Debunking the Capitalist Cowboy
Business schools fetishize entrepreneurial innovation, but their most prominent heroes succeeded because they manipulated corporate law, not because of personal brilliance.
March 21, 2019
Mar 21, 2019
18 Min read time
Business schools fetishize entrepreneurial innovation, but their most prominent heroes succeeded because they manipulated corporate law, not because of personal brilliance.
Capitalism, like the United States itself, has a mythology, and for five decades one of its central characters has been the nineteenth-century maverick cigarette entrepreneur, James B. Duke. Duke’s risk-taking investment in the newfangled machine-made cigarette, so the story goes, displaced the pricey, hand-rolled variety offered by his stodgy competitors. This, in turn, won Duke control of the national, and soon global, cigarette market. Repeated ad nauseam in business and history journals, high school and university curricula, popular magazines, and websites, the story has taught that disruptive innovation drives capitalist progress.
The problem? The Duke story is false: mid-century business historians fabricated it to accord with the theory of creative destruction, developed by libertarian economist Joseph Schumpeter. For generations, we have learned from this myth to fetishize entrepreneurial innovation as the engine of capitalism, while missing Duke’s instrumental role in rampant corporate empowerment.
For generations, we have learned to fetishize entrepreneurial innovation as the engine of capitalism.
Duke’s true “innovation” came not in the 1880s, when the cigarette machine transformed the production process, but in the 1890s, when business corporations shed the fetters of state regulation and radically redefined themselves. Duke’s American Tobacco Company (ATC) moved to the cutting edge of this process when it repelled legal challenges to its monopoly by drawing on new notions of corporate personhood in the wake of the Fourteenth Amendment. Passed during Reconstruction, the Fourteenth Amendment established federal protections of property and due process, rights previously controlled by state law, so that freed slaves would be able to claim full citizenship no matter where they resided. Though the amendment referred to “persons born or naturalized in the United States,” which suggests human persons, lawyers attempted to use the amendment to shield corporate “persons” from state regulations. With the ATC’s win in court, the corporation claimed an enhanced legal personhood, protection from states, and status as a private rather than public entity. Unrestrained, the ATC rapidly gobbled up companies across the United States and the globe, catapulting Duke to spectacular wealth and power. These changes in the corporation, though dramatic and unprecedented, came to seem so natural that they became nearly invisible. And what is natural and invisible is impervious to critique.
• • •
The myth of Duke has enjoyed a decades-long career legitimating free-market capitalism. Born at the Harvard Business School in the years after World War II, the myth took shape in the Research Center in Entrepreneurial History. Established in 1948 with a grant from the Rockefeller Foundation, the interdisciplinary Research Center linked Harvard’s economics department with the business school and business historians. Joseph Schumpeter joined the faculty in the economics department in 1932 and was a founding member of the Research Center. Much like an urban legend, the Duke myth was not the result of conscious lies. Rather, the economically flush and ideologically siloed space of the Research Center led to a narrowing of critical debate and a cascading failure of rigorous historical methods.
The Fourteenth Amendment allowed corporations to claim legal personhood, protection from states, and status as a private rather than public entity.
Schumpeter eagerly used the Research Center to promote ideas on innovation that he had been developing since the 1930s. Schumpeter’s theory narrated a drama of capitalism in which the entrepreneur entered as hardnosed antihero, the driver of capitalist innovation and progress. Schumpeter gave the entrepreneur “glamour,” in the words of economist Arthur Smithies, by painting the entrepreneur as a prescient rogue. While most businessmen are “fenced in by social habits or conventions and the like,” the innovative entrepreneur, Schumpeter claimed, is “the most rational and the most egotistical of all.” He is “more self-centered than other types, because he relies less than they do on tradition and connection and because his characteristic task . . . consists precisely in breaking up old, and creating new, tradition.” In other words, if you see an antisocial, egotistical entrepreneur leaving a path of wreckage in his wake—destroyed markets, lost jobs, bloated monopolies—you should celebrate rather than lament, because this is how the capitalist market revitalizes itself. Schumpeter never referenced the cowboy explicitly, but his antihero entrepreneur markedly resembled a John Wayne character. (Incidentally, Schumpeter loved riding horses and often showed up to Harvard faculty meetings in his jodhpurs.)
