoiding taxation. Foregoing outrageous profits in time of shortage (as both the steel companies and
automobile manufacturers did in 1947-1948) may be justified as creating a
favorable "market climate," translatable later into sales and profits, and so
forth. Verbally, one can twist the "profit-seeking" operation into strange
activities. The fact is that boards of directors or corporation executives are
often faced with situations in which quite humanly and simply they consider
that such and such is the decent thing to do and ought to be done. Or if one
chooses, that it is a politically expedient thing and ought to be done. They

apply the potential profits or public relations tests later on, a sort of lefthanded justification in this curious free-market world where an obviously
moral or decent or humane action has to be apologized for on the ground that,

conceivably, you may somehow make money by it.

The result at all events has been that in a range of action, where social,
political and human problems are pushed up, corporate managements are
frequently the first line point of impact. They deal with these as best they

can; failing, they or others invoke political or governmental action.

Finally, the age-old problem of legitimacy. This is implicit in any power

situation. Why do these men have decision-making power rather than someone else? Why he and not me? If we assume, as I think we must, that election of directors by stockholders has become, in large corporations, a ritual
rather than a reality, its legitimacy-bestowing function becomes extremely
weak. Yet the ensuing reality-self-perpetuating boards of directors conforming to a public consensus, and chosen (as most public officers are) with ob-

servance of at least minimal levels of demonstrated character and ability-

on the whole has worked remarkably well. Manne is entirely right when he

says, in brilliant phrase, that I have "legitimatized them on the firing line."22
I do not see that a better meanis of selection has yet been devised.
Schemes of "corporate democracy" mean little more in their reality than
committees, as unrelated to the body of stockholders as are directors, who
22. 62 COLUM. L. REV. at 418.

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1962] FUNCTIONS OF THE CORPORATE SYSTEM 445

make nominations on undisclosed premises. Standards of public consensus
as to management character and capacity can and perhaps should be raised;
they are being raised in connection with directors of fiduciary institutions,
notably banks and insurance companies; they are in fact being gradually raised
year by year in the case of all really large corporations. For the present, the

system on the whole functions successfully; the public consensus moves in

fairly rapidly when trouble becomes apparent; the government supervisory
system does reasonably well at making situations apparent, and there seems
to be no immediate cause for alarm. But, in the name of straight thinking,
honest academic description and the Queen's English, let us not bedevil ourselves by calling this a "management market." It is a variety of non-statist
politics which, at the moment, is giving a quite respectable account of itself.
In fact, a large corporation is a variety of non-statist political institution.
IV. THE BROAD ROAD OF PROPERTY

When Professor Manne discusses the other aspect of separation of

ownership from management, and talks about property, I find myself in

almost total disagreement. He believes that Dr. Means' and my notions of
property were "erroneous." As nearly as I can ascertain, he rejects the
conception that property includes any element of relationship between a man
and a thing:

[T] he only essential characteristic of a private property system is

that an owner must assume the risk of a rise or fall in the market
value of his property.23

Verbal redundance, of course, destroys the value of this statement as defini-

tion: "private property" is merely the assumption of risk of a rise or fall

in the value of "property," whatever "property" may be. It is anything, one

supposes, that has a "market value." This, perhaps rightly, equates a share
of stock in General Electric to a ticket in the Irish Sweepstakes.
Classic theory indeed assumed that the individual devoting property to

investment took a risk that the enterprise or management he backed with

his money would be useful and successful-or useless and unsuccessful.
The buyer of a share of stock today unquestionably takes the risk of its rise or

fall; and in theory and (to a qualified extent) in practice, the rise or fall has
a vague relation to the success or failure of the corporation in its operations
(a sweepstake ticket has a similar unpredictable relation to the speed of the
horse). A purchase of stock is, in effect, a bet between outsiders on its
success or failure-when it is not a blind bet on the "market." That particular connection between risk and operation gives the market for corporate

stock whatever validity it has. So far, so good. But when it is claimed that,
23. Id. at 407 n.20. (Emphasis added.)

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446 COLUMBIA LAW REVIEW [Vol.62:433

because of this, the stock market is an "allocator of capital" (not to mention
a place where an adverse vote against the management can be registered by a
sale) I, for one, find myself at odds. Manne's description does not at all
seem to fit the facts.

