AA HistoryHistory ofof CorporateCorporate GovernanceGovernance andand ofof thethe oddityoddity ofof thethe BritishBritish

Randall Morck

Stephen A. Jarislowsky Distinguished Professor of Finance and University Professor, The University of Alberta

Research Associate National Bureau of Economic Research

Senior Research Associate Harvard law School Labor and Worklife Program LargeLarge USUS oror UKUK CorporationsCorporations LargeLarge firmsfirms areare freefree standing;standing; mostmost areare widelywidely heldheld

Listed Corporation

100% ownership Domestic subsidiaries

Almost 100% ownership Public Shareholders Freestanding Listed corporations neither control nor are controlled by other listed companies controls no publicly traded US company Any domestic subsidiaries are 100% owned Widely held Managers usually own less than 1% Large shareholders are institutional investors with e.g. 5% “Controlling” shareholders hold eg. 5% to 20% Founders (or(or heirs)heirs) quicklyquickly sellsell sharesshares toto diversifydiversify ElsewhereElsewhere …… WealthyWealthy OldOld FamiliesFamilies && PyramidsPyramids

Family Firm

>50% >50% A1 A2

>50% >50% >50% >50% B1 B2 B3 B4

>50% >50% >50% >50% >50% >50% >50% >50% C1 C2 C3 C4 C5 C6 C7 C8

>50% >50% >50% >50% >50% >50% >50% >50% >50% >50% >50% >50% >50% >50% >50% D1 D2 D3 D4 D5 D6 D7 D8 D9 D10 D11 D12 D13 D14 D15 D16

<50% in <50% in <50% in <50% in <50% in <50% in <50% in <50% in <50% in <50% in <50% in <50% in <50% in <50% in <50% in each each each each each each each each each each each each each each each Public Shareholders –Public Individual Shareholderss or Institutional Investors AmericaAmerica WasWas OnceOnce NormalNormal ……

van Sweringens

80% voting control Vaness Company van Sweringen interest of 27.7%

40% voting control 50% voting control General Securities Corporation van Sweringen interest of 51.8%

41% voting control Alleghany Corporation van Sweringen interest of 8.8%

49% voting control 51% voting control NY, Chicago & St. Louis Railroad Missouri Pacific Railroad van Sweringen interest of 0.59% van Sweringen interest of 1.69%

71% voting control Chesapeake Corporation van Sweringen interest of 4.1%

54% voting control Chesapeake & Ohio Railway van Sweringen interest of 0.98%

53% voting control 50% voting control Wheeling & Lake Erie Railway Denver & Rio Grande Western RR van Sweringen interest of 0.26% Joint control

7% 4% 38% voting control 23% voting control 7% voting control Pere Marquette Railway Erie Railroad van Sweringen interest of 0.64% van Sweringen interest of 0.60%

31% voting control Hocking Valley Railway van Sweringen interest of 0.35% RooseveltRoosevelt’’ss NewNew DealDeal Securities and Exchange Act enforces transparency, ‘35 making makes tunneling harder to conceal Intercorproate dividend tax at 10% of regular rate No capital gains tax on property from complete liquidation of a controlled subsidiary ‘36 Public Utilities Holding Co. Act “Death Sentence Clause” bans pyramids > 2 layers high in public utilities industries Intercorproate dividends tax at 15% of regular rate ‘37 No capital gains tax on any assets from complete liquidation of subsidiary