Schumpeter’s third wife, Romaine Elizabeth Boody, whom he married in 1937, advised him on how to promote his ideas over those of his archrival, John Maynard Keynes, who advocated for government intervention and regulation. A respected economist in her own right, Boody urged Schumpeter to make his claims bigger and to coin his own term—“creative destruction”—which he did in his 1942 masterpiece Capitalism, Socialism and Democracy. In that volume, Schumpeter boldly declared that creative destruction defined capitalism itself: “This process of Creative Destruction is the essential fact about capitalism,” he wrote. “It is what capitalism consists in and what every capitalist concern has got to live in.” Here is the punch line: because the maverick entrepreneur is “the pivot on which everything turns,” he should be given free rein to act and not be hampered by regulation. Schumpeter’s ideal of the rogue entrepreneur conferred glamour on his own libertarian conservative views.
Business history emerged in the 1930s with the goal of defending the capitalist system, and like others at the Research Center, Schumpeter saw the field as a platform for the popularization of economic theory. He published a call for business students and historians to “test” his theory of creative destruction by examining “the already available secondary literature for data upon entrepreneurial characteristics and phenomena.” Advanced business and history students obliged by writing two articles for the Harvard Business Review that applied the theory of creative destruction to historical entrepreneurs, among them Duke.
‘Creative Destruction is the essential fact about capitalism. It is what every capitalist concern has got to live in.’
No surprise, the authors found that Duke exactly matched the Schumpeterian model of the entrepreneur. A 1963 article claimed that “Duke illustrates classically the Schumpeterian activities of innovation.” He was the “bold opportunist” who introduced the cigarette machine as a “new production technique.” His “cunning” allowed him to negotiate the lowest royalty rate for the machine. Because of his “tempermental difference . . . [from his] lethargic competitors,” Duke gained control of the market and forced the formation of the ATC monopoly “with Duke as president.” Another article argued that Duke displayed the personality traits of the Schumpeterian entrepreneur by being “vigorous,” “shrewd and tough,” “ambitious and fiercely competitive.” Duke’s “most significant innovation,” the introduction of the cigarette machine, allowed him to “revolutionize the entire industry.” Duke’s innovations “caught his competitors napping.” “By the time the other manufacturers saw the error of their ways,” the article went on, “Duke had stolen a long and quiet march on them.” Duke was first to see the potential of the cigarette and the first to market it abroad.
None of these points is accurate. Duke was not the first to use the cigarette machine; in fact, all of the major producers used it by 1887. Nor did he have the best royalty deal for the most efficient machine; that was held by the Lone Jack Tobacco Company. Duke was not the first U.S. entrepreneur to make a success with cigarettes or to find a foreign market for them; Lewis Ginter of Richmond, Virginia, achieved as much before Duke even began making cigarettes. Duke did not force his competitors to merge into the ATC, and he was not its first president. The five major producers formed the corporation in order to gain clout in negotiations for the foreign rights to the best cigarette machine, and Ginter was the first president. No one checked the story against primary sources. Even a look at New York Times articles from the 1880s would have revealed telling inconsistencies and errors.
The myth of Duke went viral when Alfred Chandler, long considered the doyen of U.S. business history, included it in his opus, The Visible Hand (1977). Chandler credited the Research Center as one of his most important influences, and his graduate student, Glenn Porter, had written one of the articles on Duke. The Visible Hand focused on the role of managers rather than entrepreneurs, but Chandler celebrated innovative firms that achieved vertical and horizontal integration, the ATC among them, and cast their entrepreneurs in Schumpeterian terms. The book won the Pulitzer Prize and became the single most influential business history text of the century, read by academics and general readers alike. The book shaped business-related curricula from grade school to business school. The Duke myth has remained unchallenged and unrevised in the forty years since.
