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Scylla or Charybdis? Historical Reflections on Two Basic Problems of Corporate Governance

Published online by Cambridge University Press:  14 April 2011

Naomi R. Lamoreaux
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Shareholders in corporations face two very different types of governance problems: expropriation by controlling shareholders or managers; and expropriation by greedy rulers or, more generally, by the state. The problem is that the more successful investors are in protecting their capital from the grabbing hand of the state, the less they are able to call upon the state to protect it from the grabbing hand of corporate insiders. Conversely, the more investors are able to call upon government to restrain insiders, the more they are vulnerable to expropriation by the state. Although the terms of this tradeoff have changed over time as modern democratic polities replaced absolutist monarchies, both types of threats are still very much with us.

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Business History Review , Volume 83 , Issue 1: A Special Issue on Scandals and Panics , Spring 2009 , pp. 9 - 34
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Copyright © Harvard Business School 2009

References

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14 Shareholders in corporations formed in this way bore unlimited liability, but in 1855–56 Parliament amended the law to permit them to obtain limited liability. On the advent of general incorporation, see Harris, Ron, Industrializing English Law: Entrepreneurship and Business Organization, 1720–1844 (Cambridge, U.K., 2000)CrossRefGoogle Scholar; Taylor, Creating Capitalism, ch. 4; and Freeman, Pearson, and Taylor, Shareholder Democracies, ch. 2. See also North, Wallis, and Weingast, Violence and Social Orders, ch. 6.

15 Harris, “English East India Company”; and Broz and Grossman, “Paying for Privilege.”

16 DuBois, English Business Company, 118–27.

17 Ibid., 122–23.

18 Foss v. Harbottle, 2 Hare 461 (1843).Google Scholar See Prunty, Bert S., “The Shareholders' Derivative Suit: Notes on its Derivation,” New York University Law Review 32, no. 5 (1957): 980–94Google Scholar; and Boyle, A. J., “The Minority Shareholder in the Nineteenth Century: A Study in Anglo-American Legal History,” Modern Law Review 28 (May 1965): 317–29.CrossRefGoogle Scholar

19 See Bloch and Lamoreaux, “Private Rights of Organizations.”

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24 Virtually all colleges faced similar assaults on their autonomy in the late-eighteenth and early-nineteenth centuries. See Campbell, “Dartmouth College as a Civil Liberties Case,” 671–91.

25 Dartmouth College v. Woodward, 17 U.S. 518, 625, 649 (1819).Google Scholar For an overview of the case, see White, G. Edward, The Marshall Court and Cultural Change, 1815–35 (New York, 1988), 174–81, 612–28. See also Bloch and Lamoreaux, “Private Rights of Organizations.”Google Scholar

26 For examples of other kinds of special privileges embodied in charters, see Maier, “Revolutionary Origins of the American Corporation,” 66–69; Handlin, Oscar and Handlin, Mary Flug, Commonwealth: A Study of the Role of Government in the American Economy, 1774–1861, rev. ed. (Cambridge, Mass., 1969), 106–33Google Scholar; Hartz, Louis, Economic Policy and Democratic Thought: Pennsylvania, 1776–1860 (Cambridge, Mass., 1948), 37–81CrossRefGoogle Scholar; and Lamoreaux, Naomi R., Insider Lending: Banks, Personal Connections, and Economic Development in Industrial New England (New York, 1994), 29–51.CrossRefGoogle Scholar

27 See also Sylla, Richard, Legler, John B., and Wallis, John J., “Banks and State Public Finance in the New Republic: The United States, 1790–1860,” Journal of Economic History 47 (June 1987): 391–403CrossRefGoogle Scholar; and Handlin and Handlin, Commonwealth, 129–30,174–75. Most of the New England states included provisions in early nineteenth-century bank charters requiring the banks to lend the government money on demand. In 1836, Maine's treasurer discovered that he could make some money for the state by borrowing from banks at the legally mandated rate of 5 percent and then investing the proceeds in bank stock, and the legislature voted him limited authority to borrow for this purpose. Lamoreaux, Insider Lending, 29.

