Thus far this week (see here and here), we have seen Adam Smith’s tedious and painstaking reconstruction of the rising fortunes of the East India Company. In brief, the company had accumulated massive amounts of debts, but it had also generated tons of revenue, and by 1773 — the year its five-year deal with the British government was set to expire (see my previous post) — the company was so flush with cash that it was poised to pay off its massive debts. Instead, the company’s debts began to spiral out of control! Smith writes (sentence #47):

“In 1773, however, their debts, instead of being reduced, were augmented by an arrear to the treasury in the payment of the four hundred thousand pounds, by another to the custom-house for duties unpaid, by a large debt to the bank for money borrowed, and by a fourth for bills drawn upon them from India, and wantonly accepted, to the amount of upwards of twelve hundred thousand pounds.” (Smith 1784, p. 70)

The East India Company was now forced to take drastic measures. Among other things (sentence #48), the company had to take out a loan, beg the government for a moratorium on its bribe payments (again, see my previous post), and slash its dividend payments in half:

“The distress which these accumulated claims brought upon them, obliged them not only to reduce all at once their dividend to six per cent, but to throw themselves upon the mercy of government, and to supplicate, first, a release from further payment of the stipulated four hundred thousand pounds a year; and, secondly, a loan of fourteen hundred thousand, to save them from immediate bankruptcy.” (Smith 1784, pp. 70-71)

At the same time, Smith informs us in the very next sentence of this very long paragraph (sentence #49), the employees of the East India Company engaged in shady business practices in order to enrich themselves before the company’s imminent collapse:

The great increase of their fortune had, it seems, only served to furnish their servants with a pretext for greater profusion, and a cover for greater malversation, than in proportion even to that increase of fortune. (Smith 1784, p. 71)

The situation got so out of hand that the Parliament conducted a formal inquiry and made “several very important alterations” to the company’s corporate governance. In the immortal words of Adam Smith (sentence #50):

“The conduct of their servants in India, and the general state of their affairs both in India and in Europe, became the subject of a Parliamentary inquiry, in consequence of which several very important alterations were made in the constitution of their government, both at home and abroad.” (Smith 1784, p. 71)

What were these “alterations” or changes to the company’s constitution? First off, the operations of the company in India would now be subject to strict government oversight. Smith writes (sentences ##51-54):

“In India their principal settlements of Madras, Bombay, and Calcutta, which had before been altogether independent of one another, were subjected to a governor-general, assisted by a council of four assessors, Parliament assuming to itself the first nomination of this governor and council who were to reside at Calcutta; that city having now become, what Madras was before, the most important of the English settlements in India. The Court of the Mayor of Calcutta, originally instituted for the trial of mercantile causes which arose in city and neighbourhood, had gradually extended its jurisdiction with the extension of the empire. It was now reduced and confined to the original purpose of its institution. Instead of it a new supreme court of judicature was established, consisting of a chief justice and three judges to be appointed by the crown.” (Smith 1784, p. 71)

In addition to subjecting the operations of the company in India to government oversight, Smith describes two major changes to the internal corporate governance of the East India Company. One major change, Smith says (sentences #55 & #56), was to reduce the number of shareholders with voting rights:

“In Europe, the qualification necessary to entitle a proprietor to vote at their general courts was raised from five hundred pounds, the original price of a share in the stock of the company, to a thousand pounds. In order to vote upon this qualification too, it was declared necessary that he should have possessed it, if acquired by his own purchase, and not by inheritance, for at least one year, instead of six months, the term requisite before.” (Smith 1784, p. 71)

The other major change (sentences #57 & #58) was to increase and rotate the terms of the members of the company’s board of directors:

“The court of twenty-four directors had before been chosen annually; but it was now enacted that each director should, for the future, be chosen for four years; six of them, however, to go out of office by rotation every year, and not to be capable of being re-chosen at the election of the six new directors for the ensuing year. In consequence of these alterations, the courts, both of the proprietors and directors, it was expected, would be likely to act with more dignity and steadiness than they had usually done before.” (Smith 1784, pp. 71-72)

For Smith, however, these changes in the company’s corporate governance were merely cosmetic. They do not align the private incentives of corporate officers with the common good. Smith writes (sentence #59):

“But it seems impossible, by any alterations, to render those courts [i.e. boards of directors of joint stock companies doing business overseas], in any respect, fit to govern, or even to share in the government of a great empire; because the greater part of their members must always have too little interest in the prosperity of that empire to give any serious attention to what may promote it.” (Smith 1784, p. 72, my emphasis)

Adam Smith doesn’t hold back, for he does not limit this criticism to the board of directors of the East India Company. He extends his damning critique to the company’s shareholders. Smith writes (sentences ##60-63):

“Frequently a man of great, sometimes even a man of small fortune, is willing to purchase a thousand pounds’ share in India stock merely for the influence which he expects to acquire by a vote in the court of proprietors. It gives him a share, though not in the plunder, yet in the appointment of the plunderers of India; the court of directors, though they make that appointment, being necessarily more or less under the influence of the proprietors, who not only elect those directors, but sometimes overrule the appointments of their servants in India. Provided he can enjoy this influence for a few years, and thereby provide for a certain number of his friends, he frequently cares little about the dividend, or even about the value of the stock upon which his vote is founded. About the prosperity of the great empire, in the government of which that vote gives him a share, he seldom cares at all.” (Smith 1784, p. 72, my emphases)

Then, in what has to be one of the most strongly-worded and damning passages Smith would ever write (sentence #64), Smith makes the following indictment:

“No other sovereigns ever were, or, from the nature of things, ever could be, so perfectly indifferent about the happiness or misery of their subjects, the improvement or waste of their dominions, the glory or disgrace of their administration, as, from irresistible moral causes, the greater part of the proprietors of such a mercantile company are, and necessarily must be.” (Smith 1784, p. 72, my emphasis)

Worse yet, according to Smith (sentences ##65-67), the British government only made matters (this lack of alignment between the company and the common good) worse :

“This indifference, too, was more likely to be increased than diminished by some of the new regulations which were made in consequence of the Parliamentary inquiry. By a resolution of the House of Commons, for example, it was declared, that when the fourteen hundred thousand pounds lent to the company by government should be paid, and their bond-debts be reduced to fifteen hundred thousand pounds, they might then, and not till then, divide eight per cent upon their capital; and that whatever remained of their revenues and net profits at home should be divided into four parts; three of them to be paid into the exchequer for the use of the public, and the fourth to be reserved as a fund either for the further reduction of their bond-debts, or for the discharge of other contingent exigencies which the company might labour under. But if the company were bad stewards, and bad sovereigns, when the whole of their net revenue and profits belonged to themselves, and were at their own disposal, they were surely not likely to be better when three-fourths of them were to belong to other people, and the other fourth, though to be laid out for the benefit of the company, yet to be so under the inspection and with the approbation of other people.” (Smith 1784, pp. 72-73, my emphases)

I will conclude my survey of Smith’s stinging critique of the East India Company in my next post. (To be continued …)