The Rise of Dispersed Ownership: The Role of Law in the Separation of Ownership and Control
This paper was delivered as the Annual Raben Lecture at the Yale Law School on November 27, 2000. The author is grateful for helpful comments from Brian Cheffins, John Langbein, and Roberta Romano, from my colleagues, Ronald Gilson, Victor Goldberg, Jeffrey Gordon, and Curtis Milhaupt, and from participants at the Yale Law School Raben Lecture.
Deep and liquid securities markets appear to be an exception to a worldwide pattern in which concentrated ownership dominates dispersed ownership. Recent commentary has argued that a dispersed shareholder base is 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 shareholders, (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.
But can this trend persist in the absence of strong legal protections for minority shareholders and in the presence of high private benefits of control? To understand how dispersed ownership might both arise and persist 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. and contrasts their experience with those of France and Germany over the same period. 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 Barons of the age bribed judges and legislators and effectively employed regulatory arbitrage to escape even minimal anti-fraud 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.
In contrast to the New York and London Exchanges, the Paris Bourse over this same period made little, if any, effort to develop a self-regulatory structure or to upgrade listing or disclosure standards. Why not? The answer seems closely associated with the fact that it operated as a state-administered monopoly whose stockbrokers were formally considered civil servants and who were legally denied the ability to trade as principals for their own account. Facing no competition and composed of members having little incentive to promote or enhance its reputational capital, the Paris Bourse did not innovate and fell behind the London Stock Exchange. The intrusive role of state regulation, which discouraged private self-regulatory initiatives, appears to have a factor in its competitive decline. In Germany, the state strongly supported the growth of large private banks and enacted a punitive tax on securities transactions. Because the German central bank offered very liberal rediscounting terms to the principal private banks, they were able to satisfy the capital needs of German industry without resort to the equity market. In this respect, concentrated ownership seems less to have evolved naturally than to have been subsidized by the state.
Prospectively, 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 in civil law systems the state 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.