When I buy AT&T or General Motors, I do not remotely "invest in"

either concern. I have bought from Nym, who bought from Bardolph, who
bought from Pistol, who bought through ten thousand predecessors in title
from Falstaff, who got the stock when originally issued. Let us assume Falstaff

was a genuine investor-that he bought the stock directly from the corporation, or as promoter, or in some other fashion contributed to the enterprise.
This contribution, the only real "investment" in the chain, was probably an
infinitesmal fraction of the price I paid to Nym. Now what Nym does with
the price he receives from me nobody knows; the one certainty is that he
does not contribute any of it to AT&T or General Motors. In one set of
circumstances, we do know approximately what happens. This is in the
case of "institutional" buying and selling. It accounts for about twenty per
cent of all stock exchange transactions. When the X mutual fund sells AT&T
it commonly uses the proceeds to buy General Motors or some other stock.
But, again, it is certainly buying stock from Nym, not putting money into
General Motors. By folklore habit we say the buyer of stock of AT&T or

General Motors has "invested in" these companies; but this is pure fiction.
Now if General Motors were regularly raising capital by selling stock in
the market, my purchase of General Motors stock from Nym would have an
effect on the price of its shares. This in turn would have an effect on the
price at which General Motors could float a new stock issue. In the utilities
industry, where new stock issues are standard practice, there is a traceable

effect on the price the utilities pay for new capital. But the great industrial
companies do not (or only at very rare intervals) seek capital by floating
common or any other kind of stock. Many companies, and these the largest,
either have never done so or have done it so rarely that the rise and fall of
the price of their shares has no traceable effect on the price they have paid

or will later pay for capital; for the most part they generate their capital
internally. So far as they are concerned, the market price for their stock
has only a psychological effect. In fact, if the stock market shut down completely (as it did in 1914), or if all of their stock were miraculously wiped

out, it would not have a great effect on their operations, though it might
have tangible effect on the number of buyers ready, willing, and able to buy
their cars or washing machines.

It is theoretically possible, of course, that the money invested by people

buying in the stock market somewhere, somehow, contributes to investment
capital. It would have to be demonstrated that a margin of the sellers of
stock eventually "invest" some of their proceeds in new enterprises or new

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1962] FUNCTIONS OF THE CORPORATE SYSTEM 447

security issues. But Professor Manne does not know whether that is the fact,
and neither do I. No one has ever traced what happens to the outflow of
money received by sellers of stock. The part of it that is not immediately
"reinvested" in the stock market is as likely to go for consumption or to pay

inheritance taxes or Junior's college bills as for anything else. No one knows.

What all this comes to is that the stock market is an allocator, not of
capital, but of wealth-a quite different proposition. In this aspect, it is a
substantial factor. The aggregate assumed market value of all the stocks

listed on the stock exchanges of the United States (a figure never accurately
calculated so far as I know; endless duplications and corrections are involved)
is on the order of four hundred fifty billion dollars, fluctuating, of course,
from day to day. As in the case of a commercial bank, if everyone wished to

monetize his assumed stock value by selling, that value would disappear, just
as the deposits in commercial banks "freeze" when there is a run on the

bank. The market fulfills its function by having a paying teller's window

delivering cash to sellers of stock, financed to a roughly equal extent by a

receiving teller's window into which buyers put cash and receive their pieces
of paper.

As allocators of wealth, the stock markets dq a job that Americans,

rightly or wrongly, seem to want to have done. True, the allocation is irra-

tional. Three men who have saved their money respectively buy International
Business Machines, AT&T, and New York Central Railroad-all enterprises

of obvious usefulness to the community. The IBM investor some years later
turns out a millionaire, the AT&T investor may perhaps have trebled his
money, the investor in New York Central stock has suffered substantial

loss. This is only slightly more rational than buying three tickets in a lottery,

one of which wins a good prize, one comes out with a low-grade approximation, while the third draws a blank. (I have sometimes felt that, if the
capitalist system in its present form goes under, it will not be because it is
immoral but because its wealth allocation system is essentially irrational.)
I do not see that Professor Manne and his friends have demonstrated its

function as allocator of capital with any solid base, though it had such a

function, I believe, fifty years ago. What remains now is, I submit, far
removed from the classic theory that "wealth" constitutes "capital" and is
regularly "put to work" by investment, of whose outcome the wealth-holder

"takes the risk." A vestigial remnant of the old relationship remains-the risk,
psychologically attached to the enterprise, just as the sweepstake lottery ticket-

holder takes the risk on the horse. But that vestigial remainder can, I think,
be described (this time with accuracy) as "folklore."
Attempts to rationalize property under this system might have been
expected. In fact, it is happening. In very limited degree common stock is

aggregated by insurance companies; the wealth resulting from the increasing

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448 COLUMBIA LAW REVIEW [Vol.62:433

wealth of corporations is balanced against certain kinds of risk, and is used

to equalize losses. More recently, mutual funds have aggregated corporate

stock, spreading gains (which over long periods of time seem steadily to
outbalance losses) more or less evenly among the wealth-holders who buy
their shares. (The current question is not whether these institutions are
desirable-they are-but whether or not their managers charge far too much
for their services as distributors and managers.) Third, pension trust funds

