prior probability

Due to my travels, I will resume my ongoing series on Adam Smith in my next post; in the meantime, I can vouch for the substance of this tweet (or see below) as I was one of Rob Harrison’s students at the Yale Law School back in the day!

Is it possible to use ChatGPT and other large language models to promote critical thinking in higher education? As it happens, I am a member of a five-person team of college professors who have experimented with new ways of using GenAI in the fields of tax law and tax accounting. (Two special shout outs go to our department chair, Jay Thibodeau, who motivated our team to study this question, and to our lead authors, Keri White and Rachel Detert, both of whom will be presenting our findings this afternoon (Monday, August 3) at the annual meeting of the American Accounting Association (AAA) in Las Vegas, Nevada.) In the meantime, here is a direct link to our paper, “Depreciating rollercoasters and rhinoceroses: capital asset classification, client tax advice, and the use of GenAI to develop critical thinking“, which will be published in the prestigious Journal of Accounting Education this fall.

I heard this lyrical homage to my home State at Dodger Stadium on Friday evening. (I was born and raised in Los Angeles and attended college at UCSB. #GauchoForLife!) Below is the “super mega mix” version!

“Joint stock companies, established by Royal Charter or by Act of Parliament, differ in several respects, not only from regulated companies, but from private copartneries.” (Smith 1784, p. 58)

Thus far (see here and here), we have surveyed the first 14 paragraphs of the last part (Part #13) of Adam Smith’s pamphlet Additions and Corrections to the First and Second Editions of Dr. Adam Smith’s Inquiry into the Nature and Causes of the Wealth of Nations (Smith 1784). This last part deals with overseas trading companies, which (as we saw in my previous post) can be organized as a “regulated company” (i.e. a state-sanctioned cartel) or as a “joint stock company” (the precursor of the modern corporation).

Now, let’s pick up where we left off. Next, Smith compares and contrasts the main features of “joint stock companies” with those of “private copartneries” (or general partnerships) in paragraphs 16 and 17 of Part #13:

“First, in a private copartnery, no partner, without the consent of the company, can transfer his share to another person, or introduce a new member into the company. Each member, however, may, upon proper warning, withdraw from the copartnery, and demand payment from them of his share of the common stock. In a joint stock company, on the contrary, no member can demand payment of his share from the company; but each member can, without their consent, transfer his share to another person, and thereby introduce a new member. The value of a share in a joint stock is always the price which it will bring in the market; and this may be either greater or less, in any proportion, than the sum which its owner stands credited for in the stock of the company.

“Secondly, in a private copartnery, each partner is bound for the debts contracted by the company to the whole extent of his fortune. In a joint stock company, on the contrary, each partner is bound only to the extent of his share.” (Smith 1784, pp. 58-59)

Furthermore, in the first part of the next paragraph (para. 18), the Scottish scholar identifies the main reason why — from an investor’s point of view — a stock certificate makes for a far more attractive investment than a corresponding equity stake in a traditional general partnership: the separation of ownership and control. Or in the immortal words of Adam Smith:

“The trade of a joint stock company is always managed by a court of directors. This court, indeed, is frequently subject, in many respects, to the control of a general court of proprietors. But the greater part of those proprietors seldom pretend to understand anything of the business of the company, and when the spirit of faction happens not to prevail among them, give themselves no trouble about it, but receive contentedly such half-yearly or yearly dividend as the directors think proper to make to them. This total exemption from trouble and from risk, beyond a limited sum, encourages many people to become adventurers in joint stock companies, who would, upon no account, hazard their fortunes in any private copartnery. Such companies, therefore, commonly draw to themselves much greater stocks than any private copartnery can boast of.” (Smith 1784, p. 59, my emphasis)

Adam Smith then cites in passing two spectacular examples of joint stock companies that were able to attract massive amounts of capital — the venerable Bank of England and the ill-fated the South Sea Company: “The trading stock of the South Sea Company, at one time, amounted to upwards of thirty-three millions eight hundred thousand pounds. The divided capital of the Bank of England amounts, at present, to ten millions seven hundred and eighty thousand pounds.” (Id. at pp. 59-60)

(As an aside, The Bank of England was founded on 27 July 1694 as a private joint-stock company named “The Governor and Company of the Bank of England”. It was created to raise a £1.2 million loan for the government to fund a war against France, and it operated as a private corporation with shareholders for over 250 years until it was nationalized in 1946!)