28 For examples, see Bodenhorn, Howard, “Bank Chartering and Political Corruption in Antebellum New York: Free Banking as Reform,” in Corruption and Reform: Lessons from America's Economic History, ed. Glaeser, Edward L. and Goldin, Claudia (Chicago, 2006), 231–57.CrossRefGoogle Scholar

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31 Lamoreaux, Insider Lending, 57; Ng, Kenneth, “Free Banking Laws and Barriers to Entry in Banking, 1838–1860,” Journal of Economic History 48 (Dec. 1988): 877–89.CrossRefGoogle Scholar

32 For a chronology of the relevant state constitutional provisions, see Evans, George Heberton Jr., Business Incorporations in the United States, 1800–1943 (New York, 1948), 11; and Hamill, “From Special Privilege to General Utility,” 177.Google Scholar

33 See Bloch and Lamoreaux, “Private Rights of Organizations”; and Naomi R. Lamoreaux and Jean-Laurent Rosenthal, “Corporate Governance and the Plight of Minority Shareholders in the United States before the Great Depression,” in Corruption and Reform, ed. Glaeser and Goldin, 125–52. See also Prunty, “Shareholders' Derivative Suit”; and Boyle, “Minority Shareholder.”

34 Bloch and Lamoreaux, “Private Rights of Organizations”; and Lamoreaux and Rosenthai, “Corporate Governance.”

35 Hodges v. New England Screw Co., 3 R.I. 9, 18 (1853).Google Scholar See also Hodges u. New England Screw Co., 1 R.I. 312 (1850).Google Scholar

36 Dunphy v. Traveller Newspaper Association, 146 Mass.495,497 (1888).Google Scholar

37 For a detailed account of the deals and the infighting among directors that resulted, see Bain, David Haward, Empire Express: Building the First Transcontinental Railroad (New York, 1999).Google Scholar

38 Details of the Crédit Mobilier manipulation had been reported in the press since at least 1869, but they attracted little attention until the New York Sun, which opposed the reelection of President Ulysses S. Grant, broke the bribery story in September 1872. See Bain, Empire Express, 599–600, 602, 627–28, 676. For an intriguing contrary example, however, see Eric Hilt's account of the New York State legislature's response to a major corporate-governance scandal in the 1820s, “Wall Street's First Corporate Governance Crisis,” unpublished paper (2008).Google Scholar The legislature's Revised Statutes of 1827 for a time heightened protections for investors, especially in “moneyed corporations.”

39 Flint & Fere Marquette Railway Co. v. Dewey, 14 Mich. 477, 487–88 (1866).Google Scholar

40 Hawes v. Oakland, 104 U.S. 450, 460 (1881).Google Scholar The shift away from an absolute prohibition against self-dealing by corporate officers was noted with puzzlement by Marsh, Harold Jr. (“‘Are Directors Trustees?’ Conflict of Interest and Corporate Morality,” Business Lawyer 22 [Nov. 1966]: 35–76)Google Scholar, who asserted, “One searches in vain in the decided cases for a reasoned defense of this change in legal philosophy, or for the slightest attempt to refute the powerful arguments which had been made in support of the previous rule” (p. 40). The mystery largely disappears, however, when the cases are viewed in terms of the broader legal history of minority shareholders' rights. See Lamoreaux and Rosenthal, “Corporate Governance,” and Bloch and Lamoreaux, “Private Rights of Organizations.”

41 The one exception was the state of Pennsylvania, which held its state constitutional convention around the time of the scandal and wrote into the document a prohibition against self-dealing by officers, directors, and employees of railroad and canal companies. See Cook, William W., Corporations: As Created and Regulated by Statutes and Constitutions of the Various States and Territories, also of the Federal Government, and of England, Canada, France, and Germany (New York, 1889), 88–89.Google Scholar

42 Rutledge, Wiley B. Jr., “Significant Trends in Modern Incorporation Statutes,” Washington University Law Quarterly 22 (Apr. 1937): 337.Google Scholar More generally, see Harwell Wells, “The Rise of the Close Corporation and the Making of Corporation Law,” Berkeley Business Law Journal (forthcoming).

