1991]A POLITICAL THEORY OF THE CORPORATION 15 s11 Few i are position.Although banks,insurance companies.mutual funds and pension funds have enough money,they do not take large positions. yfinancial institutions do not because would fail to be believe they But e rom the past tantalizing prospects General Motor the largest American industrial corpora tion-today has no controlling shareholder.But once it had one.Du Pont owned 25%of GM until the courts ordered antitrust divestiture. In the 1920s,an ineptly managed GM neared bankruptcy.Its manage ment was reinvigorated by neither a p stile takeo mor a leverage oxy fight,nor a h t in react on to th e prospect ofa takeover,but by the intervention of Detroit.rcorganized the company and installd w anaerSm larly,the J.P.Morgan investment bank monitored many of the country's railroads when reorganizing them at the turn-of-the-century.13 Certainly con entrated control by financial institutions is imagina ble:Japanese and German corporate ownership is quite concentrated; their financial institutions are more actively involved in their companies than are financial institutions in the United States.14 Daimler-Benz,the attomotve concem that is the largest Wrenan industrial company,has a 28%shareholder. Deutsche Ba nk ma erial inf ng re the company withou ban Dameseniot management without the replaced of a hostile takeover.15 The result in Germany- -like GM during the du Pont intervention-should be contrasted with the recent result in the United States when financial institutions(in this instance,public pe the selecti n of the next rebuffed them i6 If Ame ncan financia institu tions had a stake in GM approaching that controlled by Deutsche Bank in Daimler-Benz.that rebuff would have been difficult. Lehn,The Struc Econ,he structure of Corporate Ownership:Causes and Consequences,98 J.Pol. com:M.Ei laaiopanisnhnememaiharchodnn T1、 g4559 (1976(6 udies show that 10%blocks.while n ore thar one-third of the various s les of large firms). 12.A.Chandler S.Salsbury,Pierre S.du Pont and the Making of the Modern on V Ca 0(1971) 371-72987:RC80 onal Bankers 1854-1913,at 44 00 14.See Aoki,Toward an Economic Model of the Japanese Firm,28 J.Econ.Litera- ture 1,14(1990);Ingersoll,The Banker Behind the Shakeup at Daimler-Benz,Bus.Wk., Juy21986 36 r Muscle,N.Y.Times,Feb.11,1990,,at 13, col.2
1991] A POLITICAL THEORY OF THE CORPORATION 15 Few of the largest public firms are controlled by a holder of a substantial block of shares. " Few individuals have the wealth to take that large a position. Although banks, insurance companies, mutual funds, and pension funds have enough money, they do not take large positions. Possibly financial institutions do not because they believe they would fail to be effective. But examples from the past offer tantalizing prospects. General Motors-the largest American industrial corporation-today has no controlling shareholder. But once it had one. Du Pont owned 25% of GM until the courts ordered antitrust divestiture. In the 1920s, an ineptly managed GM neared bankruptcy. Its management was reinvigorated by neither a proxy fight, nor a hostile takeover, nor a leveraged buyout in reaction to the prospect of a takeover, but by the intervention of its large shareholder. Pierre du Pont moved to Detroit, reorganized the company, and installed new managers.' 2 Similarly, theJ.P. Morgan investment bank monitored many of the country's railroads when reorganizing them at the turn-of-the-century.' 3 Certainly concentrated control by financial institutions is imaginable: Japanese and German corporate ownership is quite concentrated; their financial institutions are more actively involved in their companies than are financial institutions in the United States.' 4 Daimler-Benz, the automotive concern that is the largest German industrial company, has a 28%o shareholder, Deutsche Bank. When managerial infighting recently left the company without clear direction, the bank replaced Daimler-Benz' senior management without the organizational violence of a hostile takeover.' 5 The result in Germany-like GM during the du Pont intervention-should be contrasted with the recent result in the United States when financial institutions (in this instance, public pension funds) sought to influence the selection of the next chairman of GM; GM management rebuffed them.16 If American financial institutions had a stake in GM approaching that controlled by Deutsche Bank in Daimler-Benz, that rebuff would have been difficult. Lehn, The Structure of Corporate Ownership: Causes and Consequences, 93 J. Pol. Econ. 1155, 1173-76 (1985) (comparing companies with fragmented shareholders to companies with concentrated stockholders). 