Corporate Ownership and Corporate Control, Essay Example
One of the most significant advancements in economic history over the past several centuries has been the rise of the corporation. They have many advantages over single ownership or partnerships, such as the ability to raise more capital due to the ability to attract investors through selling shares of the company. Also, they are often granted limited liability, where the shareholders are not held personally responsible for debts held by the corporation. For this reason, they have become the dominant form of business in most industries. However, the growing influence of corporations may have some drawbacks for the economy and for owners themselves. As shares became more diluted, each owner loses control of the company and the operations of the corporation began to fall less under their control and more to managers hired by the company. When Did Ownership Separate from Control? Corporate Governance in the Early Nineteenth Century by Eric Hilt, seeks to address the timeline of this evolution.
The standard account of the history of the corporation that this paper seeks to address is that it killed the role of the owner and operator of the business. According to this account, companies used to be owned and directed largely by the same people. Before corporations, the owner was usually in charge of the business’ daily operations himself, and even in the early days, corporations were controlled by small numbers of shareholders. Shareholders invested in small amounts of businesses, meaning they managed to devote their attention to the operations of each. However, as corporations advanced, professional investors came about, who held portfolios too diverse to ever manage each company. Corporations had been run by small groups of businessmen, but now were controlled by large groups of investors who had no time or way to actually influence the operations. The result was professional managers controlling the companies. The managers often did hold stock in the company, but this was not a requisite for them to have a say in the operations.
As this evolution is said to have begun occurring in the late nineteenth century, Hilt seeks to address the situation before this development, in the early parts of that century. If this standard account is true, ownership and control should have still been together in the early parts of the nineteenth century before diverting. Hilt goes through New York state corporate records during the 1820s, where all corporations had to give accounts of their shareholders. This allows him to see how diluted ownership was. A corporation owned entirely by two partners would expect to see them control nearly every aspect of the company. Conversely, a diluted company with one hundred owners each carrying a one percent share will be out of each of their control. It is likely that owners like that will not see too much influence, they will have a difficult time reaching consensus, and voting on every matter is impractical. For that reason, Hilt is using dilution of ownership as a proxy for the degree of control maintained by the owners.
One factor that Hilt points to as significant in this case, is the standard 19th century policy of favoring small shareholders. Usually the initial shares all came with a full voting share, but after a certain point, each additional share bought less voting power. This meant that small shareholders could maintain more control over the company without a small number of shareholders being able to dominate the operations. This strongly incentivized two things within the corporation: large shareholders had reason to seek to put shares under the names others, but more importantly, it made shareholders act in ways that were likely to dilute control. Diminishing marginal returns set in with regards to voting rights, as large shareholders were buying less voting power with each share. The increased power made the stock more valuable to small shareholders and less valuable to large shareholders, effectively ensuring dilution.
In the paper, Hilt is careful to point out the differences between corporations in different industries. At the time, they faced different rules, with one example being that manufacturers were able to simply register as corporations, while financial institutions were required to appeal to the legislature for a specific charter. On top of this, the need for capital and the requirements of direct ownership management changes based on the industry a company is in. For that reason, the situation regarding ownership and control varied widely across the economy of the time. To Hilt, this is another issue with the standard account of the development of corporations. The account holds that corporations developed together, but even in their infancy, corporations were different from one another. If they did not begin at the same place, they could not have followed the same development.
Hilt’s analysis shows several flaws with the accepted narrative in which corporations began as operations between limited numbers of businessmen and gradually developed into the conglomerates owned by professional investors. For one, the golden age where businessmen owned the companies and oversaw operations did not truly exist. Corporations were geared towards small investors by design even in the early nineteenth century, and therefore were almost always diluted past the point where anyone could control their operations. Also, he disputes the very idea of a single story about the developments of corporations. This is perhaps the best insight in the paper. Today, it is widely recognized that there is incredible diversity within corporations. Both multinational petroleum companies and family owned delis can be incorporated. These two kinds of corporations are vastly different from one another, so trying to give such a basic singular explanation for their development is bound to be insufficient.
One important reason to study this subject is because of the nature of capitalism itself. The name itself implies that the decisions in the economy are largely made by and for the benefit of the capital owners. Yet, if capital is being owned by such a large group that no individual capital holder has any power, that is not in fact true. The economy is controlled by professional managers largely out of the control of capital owners. Their goals are usually not perfectly in line with the goals of the company. This can be seen through the practice of satisficing, where high level executives strive simply to meet a threshold for profits as opposed to trying to truly maximize them (Cyert 1992). A large part of American policy is based upon the idea that capitalism most closely aligns individual goals with societal goals, yet it is difficult to say that we are truly a capitalist society anymore. Perhaps a move towards more control for ownership could be beneficial for the economy and trying to figure out the setting where this last occurred is a valuable step in that process.
In another paper, Corporate Governance and Equity Prices, authors Paul Gompers, Joy Ishii, and Andrew Metrick discuss how stronger shareholder rights legislation can improve corporate performance. This is because this type of legislation seeks to return power to the capital holders and away from managers, therefore improving performance for the corporate interests. If these laws work well, it would be beneficial to see if they can be based around legal settings that existed when control and ownership were last truly united. Although it is dangerous to assume we can recreate this scenario in such a different context from when it last existed, it is still beneficial to try and identify the causes of control and ownership unification if we are looking to cause it.
One potential flaw with this study is that is focuses on a very small setting. Hilt examines corporations in New York state between 1823 and 1828. Since corporate laws are primarily the domain of state governments, these practices could have varied wildly in other parts of America. Hilt does acknowledge this weakness, but maintains that New York had become the center of commerce in the country, the most populous state, and home of the growing finance sector. In other words, its laws were the most influential and probably similar to other states and territories. However, this study could benefit from other similar examinations into the rest of the country and perhaps a wider time frame. This issue does not invalidate the study, but it does mean that it gives a snapshot of corporations in this one specific setting as opposed to any universal truths.
Another issue is his idea that since corporations already had already split control and ownership in the 1820s, that means they were always this way. While he is responding to the idea in which this process did not begin until the late nineteenth century, that does not mean that the timeline is the essential part. If corporations were operated entirely by their owners at one point, the original narrative still holds true even if it had the dates wrong. It would be important to know what the corporations looked like before the period in the study to truly disprove the basic account given. Again, this is an area where a more expansive study could be a benefit.
Overall, Hilt does an excellent job with his study. His methodology is very exhaustive, going through corporate statements for several years, and even went through newspaper archives to compile a list of corporate directors, as that was not required to be noted in the statements. While this is an admirable amount of work for a study, it does mean that only a small amount of years in one state can be studied. For this reason, the paper can only make conclusions about the state of corporate control in New York state over a very small period. More work is needed to see if his conclusions can be extrapolated to a broader environment. However, he does show that ownership and control were split much earlier than usually though in certain sectors. One interesting insight is into the various schemes used by corporations to ensure voting power was not taken over by large investors. Perhaps these would be a good way to help small investors today, albeit with the tradeoffs of increased incentives for fraud and further dilution of corporate control.
Cyert, Richard; March, James G. (1992). A Behavioral Theory of the Firm (2 ed.). Wiley Blackwell.
Gompers, Paul, Joy Ishii, and Andrew Metrick. “Corporate Governance and Equity Prices*.”Quarterly Journal of Economics 118.1 (2003): 107-55. Print.
Hilt, Eric. “When Did Ownership Separate from Control? Corporate Governance in the Early Nineteenth Century.” The Journal of Economic History 68.03 (2008): n. pag. Print
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