Business and the Choice of Organizational Form

According to longstanding conventional wisdom, the corporate form is crucial for economic development because it allows entrepreneurs to raise funds from broad capital markets. Thus, the argument goes, countries like the US, which offered early access to the corporate form, led in industrial development. Although this view makes intuitive sense, it does not fit the facts. Relatively few industrial enterprises took the corporate form during the period of the industrial revolution. Indeed, even in the US, the majority of enterprises continued to use non-corporate forms until the deep into the twentieth century. Moreover, most industrial companies that did become corporations were closely held. They did not raise funds by issuing equities, and their existing shares were rarely traded. What role, then, did the corporate form play in economic development?

My co-authors and I approached this problem by considering the costs as well as the benefits of the corporate form. In “Legal Regime and Contractual Flexibility: A Comparison of Business’s Organizational Choices in France and the United States during the Era of Industrialization,” Jean-Laurent Rosenthal and I posited a simple tradeoff between partnerships and corporations. Under Anglo-American law the choice was stark. Partnerships subjected all members of the firm to unlimited liability and also allowed members to quit the enterprise at will, potentially imposing costs of untimely dissolution on the others. But a potential advantage of the partnership form was that all members had full decision-making powers. Corporations, by contrast, locked members’ capital into the enterprise in exchange (usually) for limited liability, but majority shareholders had full control and could ignore the views of minority holders when they made decisions. The benefits of the corporate form were thus likely to be highest (that is, investors were most likely to be willing to bear the risks of minority oppression) in industries where the potential costs of untimely dissolution were greatest—for example, those that involved expensive capital investments that were highly specific to the enterprise. Intriguingly, when we turned to France and examined the relative risks of minority oppression and untimely dissolution under French law, we found that entrepreneurs were able to mitigate the starkness of the tradeoff. The Napoleonic code enabled partnerships that registered with their local commercial tribunals to contract in ways that reduced the risk of untimely dissolution, limited at least partially the liability of members, and regulated who had decision-making power. Germany pushed this flexibility a step further by creating a new form—the Gesellschaft mit beschränkter Haftung (GmbH), essentially a limited liability company—that gave its members the ability to trade off untimely dissolution and minority oppression to get the mix of attributes that best suited their contracting needs. As Timothy Guinnane, Ron Harris, Jean-Laurent Rosenthal, and I showed in “Putting the Corporation in its Place,” by the early twentieth century most European countries had similarly flexible legal rules. US businesses did not secure this degree of contractual freedom until the end of the century, raising the possibility that the relatively high proportion of US enterprises adopting the corporate form owed not to the superiority of US legal rules but to their relative inflexibility and the lack of alternative choices.

It is also conventional in the literature to tout the shareholder friendliness of Anglo-American corporate governance rules and hold it up as a model to the world. At least with respect to British rules, however, this view is based on an error. The various British Companies Acts have always included a model set of corporate governance rules. Many scholars have treated these rules as if they were law, but they were (and are) default rules that only apply if a company does not insert its own rules into its articles of association. In “Contractual Freedom and Corporate Governance in Britain in the Late Nineteenth and Early Twentieth Centuries,” Tim, Ron, and I collected three random samples of company registrations, as well as a sample of registrations for companies traded on the exchanges, and analyzed their articles of association. Almost all the companies in these samples rejected the model articles and wrote their own provisions. Moreover, the rules they adopted were anything but shareholder friendly. Most protected a group of “managing directors” from having to stand for reelection by shareholders, and some formally entrenched particular directors for life. US firms had a more difficult time insulating managers from shareholders’ oversight, but they too turned to a variety of devices (ranging from preferred shares to voting trusts) to solidify managerial control. Jean-Laurent and I are now expanding our original analysis of the tradeoff between untimely dissolution and minority oppression to better understand why entrepreneurs cared so much about control and also the likely consequences of making control easier to secure—both for innovation and for firms’ long-run trajectory. Ron and I have explored the differences in British and American legal rules and showed that, contrary to the literature on the efficiency of the common law, the case law evolved historically in ways that accentuated the legal divergence between the two countries (see “Opening the Black Box of the Common-Law Legal Regime: Contrasts in the Development of Corporate Law in Britain and the United States in the Late Nineteenth and Early Twentieth Centuries”). In “Corporate Governance and the Expansion of the Democratic Franchise: Beyond Cross-Country Regressions,” I explored the origins of these legal differences and located them in the timing of the expansion of the suffrage relative to the enactment of general incorporation laws. In the US, the expansion of the suffrage came first, and as a result of popular feeling against corporations, general incorporation laws tended to be highly regulatory. In Britain, general incorporation laws came first and were shaped by the spread of laissez-faire ideas among the elite.