11. M. Eisenberg, The Structure of the Corporation: A Legal Analysis 45-52 (1976) (studies show that 10%o blocks, while not unheard of, were found in no more than one-third of the various samples of large firms). 12. A. Chandler & S. Salsbury, Pierre S. du Pont and the Making of the Modem Corporation 457-560 (1971). 13. See V. Carosso, The Morgans: Private International Bankers 1854-1913, at 371-72 (1987); R. Chernow, The House of Morgan 44 (1990). 14. See Aoki, Toward an Economic Model of theJapanese Firm, 28J. Econ. Literature 1, 14 (1990); Ingersoll, The Banker Behind the Shakeup at Daimler-Benz, Bus. Wk., July 27, 1987, at 36. 15. Ingersoll, supra note 14, at 36. 16. Lorsch, Funds Should Flex Their Muscle, N.Y. Times, Feb. 11, 1990, § 3, at 13, col. 2
16 COLUMBIA LAW REVIEW [Vol.91:10 Natural selection sugge adaptive mechanisms to mitigate the agency costs.Survival of the fit- test organizational structures makes the modern corporation as effi- cient as it can be.17 The political perspective raises doubts,since as I argue next in anizational form At best,th d States rn corporation is cient as it can be"only within powerful political constraints. 1 do not here argue that institutional control would have been bet- ter for the United States.Serious disadvantages would arise as well.8 Rather than prescription,I want first to understand d how politics dete mined corporate structure. II.THE FINANCIAL INSTITUTIONS:WHO HAS THE MONEY AND WHAT CAN THEY DO WITH ITP pes of financial institutions dominate: mutual fun ension funds ercial banks, They have as sets respectively,of $2 trillion,54 billion,$18 trillion,and trillion. Clearly these financial institutions have enough assets to influence orporati ons.But rules anti-n ng contro. blocks.Demonstrating this requires regulatory detail,but the rules can be summarized quickly for those who do not want the detail:Banks and bank holding companies were repeatedly prohibited from owning con- trol blocks of stock or from affiliation with investment banks that did. Insurance companies r q uite so e pr hibi ed fro nds mt eploymors hanrt o o rules still restrict their abili contro concentrated position;buying more than 5%of a company triggers on- er&Friedland,The Literature of Economics:The Case of Berle 19 18.See infra Part IV (conflicts of inter st,banking instability,politically intolerable accumulations of power,"capture"by management).And do not think that there were tional monitoring that ha e ended.Most institutions never coul k position.Fo the fe that cou d,some damaged shar lders by See L.Brandeis.Other P -And Ho oh Ban Part III. 19.Board of Govern s of the Federal Reserve System,Flow of Funds Accounts: gures for year-end 1989) ot sa 0 of the as in financial intermediaries.See Board of Governors of the Federal Reserve System,Bal- ance Sheets for the U.S.Economy 1945-1989,at 42,line 4 (Apr.1990).Mutual funds nd money market Ban also had 679 bilhon m Fed ina33（1989 tutions Examinatio】
COLUMBIA LAW REVIEW Natural selection suggests that if the separation of ownership from control created agency problems, the organization that survived found adaptive mechanisms to mitigate the agency costs. Survival of the fittest organizational structures makes the modem corporation as efficient as it can be. 17 The political perspective raises doubts, since as I argue next, important organizational forms are prohibited or made costly in the United States. At best, the modem corporation is "as efficient as it can be" only within powerful political constraints. I do not here argue that institutional control would have been better for the United States. Serious disadvantages would arise as well.' 8 Rather than prescription, I want first to understand how politics determined corporate structure. II. THE FINANCIAL INSTITUTIONS: WHO HAS THE MONEY AND WHAT CAN THEY Do wiTH IT? Four types of financial institutions dominate: commercial banks, mutual funds, insurance companies, and pension funds. They have assets, respectively, of $3.2 trillion, $548 billion, $1.8 trillion, and $1.9 trillion. 