But for Smith, these three innovative features of joint stock companies — i.e. the transferability of shares, limited liability, and the separation of ownership and control — do not mean that such companies are a better method of corporate governance than a traditional general partnership. In the second half of paragraph 18 of Part #13, Smith delivers a stunning rebuke:

“The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master’s honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. It is upon this account that joint stock companies for foreign trade have seldom been able to maintain the competition against private adventurers. They have, accordingly, very seldom succeeded without an exclusive privilege, and frequently have not succeeded with one. Without an exclusive privilege they have commonly mismanaged the trade. With an exclusive privilege they have both mismanaged and confined it.” (Smith 1784, p. 60, my emphases)

Simply put, Smith is suspicious of the separation of ownership and control because the board of directors of a joint stock company is playing with other people’s money! But does history and experience vindicate Smith’s scathing critique of joint stock companies? As we shall see when I resume my Adam Smith series next week, Smith will survey four specific examples of overseas trading companies that were organized as joint stock companies. What was their collective track record? Did they make Britain more wealthy in the long run? Or poorer? Stay tuned! (To be continued …)

Adam Smith surveys overseas trading companies in the last part of his 1784 pamphlet (Part #13). I went over the first five paragraphs of this part of Smith’s 1784 pamphlet in my previous post. The rest of Smith’s pamphlet is devoted to what today we refer to as “corporate governance” (see here, for example). To begin, Smith explains how an overseas trading company can be organized in one of two ways: either as a regulated company or as a joint stock company.

“When those companies do not trade upon a joint stock, but are obliged to admit any person, properly qualified, upon paying a certain fine, and agreeing to submit to the regulations of the company, each member trading upon his own stock, and at his own risk, they are called regulated companies. When they trade upon a joint stock, each member sharing in the common profit or loss in proportion to his share in this stock, they are called joint stock companies. Such companies, whether regulated or joint stock, sometimes have, and sometimes have not, exclusive privileges.” (Smith 1784, para. 6 on pp. 49-50, my emphases)

The main difference between both types of company is thus this: the members of a regulated company have to invest their own private capital into the company and abide by the private rules of the company, but they may compete with one another under their shared corporate charter; by contrast, the members of a joint stock company pool their money into a single corporate fund and share joint profits or losses, but it is the directors of the company who control how the fund is spent. So, which of these two forms of corporate governance is best? Alas, Smith has absolutely nothing good to say about regulated companies:

“Regulated companies resemble, in every respect, the corporations of trades so common in the cities and towns of all the different countries of Europe, and are a sort of enlarged monopolies of the same kind. As no inhabitant of a town can exercise an incorporated trade without first obtaining his freedom in the corporation, so in most cases no subject of the state can lawfully carry on any branch of foreign trade, for which a regulated company is established, without first becoming a member of that company. The monopoly is more or less strict according as the terms of admission are more or less difficult; and according as the directors of the company have more or less authority, or have it more or less in their power to manage in such a manner as to confine the greater part of the trade to themselves and their particular friends. In the most ancient regulated companies the privileges of apprenticeship were the same as in other corporations, and entitled the person who had served his time to a member of the company to become himself a member, either without paying any fine, or upon paying a much smaller one than what was exacted of other people. The usual corporation spirit, wherever the law does not restrain it, prevails in all regulated companies. When they have been allowed to act according to their natural genius, they have always, in order to confine the competition to as small a number of persons as possible, endeavoured to subject the trade to many burden some regulations. When the law has restrained them from doing this, they have become altogether useless and insignificant.” (Smith 1784, para. 7 on p. 50, my emphases)

Although Smith uses a sliding scale to describe the extent of a regulated company’s monopoly over a given trade or line of business (“The monopoly is more or less strict according as the terms of admission are more or less difficult; and according as the directors of the company … have it more or less in their power to manage in such a manner as to confine the greater part of the trade to themselves and their particular friends”), Smith concludes that such companies “always” try to “confine the competition to as small a number of persons as possible” and to “subject the[ir] trade to many burden some regulations.”

