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Laws versus Contracts: Shareholder Protections and Ownership Concentration in Brazil, 1890–1950

Published online by Cambridge University Press:  13 December 2010

Aldo Musacchio
Aldo Musacchio
Affiliation:
ALDO MUSACCHIO is assistant professor of business administration at Harvard Business School.
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Abstract

This article examines some of the institutional conditions that facilitated the development of equity markets in Brazil. A critical factor was the addition to corporate bylaws of protections for investors, which enabled relatively large corporations in Brazil to attract investors in large numbers. By availing themselves of this strategy, the firms generated a relatively low concentration of ownership before 1910. Archival evidence, such as company statutes and shareholder lists, reveals that the addition of voting rights to their bylaws, particularly maximum-vote provisions and graduated voting scales (which stipulated that less-than-proportional votes increase in parallel with shareholdings), allowed many Brazilian corporations to balance the relative voting power of their small and large investors. In companies that made such arrangements, the concentration of ownership and control was sharply lower than in the average company. Judging by the Brazilian companies examined for this article, it also appears that the concentration of control was significantly lower before 1910 than it is today.

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Articles
Information
Business History Review , Volume 82 , Special Issue 3: Business in Latin America , Autumn 2008 , pp. 445 - 473
Copyright
Copyright © The President and Fellows of Harvard College 2008

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References

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8 For the history of voting rights across states, see Dunlavy, Colleen, “From Citizens to Plutocrats: Nineteenth-Century Shareholder Voting Rights and Theories of the Corporation,” in Constructing Corporate America: History, Politics, Culture, ed. Lipartito, Kenneth and Sicilia, David B. (Oxford, 2004), 66–93CrossRefGoogle Scholar, and “Corporate Governance in Late Nineteenth-Century Europe and the United States: The Case of Shareholder Voting Rights,” in Corporate Governance: The State of the Art of Emerging Research, ed. Hopt, Klaus J. et al. (Oxford, 1998), 5–39Google Scholar. Corporate governance practices in early Antebellum New York are explored in detail by Eric Hilt, “When Did Ownership Separate from Control? Corporate Governance in the Early Nineteenth Century,” NBER Working Paper 13093, May 2007. See also Hannah, Leslie, “Pioneering Modern Corporate Governance: A View from London in 1900,” Enterprise & Society 8 (Sept. 2007): 642–86CrossRefGoogle Scholar, and “The Divorce of Ownership from Control from 1900: Re-calibrating Imagined Global Historical Trends.”

9 Colleen Dunlavy argues that mandatory maximum vote provisions and graduated voting scales included in state company laws in the United States in the middle of the nineteenth century created a more democratic (her word is plutocratic) voting system that constrained the proportion of votes that could be controlled by any large shareholder during shareholder meetings. See Dunlavy, “From Citizens to Plutocrats,” and “Corporate Governance in Late Nineteenth-Century Europe and the U.S.“

10 Arguably Cuba had the largest equity market in Latin America circa 1913, yet the number of corporations traded was very small. Also, Raghuram Rajan and Luigi Zingales estimate that in 1913 the stock market capitalization to gross domestic product (GDP) ratio for Brazil was 25 percent, and for both Argentina and Chile, 17 percent. The authors estimate that in that year Rio de Janeiro had 335 listed corporations, São Paulo 145 (excluding cross-listings), giving for the number of traded companies per million people 20.8 (assuming a population of about 23 million). Rajan and Zingales' estimates of that ratio for that year were for Argentina 15.29, for Chile, 20.62, and for Cuba, 12.69. (See Rajan, Raghuram and Zingales, Luigi, “The Great Reversals: The Politics of Financial Development in the Twentieth Century” Journal of Financial Economics 69 (2003): 50CrossRefGoogle Scholar, Tables 3 and 5; and Musacchio, Aldo, “Experiments in Financial Democracy: Corporate Governance and Financial Development in Brazil, 1882–1950” un-published book manuscript, Harvard Business School, December 2007, Tables 3–5 and 3–9Google Scholar.)

11 On the relation between religion and financial development, see Stulz, René M. and Williamson, Rohan, “Culture, Openness, and Finance,” Journal of Financial Economics 70 (2003): 313–49CrossRefGoogle Scholar; for the relation between legal origin, investor protections, and financial development, see La Porta et al., “Legal Determinants of External Finance” and “Law and Finance.” The argument that religion caused underdevelopment in Latin America was refuted by Coatsworth, John H. in his book Los Orígenes del Atraso: Nueve ensayos de historia económica de México en los siglos XVIII y XIX (Mexico, 1990), 91–93Google Scholar.

