Corporate Law’s Original Sin

The public be damned,” railroad magnate William Henry Vanderbilt snorted at a reporter in 1882. The impertinent scribe had asked whether Vanderbilt ran his railroads with an eye toward public benefit. At the time, Vanderbilt was among the most powerful men in American business—and by his own estimation the richest man in the world. His figurative middle finger to the American public was big news, appearing on the front page of hundreds of newspapers within twenty-four hours.

The week before his comment, two trains had collided on his railroad inside the Fourth Avenue tunnel in New York City, killing two passengers and injuring hundreds. Many New Yorkers blamed the accident on Vanderbilt’s unwillingness to cut into profits by spending money on safety measures. His contemptuous words, spoken as he dined in his private train car, salted an open wound. The satirical magazine Puck ran a cover cartoon of a ballooned, profligate Vanderbilt wearing a diamond pin, smoking a stogie, and leaning back in a leather chair with a foot on the throat of an eagle dressed in Uncle Sam garb.

Impolitic as it was, Vanderbilt’s comment embodied the business and political philosophy of the monied classes of the Gilded Age. And for the most part, the law was a willing ally. The Supreme Court of the era repeatedly stepped in to protect business from regulatory obligations. Its most famous decision of this kind was the 1905 case Lochner v. New York, striking down a law establishing a sixty-hour maximum workweek for bakers. New York’s law was part of a broader effort of relatively meek legislative initiatives that included minimum wage laws and bans of child labor. The Court’s libertarian reasoning undermined any regulatory protections of employees or consumers. Attempts to constrain corporate power with the use of regulation would be struck down, in the Court’s words, as “an illegal interference with the rights of individuals.”

The “Lochner era” lasted for nearly half a century; it did significant harm. Attempts to protect consumers, children, and immigrant workers were thwarted by free market ideology masquerading as constitutional law. The Lochner constitution was a Social Darwinist law of the jungle. Upton Sinclair’s The Jungle—a wilderness of unregulated greed and contempt for the
public—was what we got.

But constitutional law was not the only problem. Corporate law, too, helped to keep corporations with a narrow set of obligations. A fight between Henry Ford and his rivals John and Horace Dodge gave rise to the pivotal articulation of the rule.

In the second decade of the twentieth century, Henry Ford was making money—an incredible fortune of money—making cars. Ford Motor Company, the company in which he was the dominant shareholder, was selling his masterpiece
Model T as quickly as it could be produced. By the middle of the decade, the company was doing so well that shareholders were receiving each month in scheduled dividends an amount equal to their initial investment. The company also declared “special” dividends for several years, as much as $11 million in 1914.

Today, we are well aware of the dark side of Henry Ford’s influence—his funding of anti-Semitic propaganda, his financial support for Hitler. But in the teens and twenties, Ford cultivated an image of a benevolent mogul. He made headlines in 1914 with his “Five-Dollar Day,” when he doubled the wages of all his workers, explaining to the New York Times that companies had a direct role in improving the lives of the working class. His rhetoric sounded radical: “I believe it is better for the nation, and far better for humanity, that between 20,000 and 30,000 people should be contented and well fed than that a few millionaires should be made.”

In 1916, Ford declared that special dividends had come to an end. He wanted the money to build a new auto manufacturing facility, to be the largest in the world. (The factory that was eventually built, the River Rouge plant, built everything from Model As in the 1920s to Mustangs in the 2000s. A facility on site assembles F150 trucks even now.) Ford brashly claimed that his decision was motivated by a desire to do social good for the company’s employees and customers, arguing that shareholder gain was not the purpose of a successful business but its by-product. A business was about more than making money for shareholders, he said. It was about satisfying the obligations of a robust social contract, doing “as much good as we can, everywhere, for everybody concerned … [a]nd incidentally to make money.” Ford demoted the role of shareholders and promoted the status of workers, saying in an interview with a local newspaper reporter that the profits earned by shareholders had been “awful” and that he wanted to drive down the price of his cars so more benefits could flow to “users and laborers.”

The shareholders were not amused. Particularly upset were the Dodge brothers, John and Horace, who owned 10 percent of Ford stock. Though they had already made more than a 40,000 percent return on their initial $10,000 investment, they sued for more, asking the Michigan courts to force the board of Ford Motor Company to declare a special dividend. It was a crafty demand. The brothers ran the car company that bore their name, a rival to Ford. An extraordinary dividend from Ford Motor Company would both drain it of its financial surplus and provide cash to capitalize the Dodges’ own competing car company.

Henry Ford understood as much. He had no reason to fill the coffers of a competitor, and numerous solid business reasons to keep the capital in-house and keep his customers and employees happy. But instead of defending his refusal to issue special dividends as an exercise of his considered business judgment, which was both true and something that would have easily won the deference of a court, Ford defended his actions by relegating shareholder interests and bringing workers’ rights to the forefront: “My ambition is to employ still more men, to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes. To do this we are putting the greatest share of our profits back in the business.” The Dodge brothers seized on that rhetoric as evidence that Ford was using the company to further his own social agenda.

The case eventually made it to the Michigan Supreme Court. Ford’s assertions of worker rights and shareholder subordination—in an era when the Russian Revolution had already begun and socialism was on the rise in the United States—were too much for the state court to endorse. Legal scholar Todd Henderson explains that “if a firm as large and important to the American economy were permitted to pursue an overtly socialist strategy, the political impact and the effect on other firms could be enormous.” On the surface, the case was about whether shareholders were due some dividends. But more fundamentally, Henderson says, it was a “test case of the foundations on which American capitalism would be built.”

The eventual decision was, and still stands for, an iconic statement that corporations have no obligations beyond the bottom line. In one of the most famous passages in the history of corporate law, the Michigan supreme court announced,

A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction in profits, or to the nondistribution of profits among stockholders in order to devote them to other purposes.

Courts, then and now, follow something called the “business judgment rule”—meaning that they did not, and still do not, typically overturn the considered decisions of corporate managers. But Ford’s rhetoric of worker and customer protection was so radical that it moved the court to rule such motivation out of bounds. Dodge v. Ford was a pivotal moment in the development of corporate law. It defined the core purposes of corporations as being distinct from—even contrary to—the interests of workers, customers, and society. The case remains, a century later, as one of the first opinions law students read in their introductory business law course. It is corporate law’s original sin. —K.G.

Kent Greenfield

Kent Greenfield is professor of law and Dean's Research Scholar at Boston College Law School. He is the author of The Failure of Corporate Law: Fundamental Flaws and Progressive Possibilities and The Myth of Choice: Personal Responsibility in a World of Limits.