How a creative legal leap helped create vast wealth

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Nicholas Murray Butler was one of the leading thinkers of his age: a philosopher, Nobel Peace Prize winner, the president of Columbia University.

In 1911, someone asked Butler to name the most important invention of the industrial era.

Steam, perhaps? Electricity?

“No,” he said. They would both “be reduced to comparative impotence” without “the greatest single discovery of modern times” – the limited liability corporation.

50 Things That Made the Modern Economy highlights the inventions, ideas and innovations that helped create the economic world.

It is broadcast on the BBC World Service. You can find more information about the programme’s sources and listen online or subscribe to the programme podcast.

It seems odd to say the corporation was “discovered”. But it didn’t just appear from nowhere.

Creative legal leap

The word “incorporate” means take on bodily form – not a physical body, but a legal one.

In the law’s eyes, a corporation is something different from the people who own it, or run it, or work for it.

And that’s a concept lawmakers had to dream up.

Without laws saying that a corporation can do certain things – such as own assets, or enter into contracts – the word would be meaningless.

The legal ingredients that comprise a corporation came together in a form we would recognise in England, on New Year’s Eve, in 1600.

Back then, creating a corporation didn’t simply involve filing in some routine forms – you needed a royal charter.

And you couldn’t incorporate with the general aim of doing business and making profits – a corporation’s charter specifically said what it was allowed to do, and often also stipulated that nobody else was allowed to do it.

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The East India Company’s 218 shareholders had limited liability for the company’s actions

The legal body created that New Year’s Eve was the Honourable East India Company, charged with handling all of England’s shipping trade east of the Cape of Good Hope.

Liability liberation

Its shareholders were 218 merchants. Crucially – and unusually – the charter granted those merchants limited liability for the company’s actions.

Why was that so important? Because otherwise, investors were personally liable for everything the business did.

If you partnered in a business that ran up debts it couldn’t pay, its debtors could come after you – not just for the value of your investment, but for everything you owned.

That’s worth thinking about: whose business might you be willing to invest in, if you knew that it could lose you your home, and even land you in prison?

Perhaps a close family member’s? At a push, a trusted friend’s?

The way we invest today – buying shares in companies whose managers we will never meet – would be unthinkable. And that would severely limit the amount of capital a business venture could raise.

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At its peak, the East India Company accounted for about half of the world’s trade

Back in the 1500s, perhaps that wasn’t much of a problem. Most business was local, and personal. But handling England’s trade with half the world was a weighty undertaking.

Over the next two centuries, the East India Company grew to look less like a trading business than a colonial government.

At its peak, it ruled 90 million Indians and employed an army of 200,000 soldiers. It had a meritocratic civil service and issued its own coins.

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The East India Company initially used silver coins from the New World, but soon began minting its own currency

Meanwhile, the idea of limited liability caught on.

In 1811, New York state introduced it, not as a royal privilege, but for any manufacturing company. Other states and countries followed, including the…

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