Shareholder Democracies?: Corporate Governance in Britain and Ireland before 1850

by Mark Freeman, Robin Pearson, James Taylor

Overview

Understanding the challenges of corporate governance is central to our comprehension of the economic dynamics driving corporations today. Among the most important institutions in capitalism today, corporations and joint-stock companies had their origins in Europe during the seventeenth and eighteenth centuries. And as they became more prevalent, the issue of internal governance became more pressing. At stake—and very much contested—was the allocation of rights and obligations among shareholders, directors, and managers.

This comprehensive account of the development of corporate governance in Britain and Ireland during its earliest stages highlights the role of political factors in shaping the evolution of corporate governance as well as the important debates that arose about the division of authority and responsibility. Political and economic institutions confronted similar issues, including the need for transparency and accountability in decision making and the roles of electors and the elected, and this book emphasizes how political institutions—from election procedures to assemblies to annual reporting—therefore provided apt models upon which companies drew readily. Filling a gap in the literature on early corporate economy, this book provides insight into the origins of many ongoing modern debates.

Product Details

ISBN-13:	9780226261874
Publisher:	University of Chicago Press
Publication date:	12/28/2011
Pages:	360
Product dimensions:	6.10(w) x 9.10(h) x 1.10(d)

About the Author

James Taylor is a senior lecturer in the Department of History at the University of Lancaster and the author of Creating Capitalism.

Read an Excerpt

Shareholder Democracies?

Corporate Governance in Britain and Ireland before 1850

---

By MARK FREEMAN ROBIN PEARSON JAMES TAYLOR

THE UNIVERSITY OF CHICAGO PRESS

Copyright © 2012 The University of Chicago
All right reserved.
ISBN: 978-0-226-26187-4

---

Chapter One

Introduction

The contradiction inherent in representation ... lies in the fact that it is on the one hand necessary to the action of the masses, but on the other hand easily becomes a conservative obstacle to it.—Leon Trotsky

The tension between rule and popular voice, between executive power and representation, was present at the birth of democracy. When Cleisthenes, backed by a popular uprising, drove the Spartans and their aristocratic allies out of Athens in 508 BC, he reorganized the city's constitution along lines partially recognizable to students of modern democracies. A ruling council of five hundred was established, answerable to an assembly of the people, with annual rotation of office and regular auditing of accounts. The assembly could not vote on any question not first discussed by the council, but some acts of the council were subject either to ratification by the courts or to direction by the assembly. Assembly debates were genuinely popular affairs, with all adult male citizens—women and slaves were excluded—having the right to participate. It is true that two key features of the Athenian constitution are alien to modern constitutions: first, most offices of state, including membership in the council, were chosen by lot rather than by election; second, the assembly held an annual ticket vote to ostracize the individual deemed most likely to threaten democratic government in the city. Modern states have opted for neither device. Both devices, however, along with other elements in the constitution of Cleisthenes, were aimed at resolving the fundamental issue in all democracies, ancient and modern, namely, control of the executive and establishment of accountability.

This issue lies at the heart of this book. Our principal finding is that there was a convergence in the forms of power and representation in politics and business in the world's first industrializing nation. The long search for checks and balances between the executive and legislature in the British polity, which was already well developed by the end of the seventeenth century, had its parallel, we argue, in corporate organizations, including the new joint-stock companies that came to dominate important sectors of the economy during the following centuries. The chapters that follow focus on the internal governance regimes of these companies as the latter worked out what each perceived to be the optimal allocation of rights and obligations among shareholders, directors, and managers. Yet much of this debate in the corporate economy mirrored, to a degree that few have hitherto remarked upon, wider constitutional debates about the relative power of the estates and classes in eighteenth- and nineteenth-century Britain and about the role of electors and the elected and the transparency and accountability of decision making in civil government.