19 Clearly these financial institutions have enough assets to influence large corporations. But portfolio rules, anti-networking rules, and other fragmenting rules disable them from systematically taking control blocks. Demonstrating this requires regulatory detail, but the rules can be summarized quickly for those who do not want the detail: Banks and bank holding companies were repeatedly prohibited from owning control blocks of stock or from affiliation with investment banks that did. Insurance companies were for quite some time prohibited from owning any stock, and portfolio rules still restrict their ability to take control. Mutual funds cannot deploy more than a fraction of their portfolio in a concentrated position; buying more than 5% of a company triggers on- 17. See, e.g., Stigler & Friedland, The Literature of Economics: The Case of Berle and Means, 26J.L. & Econ. 237, 258-59 (1983). 18. See infra Part IV (conflicts of interest, banking instability, politically intolerable accumulations of power, "capture" by management). And do not think that there were halcyon days of institutional monitoring that have ended. Most institutions never could take a large stock position. For the few that could, some damaged shareholders by "siphoning" off value, or helped shareholders only by organizing monopolies and cartels. See L. Brandeis, Other People's Money-And How the Bankers Use It 33 (1914); infra Part III. 19. Board of Governors of the Federal Reserve System, Flow of Funds Accounts: Financial Assets and Liabilities (Mar. 1990) (preliminary figures for year-end 1989). Bank assets are only those of FDIC-insured commercial banks, not savings associations, which have another $1.7 trillion. These institutions account for nearly 90o of the assets in financial intermediaries. See Board of Governors of the Federal Reserve System, Balance Sheets for the U.S. Economy 1945-1989, at 42, line 4 (Apr. 1990). Mutual funds exclude closed-end and money market mutual funds. Banks also had $679 billion in discretionary trust funds at year-end 1988. Federal Financial Institutions Examination Council, Trust Assets of Financial Institutions: 1988, at 33 (1989). [Vol. 91:10
1991] A POLITICAL THEORY OF THE CORPORATION 17 erous rules.Pension funds are less restricted,but they are fragmented; rules make it difficult for them to operate jointly to assert control.Pri- vate pension funds are under management control:they are not con- structed for a palace revolution in which they would assert control ov their manager al bosses Do not be deceived by the detail that follows:A pattern is there 三 that emerges with clarity in Part III when we look at legislative history, ough to cont rol op erating compan destroyed the most prominent alternative to the Berle-Means corpora- tion:concentrated institutional ownership. A.Banks and Commerce Banks have half of the financial assets available for investment e the mo ial ownership is simple: s cannot own stoc 1.The Historical Separation of Banks from Commerce. Some early American banking charters expected banks to be in commerce.The Manhattan Bank was also a waterworks;some manufacturers had cor- achaters that included the right to open a bank.But other cha opied English ch which sepa rated banks By the mid-nin omThe important National Bank Act of 1863 gave national banks eteenth century,separation was the only limited powers.Control of an industrial company was out of the question.When controversy arose over whether banks could own stocks,the Supreme Court resolved that question against the banks: the pow t wn stock s no t listed, ngly it wa 2.The Glass-Ste granted.21 gall Act.- To avoid the direct prohibition on stock dealing,commercial banks dealt in securities through affiliates. In 1933,Congress believed that the failure of these stock affiliates dam- aged banks.and the resulting bank failures caused.not refected.the Dep ession The ng Glass-Ste eagall Act of 1933 pr ohibited bank tes f owning and dealing in curties,there everng com mercial banks from investment banks. Today,prohibitions on com- mercial banks'underwriting and affiliation with companies dealing in securities are breaking down.2s But the prohibition on bank ownership 20.B.Hammond.Banks and Politics in America from the Revolution to the Civil war149-55(1957). k v.Ker nedy,167 U.S.362,366-67(1897);National Bank Ac of Fet th s5⊙，12U.s.C.s3351988). Banking Banking Act of (Glass-Stcagal)6,12U..C.4(scventh)() 23.Securities Indus.Ass'n v.Board of Governors of the Fed.Reserve Sys.,468 U.S 207,214-21 (1984)(upholding FRB's authorization of Bank of America to acquire