12 Acemoglu, Daron, Johnson, Simon, and Robinson, James, “The Colonial Origins of Comparative Development: An Empirical Investigation” American Economic Review 91, 5 (2001): 1369–1401CrossRefGoogle Scholar. In a less deterministic fashion, Stanley Engerman and Kenneth Sokoloff proposed that the initial endowments of the region mattered for long-term development. For them, places with high ratios of natives or slaves to colonizers that relied on large-scale agriculture (e.g., plantations) usually ended up with weaker institutions and weak rules of law. See, for example, Engerman, Stanley and Sokoloff, Kenneth, “Factor Endowments, Institutions, and Differential Paths of Growth” in Why Latin America Fell Behind, ed. Haber, Stephen (Stanford, 1997), 260–304Google Scholar.

13 See La Porta, Rafael, Lopez-de-Silanes, Florencio, and Shleifer, Andrei, “The Economic Consequences of Legal Origins,” Journal of Economic Literature 46–2 (June 2008): 285–332CrossRefGoogle Scholar, for a summary of the main arguments of the literature (and the long list of publications by these authors).

14 The methodology to estimate the index of shareholder rights comes mostly from La Porta et al., “Law and Finance,” Tables l and 2.

15 See La Porta et al., “Legal Determinants of External Finance,” 9.

16 For the case of Great Britain, see Julian Franks, Colin Mayer, and Stefano Rossi, “Ownership: Evolution and Regulation,” Institute of Finance and Accounting Working Paper FIN 401, London Business School, 2004, 3–4. The German case is discussed in Franks, Julian, Mayer, Colin, and Wagner, Hannes F., “The Origins of the German Corporation: Finance, Ownership and Control,” Review of Finance 10, no. 4 (2006): 537–85CrossRefGoogle Scholar. Similar arguments about the role of banks in corporate governance in Germany are offered by Fohlin, Caroline, “Does Civil Law Tradition and Universal Banking Crowd Out Securities Markets? Pre–World War I Germany as a Counter-Example,” Enterprise & Society 8 (Sept. 2007): 602–41CrossRefGoogle Scholar; and Fear, Jeffrey and Kobrak, Christopher, “Diverging Paths: Accounting for Corporate Governance in America and Germany,” Business History Review 80 (Spring 2006): 1–48CrossRefGoogle Scholar, and “Banks on Board: Banks in German and American Corporate Governance, 1870–1914,” un-published paper, Harvard Business School, May 2007.

17 See Hilt, “When Did Ownership Separate from Control?”; Dunlavy, “Corporate Governance in Late Nineteenth-Century Europe and the U.S.,” 28; and Lamoreaux and Rosenthal, “Corporate Governance and the Plight of Minority Shareholders in the United States before the Great Depression,” 147.

18 See Law 3150, 4 Nov. 1882, especially Article 11 and Decree 603, 17 Oct. 1891, Article 189, blocking shares before meeting, and Article 209, allowing legal action against directors.

19 See Decree-Law 2627,1940. Articles 17 and 107 permitted shareholders who disagreed with directors or assembly decisions to walk away from the company with the share of net worth that corresponded to the lot of shares held. The 1940 law included the right of minority shareholders to elect members of the board of overseers. Any group of shareholders, ordinary or preferred, that represented at least 20 percent of capital that disagreed with the election of a member of that board (conselho fiscal) could name one member of its preference.

20 The literature that studies “private benefits of control,” or the nonpecuniary benefits of those who control a corporation, finds that in the 1990s Brazil was the country with the highest expropriation of shareholder value by controlling shareholders. See Nenova, Tatiana, “Control Values an d Changes in Corporate Law in Brazil,” in Latin American Business Review 6, no. 3 (2005): 1–37CrossRefGoogle Scholar; and Zingales, Luigi and Dyck, Alexander, “Private Benefits of Control: An International Comparison,” Journal of Finance 49 (Apr. 2004): 537–600Google Scholar.

21 La Porta et al., “Legal Determinants of External Finance.”

22 See Law 556, 25 June 1850, Article 298 and Law 3150, 4 Nov. 1882, Article 16.

23 Law 3150,4 Nov. 1882, Articles 15 and 16. The overseeing board was composed of three shareholders elected at the shareholders' meeting usually to a term of three years. Most of the provisions that regulated the overseeing board were mandated by law.

24 Decree 603, 20 Oct. 1891, Article 211 required directors to prepare and publish in a newspaper a balance sheet and a profit-and-loss statement one month before the annual general shareholders' meeting.

25 See Baskin and Miranti, A History of Corporate Finance, 141; and Hannah, “Pioneering Modern Corporate Governance,” 15–17.

