Up to the late middle ages, business was pretty steady. One family owned a cow, another owned a goat, there was mutual jealousy and so they were swapped. In time, money was used to facilitate more complex exchanges. All in all, relatively few people were involved and there wasn’t a huge need for capital.
Around the 1600s though, people started exploring the world. Trade followed exploration and trade was very profitable so naturally the great families of the era liked to keep it to themselves.
However, there were two essential problems:
- firstly, intercontinental explorers were thin on the ground and trade required the wealthy to give some bold upstart a great deal of money and send him to some remote corner of the world; and
- secondly, trade exploration required a lot of capital and given the risks, often more than one family was willing to contribute on their own, so there was a need for joint investment from unrelated parties.
A system was needed to record who was trustworthy and who held whose money, so the monarch assumed the right to allow these early joint stock companies to operate. One of the earlier companies to receive a Royal Charter was the British East India Company which developed a reputation for oppressing India over a few centuries, so they changed their name to the Honourable East India Company to clear things up.
Through the colonial period, trade increased nations’ GDP which even the royal families saw as a good thing so slowly the regulation of companies was lowered and stock certificates came to be traded amongst progressively more common people.
The industrial revolution increased business size and technicality to unprecedented levels and the essential problems were heightened:
- investors didn’t have the foggiest understanding of Carnegie’s Steel or Rockefeller’s oil, and while they didn’t like these risks, they didn’t want to forgo their profits either; and
- companies had become so big, that they required the continual diversified funding of a large number of investors to continue expansion and operation.
Thus emerged the concept of limited liability. To get people to invest it was seen as necessary to create a law that:
- separated the shareholders from the company itself; and
- provided that shareholders could only be liable for the company’s risks up to the amount of share capital they had initially purchased.
That remains the essence of a limited liability company today, and explains why a right to sue a company does not include a right to sue its directors or shareholders. Without the rule, which sometimes seems harsh, our economy could not have developed as it has.
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