Incorporation laws Summary

  • Last updated on November 10, 2022

In the United States, nearly 4 million corporations generate more than 85 percent of the country’s gross business receipts. The laws that regulate the formation and operation of corporations affect their efficiency and profitability and thus play a major role in the national economy.

Corporations are owned by shareholders, each of whom owns a percentage of the corporation. Ownership is often represented by shares of stock. The shareholders elect a board of directors, which runs the major operations of the corporation. The board of directors chooses the chief executive officer (CEO), president, treasurer, and other officers of the corporation, who in turn run the day-to-day functions of the corporation.Incorporation lawsLaws;incorporation

State laws regulate corporations. Articles of incorporation are the founding documents of corporations. They must include the name of the corporation, the number of shares the corporation is authorized to issue, the name and address of the corporation’s registered agent (the main contact of the corporation), and the name and address of each incorporator (the people or entities signing the articles of incorporation). The articles of incorporation have to be filed and approved by the incorporating state government before the corporation can begin doing business.

The Advantages

Corporations offer many advantages to American business. One of the most important features of a corporation is that the corporation is a separate legal entity, an artificial but legal person, and therefore separate and distinct from the shareholders. Because corporations are “legal” people, they can do all the things that “real” people do, such as own property, make and receive loans, sue and be sued, and be found liable for violations of the law. Incorporated businesses have distinctive features that separate them from sole proprietorships and partnerships, including limited liability for shareholders, transferability of shares, perpetual existence, and centralized management.

Limited liability means that corporations are responsible for their own debts and responsibilities under contracts but that the shareholders are not. Under corporations, a shareholder’s liability is limited to the extent of the money or capital that person has contributed to the corporation, and the shareholder is not personably liable for the corporation’s debts or contractual responsibilities. During the Industrial Revolution, limiting the liability of shareholders to their contributions was of great benefit to shareholders, because their personal wealth was not at risk in the corporation. This allowed shareholders to invest in many risky or dangerous enterprises, such as building canals, railroads, or sailing across oceans. If the venture was successful, the corporation often paid shareholders handsomely; if it failed, the shareholder lost only the capital invested. Incorporation laws that limited shareholder liability made it possible for the United States to rapidly grow and prosper.

Free transferability of shares means that shareholders can transfer their shares of stock to other people or entities by sale, gift, or assignment. Most major shares are bought and sold in large security markets, such as the New York Stock Exchange. These large security markets have been created and regulated for the orderly and reliable transfer of shares of stock. Incorporation laws that allow shares to be freely bought and sold allow for appropriate values to be placed on shares of stock. This freedom to buy and sell shares allows people to make their own determination of the value of a corporation’s stock. American business has profited greatly from this because strong, healthy businesses are rewarded by attracting the highest prices.

Corporations exist forever unless ended by the shareholders or bankruptcy. Having corporations exist forever allows a corporation to grow and evolve over time and not be threatened by the death or sickness of any one shareholder, corporate officer, or director. Perpetual existence allows for profitable corporations to grow and expand into new areas of business and permits corporations to evolve and migrate into more lucrative areas of business while departing from less profitable enterprises. American business history has many examples of corporations that have done this, including Citigroup and General Electric.

Management of corporations is centralized in the board of directors and the corporate officers. The shareholders elect the board of directors, which has the necessary expertise to oversee the corporation. The board of directors in turn chooses corporate officers that have the requisite business experience to run the daily operations of the corporation. This system allows shareholders to invest in corporations without involving themselves in the corporation’s daily operations.

History

Corporations are a cornerstone of the American business landscape and have roots in British legal tradition. The British king often granted charters of incorporation to select groups of people within the British Empire. These royal corporate charters helped develop the American colonies. The founding of new colonies was both expensive and risky, and royal charters, by selling shares of ownership in the colonies, allowed funds to be raised for these ventures and limited the liability of the shareholders in case of financial failure.

After the United States achieved independence, the states assumed the role of granting corporate charters. New York state was the first jurisdiction to allow incorporation of businesses in 1811. The extent of state authority over corporations was first tested in the case of Dartmouth College v. Woodward (1819)Dartmouth College v. Woodward (1819), in which the U.S. Supreme Court held that the state of New Hampshire could not revoke the college’s charter without its consent because the incorporation charter created the college as an “artificial being,” independent of its creator, and as such, the college enjoyed constitutional protections.