26 Hannah, “Pioneering Modern Corporate Governance,” 19–20.

27 Quotes from Levy, Mária Bárbara, A Indústria do Rio de Janeiro através de suas Sociedades Anônimas (Rio de Janeiro, 1994), 179Google Scholar (translated by the author).

28 See Decree 603, 20 Oct. 1891, Articles 89, 90 and 105. See also, Law 3150, 4 Nov. 1882, Article 3.

29 See Decree 603, 20 Oct. 1891, Article 28 2 (for shareholder rights in mergers), 148 for restrictions on transactions with family members, and 165 for constraints on family members serving on boards.

30 La Porta, Lopez-de-Silanes, and Shleifer, “What Works in Securities Laws?” 1–32; for the methodology of the index, see Table 1.

31 See Franks, Mayer, and Rossi, “Ownership: Evolution and Regulation,” Table 1, Panel D; and Franks, Mayer, and Wagner, “The Origins of the German Corporation,” Table 3, Panel B.

32 See La Porta, Lopez-de-Silanes, and Shleifer, “What Works in Securities Laws?” Table 2.

33 See, for example, Decree 603, 20 Oct. 1891, Articles 125 and 126.

34 The Investor's Monthly Manual lists tens, perhaps hundreds, of corporations with guaranteed dividends or coupons, which implies that the practice was common in Great Britain. For government guarantees in Canada, see Carlos, Anne and Lewis, Frank D., “Foreign Financing of Canadian Railroads: The Role of Information,” in Anglo-American Financial Systems: Institutions and Markets in the Twentieth Century, ed. Bordo, Michael and Sylla, Richard (New York, 1995), 383–414Google Scholar.

35 Some of the earliest railroad companies were not particularly successful, a number failing altogether. The railroad Dom Pedro II, for example, established to transport coffee from the Paraiba Valley to the port of Rio de Janeiro, had to be bailed out in 1865 when it ran out of funds to complete construction. See Saes, Flávio A. M., A Grande Empresa de Serviços Públicos na Economia Cafeeira (São Paulo, 1986), 37–38Google Scholar.

36 On the history of the expansion of railroads and subsidy policies, see Summerhill, William R. III, Order Against Progress: Government, Foreign Investment, and Railroads in Brazil, 1851–1913 (Stanford, 2003)Google Scholar, ch. 3; and Saes, Flávio A. M., As Ferrovias de São Paulo, 1870–1940 (São Paulo, 1981), 151–54Google Scholar. A more detailed contemporary account is provided by de Sá, Chrockatt, Brazilian Railways; Their History, Legislation and Development (Rio de Janeiro, 1893)Google Scholar.

37 This was the case of the Sorocabana Railway in 1902 and the E. F. Dom Pedro II in 1865. See Sorocabana, Estrada de Ferro, Relatório: Anno de 1904 (São Paulo, 1905)Google Scholar for a description of the acquisition of the assets of the Sorobana by the federal government; and Saes, A Grande Empresa de Serviços Públicos na Economia Cafeeira, 36, for the story of the E. F. Dom Pedro II.

38 This might be the case when two rival groups with large shareholdings monitor one another or when a large shareholder with a good reputation monitors the actions of directors or founders. In both cases, small shareholders would buy equity as a way to free ride on the monitoring efforts of the large shareholders.

39 Article 15 of Law 3150, 4 Nov. 1882 stated that voting rights were to be established by each company in its bylaws.

40 These figures are based on a compilation of voting rights data for all the companies surveyed in the Brazilian Year Book 1909 (London, 1910)Google Scholar. Unfortunately not all companies surveyed in this publication reported voting rights. There were 135 companies that reported voting rights. These companies were from all over Brazil.

41 For salary data, see Lobo, Mária Eulália Lahmeyer, História do Rio de Janeiro: Do capital comercial ao capital industrial e financeiro (Rio de Janeiro, 1978)Google Scholar, Table 4.44.

42 See Cia. Mogyana (Mojiana) de Estradas de Ferro, Relatório da Diretoria em Assembléia Geral… (Rio de Janeiro, 1878–1922)Google Scholar; and Estatutos da Companhia São Paulo Fabril (São Paulo, 1890)Google Scholar.

43 The sample studied was compiled by looking at all of the files of companies listed in the Rio de Janeiro Stock Exchange, from the Arquivo da Bolsa de Valores do Rio de Janeiro, housed at the National Archive of Brazil. I only included companies with more than 1,000,000$000 of 1913 in capitalization (the equivalent of US$330,000). The sample also includes all the companies with complete shareholder lists that I found at the São Paulo State Archive. The sample is limited by the fact that I only include companies for which I have complete shareholder lists.