1991] A POLITICAL THEORY OF THE CORPORATION 17 erous rules. Pension funds are less restricted, but they are fragmented; rules make it difficult for them to operate jointly to assert control. Private pension funds are under management control; they are not constructed for a palace revolution in which they would assert control over their managerial bosses. Do not be deceived by the detail that follows: A pattern is there that emerges with clarity in Part III when we look at legislative history, popular ideology, the power of interest groups, and the views of opinion leaders. Politics never allowed financial institutions to become powerful enough to control operating companies. American politics destroyed the most prominent alternative to the Berle-Means corporation: concentrated institutional ownership. A. Banks and Commerce Banks have half of the financial assets available for investment. They are still where the money is. But legal analysis of bank power in industrial ownership is simple: Banks cannot own stock. 1. The Historical Separation of Banks from Commerce. - Some early American banking charters expected banks to be in commerce. The Manhattan Bank was also a waterworks; some manufacturers had corporate charters that included the right to open a bank. But other chartering authorities just copied English charters, which separated banks from commerce. By the mid-nineteenth century, separation was the norm. 20 The important National Bank Act of 1863 gave national banks only limited powers. Control of an industrial company was out of the question. When controversy arose over whether banks could own stocks, the Supreme Court resolved that question against the banks: the power to own stock was not listed, accordingly it was not granted. 2 1 2. The Glass-SteagallAct. - To avoid the direct prohibition on stock dealing, commercial banks dealt in securities through affiliates. In 1933, Congress believed that the failure of these stock affiliates damaged banks, and the resulting bank failures caused, not reflected, the Depression. The resulting Glass-Steagall Act of 1933 prohibited bank affiliates from owning and dealing in securities, thereby severing commercial banks from investment banks. 22 Today, prohibitions on commercial banks' underwriting and affiliation with companies dealing in securities are breaking down.23 But the prohibition on bank ownership 20. B. Hammond, Banks and Politics in America from the Revolution to the Civil War 149-55 (1957). 21. California Bank v. Kennedy, 167 U.S. 362, 366-67 (1897); National Bank Act of Feb. 25, 1863, § 11, 12 U.S.C. § 24 (seventh) (1988). State member banks of the Federal Reserve System were later similarly restricted. Banking Act of 1933 (GlassSteagall), § 5(c), 12 U.S.C. § 335 (1988). 22. Banking Act of 1933 (Glass-Steagall), § 16, 12 U.S.C. § 24 (seventh) (1988). 23. Securities Indus. Ass'n v. Board of Governors of the Fed. Reserve Sys., 468 U.S. 207, 214-21 (1984) (upholding FRB's authorization of Bank of America to acquire
18 COLUMBIA LAW REVIEW [Vol.91:10 of equity remains stable. Bank trust departments are commercial banks'only remaining di- rect link to equity.Rules fragment trust fund investments:no more than 10%of a bank's trust f nds may be invested in the stock of any corpora ration.The regulation first came down a few years after Report warned against the growing power of bank trust de partments.Other trustee laws foster a hyper-fragmentation of the bank trust portfolio,well beyond that which financial economists say is needed for diversification.26 3.The Bank Holding Compa Legislation -Many bank owne wished to operate from several loc s or to chain several banks to- o6二 reincorporated themselves as holding companies,each owning several separately incorporated banks.The holding company had other regu latory advantage s:it was not subject to the same ngent regulatio as were the ubs diaries the 082 own businesses and stock,including control block company could In response, Congress enacted the Bank Holding Company Act of 1956,restricting a holding company's activities to those closely related to banking.A bank holding company cannot own more than 5%of the voting stock of any nonbanking company and cannot otherwisec ndustrial firm.28 Holdi con rol an ng compa only if the additional stock is nonvoting. Schwab.a securities dealer): o IP Mo &Co..11988-1989 Transfer Binder Fed.Banking ep.(CCD)(an.19RB approves application aR28 to establish under writing affiliate);Bankers Trust New York Corp.,75 89)(FRB approves application of commercial banks oc22CF.R.s9.18( 9 25.1 Staff of House Subcomm.on Domestic Finance,Comm.on Banking and Cur rency,90th Cong.,2d Sess.,Commercial Banks and Their Trust Activities:Emerging Repoitee on the American Economy 14 Comm.Print 1968)Chereinater Patnan rd Investor Challenges and(Samset Bicksler (forthcoming). d Tucker,Interst te Banking and the Feder Historical Per. Act of 1956,4(c (1988).Shares acquired in a fiduciar not included in the5%limit 29.Id.;P.Heller,Federal Bank Holding Company Law $4.03[2][b](1990).Au i companics couldm recn issu ompany Manual -11--14 (Feb.1990) xchange
