21 February 2019

Could Corporate Finance Manage Without Securities Laws?

In the late nineteenth century Britain had almost no mandatory shareholder protections, but had very developed financial markets. We argue that private contracting between shareholders and corporations meant that the absence of statutory protections was immaterial. Using approximately 500 articles of association from before 1900, we code the protections offered to shareholders in these private contracts. We find that firms voluntarily offered shareholders many of the protections that were subsequently included in statutory corporate law. We also find that companies offering better protection to shareholders had less concentrated ownership.
From here via Marginal Revolution.

I would also observe, however, that while private corporations were a fairly new and unregulated area in Britain in the 19th century, that Britain did have a very substantial body of private law and, in particular, commercial law, by the time that private corporations started to emerge. Corporations emerging in a context in which there was a large and well established class of urban merchants who were used to being regulated legally by a strong state that had very predictable approaches to resolving business disputes with long pedigrees of case law and economic practice behind them. It also had a substantial community of lawyers with business oriented practices who had a good understanding of what protections were important to have for shareholders in corporations, and a large class of sophisticated and experienced investors who were cognizant of the details enough to insist on corporate governance document provisions necessary to adequately protect their investments.

In contrast, in many countries that are economically developing or that have "Third World" economies, the country itself has only been independent of colonial rule since 1960 or later, there have been multiple post-independence regimes interrupted by successions of coups or civil wars or insurgencies, the country's boundaries often don't coincide with the geographic distribution of people who share of a common ethnic or national identity, the current regime is quite weak, and neither the leading economic actors nor the common people are accustomed to operating in a Western style elected government which implements its policies via a substantial bureaucratic structure and pervasive regulation of all facets of life by the courts.

It is one thing to have a laissez faire approach to high level business regulation, when at the local level, there are courts and sheriffs and police and local governments that enforce contract and property rights, sanction people who don't respect the rights of others, keep water and sewer systems operating smoothly, keep local roads in good repair, confirm that construction activity adheres to safety standards both in terms of what is built and worker safety, funds schools that provide universal education and a literate public, and so on. And, where, corruption in local government administration is not pervasive.

It is another thing to try to manage without formal business regulation without such a sound foundation and the norms reflected in securities laws and corporate law are already widely shared by the people who are affected by them. In Albania, for example, one of the very early problems it faced economically when it converted from Soviet style communism in its purest autarkic form to a market economy, was that its securities laws were inadequate to address the needs of the many newly privatized enterprises. Russia also faced serious problems in its privatization process that have caused it to develop a corrupt crony capitalist system run by oligarchs.

The study itself should also be taken with a grain of salt. Consider this comment to the Marginal Revolution post linked above:
clockwork_prior February 19, 2019 at 8:39 am

Always look at the generally carefully chosen dates for such studies, as that way, they avoid discussing things like this - 'Railway Mania was an instance of speculative frenzy in the United Kingdom of Great Britain and Ireland in the 1840s. It followed a common pattern: as the price of railway shares increased, more and more money was poured in by speculators until the inevitable collapse. It reached its zenith in 1846, when no fewer than 272 Acts of Parliament were passed, setting up new railway companies, with the proposed routes totalling 9,500 miles (15,300 km) of new railway. Around a third of the railways authorised were never built – the companies either collapsed due to poor financial planning, were bought out by larger competitors before they could build their line, or turned out to be fraudulent enterprises to channel investors' money into other businesses.' https://en.wikipedia.org/wiki/Railway_Mania 
Bubbles come and go, but that fraudulent diversion just might have made a certain impression on both law makers and investors in the UK. Along with laying a lot of rail, of course.
Donald Pretari February 19, 2019 at 12:43 pm

We have financial oversight to protect the interests of average citizens, not to protect James Grant or George Selgin. Do you really expect the average citizen to be able to monitor banks, when experts can't agree about MMT? You need to keep up with current events. The recent crisis involved massive fraud and deception on the part of financial and investment concerns. Read "The Chickenshit Club: Why the Justice Department Fails to Prosecute Executives" by Jesse Eisinger. And don't mention other countries unless you allow mention of them when it doesn't suit your purposes. I actually find comparing our country today and 18th Century Britain disturbing, although I agree its historically interesting. In any case, expecting banks and investment services to be trusted nowadays is not likely, nor should it be.
Along the same lines that I have suggested, see also this comment to the Marginal Revolution post (emphasis added):
jack February 19, 2019 at 8:58 am  
Britain still has almost no statutory shareholder protections and no governmental regulator like the SEC. Its companies law is is way less bureaucratic than the US's with far less lawyer involvement. It does have perhaps the best commercial courts in the world with judges not juries deciding commercial cases and cost shifting. It also has a culture that values probity -- perhaps more than the US.
Indeed, even the word "probity" is so uncommon in the U.S. that I feel the need to provide this definition of it (the featured one in a Google search):
the quality of having strong moral principles; honesty and decency.
"financial probity" 
synonyms: integrity, honesty, uprightness, decency, morality, rectitude, goodness, virtue, right-mindedness, trustworthiness, truthfulness, honor, honorableness, justice, fairness, equity . . .
Britain does have a "Financial Conduct Authority" (the FCA) whose role is somewhat analogous to the SEC and state securities regulators in the U.S., but it regulates with a lighter hand.

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