As an aside, do these negative and monopolistic features of so-called regulated companies sound familiar? They should, for such companies have all the negative features of our pernicious and pervasive system of occupational licensing today. In both systems of economic governance (i.e. regulated companies and occupational licensure), workers have to obtain the previous permission of a corporate body before they ply their trades. (In California, for example, one in six workers requires a state license!)

Next, Smith surveys several specific examples of regulated companies: the Hamburgh Company and the Russian Company (para. 9), the Turkey Company (para. 10), and the Africa Company (paras. 12 to 14). Amid this survey (para. 11), Smith compares and contrast the incentive structure of the directors of a regulated company with that of the directors of a joint stock company. Here (para. 11), Smith presents a favorable picture of the governance of joint stock companies. More specifically, in the process of explaining why overseas trading companies organized as regulated companies did not invest in “forts and garrisons”[*] to protect its business interests, while trading companies organized as joint stock companies did make such investments, Smith makes a deeper and more timeless observation about economic incentives:

“First, the directors of a regulated company have no particular interest in the prosperity of the general trade of the company for the sake of which such forts and garrisons are maintained. The decay of that general trade may even frequently contribute to the advantage of their own private trade; as by diminishing the number of their competitors it may enable them both to buy cheaper, and to sell dearer. The directors of a joint stock company, on the contrary, having only their share in the profits which are made upon the common stock committed to their management, have no private trade of their own of which the interest can be separated from that of the general trade of the company. Their private interest is connected with the prosperity of the general trade of the company, and with the maintenance of the forts and garrisons which are necessary for its defence. They are more likely, therefore, to have that continual and careful attention which that maintenance necessarily requires.” (Smith 1784, para. 11 on p. 54, my emphasis)

In addition, Smith provides another reason why the incentive structure of joint stock companies is more conducive to long-term investment decisions (e.g. the building of forts and garrisons overseas):

“Secondly, the directors of a joint stock company have always the management of a large capital, the joint stock of the company, a part of which they may frequently employ, with propriety, in building, repairing, and maintaining such necessary forts and garrisons. But the directors of a regulated company, having the management of no common capital, have no other fund to employ in this way but the casual revenue arising from the admission fines, and from the corporation duties imposed upon the trade of the company. Though they had the same interest, therefore, to attend to the maintenance of such forts and garrisons, they can seldom have the same ability to render that attention effectual. The maintenance of a public minister requiring scarce any attention, and but a moderate and limited expense, is a business much more suitable both to the temper and abilities of a regulated company.” (id. at pp. 54-55, my emphasis)

In short, a joint stock company has — in theory, at least — a better incentive structure than regulated companies have. How about in practice? How do joint stock companies actually perform in the real world? I will turn to this governance question in my next post. (To be continued …)

[*] A point of order is in order! Why would a private company in Smith’s day, regardless of whether it was organized as regulated company or as a joint stock company, ever build a fort or garrison overseas? Why shouldn’t it be the government who builds and pays for the fort? To answer this question, we must remember that the private companies we are talking about are overseas trading companies — i.e. private firms that are doing business in foreign countries — so the government back home would not have the legal jurisdiction to build or operate a fort overseas.

Nota bene: I discuss Adam Smith’s first “dire warning” here.

As promised (see here and here), I will now turn to the last part of Adam Smith’s 79-page pamphlet (Part #13, pp. 47-79), Additions and Corrections to the First and Second Editions of Dr. Adam Smith’s Inquiry into the Nature and Causes of the Wealth of Nations (Smith 1784). This part, by far the longest section of Smith’s 1784 pamphlet (it consists of 40 paragraphs spread across 33 pages), was later inserted into “Part Third” of Chapter 1 of Book V of all subsequent editions of Smith’s Wealth of Nations, where Smith surveys “Public Works and Public Institutions”.