Both archives have special sections on Sociedades Anônimas, with files for each company that usually include company statutes, shareholder lists, and changes to statutes every time there was a bond or new share issue. See, for example, the Sociedades Anônimas collection in the National Archive of Brazil, Rio de Janeiro.

44 The Herfindahl-Hirschman Index is a convenient measure of concentration because its inverse (i.e., 1/x ) gives the equivalent number of shareholders needed to have a specific level of concentration. For instance, say a company with 200 shareholders had a few shareholders holding a proportion of shares such that the HHI is 0.20 (by definition it is always between O and 1). This would be the equivalent of a company that had five shareholders with equal shares (or 1/0.20). Even if there are 200 shareholders, an HHI of 0.20 tell us that there is relative concentration of ownership. On the HHI and some of its interpretations, see Adelman, M. A., “Comment on the ‘H’ Concentration Measure as a Numbers-Equivalent” Review of Economics and Statistics 51 (Feb. 1969): 99–101CrossRefGoogle Scholar.

45 See Estatutos da Companhia Antarctica Paulista, 1891–1913, published in Decree 217, 2 May 1891, Decree 3348,17 July 1899, Decree 10,036, 6 Feb. 1913, and Antarctica, Cia., Atas da Assambléia de Acionistas da … (São Paulo, 1891–1927)Google Scholar.

46 See Hanley, Anne, “Is It Who You Know? Entrepreneurs and Bankers in São Paulo, Brazil, at the Turn of the Twentieth Century,” Enterprise and Society 2, no. 2 (2004): 187–225Google Scholar, for a description of some of the relations between these coffee planters and their role in the network of investors and directors in São Paulo.

47 See “Companhia Petropolitana,” in Diario Oficial, 16 Apr. 1898; and Petropolitana, Companhia, Relatorio da directoria da Companhia Petropolitana apresentado à Assembléa Geral Ordinaria dos Snrs. Accionistas (Rio de Janeiro, 1928 and 1929)Google Scholar.

48 The changes made by shareholders to the statutes of Banespa in the extraordinary shareholders' meeting of May 29,1926 are reported in “Decreto n. 17544—de 10 de Novembro de 1926” in Diario Oficial do Estado de São Paulo, 4 Jan. 1927. The concentration of control in the bank is clear in the extraordinary shareholders' meeting of October 11, 1933 reported in “Decreto N. 2—de 25 de Julho de 1934” in Diario Oficial do Estado de São Paulo, 15 Aug. 1934. For the Matarazzo company example, see the detailed description in the section dealing with family-controlled corporations.

49 This was estimated using data in the Appendix, but excluding repeated observations for companies with multiple observations, taking the average by company. Data for 2004 are estimated using the Economatica database and selecting the top 20 companies on the basis of total assets as reported by Bovespa (São Paulo's Stock Exchange).

50 See Franks, Mayer, and Rossi, “Ownership: Evolution and Regulation,” Table 4.

51 See “Estatutos da Companhia Fabricadora de Papel (Klabin),” in Diário Oficial do Estado de São Paulo, 6/15/1909; and “Cia. Fabricadora de Papel (Klabin),” in Diário Oficial do Estado de São Paulo, 5/8/1937. For the list of top business groups, see the magazine Balanço, part of the newspaper Gazeta Mercantil.

52 In 1891, the Matarazzo family chartered its first corporation, the Companhia Matarazzo. The main objective of this company was to process and sell pork lard in the states of São Paulo and Rio Grande do Sul. This company required 10 shares for one vote and limited the number of votes to 50. See “Cia. Matarrazo,” in Diario Oficial do Estado de São Paulo, 2 June 1891.

53 The changes made to statutes at the extraordinary shareholders' meeting of May 29, 1926 are reported in “Decreto n. 17544–de 10 de Novembro de 1926”; and the shareholder list and voting count of the extraordinary shareholders' meeting of October 11,1933 are reported in “Decreto N. 2–de 25 de Julho de 1934.”

54 In the 1930s, the cost of controlling a corporation was significantly altered with the introduction of (nonvoting) preferred shares. Decree 21,526,15 June 1932, regulated preferred shares. By this decree there was no explicit limit as to what percentage of total equity these shares could represent. Usually preferred shares did not have voting rights (it was up to each company to decide) but instead granted their owners first rights when the company distributed dividends and/or priority when the company repurchased shares. The right to vote was sacrificed in exchange for a fixed dividend. In the case that the fixed dividend was not paid for three years, preferred shares became ordinary shares with full voting rights.