An article in today's WSJ ($) on the SEC's pending shareholder access proposal perpetuates a number of myths about the history of corporate governance and law. One of the more egregious examples is the authors' discussion of the purported process by which the separation of ownership and control evolved in the US:
In the early 19th century, companies usually had just a handful of shareholders. They ran the company, controlled the board and chose directors from among themselves. At the time, U.S. companies granted shareholders one vote per person, according to Colleen Dunlavy, a professor at the University of Wisconsin-Madison.* As competition for capital increased, rules were changed to give more say to bigger investors. By 1850, most companies awarded one vote per share. Directors tended to represent the largest investors.
In the early 20th century, power was diffused as stock ownership spread. Individual shareholders' clout was diluted. Sometimes they were asked to vote for directors without knowing the identity of the nominees, says Mr. Seligman, who has written a history of Wall Street.
As companies grew, "no shareholders or groups of shareholders had enough shares to dominate the board," says Charles Elson, a corporate-governance scholar at the University of Delaware, who sits on three boards. "There was a vacuum, and management filled that vacuum by nominating their own folks."
This account is based on Adolf Berle and Gardiner Means' 1932 book The Modern Corporation and Private Property, which did much to popularize this version of history (although it did not originate it). Being based on what is probably the most famous and influential book ever written about corporate governance doesn't make the account true, however. I recounted the real history in my article, The Politics of Corporate Governance: Roe's Strong Managers, Weak Owners, where I explained that:
Economic separation of ownership and control in fact was a feature of American corporations almost from the beginning of the nation: “Banks, and the other public-issue corporations of the [antebellum] period, contained the essential elements of big corporations today: a tripartite internal government structure, a share market that dispersed shareholdings and divided ownership and control, and tendencies to centralize management in full-time administrators and to diminish participation of outside directors in management.” The legal rules upon which Berle and Means laid most of the blame for the separation of ownership and control came along much later, however, presumably as an adaptive response to the economic forces that caused ownership and control to separate. [Citations and footnotes omitted]
Corporations have never been democracies in which ownership and control were united either in law or fact. Claims to the contrary are ahistorical, frequently motivated by the present-day ideological concerns of institutional investors (in particular public and union pension funds, whose interests in corporate control obviously can diverge from those of investors at large).
* The claim attributed to Professor Dunlavy is another historical error. The actual pattern of shareholder voting rights was more complicated. Prior to the adoption of general incorporation statutes in the mid-1800s, the best evidence as to corporate voting rights is found in individual corporate charters granted by legislatures. Three distinct systems were used. A few charters adopted a one share-one vote rule. Many charters went to the opposite extreme, providing for one vote per shareholder without regard to the number of shares owned. Most followed a middle path, however, limiting the voting rights of large shareholders. Some charters in the latter category simply imposed a maximum number of votes to which any individual shareholder was entitled. Others specified a complicated formula decreasing per share voting rights as the size of the investor's holdings increased. These charters also often imposed a cap on the number of votes any one shareholder could cast. Gradually, to be sure, a trend towards a one share-one vote standard emerged. Yet, this history demonstrates the fundamentally undemocratic nature of the corporation. Contrary to the democratic rhetoric of today's shareholder activists, limitations on shareholder voting rights in fact are as old as the corporate form itself.
Update: Gordon Smith expands the historical background to the discussion by observing that:
Most early American businesses were closely held, but they typically were organized as partnerships (or, in some instances, limited partnerships), not as corporations. Businesses that organized as corporations were capital-intensive undertakings, such as banks, toll roads and bridges, insurance companies, etc. In these entities, the separation of ownership and control was alive and well. What changed in the late 1800s and early 1900s was that the corporate form was used for all sorts of businesses, not just "public works" projects. In short, the corporation became a more important feature of American business life. Since that time, it has commanded most of our attention in debates about economic development.Quite right. Probably the best treatment of the historical issues is Walter Werner, Corporation Law in Search of its Future, 81 Colum. L. Rev. 1611 (1981). I also highly recommend The Company : A Short History of a Revolutionary Idea.