In summary, in the first two editions of The Wealth of Nations (1776, 1778), “Part Third” of Book V, Chapter 1 begins with a survey of public goods, such as roads and canals. According to Smith, one of three main duties of government (along with national defense and justice) is the provision of such public goods in order to promote “commerce in general” (my emphasis). The last part of Smith’s 1784 pamphlet, however, added a new subsection to “Part Third” of Book V, Chapter 1, which is titled “Of the Public Works and Institutions which are necessary for facilitating particular Branches of Commerce” (my emphasis). Part #13 begins thus:

“The object of the public works and institutions above mentioned [e.g. roads and canals] is to facilitate commerce in general. But in order to facilitate some particular branches of it, particular institutions are necessary, which again require a particular and extraordinary expense. (Smith 1784, paragraph 1 on p. 47)

So, what are these “particular branches” of commerce that “require a particular and extraordinary expense” by the government? Alas, one is the slave trade:

“Some particular branches of commerce, which are carried on with barbarous and uncivilised nations, require extraordinary protection. An ordinary store or counting-house could give little security to the goods of the merchants who trade to the western coast of Africa. To defend them from the barbarous natives, it is necessary that the place where they are deposited should be, in some measure, fortified.” (Smith 1784, para. 2 on p. 47)

More generally, these “particular branches” of commerce also encompass the activities of any firm that does business overseas. Here (para. 2), Smith surveys three specific examples of overseas trading in the second paragraph of Part #13: Indostan, Turkey, and Russia. Smith writes:

“The disorders in the government of Indostan have been supposed to render a like precaution necessary even among that mild and gentle people; and it was under pretence of securing their persons and property from violence that both the English and French East India Companies were allowed to erect the first forts which they possessed in that country. Among other nations, whose vigorous government will suffer no strangers to possess any fortified place within their territory, it may be necessary to maintain some ambassador, minister, or counsel, who may both decide, according to their own customs, the differences arising among his own countrymen, and, in their disputes with the natives, may, by means of his public character, interfere with more authority, and afford them a more powerful protection, than they could expect from any private man. The interests of commerce have frequently made it necessary to maintain ministers in foreign countries where the purposes, either of war or alliance, would not have required any. The commerce of the Turkey Company first occasioned the establishment of an ordinary ambassador at Constantinople. The first English embassies to Russia arose altogether from commercial interests. The constant interference which those interests necessarily occasioned between the subjects of the different states of Europe, has probably introduced the custom of keeping, in all neighbouring countries, ambassadors or ministers constantly resident even in the time of peace. This custom, unknown to ancient times, seems not to be older than the end of the fifteenth or beginning of the sixteenth century; that is, than the time when commerce first began to extend itself to the greater part of the nations of Europe, and when they first began to attend to its interests.” (para. 2 on pp. 47-48, my emphasis)

In other words, when a private company does business in a foreign country it may have to take pro-active measures, such as the building of fortresses, to protect its agents and property overseas. But Smith also recognizes that most foreign governments are jealous of their sovereignty and won’t allow outside companies to take such pro-active security measures on their soil. As a result, Smith concludes that the British government will have to establish embassies and appoint ambassadors in these foreign countries in order to protect the economic interests of its citizens and firms who are doing business overseas.

But how should these overseas embassies and ambassadors be financed? Smith proposes a kind of “user fee” in the third paragraph of Part #13:

“It seems not unreasonable that the extraordinary expense which the protection of any particular branch of commerce may occasion should be defrayed by a moderate tax upon that particular branch; by a moderate fine, for example, to be paid by the traders when they first enter into it, or, what is more equal, by a particular duty of so much per cent upon the goods which they either import into, or export out of, the particular countries with which it is carried on. The protection of trade in general, from pirates and freebooters, is said to have given occasion to the first institution of the duties of customs. But, if it was thought reasonable to lay a general tax upon trade, in order to defray the expense of protecting trade in general, it should seem equally reasonable to lay a particular tax upon a particular branch of trade, in order to defray the extraordinary expense of protecting that branch.” (para. 3 on pp. 48-49, my emphasis)

Simply put, it is the direct beneficiaries of Britain’s overseas embassies and ambassadors — i.e. the trading companies — who should pay for these public services, either by imposing “a moderate tax” or “a moderate fine” on them, or in the alternative, by imposing “a particular duty” on the imports and exports of those overseas trading companies.

