Corporate Control and Corporate Governance Why Are the

Corporate Control and Corporate Governance: Why Are the UK and US So Different From Continental Europe? Julian Franks and Colin Mayer

Britain Is A Strange Country

In Most Countries Ownership Is Concentrated Source : country chapters in Barca and Becht (2001)

In Britain It Is Not

In Most Countries Family Ownership Is Widespread

In Britain It Is Not

In Most Countries, Dual Class Shares are Commonplace Porsche/Piech Family Voting Pool 100% 10%* Porsche AG Voting Stock Porsche AG Non-Voting 50: 50 capital

In Britain They Are Not

Britain Is Odd Not Just By European Standards Dominant Owners Today Canada Family pyramids Germany Family pyramids Corporate Japan UK US Widely held Institutions Widely held

Even A Hundred Years Ago It Was A Little Odd Dominant Owners Canada Families Germany Families Japan Families UK Widely held Families US

How Did We Get To Where We Are Today? 1. Linear progression, eg Chandler progression to managerial capitalism 2. Correlated changes across countries 3. Random

At First It Was All So Linear and Anglo-American Canada Germany Japan UK US 1900 -1910 -1920 Family pyramids 1920 -1930 Growing dispersion Families Growing dispersion Family pyramids Growing dispersion Families Growing dispersion

But Then There Were Some Hiccups 1930 -1940 Canada Germany Japan UK US 1940 -1950 -1960 Widely held Increased family Growing dispersion Increased corporate State Widely held Growing dispersion Widely held Institutions Widely held

And Then It Looked All So Different 1960 -1970 Canada Germany Japan 1970 -1980 -1990 Re-emergence of family pyramids Family pyramids Corporate UK Widely held Institutions US Widely held

So The Progression From The Last Century Was • • Not linear Correlated pre-WW 2 Divergent around WW 2 Very different after WW 2

Why?

Political and Legal Explanations in the US • Dispersion in the US was consequence of regulation enacted in response to populist agenda of limiting concentration of power – Sherman (1890), Clayton (1914), Glass-Steagall (1933), Public Utilities Holding (1935) Acts • In the absence of strong investor protection, investors seek protection through concentrated ownership. The US’s common law promotes investor protection and therefore dispersed ownership

Implications of These Views • Regulation has undermined the efficient workings of the economy, eliminated active owners from the US and caused its corporate governance failures • Regulation is required for the successful development of markets and is the explanation for the more highly developed nature of markets in the UK and US • Should we praise or condemn regulation? • What happened when we didn’t have it?

Regulation in the UK • No restrictions on concentration of shareholdings at any stage in 20 th century • Weak competition law for most of the century • Minority investor protection was very weak in the first half of the century and UK markets were largely unregulated • Common law contributed to this low level of protection

Foss v Harbottle (1843): The Majority Rules First, the proper plaintiff in an action in respect of a wrong alleged done to a company…is prima facie the company itself Secondly, no individual member of the company is allowed to maintain an action in respect of that matter for the simple reason that if a mere majority of the members of the company… is in favour of what has been done then cadit quaestio – the matter admits of no further argument.

Implications For Capital Markets In Britain In First Half of 20 th Century • • Concentrated ownership Undeveloped financial markets Little external equity financing A lot of minority investor abuse

Regulatory Innovation • Investor protection introduced into Britain from 1948 Companies Act • Accompanied by tighter listing rules on London Stock Exchange • Would therefore expect dispersion of ownership to have occurred in second half of century

First Long-Run Analysis of Ownership • Use unique data set that exists of accounts of UK corporations going back to the beginning of the 20 th century • Trace ownership of firms incorporated around 1900 over subsequent 100 years • Compare with evolution of ownership of firms incorporated around 1960 after introduction of investor protection

Results • Large and active stock markets in the UK at the beginning of the 20 th century • 19 stock exchanges including many provincial exchanges • “Several thousand” stocks traded • Large amount of equity issued on exchanges (average growth in equity was 10% per annum in our sample of firms)

Equity Issuance • Only one class of ordinary equity • Most equity issued to finance acquisitions – 88% in our sample • Relatively little for internal investment • Issued at one price • Even in the absence of takeover code, discriminatory pricing did not occur

Takeovers and Dilution • In process of taking over other firms, they issued equity • This diluted the shareholding of the families and insiders: 40% of decline in directors’ ownership between 1900 and 1910 attributable to share issuance in acquisitions • As a consequence their ownership declined rapidly from the beginning of the century

Shareownership in 1900 Sample Year No. of Shareholders No. of Companies Required for 25% Where Families Shares Holdings > 25% No. of Companies Where Institution Largest Shareholder 1900 1920 1940 1960 1980 2000 2 11 18 26 58 48 0 0 4 8 8 17 18 15 8 5 1 0

The Equity Issue Puzzle • How did equity issuance occur in the absence of investor protection? • Role of trust. Companies dependent on local stock markets for raising equity • Directors concerned to maintain value of equity • Upheld interests of minorities for this purpose