43 Navin, Thomas R. and Sears, Marian V., “The Rise of a Market for Industrial Securities, 1887–1902,” Business History Review 29 (June 1955): 105–38.CrossRefGoogle Scholar See also O'Sullivan, Mary, “What Drove the U.S. Stock Market in the Last Century?” unpublished paper (2004).Google Scholar

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46 Carosso, Vincent P., The Morgans: Private International Bankers, 1854–1913 (Cambridge, Mass., 1987)Google Scholar; Long, J. Bradford De, “Did J. P. Morgan's Men Add Value? An Economist's Perspective on Financial Capitalism,” in Inside the Business Enterprise: Historical Perspectives on the Use of Information, ed. Temin, Peter (Chicago, 1991), 205–49Google Scholar; Simon, Miguel Cantillo, “The Rise and Fall of Bank Control in the United States: 1890–1930,” American Economic Review 55 (Dec. 1998): 1077–93.Google Scholar

47 The most famous expression of this concern was by Berle, Adolf A. Jr. and Means, Gardiner C., in The Modern Corporation and Private Property (New York, 1933).Google Scholar Kenneth Lipartito and Yumiko Morii have recently argued that Berle and Means were as worried about t he abuse of power by those with controlling interests in large-scale businesses as they were about the separation of ownership and control, the issue that later interpreters of their work brought to the fore. See Lipartito, Kenneth and Morii, Yumiko, “Rethinking the Separation of Ownership from Management in American History,” unpublished paper (2007).Google Scholar

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49 McCraw, Prophets of Regulation.

50 There is an enormous literature on Progressive-Era Americans' faith in experts, but see especially Wiebe, Robert, The Search for Order, 1877–1920 (New York, 1967).Google Scholar For a survey of the growth of regulatory agencies, see Vogel, David, “The ‘New’ Social Regulation in Historical and Comparative Perspective,” in Regulation in Perspective: Historical Essays, ed. McCraw, Thomas K. (Cambridge, Mass., 1981), 155–85.Google Scholar

51 For an example of the skeptical view, see Benston, George J., “Required Disclosure and the Stock Market: An Evaluation of the Securities Exchange Act of 1934,” American Economic Review 63 (Mar. 1973): 132–55.Google Scholar On the value of the SEC, see McCraw, Prophets of Regulation 153; and Holmstrom, Bengt and Kaplan, Steven N., “The State of U.S. Corporate Governance: What's Right and What's Wrong?” NBER working paper 9613 (2003).Google Scholar Statements about popular (and business) faith in the SEC abound in the literature. See, for examples, Macey, Jonathan R. and O'Hara, Maureen, “Regulating Exchanges and Alternative Trading Systems: A Law and Economics Perspective,” Journal of Legal Studies 28 (Jan. 1999): 17–54CrossRefGoogle Scholar; and Coates, John C. IV, “Private vs. Political Choice of Securities Regulation: A Political Cost/Benefit Analysis,” Virginia Journal of International Law 41 (Spring 2001): 531–82.Google Scholar

52 The data from the U.S. Census of Manufactures are analyzed in Lamoreaux, Naomi R. and Rosenthal, Jean-Laurent, “Contractual Tradeoffs and SME's Choice of Organizational Form: A View from U.S. and French History,” NBER working paper W12455 (2006).Google Scholar For the IRS data, see Carter, Susan B. et al., Historical Statistics of the United States: Earliest Times to the Present (New York, 2006), 3: series Ch1–18.Google Scholar

53 The limited-partnership form was not available in Britain until 1907. It was available in the United States, but adverse court decisions kept the number of firms using it comparatively small. See Guinnane, Timothy W., Harris, Ron, Lamoreaux, Naomi R., and Rosenthal, Jean-Laurent, “Putting the Corporation in its Place,” Enterprise and Society 8 (Sept. 2007): 687–729CrossRefGoogle Scholar; and “Pouvoir et propriété dans l'entreprise: Pour une histoire internationale des sociétiés a responsabilité limitée,” Annales: Histoires, Sciences Sociales 63 (Jan.-Feb. 2008): 73–110.Google Scholar An English version of the latter article is available as “Ownership and Control in the Entrepreneurial Firm: An International History of Private Limited Companies,” Yale University Economic Growth Center discussion paper #959 (Dec. 2007).Google Scholar For an intriguing discussion of how the form was used in the United States, see Hilt, Eric, “Partnerships without Kinship: The Effect of New York's 1822 Limited Partnership Act,” unpublished paper (2008).Google Scholar

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55 Guinnane et al., “Putting the Corporation in its Place,” 697–98; and “Pouvoir et propriete dans l'entreprise.”