So far, so good. In the fourth paragraph of Part #13, however, Smith makes the following ominous observation:

“The protection of trade in general has always been considered as essential to the defence of the commonwealth, and, upon that account, a necessary part of the duty of the executive power. The collection and application of the general duties of customs, therefore, have always been left to that power…. But in this respect, as well as in many others, nations have not always acted consistently; and in the greater part of the commercial states of Europe, particular companies of merchants have had the address to persuade the legislature to entrust to them the performance of this part of the duty of the sovereign, together with all the powers which are necessarily connected with it.” (para. 4 on p. 49, my emphasis)

That is, although the protection of overseas trade is one of the main duties of the government, overseas trading company have lobbied their home legislatures to allow them to assume this duty themselves! Next (para. 5 of Part #13), Smith presents the following dire warning about the dangers of self-regulation, an admonition that is still relevant today:

“These companies, though they may, perhaps, have been useful for the first introduction of some branches of commerce, by making, at their own expense, an experiment which the state might not think it prudent to make, have in the long run proved, universally, either burdensome or useless, and have either mismanaged or confined the trade.” (para. 5 on p. 49, my emphasis)

In short, the policy of giving these overseas trading companies the power to protect their own interests has “universally” proved to be “either burdensome or useless”! According to Smith, overseas trading companies with the power to self-regulate have “either mismanaged or confined” their overseas trade. But how is this possible? What happened to Smith’s invisible hand? Is unbridled capitalism really so bad? I shall turn to these crucial questions in my next post. (To be continued …)

Earlier this month (6-8 July), I had surveyed Part #11 of Adam Smith’s 1784 pamphlet, Additions and Corrections to the First and Second Editions of Dr. Adam Smith’s Inquiry into the Nature and Causes of the Wealth of Nations (Smith 1784, pp. 13-22), where Smith analyzes and critiques British herring subsidies. For reference, links to my herring-subsidy posts are below:

1. The herring subsidy scam (6 July 2026)
2. Adam Smith’s *negative invisible hand* (7 July 2026)
3. Some closing thoughts on Adam Smith’s critique of the herring bounty scam (8 July 2026)

As a short postscript to my three-part survey, I would now like to bring to your attention a follow-up paper by John Leazer, a scholar who specializes in British history. Professor Leazer’s fascinating paper, which I had not discovered until after writing up my three posts above, is titled “A Case for Subsidies? Adam Smith and the Eighteenth Century Scottish Herring Fishery” and is available here (via JSTOR).

In brief, Leazer surveys the history of British herring subsidies, which he traces back to the historic 1707 “Act of Union” treaty that united England and Scotland into a single kingdom (see Leazer 2013, pp. 51-53), and concludes that Smith’s critique of these subsidies was premature. Although the amount of herring caught declined from 1775 to 1782 despite the subsidies (ibid. at Figure 8, p. 62), upon closer examination Leazer attributes this decline to exogenous factors, including “dramatic price increases in materials” and an “onslaught of privateers” (ibid. at p. 64).

Moreover, inspecting the fishery data from 1787 to 1799, Leazer concludes that the herring subsidies actually worked in the long run, for the subsidies created “a thriving industry where none existed before” (p. 47). Also, according to Leazer the true costs of the subsidies were not as high as Smith had imagined, for after 1786 “an increasing amount of [herring] were caught for the same amount of subsidy invested in the industry” (pp. 58-59). Or in the words of Leazer: “How could Smith be so wrong?” (p. 64)

Alas, Professor Leazer fails to consider another intriguing possibility: what if it was Adam Smith’s critique of herring subsidies that (perhaps unwittingly) set into motion the train of events that was ultimately responsible for this increase in herring production? After all, Parliament decided to tweak the subsidy scheme when it enacted the Fishery Act of 1786, two years after Smith had first published his stinging critique of herring subsidies in 1784.