• • •
Duke was not the first entrepreneur to make a success with cigarettes. So how did he achieve his extraordinary power?
So how did Duke achieve his extraordinary power, if not through clever innovations with the cigarette machine? Three maneuvers gave him control of the ATC and transformed the corporation itself. The ATC’s opposition, ironically, supplied the first maneuver. The ATC originally incorporated in Virginia with Ginter, a Virginia resident, as president. But just days after approving the ATC’s charter, alarmed tobacco planters in the Virginia legislature launched a successful campaign to rescind it. They claimed they had read the bill they had just voted on, but fear of the impact of the new monopoly on tobacco leaf prices had spread like wildfire through the state, prompting their about-face. The five companies then turned to New Jersey for a corporate charter, and Duke, the second most powerful of the ATC entrepreneurs, assumed the presidency.
The move to New Jersey was profoundly consequential because lawyers there had just succeeded in radically weakening the state’s incorporation laws so that corporations could do virtually anything they wished. The Delaware of the nineteenth century, New Jersey drew the ire of other states because incorporators rushed to establish their charters there, and New Jersey raked in tax revenues. The ATC was one of the first.
When Duke proceeded to pursue controversial, monopolistic business practices, now perfectly legal in New Jersey, he faced pitched opposition from his fellow incorporators. Some objected to practices that they deemed unethical, while others believed Duke neglected the markets they had built in order to take over the pipe and chewing tobacco industry. But Duke made an alliance with financiers who wanted a piece of the action and forced the other entrepreneurs out of the corporation. Duke now enjoyed unchallenged authority over ATC decision-making.
The most significant maneuver, however, happened in the courts, when the ATC prevailed against lawsuits challenging its monopolistic practices and thereby solidified the corporation’s legal redefinition. The ATC’s lawyers drew on the Fourteenth Amendment to declare that the corporation should be treated “as if it were an individual carrying on the same business.” The corporation was not a public but a private entity, “owing no duty to the public or any part of it.”
New Jersey’s laws put virtually no limits on corporate activities and corporate law did not yet exist. It was the corporate version of the Wild West.
As a New Jersey corporation, the ATC freely used its monopoly over cigarettes to force previously independent distributors to carry its products exclusively. Distributors quickly lost their status as business owners and became dependent, contract employees of the ATC, with a dramatic decline in income. Competitors, meanwhile, could no longer get their products to retailers or consumers. Already the biggest cigarette firm in the country, the ATC got bigger still. Though common in today’s economy ruled by Amazon and Walmart, these business practices were highly controversial at the time because they stifled competition, believed to be necessary to a healthy economy.
Previously, business practices like these could be challenged legally by claiming a corporation had exceeded state incorporation laws as expressed in its charter—called an ultra vires (“beyond the powers”) complaint. But New Jersey’s new laws put virtually no limits on corporate activities and corporate law did not yet exist. It was the corporate version of the Wild West.
The ATC’s power grab won it many enemies, some of them in powerful places. A coalition quickly formed to bring creative legal challenges to the ATC’s practices—and by implication, the New Jersey laws—through linked cases in New Jersey (1893) and New York (1895). The coalition consisted of the National Cigarette and Tobacco Company (a company formed with the sole purpose of challenging the ATC in court), the attorneys general of both New York and New Jersey, and distributors. Duke saw these cases as serious threats: he paid the ATC’s top lawyer an annual salary of $50,000—roughly $1.3 million today—and prepared for war.
Both cases had the potential to stop the advance of the ATC and to put great pressure on New Jersey to revise its lax incorporation laws. The New Jersey case, brought in equity court, claimed that ATC business practices harmed trade and commerce in the state and demanded that the corporation be restrained from utilizing its charter. New Jersey state lawyer Benjamin F. Einstein argued that states chartered corporations for the public good and that states had the power to restrain corporations that caused public injury. Had this case succeeded, the ATC would have been forced to cease operations and New Jersey’s courts would have been at odds, likely carrying the case to the Supreme Court and forcing a national debate about the corporation’s expanding legal powers.
