An old lawyer walks into a boardroom of a public company and explains that a director's duty is to act in the best interest of the corporation - a distinct legal entity that exists independently of its shareholders. The young Chairman says " You may have been to law school, but as a matter of practice we all know that the corporation is a fiction and nothing more than an aggregation of shareholders" he continued "Corporations don't have interests. Only our shareholders have interests and it's our duty to act in theirs"". The lawyer, not wanting to contradict the Chair, asks "But what if the shareholder is a corporation. In whose interest will you then act?". "You're a very clever, old man, very clever", said the Chairman. " But it's shareholders all the way down!"
This tale is based on one retold by Stephen Hawking:
”A well-known scientist (some say it was Bertrand Russell) once gave a public lecture on astronomy. He described how the earth orbits around the sun and how the sun, in turn, orbits around the center of a vast collection of stars called our galaxy. At the end of the lecture, a little old lady at the back of the room got up and said: "What you have told us is rubbish. The world is really a flat plate supported on the back of a giant tortoise." The scientist gave a superior smile before replying, "What is the tortoise standing on?" "You're very clever, young man, very clever", said the old lady. "But it's turtles all the way down!”
The young Chair and the old lady are guilty of the same logical fallacy. By proposing a solution that begs exactly the same problem they have fallen into the bottomless pit of infinite regression - where the validity of one proposition depends on the validity of the proposition which follows and/or proceeds it. Leading to a series of never ending cascading turtles and incorporated shareholders. There is no logical end and therefore no shareholder to whom the director owes his duty.
The Chair had fallen for incorporated shareholder paradox:
If a shareholder is a corporation, and all corporations are fictions, incorporated shareholders must be fictions too.
In a public company, the corporation and the shareholder are both likely to be corporations. Both have exactly the same ontological status. What separates them is their relationship and not the stuff they are made of. That's a problem for the chair. If corporations are fictions and don't really exist , and if most shareholders are also corporations, logically both must be mere legal fictions incapable of existence and interests too.
The Chair is not alone in falling for the paradox. Even the most learned of legal scholars who reject any view of the corporation as an entity, accept that a corporation can be an aggregate of those non existent entities:
This leaves the chair and his fellow directors in a bind - if the corporation doesn't really exists and each incorporated shareholder doesn't exist, in whose best interest is the board supposed to act?
Puzzled, the Chair asks "But surely, the shares are held for the benefit of humans ".
Not according to one survey by Peetz and Murray. Based on their analysis only 3.3% of the shares in the world's very large companies were held by humans. Nearly all the shares were held, through a vast network of interposed entities, by a very small number of corporations. And, it's not necessarily the case these these corporations are acting as trustees on behalf of humans. For the most part, these corporations don't hold shares on trust for individuals. Rather, shares are bought as inputs into their business models to create financial products to be sold to individuals to produce profits to be consumed by other corporations. Just like a steel company buys iron ore, insurance companies buy shares.
Exasperated, the chair says "we'll act for the 3.3% then."
"You misunderstand the problem" responded the old lawyer. "The incorporated shareholder, exists in the same way as this corporation. But the law does not require that you act for the benefit of individual or incorporated shareholders. Your responsibility is to this corporation. It may be an artificial legal person, but it's no fiction. It exists and what exist will cease to exist if the Board fails in its duty. That's the problem this board needs to solve" The lawyer continued:
Your duty is to promote the continuing existence of the corporation by acting in its best interests.
That doesn't mean its interests can't intersect or correspond with the the interests of shareholders and others. But, the interests of the corporation in sustaining and maintaining its existence as an entity must come first".
The chair, interrupted "But why? What about our purpose and duty to shareholders?".
The lawyer paused, "There is no purpose without existence. What ever the desire of the shareholder, it is contingent upon and subordinate to the long term survival of the corporation. That's the standard that the law requires."