Or perhaps it was the steady decline in herring production (especially between the years 1775 to 1782; see above), along with the spotlight Smith shined on this topic in his 1784 pamphlet, that motivated Parliament to enact the 1786 Fishery Act? Either way, what specific change did Parliament end up making to the herring subsidy in 1786? As it happens, Parliament totally ignored — or rejected! — Smith’s advice; instead, it doubled-down on the herring bounty, or to quote Leazer:

“After the Act of 1786 adjusted the bounty system, bounty payments increased dramatically, and herring catches increased as well. Figure 4 shows the yearly tonnage bounty payments between 1783 and 1799. These bounties rose from just over £10,000 in 1783 to almost £20,000 in 1787 and remained consistently around £20,000 between 1788 and 1799.” (Leazer 2013, p. 56, footnote omitted)

Simply put, the subsequent increase in herring production from 1787 to 1799 that Leazer touts so much in his paper was thus most likely due to the dramatic increase in subsidies made in 1786. But what is even more damning for Leazer — and more exculpatory for Adam Smith — is the following fact: Parliament eventually eliminated the herring bounty altogether in the 1830s. Yet, by Leazer’s own admission, “In 1850, total herring catches grew to a half million barrels and, by the end of the 19th century, production reached close to two million barrels …” (pp. 65-66; my emphasis). In other words, to paraphrase one of the characters in The Treasure of the Sierra Madre, we don’t need no stinkin’ subsidies! Smith’s critique of herring subsidies was vindicated by history.

Nota bene: I will proceed to the last part of Smith’s 1784 pamphlet (Part #13) in my next post.

Works cited

John Leazer, A Case for Subsidies? Adam Smith and the Eighteenth Century Scottish Herring Fishery, The Historian, vol. 75 no. 1 (Spring, 2013), pp. 47-68.

Adam Smith, Additions and Corrections to the First and Second Editions of Dr. Adam Smith’s Inquiry into the Nature and Causes of the Wealth of Nations (1784).

Shout out to my favorite L.A. bookstore, Lost Books (the entrance of which is pictured below), where I found a veritable treasure trove of erudite tomes — listed below in alphabetical order (by author):

1. Ananyo Bhattacharya, The Man from the Future: The Visionary Life of John Von Neuman (Norton, 2022). Full disclosure: I have been wanting to read a book-length biography of the great Hungarian-American polymath John von Neuman for many years now. Thanks to Dr Bhattacharya, I now have my chance!
2. T. C. Boyle, The Relive Box and Other Stories (Ecco 2017). Along with Junot Diaz, T. C. Boyle is my favorite North American novelist and short story writer.
3. Ian Klaus, Forging Capitalism: Rogues, Swindlers, Frauds, and the Rise of Modern Finance (Yale, 2016). This book not only surveys many long-forgotten financial frauds; it also poses a provocative question: what would Adam Smith have to say about stock markets, “futures” contracts, and other 19th-century developments in financial capitalism?
4. Michael Lewis, The Money Culture (Norton, 2011). It’s by Michael Lewis. What more do I need to say!
5. Hilary Powell & Dan Edelstyn, Bank Job (Chelsea Green, 2020). Two idealistic artists print their own money and pull off a “reverse heist” to protest the 2008 bank bailouts and consumer debt culture more generally.
6. Guy Standing, Basic Income: A Guide for the Open-Minded (Yale, 2017). Is “universal basic income” (UBI) feasible? Among other things, this book describes many different types of UBI proposals and explains why some of them might be doable.

Nota bene: I will be resuming my previous multi-part series on Adam Smith’s 1784 pamphlet, Additions and Corrections to the First and Second Editions of Dr. Adam Smith’s Inquiry into the Nature and Causes of the Wealth of Nations (see here, for example), as well as writing up mini-reviews of the above works in the days ahead.

Below are links to some free mathematics textbooks/lecture notes: (hat tips: @pickover, @gemchange_ltd, @LunesDes, and @ParamSiddh)

• Donna Kirk, Contemporary Mathematics (2026)
• MIT Sloan Business Club, Quant Bible (not dated)
• W. W. Sawyer, A Path to Modern Mathematics (1966)
• C. H. Taubes, Probability, Statistics, and Linear Algebra (2010)
• Sergei Treil, Linear Algebra Done Wrong (2026)

Bonus link: See also my 2015 paper “Finding Santiago“, where I trace the biographical origins of the legendary protagonist of Ernest Hemingway’s timeless novella The Old Man and the Sea.