Investment Companies Act regulates listed ‘40 companies with extensive shareholdings in other listed companies as investment companies Source: Morck (2005). Table 3. The Elimination of US Holding Company Structures: Important US Companies Listed in 1937 as recently Eliminating One or More Holding Company Structures Company Role of Intercorporate Dividend Tax A.G. Spalding & Brothers Apparent tax saving, but not explicit mention Acme Steel Company Apparent tax saving, but not explicit mention Air Reduction Company Inc. Apparent tax saving, but not explicit mention Associated Gas & Electric Company Apparent tax saving, but not explicit mention Atlas Corporation Apparent tax saving, but not explicit mention Atlas Powder Company Apparent tax saving, but not explicit mention Bethlehem Steel Corporation Explicitly cited as justification Blackstone Valley Gas & Electric Company Apparent tax saving, but not explicit mention Borden Company Explicitly cited as justification Central Main Power Company. Apparent tax saving, but not explicit mention Central Power & Light Company Apparent tax saving, but not explicit mention Consolidated Oil Corporation Apparent tax saving, but not explicit mention Diamond Match Company Explicitly cited as justification E.I. de Pont de Nemours & Co. Explicitly cited as justification Eastern Gas & Fuel Associates Apparent tax saving, but not explicit mention Eastman Kodak Company Apparent tax saving, but not explicit mention Electric Bond & Share Company Apparent tax saving, but not explicit mention Electric Power and Light Apparent tax saving, but not explicit mention General Foods Apparent tax saving, but not explicit mention International Harvester Company Apparent tax saving, but not explicit mention International Hydro-Electric System Company Explicitly cited as justification McKesson and Robbins Incorporated Apparent tax saving, but not explicit mention Nevada-California Electric Corporation Apparent tax saving, but not explicit mention Northern New York Utilities Apparent tax saving, but not explicit mention Pacific Gas & Electric Company Apparent tax saving, but not explicit mention Pillsbury Flour Mills Company Apparent tax saving, but not explicit mention Safeway Stores Apparent tax saving, but not explicit mention Southern Pacific Company Apparent tax saving, but not explicit mention Union Pacific Railroad Apparent tax saving, but not explicit mention United States Rubber Company Explicitly cited as justification GermanyGermany isis AlsoAlso OddOdd HitlerHitler’’ss ProblemProblem TheThe NationalNational SocialistSocialist (Nazi)(Nazi) partyparty wantswants toto controlcontrol thethe entireentire economy,economy, butbut cancan’’tt seemseem ‘‘communistcommunist’’ HjalmarHjalmar SchachtSchacht’’ss solutionsolution ““EntrustEntrust”” banksbanks withwith publicpublic shareholdersshareholders’’ votesvotes ““AryanizationAryanization”” putsputs NaziNazi’’ss inin chargecharge ofof thethe banksbanks && unionsunions ““FFüühreprinziphreprinzip”” transferstransfers fiduciaryfiduciary dutyduty toto stakeholdersstakeholders –– employees,employees, banks,banks, andand (most(most importantly)importantly) thethe ReichReich

Reichsbank governor Hjalmar Schacht GermanGerman CorporateCorporate GovernanceGovernance bank voted bank via bank’s industrial proxies subsidiaries direct stake total Siemens 0% 9.87% 85.81% 95.48% Volkswagen 0 8.89 35.16 44.05 Hoechst 0 10.74 87.72 98.46 BASF 0.09 13.81 81.01 94.71 Bayer 0 11.23 80.09 91.32 Thyssen 6.77 3.82 34.98 45.37 VEBA 0 12.82 78.23 90.85 Mannesmann 0 7.78 90.35 98.11 MAN 8.67 12.69 28.84 48.20 Preussag 40.65 4.51 54.30 99.48 VIAG 10.92 7.43 30.75 49.10 Degussa 13.65 8.65 38.35 60.65 AGIV 61.19 15.80 22.10 99.09 Linde 33.29 14.68 51.10 99.07 Deutsche Babcock 3.22 11.27 76.09 90.58 Schering 0 19.71 74.79 94.50 KHD 59.56 3.37 35.03 97.96 Bremer Vulkan 0 4.43 57.10 61.53 Strabag 74.45 3.62 21.21 99.28 The Deutsche Bank pyramid

(5.03% O&C) Deutsche Bank AG  (10% O&C)   (25% O&C) (25%O&C)  Münchener Rückversicherungs-ges AG  Allianz AG (10% O&C)  (10% O&C)  (4.92%O; (10% O&C) (30% O&C) 5.21% C)  (10% O&C) (6.2% O&C) (10% O&C) (62.11% O&C)   Bayerische Vereinsbank AG Berlinische Lebensversicherung IKB Deutsche Industriebank AG DLW AG Bayer AG RWE Aktiengesellschaft  (4.16%O; 4.4% C) (64.6% O&C) (12% O&C) (12.86% O&C) (5.01% O&C) (4.93%O; 8.1% C)

Forst Ebnath AG Bayerische Hypotheken-ünd Hermes Kreditversicherungs AG Schering AG Monachia Grundstücks AG Rheinelektra AG  (96.7% O&C) Wechsel-Bank (2.8%O; 5.8%C) (75.3% O&C) (10.6% O&C) (45.22% O&C) (10.7% O&C)

