Corporate Ownership and Control: British Business Transformed

This post is by Brian R. Cheffins of the University of Cambridge.

U.K. corporate governance is characterized by a separation of ownership and control, in the sense that a majority of British publicly traded companies lacks a shareholder owning a sufficiently sizeable voting block to dictate corporate policy. This pattern has not only influenced the tenor of corporate governance debate in Britain but serves to distinguish the U.K. from most other countries. Existing theories fail to account adequately for ownership and control arrangements in Britain. My book, Corporate Ownership and Control: British Business Transformed, just published in the U.K. and soon to be available in the U.S., accordingly explains when and why ownership became divorced from control in major British companies.

The approach I adopt in the book is strongly historical in orientation, as I examine how matters evolved from the 17th century through to today. While a modern-style divorce of ownership and control can be traced back at least as far as mid-19th century railways, the “outsider/arm’s-length” system of ownership and control that currently characterizes British corporate governance did not crystallize until the second half of the 20th century. Corporate Ownership and Control: British Business Transformed brings the story right up to date by showing current arrangements are likely to be durable. The insights it offers correspondingly should remain salient for some time to come.

Corporate Ownership and Control: British Business Transformed is divided into eleven chapters:

One: Setting the Scene
Two: The Determinants of Ownership and Control: Current Theories
Three: The ‘Sell Side’
Four: The ‘Buy Side’
Five: Up to 1880
Six: 1880–1914
Seven: The Separation of Ownership and Control by 1914
Eight: 1914–1939
Nine: 1940–1990: The Sell Side
Ten: 1940–1990: The Buy Side
Eleven: Epilogue: Current Challenges to the UK System of Ownership and Control

Key arguments I make in Corporate Ownership and Control: British Business Transformed include:

The Existing Comparative Corporate Governance Literature Fails to Account Adequately for Developments in the UK

The “law matters” thesis, initially framed by La Porta, Lopez-de-Silanes, Shleifer and Vishny, implies that company law highly protective of outside investors is an essential pre-condition to a divorce between ownership and control. As I show, British company law did not offer extensive protection for shareholders as ownership separated from control. Franks, Mayer and Rossi rely on “trust” to account for the development of robust equity markets in the U.K. but I argue “trust” is an insufficiently precise concept to have substantial explanatory power in this context. Theories concerning the regulation of financial institutions, politics and “legal origins” (the legal family to which a country belongs) similarly fail to account for how matters developed in Britain and analyzing what happened in terms of path dependence generally obscures more than it reveals.

The Separation of Ownership and Control in Britain Can be Explained by Reference to the “Buy Side” and the “Sell Side”

I argue three questions need to be addressed to explain why ownership might separate from control in large business enterprises. These are: 1) Do those owning large blocks of shares want to exit? 2) Will there be demand for shares available for sale? 3) Will the new investors be inclined to exercise control themselves? Corporate Ownership and Control: British Business Transformed explains how ownership became divorced from control in large U.K. business enterprises by addressing each of these questions in historical terms. The book uses the term “sell side” as shorthand in analyzing the factors that can prompt blockholders to dilute their ownership stake or sell their shares outright and employs the term the term “buy side” to embrace factors that determine whether investors will buy shares and will (or will not) take a “hands on” role with respect to the companies they own. Since the analytical framework is not U.K.-specific it should be suitable for assessing developments elsewhere, though the manner in which it is applied would need to be tailored to address local circumstances.

A Divorce of Between Ownership and Control Was Not the Norm in the UK Until the Mid 20th Century

Hannah, a well-known business historian, has provocatively claimed ownership was divorced from control in large U.K. companies by the early 20th century, inviting re-examination of entrenched assumptions in so doing. Corporate Ownership and Control: British Business Transformed shows his bold assertions need careful qualification, doing so by offering a detailed analysis of ownership patterns in major sectors of the British corporate economy as of 1914. Pre-World War I momentum in favour of diffusion of share ownership was sustained up to 1939 but the available empirical evidence indicates a full divorce between ownership and control remained the exception to the rule up to 1940. It was between 1940 and 1990 when a separation of ownership and control became the norm in large business enterprises in Britain.

Dividends Were a Catalyst for the Separation of Ownership and Control

Though there was discretion to do otherwise, extending back at least through the 19th century the vast majority of U.K. public companies paid sizeable dividends and most shied away from cutting the pay-out level from the previous year. The cash distributions being made would have reduced the scope for blockholders to skim or squander the profits their companies were generating. With private benefits of control thus curtailed, exit would have become a more attractive option and investor confidence in equity markets would have been enhanced, thus fortifying the buy side. Dividends also played an important signaling function, providing valuable clues about corporate performance decades before U.K. companies legislation imposed detailed disclosure requirements on companies.

So Was Tax

Stiff taxes imposed on corporate profits during World War I and World War II, a post-World War II profits tax biased against dividends and very high taxes on personal income in place from the late 1930s to the end of the 1970s all encouraged blockholders to exit. Between World War II and the 1980s taxes also discouraged investment in shares, at least by retail investors. Individual investors, who dominated the buy side until the 1950s, correspondingly were net sellers of shares from the end of World War II onwards. However, the decline of the private investor was more than matched by the rise of institutional investors – primarily pension funds and insurance companies — meaning conditions were hospitable on the buy side for the unwinding of ownership and control. Institutional investment in shares was sparked by a “wall” of institutional money accumulating partly due to major tax advantages associated with investing through pensions and life insurance and tax rules that biased institutional investors in favour of shares as an asset class.

The Separation of Ownership and Control in the U.K. is Likely to be a Durable Arrangement

Various trends emerging over the past few years suggest the future of the U.K.’s outsider/arm’s-length system of ownership and control is not guaranteed. These are: 1) unprecedented assertiveness by traditionally dominant institutional shareholders 2) the appearance of a new breed of intervention-minded shareholder, minded to accumulate “offensively” sizeable stakes in publicly traded companies with the express intention of agitating for changes in corporate policy 3) high-profile private equity buyouts involving the acquisition and taking private of publicly traded enterprises. The concluding chapter of Corporate Ownership and Control: British Business Transformed argues that none of these trends is likely to disrupt existing arrangements fundamentally and that they may even fortify the status quo by helping to keep agency costs in check. Thus, for the foreseeable future a separation of ownership and control will remain a hallmark of U.K. corporate governance.

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Partly due to a lack of consensus on the numerical thresholds that signify a separation of ownership and control, Corporate Ownership and Control: British Business Transformed refrains from adopting a single “bright line” test of concentrated vs. dispersed ownership. Also, while numerical evidence is offered throughout the book, due to inadequacies with the available data the hypotheses advanced are not tested by means of rigorous quantitative analysis. Due to these caveats, the book’s treatment of relevant issues cannot be definitive in nature. Nevertheless, Corporate Ownership and Control: British Business Transformed offers numerous insights for those interested in comparative corporate governance, for those engaged in the study of British business and economic history and for those intrigued by the relationship between law and markets.

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