Beyond the public corporation: Insights from history
Financial economists have noted for some years that the public corporation is in decline. The number of public companies has fallen considerably in the US and many other OECD countries.1 This development raises worries about corruption; while the public corporation’s disclosure rules may be imperfect, the private company seems more vulnerable to abuses (Ferris et al. 2020). Concern about its decline also reflects the widely-held belief that the public corporation has been central to economic growth; it can amass large sums of capital from disbursed investors, and thus is crucial to projects that require substantial, long-term investments. Alfred Chandler (1977)’s pioneering study of the US in the 19th century stressed that large public corporations could take advantage of the economies of scale implicit in the railroad. This view has been extended to other contexts and remains influential. Kuran (2012), for example, sees the Islamic prohibition on corporations as one way through which Islamic law discouraged economic growth in the Middle East. On the other hand, there were few corporations at the onset of the British Industrial Revolution (Harris 2000). Recent literature in economic history (pioneered by Lamoreaux and Rosenthal 2005) argues that the corporation’s role in long run economic development has been exaggerated.2
Until the mid-19th century, most countries required entrepreneurs to obtain permission to form a corporation. This concession system gave way to general incorporation laws that allowed any group of entrepreneurs to create a corporation as long as the firm adhered to specific norms. General incorporation came to Britain in 1844, but did not reach France until 1867, most of Germany until 1870, and other European countries even later. Several US states adopted general incorporation before Britain, and others had de facto general incorporation before formally changing their statutes.
Partnerships faced no such restrictions. Entrepreneurs could create partnerships that allocated capital investment, control, and cash-flow as they wished. The ordinary partnership required all owners to assume unlimited liability. The limited partnership had general partners who ran the firm and bore unlimited liability for the firm’s debts, as well as additional partners with limited liability and a smaller role in running the firm. Most continental countries required partnerships and corporations to enroll in a public business registry. Spain’s registration system provides unusually consistent, long-term data. Figure 1 reports the distribution of new enterprises in Spain by legal form for 1886-1989. In the late 19th century, the overwhelming majority of new firms in Spain were partnerships, even though Spain had adopted general incorporation for good in 1869. This pattern held decades earlier in most economies, i.e. partnerships dominated even after corporations could be formed freely.3
Figure 1 Choice of enterprise form in Spain, 1886-1989
Note: The figure reports the proportion of all Spanish firms that registered in a given year using one of the four main legal forms for business enterprise. The PLLC is the “Private limited-liability company,” a general term for enterprises like Spain’s Sociedad con Responsabilidad Limitada (SRL). Source: Guinnane and Martínez-Rodríguez (2018a).
Focus on the corporation also risks overlooking a key legal innovation of the late 19th and early 20th century: a new type of enterprise form that has some features of the corporation but also has the partnership’s flexibility and modest formalities. Guinnane et al. (2007) call these new enterprises collectively ‘private limited-liability companies’ (PLLCs). These enterprise forms allow all owners to have limited liability and participate in management. They also share another feature of the corporation: they lock in capital. Partnerships are effectively at-will, subjecting investors to hold-up problems. An investor unhappy with her corporation’s policies cannot break up the company, she can only sell her shares to someone else.
The PLLC came about in several different ways. The British 1907 Act authorising the private limited company codified existing practice that had grown out of the flexible approach to companies reflected in the 1862 Act. Germany’s 1892 Gesellschaft mit beschränkter Haftung (GmbH) embodied concerns that the strict German 1884 Corporations Act had made the form unworkable for too many firms. The French Société à responsabilité limitée (SARL 1925) reflected, in part, the awkwardness of firms in provinces Germany returned to France after WWI; many had organized as GmbHs, but there was no equivalent French legal form in 1919. The US presents a more complex story. Some states began to modify their rigid incorporation statutes in the mid-20th century, leading to close corporations that resemble the PLLCs created elsewhere. The 1980s saw the first limited-liability company (LLC) forms, which in most ways mimic earlier PLLCs (Guinnane et al. 2007: 28-37).4
The PLLC forms typically became popular within a short space of time. In Spain, the 1920 Sociedad de Responsabilidad Limitada (SRL) displaced many corporations and ordinary partnerships and eliminated the limited partnership. The Japanese PLLC (Yugen Kaisha), on the other hand, displaced partnerships rather than corporations. France’s SARL had a similar impact. The German GmbH at first proved less popular than France’s SARL, in part because the GmbH’s more corporation-like rules made it more difficulty for minority owners to retain control of the enterprise.
Figure 2 Capitalisation of new enterprises in Spain, 1886-1989
Note: The figure reports the proportion of all new nominal capital in Spain accounted for by each of the four main business enterprise forms. Source: Guinnane and Martínez-Rodríguez (2018a).
The corporation entailed organisational and reporting fixed costs not faced by other enterprises. It could also access public equity markets, unlike partnerships or PLLCs. Thus, corporations account for the lion’s share of capital in new firms. Figure 2 reports the Spanish experience. However, the largest firms were not always corporations. In 1877, even after general incorporation came to Germany, 15 of the largest 100 German industrial enterprises remained partnerships (Kocka 1981). The partnership and PLLC forms were not limited to specific areas of the economy. In Germany, they appeared in virtually every sector in 1895 and 1907, even in heavy industry (Figure 3).