COLUMBIA LAW REVIEW of equity remains stable. Bank trust departments are commercial banks' only remaining direct link to equity. Rules fragment trust fund investments: no more than 10% of a bank's trust funds may be invested in the stock of any single corporation. 24 The regulation first came down a few years after the Patman Report warned against the growing power of bank trust departments. 25 Other trustee laws foster a hyper-fragmentation of the bank trust portfolio, well beyond that which financial economists say is needed for diversification. 26 3. The Bank Holding Company Legislation. - Many bank owners wished to operate from several locations or to chain several banks together. However, many states prohibit banks from branching and prohibit out-of-state banks from operating locally. In the 1950s, banks reincorporated themselves as holding companies, each owning several separately incorporated banks. The holding company had other regulatory advantages: it was not subject to the same stringent regulation of activities as were the bank subsidiaries-the holding company could own businesses and stock, including control blocks.27 In response, Congress enacted the Bank Holding Company Act of 1956, restricting a holding company's activities to those closely related to banking. A bank holding company cannot own more than 5% of the voting stock of any nonbanking company and cannot otherwise control an industrial firm. 28 Holding companies can own more than 5% (up to 25%o), but only if the additional stock is nonvoting.29 Schwab, a securities dealer); see also J.P. Morgan & Co., [1988-1989 Transfer Binder] Fed. Banking L. Rep. (CCH) 87,554 (Jan. 19, 1989) (FRB approves application of commercial bank to establish underwriting affiliate); Bankers Trust New York Corp., 75 Fed. Reserve Bull. 829 (Oct. 30, 1989) (FRB approves application of commercial banks to engage in some brokerage activities). 24. 12 C.F.R. § 9.18(b)(9)(ii) (1990). 25. 1 Staff of House Subcomm. on Domestic Finance, Comm. on Banking and Currency, 90th Cong., 2d Sess., Commercial Banks and Their Trust Activities: Emerging Influence on the American Economy 1-4 (Comm. Print 1968) [hereinafter Patman Report]. 26. See Roe, Institutional Fiduciaries in the Corporate Boardroom, in Institutional Investors: Challenges and Responsibilities (A. Samsetz & J. Bicksler eds. 1991) (forthcoming). 27. Clair & Tucker, Interstate Banking and the Federal Reserve: A Historical Perspective, Fed. Reserve Bank of Dallas Econ. Rev., Nov. 1989, at 1, 6-12. 28. Bank Holding Company Act of 1956, § 4(c)(4)-(5), 12 U.S.C. § 1843(c)(5)-(6) (1988). Shares acquired in a fiduciary capacity are not included in the 5% limitation. Id. 29. Id.; P. Heller, Federal Bank Holding Company Law § 4.03[2][b] (1990). Authority to own nonvoting stock of public companies was until recently largely illusory. Public companies could not issue nonvoting stock for most of the post-1956 era because of one-share, one-vote rules. New York Stock Exchange, New York Stock Exchange Listed Company Manual 3-11-3-14 (Feb. 1990). [Vol. 9 1: 10
1991] A POLITICAL THEORY OF THE CORPORATION 19 B.Mutual Funds Mutual funds pool the investment funds of hundreds of investors, thereby enabling the investors both to diversify and to buy the invest- ment expertise of the fund's managers.If mutual funds could have taken la rge blocks,they mi ave nitoring worthwhile theory,they could have evolved into the missing monitoring link be- tween fragmented investors and large operating firms. However,Congress was suspicious of mutual funds'potential to control industrial companies.A 1934 Senate securities repor t distin guished two functions:investment and management control Only un- scrupulous financiers mixed investment with control: “The investment company [has]bec[o]me the instrumentality of financiers and industri- alists to facilitate acquisition of concentrated control of the wealth and industries of the "30 As a cons gres vent the of these [inves trust from their normal chan of diersified investment to the o avenues of cor of Congress might have "to completely divorce investment trusts from investment banking."32 Mutual funds should invest only passively;holding companies were organized for control and they w den gated,becag nflicts of inte ged outsider sha ers Congress directe the SEC to draft legislation. 