Contractual Freedom and the Evolution of Corporate Control in Britain, 1862 to 1929

Abstract

British general incorporation law granted companies an extraordinary degree of contractual freedom to craft their own governance rules. It provided companies with a default set of articles of association, but incorporators were free to reject any part or all of the model and write their own rules instead. We study the uses to which incorporators put this flexibility by examining the articles of association filed by random samples of companies from the late nineteenth and early twentieth centuries, as well as by a sample of companies whose securities traded publicly. One might expect that companies that aimed to raise capital from external investors would adopt shareholder-friendly corporate governance rules. We find, however, that regardless of size or whether their securities traded on the market, most companies wrote articles that shifted power from shareholders to directors. We also find that there was little pressure—from the government, the financial press, shareholders, or the market—to adopt governance structures that afforded minority investors greater protection. Although there were certainly abuses, it seems that incorporators made an implicit bargain with investors that offered them the chance to earn high returns in exchange for their passivity. These findings have implications for the literature on corporate control, for the “law-and-finance” argument that corporate governance in common-law countries was more shareholder friendly than in civil-law countries, and for the debate about entrepreneurial failure in Britain during the late nineteenth and early twentieth centuries.