Raising of the Corporate Veil - ENRON

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1 Important Concepts

In his landmark work "Wealth of Nations," Adam Smith recounts a fascinating history of development of commerce. From the days of feudal lords, to those of merchants, guilds and sovereigns, he narrates a logical sequence of evolution that has led to the current day "corporations".

As business grew, it was felt that businesses might outlive the proprietors. Thus surfaced the concept of treating the business as a separate legal entity. Then, to encourage a spirit of entrepreneurship and risk-taking, the concept of limited liability was introduced. This assured the business owner that he/she would be liable to a limited extent in case of the failure of business. Soon, it was felt that professional help was needed in the ever-increasing complexity of the businesses. Also, distributed pattern of ownership necessitated a separation between the ownership and management. This then led to the problem of Principal/Agent conflict and agency costs, as the interests of the owners and the managers were often divergent.

In this section, we discuss these concepts as they apply to corporates.

1.1 Separate Legal Entity

The word "corporation" derives from the Latin corpus (body), representing a "body of people", i.e.: a group of people authorised to act as an individual.

A corporation is a legal entity (distinct from a natural person) that often has similar rights in law to those of a natural person. It has its own rights, privileges, and liabilities distinct from those of its members. It has special privileges not vouchsafed to ordinary unincorporated businesses, to voluntary associations, or to groups of individuals. It is therefore extremely important that a corporation have its own separate bank accounts and that it be treated at all times as a separate entity with its own assets.

This ensures that a corporation will continue uninterrupted even...