In this book we define a joint-stock company as one with thirteen or more partners and transferrable shares—this definition is explained below. Our study comprises both companies incorporated by royal charter or act of Parliament and unincorporated companies that existed under English, Irish, and Scottish law as mere partnerships without a separate corporate legal identity. Notwithstanding their proscription under the Bubble Act of 1720, the latter constituted more than 40 percent of all joint-stock companies formed in Britain and Ireland during our period. We explore the reasons for their proliferation in chapters 2 and 3. It is sufficient to note here that they are an important part of British corporate governance history, not just because of their numbers, but because they experienced many of the problems of agency and representation that were faced by the corporations. It is also worth noting, particularly for our North American readers, that the British incorporated company in our period was unlike the early US business corporation in several ways, most obviously in the degree of state regulation to which it was subjected. While the concepts of public utility and public welfare were applied by legislators to petitions for incorporation on both sides of the Atlantic, they were applied with greater vigor in the young American republic. In the United States between the 1790s and 1830s supporters of incorporation had to work hard to counter criticisms of the business corporation as an "aristocratic," monopolizing, and corrupting element in the economy. One consequence was a greater regulation of corporations and their constitutions—for example in the reporting requirements, in the duration of charters, and in the level of direct interference by state legislatures—than was experienced in the United Kingdom. The closer oversight of business incorporation by the New England states soon led to its acceptance there as the predominant form for joint-stock enterprise. Over thirty-five hundred companies were incorporated in New England between 1800 and 1844. By the 1850s the process was being streamlined further by the introduction of general acts of incorporation in most states. By contrast, the British Parliament, backed by a conservative judiciary, remained reluctant to make corporate privileges more freely available, even after the Bubble Act was repealed in 1825. The result was that many company promoters, particularly in England, had to organize their joint-stock ventures under a variety of legal vehicles, including the trust, while trying at the same time to mimic the rights enjoyed by corporations. For the most part, legislators and the judiciary left such companies to their own devices, just as they seldom interfered in the operations of corporations. In the United Kingdom, unlike in the early American republic, the business corporation generally operated no more, and no less, in the public sphere than the unincorporated company. In Britain during our period, notwithstanding their different legal origins, we find that there was a convergence in the constitutions and governance of incorporated and unincorporated companies and that this convergence manifested itself in a fundamental shift in the power relations between shareholders and directors in both types of enterprise. The evidence for this is presented in the following chapters.

Modern Corporate Governance and Its Theories

The governance of business has been the object of considerable public and academic debate during the past two decades, prompted by instances of scandal and mismanagement, such as those at Enron and WorldCom in the United States, Northern Rock and Royal Bank of Scotland in the United Kingdom. Particular concerns have focused on the quality of auditing, the role of nonexecutive directors, agency problems, and executive remuneration. It has been argued that governance structures allowing managers to pursue their own preferences have provided a dissemblance of democracy in many firms, while sustaining elitism and self-interest in the boardroom. In Britain, the Cadbury Report of 1992 recommended the adoption of independent audit and executive remuneration committees, and from this and subsequent reports a code of best practice has been developed. In the United States, the Sarbanes-Oxley Act of 2002 required more stringent reporting of internal financial controls in corporations, brought in new rules for auditors, specified the duties of directors, and introduced a range of penalties for filing misleading financial statements, falsifying documents, and coercing independent auditors.

Such governance issues are not merely pertinent to the internal affairs of large corporations but also have a resonance for the wider community of stakeholders and, more generally, for the kind of democracy we wish to see develop within modern capitalism. What has determined the type of corporate governance that we get? How can the divergent interests of stakeholders be reconciled in a viable governance system? A large body of theoretical literature has attempted to answer these questions. Agency theory in particular has focused on the misaligned incentives of two main interest groups within the firm: managers (agents), who were employed by owners (principals). While the latter sought to maximize the returns on their investments, the former sought to maximize their own utility, which might include, for example, enhanced remuneration linked to asset growth rather than profits, or power, prestige, and other forms of nonpecuniary reward. The costs of agency were threefold: the monitoring costs of the principal, the bonding costs (the guarantees) of the agent, and the residual loss to the firm caused by the divergence of interests. Agency theory not only described the problem but also claimed to explain how it could be resolved. The market, it was held, conveyed the means by which managerial incentives could be aligned with those of shareholders, through devices such as stock options and the hostile takeover, disciplining managers who consistently failed to enhance shareholder value.

Subsequent shareholder models of corporate governance have drawn upon this contention that there are automatic mechanisms that mitigate the agency problem between owners and managers and that these mechanisms have become refined over time. Such models hold that optimal risk allocation in an economy depends on the functional separation of powers between owners and managers, with the latter being responsible for decision making and the former for residual risk bearing. Shareholders are (fully) rewarded for "waiting" (deferring consumption) and bearing residual risk so that dividends equate to the payment of pure interest (waiting) plus an equity risk premium. This approach underpinned the work of Alfred Chandler on the development of the modern managerial corporation. Although Chandler himself never examined the question at any length, business historians have tended to follow him in regarding governance forms as the outcome of the internal evolution of the firm and the separation of ownership and control. Agency theory, therefore, was chiefly responsible for the view—which became an orthodoxy of institutional economics by the 1980s—that shareholders, as residual risk-takers and residual claimants, merely represented one of several forms of input into the firm, with no privileged right to insist that the corporation be operated in their sole interest. This marked the final disembodiment of shareholding from control, the last stage in the long historical process, whose genesis is traced in this book, of equating the separation of ownership and control with business efficiency, and of making ownership "irrelevant."