Figure 3 Choice of enterprise form, selected sectors, Germany, 1895 and 1907
Note: The figure reports, for selected industries in Germany, the proportions existing firms that use one of the four main legal forms for business enterprises. Source: Guinnane and Schneebacher (2020), from the occupational and enterprise census of Germany.
Why did partnerships persist?
Why did entrepreneurs continue to use the partnership, even when the corporation was available? Recent work suggests two, partial reasons. First, the partnership’s unlimited liability facilitated the use of credit in an age when many industrial firms had little fixed capital. Lenders viewed the owners’ personal assets as better security than the firm’s own assets. Second, some entrepreneurs saw the partnership’s lack of capital lock-in as a virtue. In early 20th Egypt, for example, partnerships allowed investors to experiment with working together before organising the more expensive and permanent corporation (Artunç and Guinnane 2019).
Another line of research notes that the ordinary partnerships worked well in family groups, where kin relationships substituted for strong governance rules. Family connections were ubiquitous among partners. Family ties partially substitute for the lack of strong formal governance in partnerships, and unlimited liability is less daunting for family members who co-insure irrespective. Expanding the menu of legal forms fostered better matches of capital and talent by allowing firm formation among unrelated individuals. Just offering limited liability (in the limited partnership) opened things up considerably. Hilt and O’Banion (2009) show that mid-19th century New York’s limited partnerships encouraged unrelated owners to start businesses together. About 40% of Spanish ordinary partnerships formed in the period 1886-1936 had some owners who were close relatives. Family members comprised the entire partnership in more than one-quarter of firms. This was true for only 10% of SRLs (Guinnane and Martínez-Rodríguez 2018b).
Chandler correctly drew attention to the corporation’s unique properties and the role it plays in structuring important business organizations. His message led some, however, to exaggerate the public corporation’s role, missing both the long survival of partnership forms and the rise of the PLLC. As economies continue to develop, firms will draw on whatever flexibility organisational law offers. Some apparently new patterns might be quite old.
Artunç, C and T W Guinnane (2019), “Partnership as Experimentation: Business Organization and Survival in Egypt, 1910–1949”, Journal of Law, Economics and Organization 35(3): 455-488.
Guinnane, T W, R Harris, N R Lamoreaux and J-L Rosenthal (2007), “Putting the corporation in its place”, Economy and Society 8(3): 687-729.
Guinnane, T W and S Martínez-Rodríguez (2018a), “Choice of Enterprise Form: Spain, 1885-1936”, Journal of Law, Economics, and Organization 34(1): 1-26.
Guinnane, T W and S Martínez-Rodríguez (2018b), “Instructions not included: Spain’s Sociedad de Responsabilidad Limitada, 1919–1936”, European Review of Economic History 22(4): 462-482.
Guinnane, T W and J Schneebacher (2020), “Enterprise Form: Theory and History”, Explorations in Economic History 76: 1 -21.
Harris, R (2000), Industrializing English Law: Entrepreneurship and Business Organization, 1720-1844, Cambridge: Cambridge University Press.
Hilt, E and K E O’Banion (2009), “The Limited Partnership in New York, 1822–1858: Partnerships without Kinship”, The Journal of Economic History 69(3): 615-645.
Jensen, M C (1989), “Eclipse of the Public Corporation” Harvard Business Review, September-October.
Kahle, K M and R M Stulz (2017), “Is the US Public Corporation in Trouble?” Journal of Economic Perspectives 31(3): 67-88.
Kocka, J (1980), “Großunternehmen und der Aufstieg des Manager-Kapitalismus im späten 19. und frühen 20. Jahrhundert: Deutschland im internationalen Vergleich.” Historische Zeitschrift (HZ), 232(1): 39-60.
Kuran, T (2012), The long divergence: How Islamic law held back the Middle East, Princeton University Press.
Lamoreaux, N R and J-L Rosenthal (2005), “Legal regime and contractual flexibility: A comparison of business’s organizational choices in France and the United States during the era of industrialization”, American Law and Economics Review 7(1): 28-61.
1 Jensen (1989)’s warning provoked a literature summarised most recently by Kahle and Stulz (2017). See also Doidge et al. (2011).
2 Guinnane and Schneebacher (2020) survey the subject and provide additional references and evidence.
3 Figures 1 and 2 reflect the registration of new firms. The later years reflect major legal reforms for corporations (19501) and private companies (1953). Guinnane et al. (2007) report the distribution of enterprise forms in France and Germany starting slightly earlier. Neither the UK nor the US registered partnership forms, making it harder to examine the full range of choices in those countries.
4 Changes in US law reflected the tax treatment of personal and business incomes. More generally, tax law doubtless affects choice of enterprise form, although it must be stressed that until the early twentieth century, some jurisdictions did not have business-income taxes, and those that did at first treated the PLLC as ‘pass-through’ entities like the partnership.