aggregate these stocks; the increased wealth they gain is eventually allocated
through the pension arrangement to take care of old age and other vicissitudes
of life for many millions of beneficiaries; this is a solid advance in rationalizing the system. Fourth, corporate stocks in increasing measure are aggregated
in the endowment funds of universities, foundations, hospitals, and all manner
of socio-service activities; the trustees of these funds allocate the increased
wealth where they consider it needed or useful. Finally, about one-fourth of

the gains realized by individuals is taken by the federal government through

capital gains tax as, more or less irrationally, their wealth is increased by
growth in market value. In addition, a further substantial fraction of these

gains is socialized through gift and inheritance taxes.

These five categories of aggregation and rationalization do represent

a solid evolution in the system of passive property and wealth allocation.
This being a law review article, I observe here that their legal relationships
have not been worked out. No one quite knows what the relation of the beneficiary of a pension fund is to its management, let alone to the corporations
whose stock the fund holds. I am of opinion (without certainty) that his
"beneficial interest" has been completely, solidly, and finally severed from the
economic and productive enterprise of the corporation whose shares form the
corpus of the trust, on whose success, at long last, he and his fellow bene-

ficiaries depend.

Dr. Means and I wrote thirty years ago that property was in flux, and

we suggested that the classic economic logic did not apply. It applies even
less in 1962 than in 1932. For the fact is that purely passive property-that

is, property divorced from any responsibilities of ownership, whose value

grows or diminishes in the owner's hands without any relationship to his risktaking, work, or effort-has outlived most of the economic justification that
gave it birth. It must seek new philosophical as well as economic bases.
These can be found indeed, but not in terms of "investment" or "capital

markets." This, however, is a different subject not apposite here.24

24. The peculiar qualities of passive property, primarily attractive because of its
extreme liquidity, I discussed in BERLE & PEDERSON, LIQUID CLAIMS AND NATIONAL
WEALTH: AN EXPLORATORY STUDY IN THE THEORY OF LIQUIDITY (1934), and commented that in 1932 the total of stocks and bonds listed on exchanges in the United

States was on the order of $40,000,000,000-as against the figure of $450,000,000,000 for
stocks alone listed on the New York and other American exchanges today. I noted

the steady increase, interrupted to be sure by the great depression that began in 1929,

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1962] FUNCTIONS OF THE CORPORATE SYSTEM 449

I find this failure to redescribe and rethink passive property frightening.
Attempts to describe it as nineteenth-century "investment" seem largely unreal. Essentially, this form of wealth more nearly resembles bank depositsa form of currency. Precisely because it is malleable, and can be directed, it
offers an opportunity unique in history to accomplish popular distribution of
wealth without tyranny, and also without interrupting the productive processes

that have, on the whole, achieved striking success. Also, it offers surprising
opportunity for abuse. When Dr. Means and I observed in 1932 that property
was in transition, I think we understated the case. When we said the corporate system bade fair "to be as all-embracing as was the feudal system in
its time," we were, quantitatively (so far as industrial wealth is concerned)

not too far wrong. When we concluded that the traditional theories of property no longer applied to the relation of stockholders in large corporations to
the underlying production and wealth, and that the applicable logic would

become increasingly social, we were stating a plain fact. When we stated that

the corporation would be operated financially in the interest of "control,"

we stated at least part of what has happened. Not that the "control" or the
managements have become thieves; quite the contrary. Rather, they have
come to recognize (perhaps as "business statesmen") that first claim on ac-

cumulated profits is the claim of the enterprise itself-that, for example, the
first duty of a steel company is to make steel, and have it there in sufficient
quantity to meet the existing or foreseeable future requirements of the community. These needs take precedence over the dividend desires of any body of

passive stockholders-as indeed they should.

Continuously, subtly, and imperatively the relationships have thus continued to change in the past thirty years. Probably more changes are due

as the proportionate volume of passive property increases. They will register

themselves in all manner of ways, from national planning and more intelligent

handling of taxation, to possible inducements offered for extremely wide

distribution of this passive property-until, perhaps, practically every American family, in one form or another, thereby shares in the conltinuing advance
of the industrial system. And, no doubt, they will be manifested in other
ways as well. I see no possibility of avoiding this. The more rapidly it comes,

perhaps the better for all of us. Meanwhile, I do not find that endeavoring
to describe late twentieth-century processes, institutions, and relations in the
terms of nineteenth-century economic folklore does more than impede the
discussion.
in the ratio of liquid claims (including stocks) to the national wealth. Id. at 220. The
ratio of the assumed market value of stocks (purely passive) to total national wealth
has been and still is steadily rising.

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