Hong Kong must not add another cloak of secrecy to company operations

News of a government proposal to obscure the identities of company directors was met internationally with bewilderment and locally with embarrassment. Officials have again showed a profoundly flawed understanding of the role of companies in a well-administered society. They are in need of a history lesson: the legal fiction we call a company can be both a boon to society and the cause of financial loss.

The concept of the company as a legal person has been around since at least the Roman Empire. Groups of people were granted the right by the state to act as if they were one person. Clubs and guilds started the trend, but private enterprise provided the catalyst for growth of the corporate form.

As companies grew larger, shareholders became increasingly distant from any kind of influence on company behaviour. But when liabilities arose, each shareholder was on the hook for the total bill. Predictably, shareholders wanted to avoid liability for company actions over which they had no control. Political agitation led to the introduction of laws to limit the liability of shareholders to the amount invested.

With the introduction of limited liability, governments and citizens implicitly struck a grand bargain. The state would grant to shareholders the gift of walking away when things went bad. In return, companies would act as aggregators of capital, funding the corporations that would fuel economic growth and raise living standards.

It behooves us to question if both sides have stuck to the terms of the deal.

The first question we should ask is whether corporations (a term that derives from the Latin word for "body of people") are aggregating money and deploying it in commercial enterprises. Well, yes and no. Public companies around the world operate in every industry, but there are also innumerable companies with only one shareholder, who in most cases is also the sole director.

The second question follows from the first: do companies with only one shareholder (who, incidentally, is likely to be another company) fulfil any useful social purpose? The answer is no. Running a business as a company is no better for society than an individual running the same business in her own name.

In fact, it is worse. Liabilities incurred by an individual must be borne by that individual. But debts and liabilities incurred by the company, to the extent that they exceed the assets of the company, are simply never paid. If a company's shareholder has emptied its coffers through active dividend payments or other sophisticated tactics, the creditors are out of luck.

So, too, in fact, is the government. The tax advantages of running a small businesses or owning property through a company are basic and obvious. And stories of shifting assets and reappearing businesses are commonplace in Hong Kong.

Creditors and tax collectors who come up empty-handed must resort to sleuthing their way through the foggy layers of corporate structures. We all know that the perpetrator of tax and liability evasion is the shareholder, but the government has granted the shareholder an "alter ego" through which to operate, separating negative consequences from bad behaviour.

The government not only allows individuals to hide behind corporate facades, it facilitates this deviant behaviour. It created a mechanism, through shareholding by nominees, by which the public can be legally barred from uncovering the true ownership of companies. A similar mechanism is employed to conceal the identities of company directors. In other words, the government allows a cloak of secrecy to envelop the commercial dealings of individuals. This is counterproductive for society, regardless of how beneficial it is for shareholders.

Recently, both in Hong Kong and mainland China, corrupt or illegal behaviour by individuals has been perpetrated through investment vehicles.

Whether owning subdivided flats through companies run by wives, or investing at miraculously timed moments through companies run by mothers, the game is the same. Set up a company; obscure ownership and control; engage in bad behaviour; evade responsibility through the government-provided mechanism of corporate personhood.

There is no benefit to society from a company wholly owned by one individual or another legal entity, and there is certainly no benefit to obscuring true ownership, or director identity, as the government now proposes. There is only the potential for aggregate loss to society, as creditors are left uncompensated, and real-person taxpayers are left to pick up the tab.

Of the more than one million companies registered in Hong Kong, how many are actually aggregating capital from a "body of people" and employing it in active commerce? My guess is few.

Beau Lefler is a lecturer in the Faculty of Business and Economics at the University of Hong Kong