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Corporate Governance and the Plight of Minority Shareholders in the United States Before the Great Depression


  • Naomi Lamoreaux
  • Jean-Laurent Rosenthal


Legal records indicate that conflicts of interest -- that is, situations in which officers and directors were in a position to benefit themselves at the expense of minority shareholders -- were endemic to corporations in the late-nineteenth and early-twentieth century U.S. Yet investors nonetheless continued to buy stock in the ever increasing numbers of corporations that business people formed during this period. We attempt to understand this puzzling situation by examining the evolution of the legal rules governing both corporations and the main organizational alternative, partnerships. Because partnerships existed only at the will of their members, disputes among partners had the potential to lead to an untimely (and costly) dissolution of the enterprise. We find that the courts quite consciously differentiated the corporate form from the partnership so as to prevent disputes from having similarly disruptive effects on corporations. The cost of this differentiation, however, was to give controlling shareholders the power to extract more than their fair share of their enterprise's profits. The courts put limits on this behavior by defining the boundary at which private benefits of control became fraud, but the case law suggests that these constraints became weaker over our period. We model the basic differences between corporations and partnerships and show that, if one takes the magnitude of private benefits of control as given by the legal system, the choice of whether or not to form a firm, and whether to organize it as a partnership or a corporation, was a function of the expected profitability of the enterprise and the probability that a partnership would suffer untimely dissolution. We argue that the large number of corporations formed during the late nineteenth and early twentieth centuries were made possible by an abundance of high-profit opportunities. But the large number of partnerships that also continued to be organized suggests that the costs of corporate form were significant.

Suggested Citation

  • Naomi Lamoreaux & Jean-Laurent Rosenthal, 2004. "Corporate Governance and the Plight of Minority Shareholders in the United States Before the Great Depression," NBER Working Papers 10900, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:10900
    Note: CF DAE

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    References listed on IDEAS

    1. Alchian, Armen A & Demsetz, Harold, 1972. "Production , Information Costs, and Economic Organization," American Economic Review, American Economic Association, vol. 62(5), pages 777-795, December.
    2. Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 691-719, August.
    3. James B. Rebitzer & Lowell J. Taylor, 2007. "When Knowledge Is an Asset: Explaining the Organizational Structure of Large Law Firms," Journal of Labor Economics, University of Chicago Press, vol. 25, pages 201-229.
    4. Howard Bodenhorn, 2002. "Partnership and Hold-Up in Early America," NBER Working Papers 8814, National Bureau of Economic Research, Inc.
    5. Julian Franks & Colin Mayer & Stefano Rossi, 2003. "Spending Less Time with the Family: The Decline of Family Ownership in the UK," OFRC Working Papers Series 2003fe15, Oxford Financial Research Centre.
    6. Cai, Hongbin, 2003. " A Theory of Joint Asset Ownership," RAND Journal of Economics, The RAND Corporation, vol. 34(1), pages 63-77, Spring.
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    Cited by:

    1. Randall Morck & Lloyd Steier, 2005. "The Global History of Corporate Governance: An Introduction," NBER Chapters,in: A History of Corporate Governance around the World: Family Business Groups to Professional Managers, pages 1-64 National Bureau of Economic Research, Inc.
    2. Enrico Perotti, 2013. "The Political Economy of Finance," Tinbergen Institute Discussion Papers 13-034/IV/DSF53, Tinbergen Institute.
    3. Stephen Haber & Enrico Perotti, 2008. "The Political Economy of Financial Systems," Tinbergen Institute Discussion Papers 08-045/2, Tinbergen Institute.

    More about this item

    JEL classification:

    • N4 - Economic History - - Government, War, Law, International Relations, and Regulation
    • K2 - Law and Economics - - Regulation and Business Law

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