ERGO-Versicherungsgruppe AG Victoria Holding Allianz Lebensverischerungs AG Allianz Versicherungs AG Vereinte Versicherung AG Beiersdorf AG (50% O&C) (18.3% O&C) (46.5% O&C) (100% O&C) (98.7% O&C) (37.7% O&C)  (44.4% O&C) Deutscher Lloyd Versicherungs AG (29.76% O&C)  Basf AG (10.6% O&C) (10.06% O&C)    Dresdner Bank AG (7.55%O; 11.33% C) (11.16%O; 21.97%C)    WMF Württemberische Metallwarenfab. AG Leifheit AG (6.05%O; 9.07% C) (11% O&C) (17.94%O; 20.5% C) Eurohypo AG Europeische Hypothekebank  Heidelberger Zement AG (95.1% O&C) (8.84%O; 10.1% C) (12.15%O; 14.6%C) Deutsche Beteiligungs AG  Metallgesellschaft AG (20% O&C) (13.82%O; 16.6% C)

Transtec AG MG Vermoegensverwaltungs A G (12% O&C) (99.4% O&C) (6.5% O&C)  (5.03% O&C) Hindrichs Auffermann AG Continental AG  (24.96% O&C) (10.2% O&C)

Deutz AG Südzucker AG (38.2% O&C) (10.23%O; 12.8% C)

Maschinenfabrik Fahr A G KWS Saat A G (99.8% O&C) (24.99% O&C) (25.11% O&C)  BHS Tabletop AG Linde AG  (13.09% O&C) (32% O&C) (10.1% O&C)

Verseidag AG Nürnberger Beteligungs AG (10.4% O&C) (7.60%; 10% C)

Phoenix AG Daimler Benz AG (10% O&C) (22.6% O&C) Source: Faccio and Lang (2001). JapanJapan isis OddOdd TooToo …… Meiji Restoration and the great zaibatsu family pyramids Mitsubishi, Sumitomo, Mitsui lever large family fortunes into control over corporate assets of vastly greater assets The Great Depressions of the 1920s and 1930s The collapse of the Suzuki zaibatsu and other great family pyramids Suzuki Mitsui BANK Family

BANK Wartime economy run by Soviet-trained planners The American Occupation & de facto mass privatization The widely held economy leads to hostile raids and greenmail The keiretsu that characterize modern Japan emerged in the 1960s and 1970s as networks of white squires to protect each other against hostile takeovers Each group firm owns a small stake in every other group firm Collectively, other group firms control every group firm Group firms are Free of any controlling shareholder Professionally managed Takeover-proof Banks fading

Bank

AA stylizedstylized JapaneseJapanese keiretsukeiretsu groupgroup ItalyItaly’’ss StateState ControlledControlled PyramidsPyramids MussoliniMussolini’’ss ProblemProblem HowHow toto controlcontrol thethe economyeconomy butbut notnot seemseem communistcommunist MussoliniMussolini’’ss solutionsolution FascistFascist runrun sovereignsovereign wealthwealth fundsfunds atat apexesapexes ofof hugehuge pyramidalpyramidal businessbusiness groupsgroups ofof listedlisted firmsfirms

State-ownedFamily FirmEnterprise

>50% >50% A1 A2

>50% >50% >50% >50% B1 B2 B3 B4

>50% >50%>50% >50% >50% >50% >50% >50% C1 C2 C3 C4 C5 C6 C7 C8

>50% >50%>50% >50%>50% >50% >50% >50% >50% >50% >50% >50%>50% >50% >50% D1 D2 D3 D4 D5 D6 D7 D8 D9 D10 D11 D12 D13 D14 D15 D16

<50% in <50% in <50% in <50% in <50% in <50% in <50% in <50% in <50% in <50% in <50% in <50% in <50% in <50% in <50% in each each each each each each each each each each each each each each each Public Shareholders Aganin, Alexander and Paolo Volpin. 2005. The History of Corporate Ownership in Italy

