The Rise of Dispersed Ownership: The Roles of Law and the State in the Separation of Ownership and Control

id=206448. 121. Ironically, economic analysis today regards the issuance of nonvoting common stock as essentially innocuous, as the purchasers will pay little for such a security and hence they risk little. Imaged with the Permission of Yale Law Journal [Vol. 111: 1 The Rise of Dispersed Ownership The point of this story is not that the NYSE has always behaved as a public-regarding, altruistically motivated entity. Rather, it is that for a variety of path-dependent reasons, the NYSE organized itself as an exclusive, high-quality securities market that would list only securities that were suitable for the public investor-while the LSE did not. In the total absence of legal requirements, the NYSE imposed mandatory disclosure obligations on its listed firms and protected shareholder voting rights. Correspondingly, the larger size of U.S. brokerage firms, which again was originally attributable to differences in the organizational rules of the NYSE and the LSE, gave U.S. brokers greater ability to underwrite securities and to develop and pledge their reputational capital to their investor customers. These two developments-the development of a monitoring capacity by the NYSE and the bonding mechanisms first developed by U.S. underwriters to attract foreign capital-constitute the twin pillars that supported the development of a liquid equity securities market in the United States. Such a public market arose more quickly in the United States than in the United Kingdom. For example, by 1907, one Wall Street firm already had 22,000 customers, 122 indicating that it was providing services on a mass scale. Yet, the legal framework that today characterizes the United States securities markets did not arise until decades later. B. The British Experience In contrast to the high listing standards that the NYSE imposed by the late 1800s, the LSE's basic policy was to list any security that was expected to generate business. '23 Only in "rare cases, where something adverse was known about the security and the circumstances surrounding its issue," would a listing application be denied for reasons other than lack of trading interest.124 Of course, this attitude reflected the natural attitude of an "open" exchange with broad membership: More listings implied more business, and the failure of an occasional brokerage firm (which were characteristically smaller in size) did not constitute as serious a threat to the LSE as it did to the NYSE-in part because the LSE had a considerably More sinister in the view of most recent commentators is the issuance of a high-voting security after common stock has been sold to public investors, because this later issuance dilutes the voting power of outstanding shares. Ronald J. Gilson, Evaluating Dual Class Common Stock: The Relevance of Substitutes, 73 VA. L. REv. 807, 840-42 (1987); Jeffrey N. Gordon, Ties That Bond: Dual Class Common Stock and the Problem of Shareholder Choice, 76 CAL. L. REV. 3, 4 (1988). Yet, however myopic its original purpose, the NYSE's "one share, one vote" rules served to protect common shareholders from any significant dilution of their voting power. 122. MICHIE, supra note 70, at 228. 123. MICHIE, supra note 113, at 96. 124. Id. Imaged with the Permission of Yale Law Journal 2001] The Yale Law Journal deeper capital base. 2 ' Finally, stock issuances were typically arranged in the United Kingdom by stock promoters, not the largest merchant banks. These promoters often had unsavory reputations and little reputational capital to pledge. '26 Given the LSE's laissez-faire approach and, indeed, its caveat emptor attitude, it is thus not surprising that the public equity market developed more slowly in the United Kingdom than in the United States. Exactly when dispersed ownership arrived in the United Kingdom is debatable. In 1936, the median proportion of the voting share held by the twenty largest shareholders in the eighty-two largest nonfinancial U.K. corporations was approximately 40% (whereas the same ownership level for U.S. corporations was then 28%). 27 Moreover, in 40% of U.K. companies, the twenty largest shareholders held a collective absolute majority. 128 Thus, although share ownership may have been dispersed, the separation of ownership and control had not yet truly occurred. A parallel study based on 1977 data found that the largest twenty shareholders then held between 20% and 29% of the voting stock. 29 Although such a block might still carry control, it is doubtful that the twenty largest shareholders were by this point truly a cohesive group, as institutional investors were now heavily represented in the top twenty. 3 ° Hence, sometime between the late 1930s and the mid1970s, ownership and control probably separated in most U.K. companies. 3 ' The deeper question is not when dispersed ownership arrived, but why it occurred. In the absence of high listing standards or underwriting practices that placed the reputational capital of credible financial intermediaries behind most offerings, why did public investors place trust and confidence in the United Kingdom market? 125. MICHIE, supra note 70, at 272 (noting that the NYSE's capitalization was one-third that of the LSE). 126. For this common assessment, see W.A. THOMAS, THE FINANCE OF BRITISH INDUSTRY 23 (1978); and John Armstrong, The Rise and Fall of the Company Promoter and the Financing of British Industry, in CAPITALISM IN A MATURE ECONOMY 115, 130-31 (J.J. Van Helten & Y. Cassis eds., 1990). 127. P. SARGANT FLORENCE, THE LOGIC OF BRITISH AND AMERICAN INDUSTRY 189 (1953). 128. ld. 129. JOHN SCOTT, CAPITALIST PROPERTY AND FINANCIAL POWER 95 (1986). For a review of this literature, see Bernard S. Black & John C. Coffee, Jr., Hail Britannia? : Institutional Investor Behavior Under Limited Regulation, 92 MICH. L. REV. 1997, 2029-33 (1994). 130. Id. at 2030-31 (analyzing the list of twenty largest shareholders in Scott's study). 131. Cambridge University Professor Brian Cheffins opines that "[t]here is some evidence which suggests that the period prior to 1950 was pivotal. " CHEFFINS, supra note 20, at 19. While he is equivocal about 1950, he is more convinced that it arrived before 1970. Leslie Hannah, a British business historian, similarly concludes that the separation of ownership and control was established in Britain by the middle of the twentieth century. LESLIE HANNAH, THE RISE OF THE CORPORATE ECONOMY 90-91, 123-24 (2d ed. 1976); CHEFFINS, supra note 20, at 22. These dates precede the appearance of Margaret Thatcher on the political scene and suggest that dispersed ownership arrived during a social-democratic era in Britain. Imaged with the Permission of Yale Law Journal [Vol. Illl: 1 The Rise of Dispersed Ownership Several tentative hypotheses can be advanced. First, less effort may have been expended on self-regulation in the United Kingdom because judicial corruption and regulatory arbitrage posed less of a threat. In this light, self-regulation is an example of a functional substitute that arose at least in part to solve the problem of endemic judicial corruption in the United States during the late nineteenth century. Again, this is an illustration of functional convergence. Second, the United Kingdom may have had a more cohesive business community than did the United States in this era, with either a stronger normative code or a perceived greater exposure to the loss of reputational capital based on any association with a securities scandal. Either factor could have restrained U.K. managers in the absence of law. Contemporary data show that the private benefits of control differ significantly among countries, even countries belonging to the same legal family. ' As of the late nineteenth century, there is every reason to believe that in the United Kingdom, the business community in general, and the securities industry in particular, was more socially stratified and class-bound than in the United