Related Publications:

Naomi R. Lamoreaux, “Three Regimes: Corporations and Regulation in US History,” in The Origins of Company Law, eds. Victoria Barnes and Jonathan Hardman (London:  Bloomsbury-Hart, forthcoming).

Naomi R. Lamoreaux and Jean-Laurent Rosenthal, “Do Entrepreneurs Want Control?  And Should They Get What They Want?  A Historical and Theoretical Exploration,” NBER Working Paper 31106 (April 2023).

Ron Harris and Naomi R. Lamoreaux, “Opening the Black Box of the Common-Law Legal Regime: Contrasts in the Development of Corporate Law in Britain and the United States in the Late Nineteenth and Early Twentieth Centuries,” Business History 61 (issue 7, 2019): 1199-1221.

Timothy W. Guinnane, Ron Harris, and Naomi R. Lamoreaux, “Contractual Freedom and Corporate Governance in Britain in the Late Nineteenth and Early Twentieth Centuries,” Business History Review 91 (Summer 2017), 227-77.

Naomi R. Lamoreaux, “Corporate Governance and the Expansion of the Democratic Franchise: Beyond Cross-Country Regressions,” Scandinavian Economic History Review 64 (issue 2, 2016): 103-21.

Naomi R. Lamoreaux, “Revisiting American Exceptionalism: Democracy and the Regulation of Corporate Governance: The Case of Nineteenth-Century Pennsylvania in Comparative Context,” in Enterprising America: Businesses, Banks, and Credit Markets in Historical Perspective, ed. William J. Collins and Robert A. Margo (Chicago: University of Chicago Press, 2015), 25-71.

Naomi R. Lamoreaux, “Entrepreneurship in the United States, 1865-1920,” in The Invention of Enterprise: Entrepreneurship from Ancient Mesopotamia to Modern Times, eds. David S. Landes, Joel Mokyr, and William J. Baumol (Princeton: Princeton University Press, 2010), 367-400.

Naomi R. Lamoreaux, “Scylla or Charybdis? Some Historical Reflections on the Two Basic Problems of Corporate Governance,” Business History Review 83 (Spring 2009): 9-34.

Timothy W. Guinnane, Ron Harris, Naomi R. Lamoreaux, and Jean-Laurent Rosenthal, “Pouvoir et propriété dans l’entreprise: pour une histoire internationale des sociétiés á responsabilité limitée,” Annales: Histoire, Sciences Sociales 63 (janvier-février 2008): 73-110. (An English version available as “Ownership and Control in the Entrepreneurial Firm: An International History of Private Limited Companies,” Yale University Economic Growth Center Discussion Paper #959 [December 2007].)

Timothy W. Guinnane, Ron Harris, Naomi R. Lamoreaux, and Jean-Laurent Rosenthal, “Putting the Corporation in its Place,” Enterprise and Society 8 (Sept. 2007): 687-729.

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: Lessons from America’s Economic History, eds. Edward L. Glaeser and Claudia Goldin (Chicago: University of Chicago Press, 2006), 125-52.

Naomi R. Lamoreaux, “Business Organization,” essay and tables in Historical Statistics of the United States: Earliest Times to the Present, eds. Susan B. Carter, et al. (Millennial edn.; New York: Cambridge University Press, 2006), Vol. 3, 477-582.

Naomi R. Lamoreaux and Jean-Laurent Rosenthal, “Entity Shielding and the Development of Business Forms: A Comparative Perspective,” Harvard Law Review Forum 119 (March 2006): 238-45.

Naomi R. Lamoreaux and Jean-Laurent Rosenthal, “Legal Regime and Contractual Flexibility: A Comparison of Business’s Organizational Choices in France and the United States during the Era of Industrialization,” American Law and Economics Review 7 (Spring 2005): 28-61.

Naomi R. Lamoreaux, “Partnerships, Corporations, and the Limits on Contractual Freedom in U.S. History: An Essay in Economics, Law, and Culture,” in Constructing Corporate America: History, Politics, and Culture, eds. Kenneth Lipartito and David B. Sicilia (New York: Oxford University Press, 2004), 29-65.

Naomi R. Lamoreaux, “Partnerships, Corporations, and the Theory of the Firm,” American Economic Review, Papers and Proceedings 88 (May 1998): 66-71.

Naomi R. Lamoreaux, “The Partnership Form of Organization: Its Popularity in Early-Nineteenth-Century Boston,” in Entrepreneurs: The Boston Business Community, 1750-1850, eds. Conrad E. Wright and Katheryn P. Viens (Boston: Massachusetts Historical Society, 1997), 269-95.

Naomi R. Lamoreaux, “Constructing Firms: Partnerships and Alternative Contractual Arrangements in Early-Nineteenth-Century American Business,” Business and Economic History, 24 (Winter 1995): 43-71.