IRI etc. ButBut MostMost CountriesCountries BigBig CompaniesCompanies LookLook LikeLike ThisThis SlimSlim HeluHelu GroupGroup (Mexico)(Mexico) WhoWho ControlsControls thethe WorldWorld’’ss GreatGreat Businesses?Businesses? WhyWhy AreAre thethe EnglishEnglish Odd?Odd? Formal Shareholder Rights: Few & Late 1890 Directors Liability Act – shareholder can sue for ill-faith prospectus 1900 Companies Act lets 10% block call shareholders meeting 1948 Companies Act requires proxy voting Mid ’60s LSE disclosure requirements grow tougher 1967 Companies Act forces ownership structure disclosure 1968 LSE control block cap 1980 insider trading illegal 1986 Financial Services Act makes LSE regs “subordinate legislation” Mid ‘90s tax reforms made share repos viable alternative to dividends 1995 disclosure of director pay ButBut Very high historical dividend yields c/c other countries UK firms had to rely on repeated securities issues, not retained earnings, to fund new projects PowerfulPowerful institutionalinstitutional investorsinvestors insistedinsisted onon veryvery highhigh dividendsdividends SelfSelf--regulationregulation TheThe CadburyCadbury CommitteeCommittee andand thethe TakeoverTakeover PanelPanel EntrustEntrust regulatingregulating ofof businessbusiness toto businessbusiness leadersleaders HiringHiring thethe foxfox toto guardguard thethe henhouse?henhouse? Oddly,Oddly, itit seemsseems toto workwork …… Why?Why? ““SelfSelf--regulationregulation”” isis directeddirected byby institutionalinstitutional investors,investors, notnot listedlisted companies,companies, brokers,brokers, jobbers,jobbers, …… UponUpon closercloser inspectioninspection …… GreedGreed FearFear DisloyaltyDisloyalty GreedGreed …… LabourLabour Govt.Govt. && thethe SupplySupply ofof SharesShares TopTop taxtax ratesrates onon personalpersonal incomeincome && dividendsdividends Fluctuated between 83% to 95% from 1945 until 1980s All “in-kind benefits” taxed as income Closely held firm dividends & capital gains taxed as income Inherited income taxed at 90% & non-monetary inheritances (deliberately?) overvalued by Inland Revenue ToTo continuecontinue livingliving inin stylestyle …… List your companies Inherited shares can be valued at market price Sell more stock each year Capital gains untaxed until 1965, then at 30% GreedGreed …… LabourLabour Govt.Govt. && DemandDemand forfor SharesShares Insurance companies as investment vehicles Insurance policy contributions tax deductible Insurance policy returns taxed at very low rate Pension funds and the victory of socialism Companies pay taxes on earnings, including dividends paid Investors pay taxes on dividends too, but get a credit for taxes already paid by the company Pension funds paid no taxes, but still got the full credit for taxes paid by the company Effective zero (even negative) tax rate on dividends received by pension funds BottomBottom lineline Massive transfer of shares from (decreasingly) wealthy individuals to insurance companies and pension funds PensionPension FundFund EquityEquity HoldingsHoldings

90%

80%

70%

60%

50%

40%

30%

20%

10%

0% 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 AsAs fractionfraction ofof totaltotal UKUK marketmarket capitalizationcapitalization FearFear …… FearFear ofof nationalizationnationalization Labour Party supports independent pension funds Union leaders like criticism of top management Unions support funds with high portfolio returns FearFear ofof losinglosing influenceinfluence Nascent pyramidal groups threatened dominance of pension funds and insurance co.s in 1960s Institutional investors responded by lobbying LSE for its 1968 Takeover Rule if you own > 30% then you must own 100% FearFear ofof losinglosing tradingtrading volume,volume, ratherrather thanthan listingslistings The LSE tries to please institutional investors Stock markets in most countries try to please issuers DisloyaltyDisloyalty ……

Milgram,Milgram, Stanley.Stanley. ObedienceObedience toto Authority.Authority. NewNew York.York. HarperHarper andand Row.Row. 1974.1974.