Some authors, however, have focused on the legal framework, itself contingent on historical processes, as the chief determinant of governance forms in business, thus placing the onus on the law to work out solutions to the principal-agent problem. Common-law regimes, it has been claimed, historically have provided stronger protection for minority shareholders and greater defenses for companies against arbitrary interventions by the courts and government than civil-code regimes. One consequence is that share ownership is more likely to be widely dispersed in common-law countries than under civil codes. Others have regarded corporate governance as an institutional response to the company's need to reduce the uncertainty in its relationship to a changing external political environment. Roe, for instance, has argued that social democracies in post-1945 Europe weakened the ties of managers to shareholders and strengthened the power of a wider body of stakeholders, especially employees, thereby eroding the business principle of maximizing shareholder value. This, in turn, has discouraged the spread of share ownership in countries such as Germany. By contrast, in polities such as that of the United States, where the shareholder value principle has not been undermined by social democratic policies, share ownership has been more widely diffused.

What relevance, if any, do the findings of this book have for the theory or practice of modern corporate governance? While this book is primarily aimed at historians rather than economists and policy makers, it is nevertheless the case that many of the issues in the present debate over corporate governance were first addressed in Britain during the period covered by our study. It is remarkable how many of those advocating remedies for corporate governance problems today appear to be entirely unaware of the fact that similar problems, with similar remedies proposed, have been recurring in business for centuries. Malcolm Salter, for example, has recently written an influential account of the Enron disaster in which he puts forward several suggestions for reform: appointing individuals to company boards who have sufficient time to devote to directing; remunerating directors more generously in order to encourage them to take their jobs seriously; obliging directors to hold a larger stake in the company; enforcing a greater division between direction and management; and boosting shareholder powers over directors. These are exactly the kinds of remedies proposed in Britain during the early nineteenth century. Indeed, arguments for the importance of aligning executive incentives with the interests of the constituents they represent have been debated in Britain since the late seventeenth century, with companies frequently requiring minimum shareholding qualifications for directors.

Without wishing to preempt the analysis in the following chapters, we may point to other findings from our study that speak to the models of modern corporate governance outlined above. First, this book indicates that what investors expected from corporate governance has varied greatly over time and that those expectations have been contingent on political, social, and cultural as well as economic factors. From the eighteenth to the early nineteenth century, most types of stock company in Britain anticipated that shareholders would be interested in the wider benefits that their enterprise would bring to the local or regional economy. Short-term financial rewards in the shape of dividends or gains in share values were often of secondary concern. Such shareholders expected to take an active role in the business of their firm, and the governance systems of many early companies reflected these expectations. One can view the company constitution in Britain, until the 1820s at least, as a risk management asset for investors interested in the degree of "active" control that company promoters were offering them as potential voting shareholders. Investors thus bought into that asset—the governance system—at the same time as they bought shares in the enterprise. In a competitive market for capital, drawing on investors with these kinds of expectations, the degree to which a constitution was aligned with shareholder expectations of control may occasionally have been decisive for company promoters trying to get a project off the ground, although our evidence suggests that this applied in only a minority of cases. The situation began to change with the rise of the "passive" or "rentier" investor during the railway age. By the 1840s, many investors in stock companies lived at a distance; relied more on intermediaries such as the financial press, solicitors, or share brokers for information about their investments; and were less interested in the management of their companies, provided their dividends kept being paid. Even at this date, however, despite the increasing disjuncture of shareholders and executives, especially in the largest firms, the belief remained widespread that the properly informed shareholder should take responsibility for actively monitoring managers and directors. Hence the call to publicize the names of company promoters and investors and the idea that personal reputations and standing rather than constitutional rules offered the best guarantee for potential investors, particularly given the continued local scope of many new share issues and the informal character of the secondary share market. Through to the end of our period, the motivation of the average shareholder was still regarded in many quarters as involving more than utility maximization. Our findings lend support to those who criticize the rationalizing assumptions of agency theory and argue that the social and political context in which a firm operates plays an important role in creating the conditions for the emergence of particular governance forms. This was as true in 1800 as it is today.