In New York, Attorney General Theodore E. Hancock had more distant jurisdiction but drew on a new anti-monopoly law that enabled him to charge the ATC in criminal court with “conspiring to stifle competition.” Hancock insisted that New York state had “sufficient jurisdiction” to restrain a corporation “from transacting an illegal business.” The ATC’s lawyers cleverly responded to the charge by arguing that two are needed to conspire and, because the ATC corporation should be considered a single individual, it was impossible for it to conspire. Had the ATC been found guilty, its New York state certificate would have been cancelled and its executives could have faced jail time. Since New York was the site of the company’s headquarters, its largest factories, and its largest market, a loss there would also have ground the company’s engine to a halt.
Both cases failed to stop the ATC. In New Jersey, Vice Chancellor Alfred Reed, the case’s judge, parroted ATC lawyers by accepting the equation between the corporation and a private individual, according them the “same authority” and protections under the law. He also scolded the plaintiffs for bringing the case in equity court rather than making an ultra vires complaint, even though such a complaint would be futile given the changes in New Jersey’s laws. Anyone wishing to challenge a New Jersey corporation after the ATC’s case faced a catch-22.
The Fourteenth Amendment was created to protect African Americans. Instead corporations immediately began using it to protect themselves.
In New York, the judge ridiculed the lawyers’ argument that the corporation was a single individual and therefore could not conspire, but the criminal court jury was hung and failed to bring a conviction. The ATC quickly patched its distributor contracts in New York to undermine the effectiveness of a retrial. With these wins, Duke’s ATC insulated itself from significant regulation for another fourteen years, until the 1911 Supreme Court busted the behemoth into four still-huge companies. In the meantime, the ATC expanded across the United States and the globe and Duke became the world’s most powerful tobacco executive.
With these cases, the ATC succeeded in using the Fourteenth Amendment to insist that the corporation not be seen as a public institution, chartered by a state for the public good, but as a private individual, deserving protection from the state. In the end, the ATC’s victory became part of the story of Reconstruction’s failures and unforeseen consequences: the Fourteenth Amendment had meant to create enhanced federal protections for individual private property rights in order to shield African Americans from state-level attacks after the close of the Civil War. Instead corporations immediately began using the Fourteenth Amendment to protect themselves from state-level regulations—and because corporations were chartered by states, all regulations at this time were at the level of the state.
The point was not whether corporations were persons, but what kind of persons they were, with what rights and protections. The common law basis of the U.S. and British legal systems is based on the individual as the unit of law. The form of the corporation developed as a way to legally render a collective as a singular entity, or legal person. States chartered such corporations as public persons with obligation to the public good. A wide variety of projects took corporate form, from public works projects, to schools, to businesses. The British East India Company and Virginia Company are two examples of British corporations chartered to pursue colonization for the good of England. As big business grew in the late nineteenth century, a conflict arose between the way states regulated large corporations such as the ATC and the legal standing of equally large companies that did not incorporate. The federal protections of the Fourteenth Amendment were a boon to lawyers looking for tools to free corporations from state-level controls.
The historically public nature of corporations could have become a way of legally construing and regulating the relationship of rapidly growing business corporations and other large companies to undeniably public resources such as water, land, infrastructures such as railroads and highways, and labor. Instead, business corporations became defined as private and their use of public resources became protected by laws historically designed to protect the privacy of white male individuals and their households, laws specifically strengthened by the Fourteenth Amendment. What does the corporation owe to the public? Duke’s lawyers were correct: if a corporation is a private “person,” it legally owes nothing whatsoever. This shift also set the ground for corporations’ successful claim in the twentieth and twenty-first centuries on liberty rights, such as the right to free speech, that originally had been intended for human individuals.