Stanley Milgram

Milgram Obedience Experiment Percent of Subjects still obedient 100 Learner complains of pain 90 Learner pleads to be let out 80 Learner screams and Refuses to answer 70

60

50

40 Voltage 0 75 150 225 300 375 450 moderate strong very intense severe XXX strong VariantsVariants LocationLocation AgeAge GenderGender NationalityNationality No Significant TimeTime periodperiod Difference SocialSocial classclass EducationEducation EtcEtc

ExitExit interviews:interviews: SubjectsSubjects stressedstressed ““loyaltyloyalty”” toto thethe experimenter,experimenter, ““dutyduty”” toto thethe experiment,experiment, andand thethe importanceimportance ofof ““doingdoing whatwhat waswas expectedexpected ofof themthem”” ReconciledReconciled toto EconomicsEconomics HobbesHobbes (1651)(1651) LeviathanLeviathan WeWe submitsubmit toto thethe StateState becausebecause anarchyanarchy isis worseworse MilgramMilgram’’ss subjectssubjects stressedstressed feelingsfeelings ofof loyaltyloyalty andand dutyduty WhyWhy dodo humanshumans derivederive suchsuch profoundprofound emotionalemotional satisfactionsatisfaction fromfrom selfself-- sacrificingsacrificing actsacts ofof loyalty?loyalty? IsIs anan obedienceobedience reflexreflex neurologicallyneurologically hardwired?hardwired? DoesDoes obedienceobedience toto authorityauthority havehave moremore ancientancient evolutionaryevolutionary rootsroots thanthan HobbesHobbes perceived?perceived? A Rival Authority Percent of Subjects still obedient 100

90 Second psychologist, same height and 80 dress as the first, states disapproval of the experiment 70

60

O

0 Voltage 0 75 150 225 300 375 450 moderate strong very intense severe XXX strong DisloyaltyDisloyalty …… TheThe capacitycapacity forfor disloyaltydisloyalty MajorMajor BritishBritish pensionpension fundsfunds && insuranceinsurance companiescompanies areare independentindependent ofof thethe corporationscorporations theythey investinvest inin AnAn expectationexpectation ofof disloyaltydisloyalty TheThe mostmost ““overover--weightedweighted”” institutionalinstitutional investorinvestor’’ss dutyduty isis toto leadlead aa ““backroombackroom revoltrevolt”” inin aa problemproblem firmfirm InstitutionalInstitutional lobbyinglobbying toto buildbuild ““rivalrival authoritiesauthorities”” IndependentIndependent directorsdirectors IndependentIndependent chairschairs IndependentIndependent committeescommittees SelfSelf--regulatoryregulatory committeescommittees Advocatus Diaboli The Holy Office of the Devil’s Advocate created during the Counterreformation by Pope Sixtus V to renew popular respect for the Church by exposing fraudulent candidates for sainthood The Devil’s Advocate was a canon lawyer ordered to contest potential saints’ character & the veracity of their miracles Abolished by John-Paul II – more new saints since then than during the previous century Advocatus Diaboli In parliamentary democracy Leader of the Official Opposition Two party system in which it is the duty of the leader of the opposition party to criticize the leader of the party (or coalition) in power This imposes costs – delays, embarrassments, etc. but most people now believe democracy is the “least bad” political system In the Common Law legal system Each side has lawyers, whose duty is to criticize the other side’s arguments and evidence The imposes costs too – legal expenses, delays, etc. but LLSV argue that the Common Law is nonetheless the “least bad” legal system AcademiaAcademia DevilDevil’’ss AdvocatesAdvocates inin academiaacademia DiscussantsDiscussants atat conferencesconferences RefereesReferees forfor journalsjournals OutsideOutside reviewersreviewers forfor tenuretenure casescases ThisThis imposesimposes costscosts –– badbad refereereferee reports,reports, publicationpublication delays,delays, etc.etc. –– butbut mostmost academicsacademics nownow believebelieve thisthis isis thethe ““leastleast badbad”” systemsystem forfor thethe advancementadvancement ofof researchresearch SelfSelf--regulationregulation ““II wantwant everyoneeveryone toto telltell meme thethe truth,truth, eveneven ifif itit costscosts himhim hishis job.job.”” SamuelSamuel Goldwyn,Goldwyn, FounderFounder ofof MetroMetro--GoldwynGoldwyn--MayerMayer The British system works because pension funds and insurance companies are charged with criticizing corporate management – usually quietly and “behind the scenes, but always with the implicit threat of public criticism. Self-regulation works because it is mainly directed by pension funds and insurance companies – the designated devils’ advocates Pension fund & insurance company managers can “tell CEOs and controlling shareholders the truth” without getting fired