(Continues...)

---

Excerpted from Shareholder Democracies? by MARK FREEMAN ROBIN PEARSON JAMES TAYLOR Copyright © 2012 by The University of Chicago. Excerpted by permission of THE UNIVERSITY OF CHICAGO PRESS. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

---

Table of Contents

List of Illustrations
Acknowledgments
Abbreviations

Chapter 1. Introduction
Chapter 2. The Joint-Stock Company and Its Environment, 1720–1850
Chapter 3. Company Formation
Chapter 4. Constitutional Rights and Governance Practice: The Executive
Chapter 5. Constitutional Rights and Governance Practice: The Proprietorship
Chapter 6. The Franchise and General Meeting
Chapter 7. Limited Liability and Company Dissolution
Chapter 8. Transparency and Accountability
Chapter 9. Conclusion

Notes
Bibliography
Index

Editorial Reviews

This is a well-written book and a pleasure to read, with fascinating anecdotes interspersed with factual information. It fills a large gap in the literature and links the work carried out on early eighteenth-century companies with the much larger literature on post-1850 corporate governance.

Economic History Review

A well-written and informative volume that provides a useful overview of many aspects of the development of the British company, as well as a detailed analysis of the changing nature of corporate governance. It should be read not only by economic historians but also by those seeking to understand the historical contexts of the latest in a long line of economic crises. It must give plenty of food for thought to those who believe that change in the structure of corporate governance is the solution to the problem of poor management.

Journal for Eighteenth-Century Studies

Shareholder Democracies? rests upon an impressive empirical foundation enriched by the authors’ extensive acquaintance with business historiography. Through explication of many nuances and fine distinctions of company policies and practices across Ireland, Scotland, and Britain, Mark Freeman, Robin Pearson, and James Taylor address fundamental issues of internal distribution of power in companies, in particular the practical, bureaucratic, and legal divergence of managerial control from shareholder rights especially evident in large companies."

Reviews in History

The struggle over political representation in Britain is more than the well-known story of parliamentary reform culminating in the Great Reform Act of 1832. It was about representation in a plethora of bodies, such as charities or improvement commissions that responded to the problems of an urban and industrial nation—and, as this excellent book shows, it was also about representation in joint-stock companies. The findings will be of great interest not only to business historians interested in corporate governance in the Industrial Revolution, but to anyone interested in wider issues of power and representation in the eighteenth and early nineteenth century. This book is a major contribution to the debate over what kind of democracy is needed within a capitalist economy.

Martin Daunton

“Shareholder Democracies? reconstructs in rich detail the early stages of industrialization, when money and voting intersected against the backdrop of an uncertain legal framework and a thriving culture of political participation among middle-class investors. The authors add impressive archival breadth and depth to what we thought we knew about the timing and contours of ‘joint-stock politics’ up to 1850—including the wide variety of corporate constitutions, the numerous arrangements for electing boards, and the increasingly inadequate strategies for rendering boards accountable once elected.

Timothy Alborn

"It is a remarkable fact that the years that saw the Industrial Revolution flourish in Britain were a time when British company law was relatively unfriendly to the needs of many entrepreneurs. Does this mean that British law and politics didn’t matter? Analyzing the impact of these forces requires an understanding of how firms were actually organized, and how the legal framework within which they operated shaped their development. . . . This is exactly what Mark Freeman, Robin Pearson and James Taylor have done for Shareholder Democracies? . . . A valuable contribution to the study of the history of the company in Britain."

EH.net

Truly impressive. Mark Freeman, Robin Pearson, and James Taylor have mined a wealth of sources in an extraordinary number of repositories to offer an unparalleled wealth of historical detail. Shareholder Democracies? represents a quantum leap in our knowledge of the governance of early joint-stock companies in Britain and Ireland from the early eighteenth to the mid-nineteenth century, and it will have strong appeal both to historians and contemporary analysts of corporate governance.

Colleen Dunlavy

“Shareholder Democracies? is a path-breaking and important work, transforming our knowledge of British and Irish companies in the decades before the Companies Acts made the corporate form available by simple registration. . . . It offers a revealing counterpoint to recent articles by Colleen Dunlavy, Eric Hilt, Richard Sylla, Robert Wright, and others on early US corporations.

Business History Review

Much ink has been spilled on the corporate governance of modern enterprises; it is refreshing, therefore, to read this important historical contribution to a contemporary debate."

Australian Economic History Review