African Americans did not fare as well by these same legal changes. At the same time that crucial state-level attempts to limit corporate claims on the Fourteenth Amendment failed, states succeeded in passing Jim Crow laws, limiting access to jobs and other public resources, such as public transport. The federal government endorsed these restrictions in Plessy v. Ferguson in 1896, ushering in a half century of legal apartheid that lasted until the 1964 Civil Rights Act.
• • •
This history shapes our collective imagination about capitalism as much as it shapes our reality. Though corporate law, regulations, and ideas of corporate responsibility surfaced in the twentieth century, the notion that so-called “private” businesses gain their power and wealth from public resources and therefore owe a duty to the public remains a difficult argument to make more than a century later. Instead we talk endlessly about innovation and the next brilliant (or despicable) entrepreneur.
Historians find in Duke’s inflated corporate power the roots of chronic inequality, economic instability, and the heedless promotion of a deadly product.
This brings us back to the Duke myth and its power to shape the present-day conversation about capitalism. Schumpeter’s economic theory battled with Keynes’s for decades, but were the two men still alive today, Schumpeter likely would be claiming the last laugh. Even Duke’s harshest critics repeat the Schumpeterian story and aid its circulation. Historians of labor and medicine find in Duke’s inflated corporate power the roots of chronic inequality, economic instability, and the heedless promotion of a deadly and addictive product. One such strident title in medical history, Robert N. Proctor’s Golden Holocaust (2012), jolts readers to recognize the scale of corporate crimes. But these historians, too, fail to check the story of how Duke gained his power, likely because the Schumpeterian mythos of the entrepreneur easily accommodates their outrage. Duke as a selfish and bombastic egotist who wrested power from calmer men while he raked in the cash? They concur and simply spin the story of innovation to the left rather than the right. Schumpeter made no secret of his conservative libertarian perspective, but his theory of creative destruction underpins many explicitly left-leaning interpretations of capitalist history.
Schumpeter’s influence has skyrocketed since the decline of Keynesian economics and the rise of neoliberal deregulation of free markets, but today the person most associated with the idea of the disruptive entrepreneur is Clayton M. Christiansen. A Harvard economist, Christiansen unveiled the theory of “disruptive innovation” in his 1997 book The Innovator’s Dilemma. Christiansen was heavily influenced by Schumpeter’s theory of creative destruction, but whereas Schumpeter focused on the entrepreneur, Christiansen elevated the startup—the innovative smaller company that catches its sleepy competition unaware. With fewer resources than its larger competitors, the small company or startup nonetheless disrupts established business practice by offering a cheaper, often inferior product, thereby capturing a new element of the market ignored by established companies. Think personal computers versus the old mainframes. When even established consumers switch to the cheaper product, forcing older companies to mimic the new business model, disruptive innovation has occurred.
As the words “big government” helped dismantle two generations of Keynesian social and economic policy, Schumpeter’s ideas of creative destruction finally triumphed over those of his old rival and found new life in destructive innovation. “Ever since The Innovator’s Dilemma,” historian Jill Lepore writes, “everyone is either disrupting or being disrupted.” As regulations fell and income inequality rose, a euphoric discourse of innovation reassured at least part of the public that society’s numerous ills were necessary—and inevitable—growing pains for a capitalist economy. Lepore’s scathing exposé of disruptive innovation reveals how the idea has enjoyed ridiculously wide uptake in contemporary life, from business to health care to higher education to media. The idea has become so popular, she argues, that it operates as a theory of history, shaping our view of the world and how it works. Lepore researched some of the “handpicked case studies” used to prove the theory in The Innovator’s Dilemma and found that Christiansen had selectively sifted and arranged historical facts with his theory in mind. Lepore also notes that Christiansen has faced very few challengers—a fact that may explain the outrage with which disruptive innovation’s true believers attacked her article.
Perhaps disruptive innovation seems so natural because the Duke myth has reigned in our school lessons and our public culture for so many decades. Corporations continue their barely restrained plunder of public resources, while “innovation” is the buzzword that keeps on buzzing.
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March 21, 2019
18 Min read time