23 Things They Don't Tell You About Capitalism

Shareholders may be the owners of corporations but, as the most mobile of the ‘stakeholders’, they often care the least about the long-term future of the company (unless they are so big that they cannot really sell their shares without seriously disrupting the business). Consequently, shareholders, especially but not exclusively the smaller ones, prefer corporate strategies that maximize short-term profits, usually at the cost of long-term investments, and maximize the dividends from those profits, which even further weakens the long-term prospects of the company by reducing the amount of retained profit that can be used for re-investment. Running the company for the shareholders often reduces its long-term growth potential.

Karl Marx defends capitalism

You have probably noticed that many company names in the English-speaking world come with the letter L – PLC, LLC, Ltd, etc. The letter L in these acronyms stands for ‘limited’, short for ‘limited liability’ – public limitedcompany (PLC), limitedliability company (LLC) or simply limitedcompany (Ltd). Limited liability means that investors in the company will lose only what they have invested (their ‘shares’), should it go bankrupt.

However, you may not have realized that the L word, that is, limited liability, is what has made modern capitalism possible. Today, this form of organizing a business enterprise is taken for granted, but it wasn’t always like that.

Before the invention of the limited liability company in sixteenth-century Europe – or the joint-stock company, as it was known in its early days – businessmen had to risk everything when they started a venture. When I say everything, I really mean everything – not just personal property (unlimited liability meant that a failed businessman had to sell all his personal properties to repay all the debts) but also personal freedom (they could go to a debtors’ prison, should they fail to honour their debts). Given this, it is almost a miracle that anyone was willing to start a business at all.

Unfortunately, even after the invention of limited liability, it was in practice very difficult to use it until the mid nineteenth century – you needed a royal charter in order to set up a limited liability company (or a government charter in a republic). It was believed that those who were managing a limited liability company without owning it 100 per cent would take excessive risks, because part of the money they were risking was not their own. At the same time, the non-managing investors in a limited liability company would also become less vigilant in monitoring the managers, as their risks were capped (at their respective investments). Adam Smith, the father of economics and the patron saint of free-market capitalism, opposed limited liability on these grounds. He famously said that the ‘directors of [joint stock] companies… being the managers rather of other people’s money than of their own, it cannot well be expected that they would watch over it with the same anxious vigilance with which the partners in a private copartnery [i.e., partnership, which demands unlimited liability] frequently watch over their own’.[1]

Therefore, countries typically granted limited liability only to exceptionally large and risky ventures that were deemed to be of national interest, such as the Dutch East India Company set up in 1602 (and its arch-rival, the British East India Company) and the notorious South Sea Company of Britain, the speculative bubble surrounding which in 1721 gave limited liability companies a bad name for generations.

By the mid nineteenth century, however, with the emergence of large-scale industries such as railways, steel and chemicals, the need for limited liability was felt increasingly acutely. Very few people had a big enough fortune to start a steel mill or a railway singlehandedly, so, beginning with Sweden in 1844 and followed by Britain in 1856, the countries of Western Europe and North America made limited liability generally available – mostly in the 1860s and 70s.

However, the suspicion about limited liability lingered on. Even as late as the late nineteenth century, a few decades after the introduction of generalized limited liability, small businessmen in Britain ‘who, being actively in charge of a business as well as its owner, sought to limit responsibility for its debts by the device of incorporation [limited liability]’ were frowned upon, according to an influential history of Western European entrepreneurship.[2]