This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
Adam Smith, the first and perhaps the greatest of economists, was extremely skeptical as to the usefulness of the large "joint-stock" companies which in his day were just beginning to play a prominent part in business life. "Without a monopoly," he says, "a 'joint-stock' company, it would appear from experience, cannot long carry on any branch of foreign trade, for it is a species of warfare in which the operations are continually changing, and which can scarcely ever be conducted successfully without such an unremitting exertion of vigilance and attention as cannot long be expected from the directors of a joint-stock company." Elsewhere he asserts that "negligence and profusion must always prevail more or less in the affairs of a 'joint-stock' company".
In view of the rapid spread of the joint-stock or corporate form of organization and the immense number now in existence, it may seem at first glance that wise old Adam Smith for once was entirely wrong. Yet, if he were to step into twentieth century life and read all the details of the life insurance scandal, the New Haven Railroad scandal, the Rock Island Railroad scandal, and the various other unsavory messes that are from time to time brought to light, he would perhaps not be easily convinced.
As a matter of fact, it is probably true that the various advantages cited in preceding paragraphs are responsible for the wide-spread adoption of the corporation, rather than any claim it can reasonably offer to superior efficiency.
There are some features of corporate organization which are no doubt an improvement in respect to efficiency, over any other forms of organization. The people who supply the money are not necessarily the ones who personally manage the enterprise; and this leaves or should leave an opportunity to engage men of special talent as managers. The custom at one time was to select one of the largest stockholders as the nominal president of an important bank, railroad or manufacturing corporation, but this has now been largely abandoned in favor of making the president the responsible manager. Often he holds only a few shares of stock. The most important or influential stockholder, instead of becoming president, is more frequently made chairman of the board - a position which usually pays no salary. Furthermore, it is at least theoretically true that the creation of a board of directors representing the owners of the business who can oversee and check or stimulate the officers, is a striking gain. On the other hand, these advantages have been in large part nullified by the selection of incompetent or overoccupied directors. As Adam Smith foresaw, these men are not so zealous in protecting the shareholders as they are in advancing themselves. Sometimes responsibility is so divided that it rests too lightly on the shoulders of each individual director. Hartlev Withers makes the interesting comment that "the real business of most boards is done by a small minority who save the rest from the consequences of their inexperience. In actual practice the notion that the board is chosen by the shareholders or is really representative of the shareholders, is generally a delusion. The board either forms itself or is formed by the promotor and fills its own vacancies, subject only to the purely formal confirmation of the shareholders. The officers are chosen by the board or by one another, and joint-stock companies are thus governed in practical fact by a self-elected oligarchy." This is true not only in London, which Mr. Withers has in mind, but in New York, Montreal, Paris, Berlin, and every other part of the world. How do these self-chosen oligarchies work, and what do they accomplish?