56 In exchange for this provision and others ensuring that the majority investors could not force a dissolution of the enterprise, she agreed that the majority would receive a greater than normal share of the firm's profits. See Guinnane et al., “Pouvoir et propriété dans l'entreprise.” Under German law, there was considerable contractual flexibility in the corporate form as well, but many provisions that one observes in GmbH contracts were not compatible with tradable shares. Not only were GmbH shares not tradable, but shareholders could insist on the right to vet all potential purchasers of shares. See also Guinnane et al., “Putting the Corporation in its Place.”

57 Guinnane et al., “Putting the Corporation in its Place”; and “Pouvoir et propriete dans l'entreprise.”

58 Ibid.

59 Ibid.

60 On the rise of dirigisme, see Berend, Ivan T., An Economic History of Twentieth-Century Europe: Economic Regimes from Laissez-Faire to Globalization (Cambridge, U.K., 2006).CrossRefGoogle Scholar See also Rajan, Raghuram G. and Zingales, Luigi, “The Great Reversals: The Politics of Financial Development in the Twentieth Century,” Journal of Financial Economics 69 (Fall 2003): 5–50CrossRefGoogle Scholar; Perotti, Enrico C. and Thadden, Ernst-Ludwig von, “The Political Economy of Corporate Control and Labor Rents,” Journal of Political Economy 114 (Feb. 2006): 145–74CrossRefGoogle Scholar; and Roe, Mark J., “Legal Origins, Politics, and Modern Stock Markets,” Harvard Law Review 120 (Dec. 2006): 460–527.Google Scholar

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63 See Gourevitch, Peter Alexis and Shinn, James J., Political Power and Corporate Control: The New Global Politics of Corporate Governance (Princeton, 2005).Google Scholar In Germany the government defined the firms subject to these “codetermination” rules by number of employees. Although technically large GmbHs had to create supervisory boards with the required proportion of labor representatives, it was easy for owners of GmbHs to reduce the board's status to symbolic significance. See Wiedemann, Herbert, “Codetermination by Workers in German Enterprises,” American Journal of Comparative Law 28 (Winter 1980): 79–92.CrossRefGoogle Scholar

64 See Collins, Robert M., The Business Response toKeynes, 1929–1964 (New York, 1981).Google Scholar Government policy in selling off the plants it built during the war was to reduce monopoly rents. See, for example, Smith, George David, From Monopoly to Competition: The Transformations of Alcoa, 1888–1986 (New York, 1988).Google Scholar This is not to say that businessmen did not gain advantages by lobbying Washington, but rather that the level of intervention was significantly lower than in Europe. See Adams, Stephen B., Mr. Kaiser Goes to Washington: The Rise of a Government Entrepreneur (Chapel Hill, 1997).Google Scholar

65 Marcus, Maeva, Truman and the Steel Seizure Case: The Limits of Presidential Power (New York, 1977).Google Scholar

66 Eichengreen, Barry, The European Economy since 1945: Coordinated Capitalism and Beyond (Princeton, 2007).Google Scholar

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68 Gourevitch and Shinn, Political Power and Corporate Control, 1.

69 Brownlee, W. Elliot, Federal Taxation in America: A Short History (New York, 1996), 89–129Google Scholar; O'Neal, F. Hodge, “Developments in t he Regulation of the Close Corporation,” Cornell Law Quarterly 50 (Summer 1965): 641–62Google Scholar; Dickinson, Kelvin H., “Partners in a Corporate Cloak: The Emergence and Legitimacy of the Incorporated Partnership,” American University Law Review 33 (Spring 1984): 559–600Google Scholar; Keatinge, Robert R. et al., “The Limited Liability Company: A Study of the Emerging Entity,” Business Lawyer 47 (Feb. 1992): 375–460Google Scholar; Stover, Fallany O. and Hamill, Susan Pace, “The LLC Versus the LLP Conundrum: Advice for Businesses Contemplating the Choice,” Alabama Law Review 50 (Spring 1999): 813–47.Google Scholar

70 Carter et al., Historical Statistics of the United States 3: series Ch193–204; SOI Bulletin, various issues; International Association of Commercial Administrators (IACA), 2007 Annual Report of Jurisdictions.