1.The Investment Company Act of 1940.- -The sEC understood its marching orders from Congress.Its bill declared that "the national public inte [is]adversely affected. when investment compa- e .[have great [and]have exce in the na tional economy. C wanted mutual funds and employees off the boards of all portfolio companies,essentially a Glass- Steagall-type severance.35 Enactment ultimately entailed compromise with the industry,but the SEC achieved much of its severance goal. A mutual fund cannot advertise itself as diversified if the regulated part of its portfolio has more than 10%of the stock of any company, even if that stock is a small portion of the fund's portfolio.36 (Only 30.Co Stock Excha C D 73d c ort,in reference to its final chief counsell. 31.ld.at 333(emphasis added);see also Investment Trusts and Investment Com- 30 Betore ong3d Sess.6(1 mm.of the Senate Comm.on Banking and 40)[herei Act F (state nent of 6 (quoting eport). 33.Public Utility 30,at3 gs Co Act of193530,15U.S.C.s79a-4(1988 conce ment and pr 35.1d.at216-20. 36.Investment Company Act of 1940,$5(b),15 U.S.C.80a-5(b)(1988)[herein- after 1940 Act
1991] A POLITICAL THEORY OF THE CORPORATION 19 B. Mutual Funds Mutual funds pool the investment funds of hundreds of investors, thereby enabling the investors both to diversify and to buy the investment expertise of the fund's managers. If mutual funds could have taken large blocks, they might have found monitoring worthwhile. In theory, they could have evolved into the missing monitoring link between fragmented investors and large operating firms. However, Congress was suspicious of mutual funds' potential to control industrial companies. A 1934 Senate securities report distinguished two functions: investment and management control. Only unscrupulous financiers mixed investment with control: "The investment company [has] bec[o]me the instrumentality of financiers and industrialists to facilitate acquisition of concentrated control of the wealth and industries of the country."30 As a consequence, Congress must "prevent the diversion of these [investment] trusts from their normal channels of diversified investment to the abnormal avenues of control of industry." 3 ' Congress might have "to completely divorce investment trusts from investment banking."'3 2 Mutual funds should invest only passively; holding companies were organized for control and they were denigrated, because conflicts of interest damaged outsider shareholders. Congress directed the SEC to draft legislation.33 1. The Investment Company Act of 1940. - The SEC understood its marching orders from Congress. Its bill declared that "the national public interest ... [is] adversely affected ... when investment companies ... [have] great size ... [and] have excessive influence in the national economy." 34 The SEC wanted mutual funds' directors and employees off the boards of all portfolio companies, essentially a GlassSteagall-type severance.3 5 Enactment ultimately entailed compromise with the industry, but the SEC achieved much of its severance goal. A mutual fund cannot advertise itself as diversified if the regulated part of its portfolio has more than 10% of the stock of any company, even if that stock is a small portion of the fund's portfolio.36 (Only 30. Comm. on Banking and Currency, Stock Exchange Practices, S. Rep. No. 1455, 73d Cong., 2d Sess. 333-34 (1934) [hereinafter Pecora Report, in reference to its final chief counsel]. 31. Id. at 333 (emphasis added); see also Investment Trusts and Investment Companies, Hearings on S. 3580 Before a Subcomm. of the Senate Comm. on Banking and Currency, 76th Cong., 3d Sess. 36 (1940) [hereinafter 1940 Act Hearings] (statement of Robert E. Healy, Comm'r, Sec. and Exchange Comm.) (quoting Pecora Report). 32. Pecora Report, supra note 30, at 393. 33. Public Utility Holdings Company Act of 1935, § 30, 15 U.S.C. § 79a-4 (1988). 34. 1940 Act Hearings, supra note 31, at 2. The statement of purpose also showed concern for efficient investment management and protection of investors. Id. 35. Id. at 216-20. 36. Investment Company Act of 1940, § 5(b), 15 U.S.C. § 80a-5(b) (1988) [hereinafter 1940 Act]