Related Investing: Corporate Ownership and Capital Mobilization During Early Industrialization

B. Zorina Khan is Professor of Economics at Bowdoin College and a Research Associate with the National Bureau of Economic Research. This post is based on her recent paper.

Family businesses and concentrated ownership have been the norm across time and place. Business historians like Alfred Chandler have noted these patterns with disapproval, attributing the decline of European industrial dominance in part to subjective “family capitalism,” and the advance of the United States to its development of objective and impersonal “managerial capitalism.”

According to economic models, market efficiency implies depersonalized transactions where outcomes are based on prices and fundamentals rather than the identity of participants. Personal or familial connections can serve as conduits for inefficiency, with the potential for nepotism, corrupt governance, and exploitation of other stakeholders. Outsider investors face the risk that both internal and external control mechanisms may be too weak to protect them from “tunneling” or corruption in the firm. By contrast, others maintain that such personalized institutions as family firms or venture capital might provide a mechanism to reduce risk or asymmetries in information, and to increase trust, social capital and the enforceability of contracts. The intergenerational links that characterize family membership can similarly provide a cost-effective signal to outsiders that a firm values continuity and future exchange.

Empirical studies typically draw conclusions from data that are limited to the top shareholders, directors, and other visible members of the firm. Apart from these key insiders, the nature of corporate ownership currently remains very much a black box. My research draws on a rich and unique data source that encompasses all of the shareholders in antebellum Maine corporations, in banking, manufacturing, and transportation, over several decades during a period of rapid structural economic growth and transformation. The panel data (cross-sections tracked over time) include information on personal characteristics of each investor including gender, age, occupation, residence, household composition, real estate holdings and personal wealth. The corporate charters specified the founding members of the company, the initial capitalization, and shareholder liability; as well as governance measures regarding restrictions on officers of the corporation, voting rights, and disclosure requirements, among other factors.

Current ongoing research examines how such patterns are related to central issues in corporate governance. Charters at that time exhibited a great deal of heterogeneity, which allows us to systematically assess variation in voting rights, restrictions on directors, and limited liability rules. The invaluable individual-level information on real estate holdings, personal wealth, and total equity ownership can also be exploited to directly investigate such questions as portfolio composition over the lifecycle; and the “Bagehot hypothesis” about the relationship between wealth and limited liability laws.

The first paper from this project is Related Investing: Corporate Ownership and Capital Mobilization during Early Industrialization. “Related investing” refers to investors whose family relationships or networks influence their decisions to enter or exit the market, the balance of their portfolios, or other actions that they might not otherwise undertake.

As most other studies have found, my results confirm that elite insiders—officers of the firm including treasurers, directors, and its presidents—were typically part of a family network in the corporation. Family networks among these business elites were positively related to concentration and did not decline over time; instead, the importance of these personal ties increased as the economy developed. Rather than seeking to expropriate their smaller investors, related founders of corporations introduced institutional mechanisms to ensure transparency, disclosure and close monitoring of the financial and accounting status of the firm. Nevertheless, these patterns might initially seem to provide support for scholars who have concerns about “unacceptable grasping.”

However, lifting the lid on the “black box” reveals a pervasive pattern in all firms and all industries over the entire period: related investing was not just limited to corporate insiders. Instead, personal ties characterized the majority of all shareholders. Indeed, it is striking that family connections were especially prevalent among women, less-wealthy shareholders, and small investors. Such groups were more likely to include individuals who were not as experienced or knowledgeable about financial markets. At least one implication of this finding is that “outsider investors” were able to overcome a lack of experience and information by taking advantage of their own networks, which also likely offered countervailing power against elite insiders.

Systematic analysis of variation across such factors as industry, gender, wealth, ownership concentration, and persistence in shareholding, offers some insights into the underlying mechanisms that in part might explain these results. For instance, differences across the banking, manufacturing, and transportation sectors suggests that family networks may have served to attenuate perceived risks and transactions costs. The expansion of the railroads (high-risk start-ups at that time) in particular required and attracted extensive investments in securities markets, that predominantly consisted of small investors who were likely to have been uneducated about financial assets. Initially, women investors were primarily associated with bank shares, but their shareholding disproportionately shifted over time towards the risky transportation securities; and this shift was positively related to kinship networks. The analysis of the effects of related investing on the concentration of ownership in the corporations similarly suggests that this phenomenon was likely associated with a reduction in perceptions of risk. Outsider investors with family connections were significantly more likely to persist in holding shares over a longer term.

The overall patterns are consistent with a more productive interpretation of related investing and its function in developing societies. The link between family networks and ownership in these corporations suggests that this phenomenon was especially beneficial for capital mobilization in emerging ventures. Familial and other social connections arguably substituted for incomplete markets and helped to resolve problems that arose in the presence of such market imperfections as high risk and asymmetrical information. Personalized trades in the context of family networks may have facilitated a process of investor education and compensated for other disadvantages that small shareholders encountered. This interpretation is consistent with my research on enterprise in France, which showed that women were able to overcome legal inhibitions on their market transactions, by participating in family firms as managers and entrepreneurs.

In general, the organization of the firm tends to be approached as a dichotomy that contrasts personalized family firms and impersonal corporations. Alfred Sloan is said to have referred to the modern corporation as “an objective organization,” rather than an institution that becomes “lost in the subjectivity of personalities.” My research instead suggests that the personal elements within the ownership structure of firms and corporations are arrayed along a continuum, that endogenously adjusts to accommodate the nature of transactions costs within the organization and in the market.


B. Zorina Khan, “Invisible Women: Entrepreneurship, Innovation and Family Firms in Nineteenth-Century France,” Journal of Economic History, vol. 76 (1) 2016: 163-195.

B. Zorina Khan, “Related Investing: Corporate Ownership and Capital Mobilization during Early Industrialization,” NBER Working Paper No. 23052, January 2017.

Randall K. Morck (ed.), A History of Corporate Governance Around the World, Chicago: University of Chicago Press, 2005.

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