1 Important ConceptsIn his landmark work "Wealth of Nations," Adam Smith recounts a fascinating history of development of commerce. From the days of feudal lords, to those of merchants, guilds and sovereigns, he narrates a logical sequence of evolution that has led to the current day "corporations".As business grew, it was felt that businesses might outlive the proprietors. Thus surfaced the concept of treating the business as a separate legal entity. Then, to encourage a spirit of entrepreneurship and risk-taking, the concept of limited liability was introduced. This assured the business owner that he/she would be liable to a limited extent in case of the failure of business. Soon, it ...view middle of the document...
New members will be induction, and the operations of the business will continue unabated. It also reflects the view that a corporation is a perpetual entity that lives forever.1.2 Separation of Ownership and ManagementInvestors in the early eighteenth century were primarily family members, partners, friends, and local people who could directly oversee the operations of the enterprise and who had enough knowledge to ensure it was properly run. As enterprises grew larger and diverse, capital needs exceeded the resources available with the "family". Also, the management needs of such complicated businesses could not be satisfied by the limited expertise available in the family.External investors were needed to fund the growing businesses. But, the investors, removed from direct observation and more sophisticated in their operation than one person or family could manage, required alternate mechanisms to guarantee that their investments were protected and being used judiciously.To gain the confidence of the shareholders/investors, businesses employed professional managers separate from the promoters. Thus, professional management hierarchies evolved, with regular reports and oversight. Also, the corporate ownership that evolved was one where investors could hold rights in the enterprise (in the form of shares); and these could be freely bought and sold.Thus, separation of ownership and management has proven enormously beneficial to both owners and managers, since it brings together those who have capital but not necessarily the skills or time to run a business and those who have managerial skills but not necessarily the capital.1.3 Limited LiabilityThe law provisions that the owners are usually not personally liable for any of the corporation's debts or obligations beyond their total investment. As a general rule, therefore, creditors or other claimants may not go "behind" the corporate entity to reach the assets of the owners. This concept of limited liability rests on sound public policy; it encourages entrepreneurship and competition, and facilitates the raising of capital and public ownership of corporations, all of which benefit consumers and the economy as a whole.Menell indicates three basic economic justifications for limited liability:1. It fosters economic growth by encouraging investors to take risks;2. It facilitates the efficient spreading of risks among corporations and their voluntary creditors;3. It avoids the enormous litigation costs that would be required for creditors to seek recovery from shareholders (if they were charged with unlimited liability)It should be noted that the social justification of limited liability stems from the move towards "separation of ownership and management". The shareholder, as owner of a corporation, enjoys limited rights. For example, he cannot sell the property of the corporation; all he can do is transfer his shares. Common sense also suggests that it is not fair to hold a shareholder persona...
