Convergence and its Critics: What are the Preconditions to the Separation of Ownership and Control?

Recent commentary has argued that deep and liquid securities markets and a dispersed shareholder base are unlikely to develop in civil law countries and transitional economies for a variety of reasons, including (1) the absence of adequate legal protections for minority shareholder, (2) the inability of dispersed shareholders to hold control or pay an equivalent control premium to that which a prospective controlling shareholder will pay and (3) the political vulnerability of dispersed shareholder ownership in left-leaning "social democracies. " Nonetheless, this article finds that significant movement in the direction of dispersed ownership has occurred and is accelerating across Europe. To understand how dispersed ownership can arise in the absence of the supposed legal and political preconditions, this article reconsiders the appearance of dispersed ownership in the late 19th and early 20th Century in the U.S. and the U.K. During this era, the private benefits of control were high, and minority legal protections in the U.S. were notoriously lacking, as the famous Robber Barron of the age bribed judges and legislators and effectively employed regulatory arbitrage to escape regulation. Nonetheless, strong self-regulatory institutions (most notably, the New York Stock Exchange) and private bonding mechanisms by which leading underwriters pledged their reputational capital by placing directors on the board of sponsored firms enabled the equity market to expand and dispersed ownership to arise. In contrast, in the U.K., the London Stock Exchange for a variety of path-dependent reasons played a far more passive role and did not become an effective self-regulator until much later in the 20th Century. Yet, dispersed ownership also arose, although at a slower pace. The lesser role for private self-regulation in the U.K. may have been the consequence of its lesser need for self-regulation as a functional substitute for formal law, given both earlier legislation in the U.K. and lesser exposure to judicial corruption and regulatory arbitrage. Based on these examples, this article argues that "functional convergence" will dominate "formal convergence" and that the principal mechanism of functional convergence may be private self-regulation. However, rather than reject the "law matters" hypothesis, this article suggests that one of the principal advantages of common law legal systems is their decentralized character, which encourages self-regulatory initiatives, whereas civil law systems may monopolize all law-making initiatives. Further, this article proposes that legal reforms, while important, are likely to follow, rather than precede, market changes - as happened in both the U.S. and the U.K. Once however a constituency for liquid and transparent securities market is thus created, it will predictably seek and secure legislation that fills in the enforcement gap that self-regulation leaves. Both in the U.S., the U.K. and Europe today, the growth of securities markets has been largely divorced from politics. What then are the preconditions for the separation of ownership and control? The key answer is that public shareholders be able to retain control, protected from the threat of stealth raiders who can assemble controlling blocks without paying a control premium. In both the U.S. and the U.K., these protections were first developed through private (or semi-private) ordering and then formalized in legislation.