Wednesday, 22 October 2014

Capitalism and joint ownership

One of the fundamental freedoms under capitalism is the freedom of association to form business organizations. Joint private ownership is different from joint public ownership in the sense that the first is voluntary and the second is compulsory. Various types of organizations have been developed throughout history, ranging from the Assyrian partnership, the Roman societates and the medieval guilds to the compagnia e banchi of the Italian renaissance. However, the modern from of incorporation as a joint stock company, that we identify with capitalism, had its origins in the XVI century with the creation of the so-called charter companies.

Chartered companies were established by private promoters that were granted some concession or monopoly by the state. For example, in London the Muscovy Company was first established in 1555 with a monopoly over the trade of goods to Russia. Indeed, since the first boom in the establishment of joint stock companies around 1719 more than 140 years passed before this form of company settled with the new British Company Law of 1862, which introduced the main features of a modern joint stock company.

This is an organization engaged in business, recognized as a distinct legal entity from its members, with certain rights and responsibilities and acting as a mechanism to share risks and rewards. Most importantly, it replaced the personal liability of its shareholders by various forms of limited liability which would allow a larger number of shareholders to be organized and therefore able to undertake much bigger projects.

The law permitted companies to be established indefinitely (without any time limit) and not, as before, only for a limited number of years. So, big corporations could now be established by private investors under the new form of a Joint Stock Company.

This facilitated the public offering and negotiability of ordinary shares, essential for pooling funds and sharing the risk and rewards of investment. The issue of tradable shares had existed ever since the early Roman times when the Societates issued their shares or particulae. Even the chartered companies, such as the East India Company, were established by pooling together the capital of about 250 merchants. Yet, as they were typically placed among a limited group of people, mostly family or business acquaintances, they were not widely held by the public and were not actively traded in the early years of the Stock Exchange.

This was due to the basic distrust of issuers about disclosing their profits and sharing them with unknown people and risking the loss of control of the business to other people. Investors were also suspicious about any hidden reasons as to why a business owner should want to share their business. This was stimulated further by the recent memory of the occasional speculative bubble and other flotation scams such as the infamous South Sea and Mississippi companies in 1719-1720.

Only after the first slave-trade mania between 1827 and 1836 were shares widely held and tradable in the Stock Exchange. Still, most of these shares were preference shares, a class of shares that dominated the issue of equity instruments until the early years of the 20th Century. Preference shares were clearly preferred by company managers as a way of keeping control of their companies.

The process to recognize by statute the existence of incorporated companies was also a long journey. Initially incorporation was seen as a very cumbersome process, which was only worthwhile if it involved the granting of some Government monopoly, as was the case with most chartered companies. For most businessmen the partnership form had the major advantage of avoiding interference of the state. Also, public opinion associated incorporation with promotions of speculative companies such as the South Sea and the Mississippi Companies.

Similarly, the process of raising capital by instalments also gave rise to scams and many investors were easy prey for unscrupulous issuers. The most common scam was to make big issues requiring little paid-in capital to attract less sophisticated investors and then run away with their money.

For many of the same reasons, the separation of ownership and control was also a long process. The overriding idea or obstacle was summarized in Carnagie’s motto that “what is anybody’s business is nobody’s business” and it is much more so when there is a large dispersion of institutional ownership.

Not surprisingly, the separation of ownership and control only reached a significant level between 1900 and 1920, with a clear separation of responsibilities into three distinct levels: the company, the shareholders and its directors. To these, one should now add a new layer made up of professional fund managers. This was partly due to the rise of investment trusts, holding companies and the result of better accounting (despite the standards of modern accounting having been developed only from the 1940s onwards).

The separation between shareholders and the company was instrumental to reach the widespread use of equity and the impressive growth in share dealing. Other factors highlighted in modern theories of the firm such as reduced transaction costs and information technology also played an important part. But, bearing in mind that the growth of big firms also implies the growth in non-market transactions, one must question if its trade destruction effects are smaller than the trade creation effects resulting from more investment and more activities being carried out by profit-driven organizations.

Marxists and other anti-capitalist thinkers in the late 19th century pointed out that capitalism had a self-destroying mechanism, since the untamed rise of big firms would cause so much trade destruction that competitive markets would account only for a residual share of total transactions, unless the growth and size of such firms was capped. This led to the introduction of antitrust laws in most countries, inspired in the US Sherman Antitrust Act of 1890. These laws were aimed at curbing anti-competive practices by prohibiting cartels, dumping and other collusion practices as well as laws to regulate corporate consolidations ending up in the creation of monopolies or oligopolies that would limit competition.

As usual, left and right wing interventionists (e.g. socialists and corporatists) wanted as much regulation as possible while right and left wing laissez-faire supporters (e.g. classical liberals and anarchists) wanted no regulation at all. So, the role of antitrust laws has been permanently questioned and changed. Yet, after more than a century we still do not have enough empirical evidence to define a "good degree of regulation". Nevertheless, a middle-of-the-road solution is to have tough anti-competition laws and flexible anti-concentration regulations.

In relation to the various forms of joint private property one needs to remember that many of the alternatives to joint stock companies like partnerships, mutuals, friendly societies, credit unions and so on, although still in operation, have been increasingly opting for corporate structures, in particular in the mortgage-banking sector.

Finally, it must be noted that joint private ownership could not develop without limited liability. Indeed, the size of large business operations needed a large number of shareholders which could be reached only if the partnership was not entirely dependent on the life of its main owner-shareholder or heirs and if the transfer of shares was possible. Moreover, this liberated the poor from their dependency on the state to invest their meagre savings. And, as a consequence, most large firms today are owned by institutional investors whose end-owners may be big or small investors. For instance, pension funds in the OECD countries accounted in 20111 for about 10% of the US$D 32 trillion invested by institutional investors in listed equities.

In conclusion, joint private ownership is an essential right under capitalism since it is one of the main drivers of its success as a wealth production machine. Nevertheless, it must be exercised mostly through regulated corporations financed by small and big capitalists alike so that capital accumulation can benefit from the pooling of resources without unnecessary damage to competitive markets.

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