71 For a section-by-section summary of the bill, see Ribstein, Larry E., “Market vs. Regulatory Responses to Corporate Fraud: A Critique of the Sarbanes-Oxley Act of 2002,” Journal of Corporation Law 28 (Fall 2002): 62–67.Google Scholar

72 Contrast Morrissey, Joseph F., “Catching the Culprits: Is Sarbanes-Oxley Enough?” Columbia Business Law Review 2003, no. 3 (2003): 801–57Google Scholar, with Ribstein, “Market vs. Regulatory Responses.” For an intermediate position, see Holmstrom and Kaplan, “State of U.S. Corporate Governance.”

73 Wilda, Nathan, “David Pays for Goliath's Mistakes: The Costly Effect Sarbanes-Oxley Has on Small Companies,” John Marshall Law Review 38 (Winter 2004): 671–92Google Scholar; Skouvakis, Andrew, “Exiting the Public Markets: A Difficult Choice for Small Public Companies Struggling with Sarbanes-Oxley,” Penn State Law Review 109 (Spring 2005): 1279–96Google Scholar; Rose, Paul, “Balancing Public Market Benefits and Burdens for Smaller Companies Post Sarbanes-Oxley,” Willamette Law Review 41 (Fall 2005): 707–48Google Scholar; Carroll, Ginger, “Thinking Small: Adjusting Regulatory Burdens Incurred by Small Public Companies Seeking to Comply with the Sarbanes-Oxley Act,” Alabama Law Review 58 (Winter 2006): 443–72.Google Scholar

74 The Corporation, released in 2003 by Big Picture Media Corporation, was written by Joel Bakan and codirected by Mark Achbar and Jennifer Abbott. See also Bakan, Joel, The Corporation: The Pathological Pursuit of Profit and Power (New York, 2004).Google Scholar

75 See Derber, Charles, Corporation Nation: How Corporations Are Taking Over Our Lives and What We Can Do About It (New York, 2000)Google Scholar; Korten, David C., When Corporations Rule the World, 2nd ed. (Bloomfield, Conn., 2001)Google Scholar; Hartmann, Thorn, Unequal Protection: The Rise of Corporate Dominance and the Theft of Human Rights (New York, 2002)Google Scholar; Nace, Ted, Gangs of America: The Rise of Corporate Power and the Disabling of Democracy (San Francisco, 2003)Google Scholar; see also Avi-Yonah, Reuven S., “Corporations, Society, and the State: A Defense of the Corporate Tax,” Virginia Law Review 90 (Sept. 2004): 1193–255.CrossRefGoogle Scholar For other justifications for intervention, see the articles in the special issue, “Regulation, Risk and Corporate Crime in a ‘Globalized’ Era,” Risk Management 5, no. 2 (2003).Google Scholar

76 On this point, see also Hilt, Eric, “When Did Ownership Separate from Control? Corporate Governance in the Early Nineteenth Century,” Journal of Economic History 68 (Sept. 2008): 645–85CrossRefGoogle Scholar; Aldo Musacchio, Experiments in Financial Democracy: Corporate Governance and Financial Development in Brazil, 1882–1950 (New York, forthcoming); and Rojas, Gonzalo Andres Islas, “Essays on Corporate Ownership and Governance” (unpublished Ph.D. diss., University of California, Los Angeles, 2007).Google Scholar For the recent period, see Holmstrom and Kaplan, “The State of U.S. Corporate Governance.” The outcry over Google's corporategovernance structure at the time of its initial public offering is a good indication of the extent to which U.S. firms voluntarily adopt rules that are more protective of minority investors than the law requires.

77 See Rajan and Zingales, “Great Reversals”; Haber, Stephen, Razo, Amando, and Maurer, Noel, The Politics of Property Rights: Political Instability, Credible Commitments, and Economic Growth in Mexico, 1876–1929 (New York, 2003)CrossRefGoogle Scholar; North, Wallis, and Weingast, Violence and Social Orders. In the United States in the early nineteenth century, state governments often took equity positions in the corporations they chartered. The political revolt against corporate privileges led to the passage in many states of constitutional prohibitions against such investments. See Stimson, Frederic Jesup, American Statute Law, Volume 2: An Analytical and Compared Digest of the Statues of all the States and Territories Relating to General and Business and Private Corporations (Boston, 1892).Google Scholar

78 See Prentice, “Inevitability of a Strong SEC.”