The federal government limited the extent of corporate power in a series of Supreme Court decisions in first half of the nineteenth century. In Gibbons v. Ogden (1824)Gibbons v. Ogden (1824), the Court held that the federal government had the right to regulate commence with foreign nations and between the states. This ruling established that Congress could pass laws affecting the business activities of corporations. In Charles River Bridge v. Warren Bridge (1837)Charles River Bridge v. Warren Bridge (1837), the Court restricted the rights of corporations if they conflicted with those of the community in which the corporations were located, and in the License cases (1847)License cases of 1847, the Supreme Court upheld a state’s police power to regulate corporations for the protection of the health of that state’s citizens.

After the U.S. Civil War, the adoption of the Fourteenth AmendmentFourteenth Amendment, which was intended to protect freed slaves from oppressive state laws that might “deprive any person of life, liberty, or property without due process of law,” was quickly used by corporations using their status as “legal persons.” This was affirmed by the Supreme Court in Santa Clara County v. Southern Pacific Railroad (1886)Santa Clara County v. Southern Pacific Railroad (1886).

In the latter part of the nineteenth century and the early twentieth century, the federal government passed a series of laws that further regulated corporations. In 1887, the federal government established the Interstate Commerce Commission primarily to regulate corporations, and in 1890, Congress passed the Sherman Antitrust Act to further regulate corporations. In 1913, with the passage of the Sixteenth Amendment, allowing the federal government to levy an income tax, corporations were subjected to this new form of taxation. In 1914, Congress further checked the power of American corporations with the establishment of the Federal Trade Commission and the passing of the Clayton Antitrust Act. In 1937, the Supreme Court held that workers had the right to organize into unions in National Labor Relations Board v. Jones & Laughlin Steel Corp. (1937)National Labor Relations Board v. Jones & Laughlin Steel Corp., and in 1942, the Court upheld the constitutionality of the Fair Labor Standards Act. The 1937 case and the establishment of the Fair Labor Standards Act cleared the way for laws regulating wages, hours, and working conditions for employees of corporations.

Twenty-first Century Issues

Issues facing corporations in the twenty-first century include deregulation, global competition, and rising costs. The increasingly competitive world market has forced corporations to streamline their operations. The drive for increased corporate efficiency and profitability have put added pressures on corporations to be more aggressive. Aggressive corporate policies often are in danger of running afoul of the law. Scandals at companies such as WorldCom and Enron Corporation have given rise to renewed calls for regulation of American corporations.

Further Reading
  • Bock, Betty, et al., eds. The Impact of the Modern Corporation. New York: Columbia University Press, 1984. A review of the historical impact of corporatations on the business environment.
  • Donaldson, T. The Ethics of International Business. New York: Oxford University Press, 1989. An overview of the ethical implications of the influence of the modern corporation.
  • Eisenberg, M. A. The Structure of the Corporation: A Legal Analysis. Toronto, Ont.: Little, Brown, 1976. An analysis of the legal history of corporations and the nature of corporate change.
  • Frederick, W. C. Values, Nature, and Culture in the American Corporation. New York: Oxford University Press, 1995. An overview of corporate culture and its impact on societal values.
  • Kotter, J., and J. Heckett. Corporate Culture and Performance. New York: Free Press, 1992. A synopsis of corporate culture and how it has changed over the years.
  • Micklethwait, J., and A. Wooldridge. The Company: A Short History of a Revolutionary Idea. New York: Modern Library, 2003. A good history of corporations, highlighting time lines and basic corporate principles. A solid starting point for understanding incorporation laws and their history.
  • Nader, R., and M. J. Green, eds. Corporate Power in America. New York: Grossman, 1973. A review of the historical impact of corporate power in American business from a liberal perspective.
  • Williamson, O. E., and S. G. Winter, eds. The Nature of the Firm: Origins, Evolution, and Development. New York: Oxford University Press, 1991. An overview of corporate history and development.

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Sherman Antitrust Act

Supreme Court and commerce

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WorldCom bankruptcy

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