Managing Agency Problems in Early Shareholder Capitalism

The following post comes to us from Paul Ingram, Professor of Business at Columbia University, and Brian Silverman, Professor of Strategic Management at the University of Toronto.

In the paper, Managing Agency Problems in Early Shareholder Capitalism: An Exploration of Liverpool Shipping in the 18th Century, which was recently made publicly available on SSRN, we use historical data on Liverpool transatlantic shipping to examine the effect of equity ownership on top manager behavior. We found that the pattern of equity ownership by captains in the vessels that they piloted was not random. Rather, vessels that were at particular risk of attack by enemy privateers were significantly more likely to have captains who were also part-owners. This is consistent with an agency view of equity ownership. Owners preferred that captains resist privateers fiercely, but it was difficult to construct contractual incentives to elicit such behavior. Partial ownership of the vessel by the captain was one mechanism by which to align captains’ and owners’ incentives regarding the privateer threat, and consequently to elicit desired behavior from captains.

We found that equity ownership was associated with a lower likelihood that a vessel would be captured by privateers. Difference of means tests indicated a statistically significant reduction. Multivariate estimation indicated a stable, negative effect of captain-ownership on the likelihood of being captured by privateers, although the statistical significance of this relation-ship varied across models. Overall, the use of equity ownership by Liverpool vessel owners, and the effect of equity ownership on vessel captains’ behavior, appears to be largely consistent with agency theory’s predictions about the modern use and effect of equity on shareholder and top management behavior.

We considered three alternative explanations for these results – endogenous matching, waves of captain retirements or migration during wartime, and a wartime change in bargaining power between ship owners and captains. Subsidiary analyses generated results that appear to be more consistent with an incentive-alignment rationale than with these explanations.

The evidence of the efficacy of captain ownership in Liverpool shipping is notable given the inconsistent results regarding the influence of CEO stock ownership in contemporary organizations. As scholars and policymakers continue to debate the precise behavior elicited by top-management-team stock ownership today, our results provide useful evidence concerning the effect of equity ownership in an analogous setting. These results also enhance our understanding of the range of mechanisms used to support far-flung and difficult-to-monitor economic transactions in the days when communications lagged far behind physical trade.

Further, our results – drawn from the eighteenth century – are also interesting in light of economic history’s favored explanation for the decline of British industry in the twentieth century: that the United Kingdom was relatively slow to adopt corporate capitalism and reap the coordinating benefits of the managerial visible hand. There was at least one industry, shipping, in one place, Liverpool, where the British appear to have been early to realize that giving managers a stake in the firm enables economic activities that might otherwise be inhibited by agency costs. Of course, there are many paths by which this early realization of the agency problem could fail to become an early adoption of modern shareholder capitalism. One that deserves attention, we think, is that captain ownership took root in the triangle trade, an industry that quite rightly became tainted with illegitimacy. Our early snapshot combines with later analyses to admit the intriguing possibility that the British political economy may have discarded valuable experience in corporate governance in its repudiation of the slave trade.

The full paper is available for download here.

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One Comment

  1. Kate Jackson
    Posted Tuesday, July 17, 2012 at 9:49 am | Permalink

    This paper suggests that perhaps the problems arising around executive compensation – stock options, shareholdings, etc. – arise not from the comp itself, but from the nature of public markets. Quarterly reporting seems to vitiate the incentive for CEO-owners, if you will, to think long-term, leading to accounting/reporting manipulation and short-termist strategies. If these captains had to report quarterly earnings, and if they could liquidate their holdings mid-trip — right before the pirate ship attacks – I wonder how successful they’d have been.

    Perhaps one could test this by studying the performance of companies whose management equity stakes are sufficiently large to render liquidation unfeasible. Moreover, studying “substantial shareholder – executive” behavior on the cusp of a M&A event may prove elucidating. How many times have such managers “settled” for an inadequate merger price? If the number is substantial, we can maybe add the following rule to executive comp as a solution to shareholder-mgmt agency costs: the comp must be structured so as to be difficult to liquidate in the short term.

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