Trust 1 – As Men of Distinction • “Sometimes a man with a “good name”, knowing nothing about the business and even without residence in the country, is set up as chairman with the principal duty of reading the annual speech, which has been written out for him, to the shareholders” May (1939) • “One well-known insurance company in 1937 had among sixteen directors, three knights, one baron, one marquis, one earl and two dukes” Florence (1953)

Trust 2 – As Gentlemen • “Many things which are perfectly legal in this country are not the acts of a gentleman…” and are “just not cricket” The Economist, July 1937 • “In England good practice is derived chiefly from the individual’s strict, unwritten ethical code and selfimposed discipline and from his voluntary restriction of conduct well within the confines of the technical law. Etiquette compensates for the absence of legally accountable trusteeship” May (1939)

Trust 3 – As Upright Local Citizens • Trust was reinforced by proximity between directors and shareholders • “Securities are rarely sold by means of a prospectus and are not underwritten, they are placed by private negotiation among local people who understand the trade”, Lavington (1921) • Of the 3000 GKN shareholders in 1910, 40. 4% lived within 5 miles of the centre of Birmingham. By 1950, proportion fell to 5%

Trust 4 – As Families • Family control persisted in the first half of the century • While their ownership was diluted, they retained control through board representation • Family board representation was disproportionate to their ownership • Families frequently retained the position of chairman of the board

Separation of Ownership and Control 1900 Sample Percentage of Family Board Representation Minus Family Ownership 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 -4. 58 3. 53 -7. 25 6. 33 12. 79 10. 41 12. 45 12. 60 11. 13 8. 71 6. 69

So Regulation Does Not Explain Dispersion In The UK • Informal relations based on trust were at least as important in the first half of the century • Regulation substituted for trust as firms expanded beyond local markets

What About The US?

Ownership Became Rapidly Dispersed in the Three Largest U. S. Corporations in 1930 Source: Becht and De Long (2004)

Minority and Management Control in 200 Largest Source : Means (1931) QJE Table II reported in Becht and De Long (2004)

Ultimate Control in 200 Largest Source : Means (1931) QJE Table III reported in Becht and De Long (2004)

Why Did Ownership Get Dispersed? • Becht and De Long have traced back widely held firms at the end of the 1930 s to trusts at the beginning of the 20 th century. • The initial source of dispersion was the great merger wave of 1897 to 1903 • Companies consolidated in holding companies to circumvent anti-cartel provisions of the Sherman Act and take advantage of “frenzied speculation”

No. of Major Industrial Combinations Source : Thorelli Fig. 5 (1890 -1900 Thorelli; 1899 -1903 Watkins)

Do Dispersion In The UK and US Have Common Roots? • Acquisitions critical to dispersion of ownership in both UK and US • Families sought to retain board control in both • Issues of shares occurred against the background of unregulated markets and weak investor protection in both countries

Edison v. Edison Phonograph • New Jersey Court of Chancery 1894: The course of a business company “is a question which the law commits absolutely and unconditionally to the judgement of a majority of the directors” • Pennsylvania Supreme Court 1872: Directors were not liable for “mistakes of judgement, even though they may be so gross as to appear to us absurd and ridiculous provided that they are honest” and not ultra vires

How Do These Compare With The Continent? Size of Stock Markets Relative to GDP in 1913 Canada 74% France 78% Germany 44% UK 109% US 39% Source: Rajan and Zingales (2003)

Regulation in Germany • 1870 company law stipulated dual board • 1884 law required complete split of functions • 1896 German Exchange Act “is the most elaborate attempt ever made to regulate speculative markets” (Emery (1898)) • Rules about organization of exchanges, membership, pricing of securities, admission of securities, enforced by State Commissioner • Of the three countries, Germany had the most extensive investor protection at turn of century

IPO Activity in Germany • 180 IPOs between 1970 and 1993 Source: Fohlin (2004) S

The First Wave of German Incorporation Source: Fohlin (2004)

Number of Companies Listed on Berlin SE 1870 325 1875 554 1880 612 1890 1, 005 1906 1, 113 1910 2, 400 2002 700 (All exchanges) Source: Fohlin (2004)

Summary • At the beginning of the 20 th century stock markets were thriving in many countries in the world where today they are small • Formal regulation does not explain their success • Relations of trust were upheld by local markets in the UK, investment banks in the US and the universal banks in Germany

Today’s Differences Are A Post WW 2 Phenomenon 1960 -1970 Canada Germany Japan 1970 -1980 -1990 Re-emergence of family pyramids Family pyramids Corporate UK Widely held Institutions US Widely held

Implications • • What is the source of their differences? Do they matter for corporate governance? Do they matter for corporate performance? Regulation was not a necessary condition for financial development. Is it sufficient once trust breaks down? • Should we worry about the growth of regulation as a substitute for trust? • And

Where Will We Be In Another 100 Years? Dominant Owners 2100 Canada Germany Japan UK US Bill Gates jr?