The legal rules governing businesses’ organizational choices have varied across nations along two main dimensions: the number of different forms that firms could adopt; and the extent to which firms had the contractual freedom to modify the available forms to suit their needs. Until the last quarter of the twentieth century, businesses in the U.S. had a narrower range of forms from which to choose than their counterparts in most other countries and also much less ability to modify the basic forms contractually. In the recent NBER Working Paper, Revisiting American Exceptionalism: Democracy and the Regulation of Corporate Governance in Nineteenth-Century Pennsylvania, I explore the exceptional character of the U.S. legal rules by focusing on the different structure of U.S. and British general incorporation laws.
There is a large “law and finance” literature based on cross-country regressions that claims that countries with the good fortune to have entered the modern era with common-law legal systems have better growth prospects than those that inherited or adopted code-based legal systems, particularly those based on French law. Just a little digging in the statutes reveals, however, that the legal rules governing corporations in the most economically successful of the common-law countries, the United States, were historically very different from those in Britain, which were themselves more like the rules in civil-law countries. From the very beginning British company law imposed few constraints on the corporations formed under it. U.S. law, however, was both more restrictive about what incorporated firms were allowed to do and more prescriptive about the forms their internal contractual relations could take. This difference resulted, I argue, from the timing of the expansion of the franchise relative to the passage of general incorporation laws. In Britain (and also on the European continent), general incorporation predated universal manhood suffrage by many years, and it was mainly the interests of those involved in organizing and financing companies that shaped the content of the legislation. In the U.S., by contrast, the timing was just the reverse, and the early achievement of universal (white) manhood suffrage shaped American corporation law in an exceptional way. The various U.S. states passed general incorporation laws in the context of a mass political movement aimed at preventing “the moneyed few” from using their political influence to gain unfair economic advantages by means of corporate privileges. They also passed them in a context where elites were taking steps to prevent democratically elected legislators from tampering with property rights.
I develop this argument by focusing on the case of Pennsylvania. The state was among the first to abolish property qualifications for voting, entering the new United States with a tax qualification that seems to have been quite minimal. In the early nineteenth century, a mass political movement formed in opposition to the special privileges that the state legislature had granted to corporations. One result of the movement’s success was the early adoption of general incorporation laws, especially for manufacturing ventures, but another was the embodiment in those laws of a number of restrictions on what corporations could do and how they could be governed. Businesses attempted (often successfully) to escape these restrictions by lobbying the legislature for special charters, but this practice only ensured that corporate privileges would continue to be a hot-button political issue until a new state constitution, ratified in 1873, outlawed such private bills. Pennsylvania’s general law remained restrictive, however, and an attempt to make an end run around the law in the form of an enabling statute for partnership associations, an early form of LLC, ran afoul of a court system whose vigilant defense of creditors’ rights was another consequence of the democratic politics of the nineteenth century.
The corporate charter-mongering competition that developed at the end of the nineteenth century opened another avenue of escape. As more and more large firms took out charters in New Jersey, Delaware, and the other charter-mongering states, legislatures elsewhere reacted to the resulting loss of revenue by liberalizing their own general incorporation statutes, generating fears of a regulatory race to the bottom. The response to this competition, however, was less full-throttled than is generally recognized. Distrust of corporate power and of the domination of large-scale corporations by the financial elite continued to shape the evolution of general incorporation statutes in the early twentieth century. Thus, decades after New Jersey’s opening salvo in the charter-mongering competition, the general incorporation statutes of Pennsylvania, Illinois, and other states retained important vestiges of the democratic politics of the nineteenth century, often in the form of restrictions on corporate governance that had been written into their state constitutions. Hence, as late as the 1950s, when the famous British company-law scholar, L. C. B. Gower, visited the United States, he was struck by the differences between British and American corporate law—how much less flexible the American statutes were. Even Delaware’s statute remained puzzlingly more prescriptive than its British counterpart.
The political pressures I describe played out somewhat differently in each state. There was no single, archetypal American story of the development of business institutions in the nineteenth century. Rather, there was a Pennsylvania story, a Massachusetts story, a New Jersey story, a Virginia story, an Ohio story, and so on. Nonetheless, the conflict over elite privileges versus property rights propelled by the early expansion of the franchise drove the evolution of business organizational forms throughout the United States in similar ways, and it continues to exert an effect on their development to the present day.
The full paper is available for download here.