The role of the state in corporate governance

Abstract

Prior empirical research in the accounting and finance literatures has often neglected the role of the state in corporate governance, preferring instead to study relationships between shareholders and directors and the effects of various corporate governance mechanisms on the economic performance of companies. In contrast, accounting and business historians have often examined the legal systems, rules, and regulations that control business enterprises, thereby acknowledging the existence of persistent interactions between the state and business entities through time. The purpose of this article is to illustrate, through a discussion and analysis of several ways in which the state has enacted its role in corporate governance, that state regulation and supervision of business entities has been both commonplace and necessary for the maintenance of a stable economic system.

Keywords

Business history corporate governance economic performance legitimacy the state

Introduction

Shleifer and Vishny (1997: 739) have defined corporate governance, as “the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment”. This rather limited definition of corporate governance has become the dominant view in the accounting and finance literatures. In contrast, Gillan and Starks (2003: 5) have articulated a broader concept of corporate governance as including “the system of laws, rules, and regulations that control corporations”, thereby emphasizing the role of the state in corporate governance.

These distinctions in the definition of corporate governance provide the basis for the primary argument of our article, which is that the mainstream empirical accounting and finance literature has often neglected the historical role of the state in corporate governance. The purpose of the article is to show, through a discussion of three historical cases, that modes of intervention by the state in corporate governance cannot be interpreted solely through the ideologies that have prevailed in recent periods regarding neo-liberalism and social welfare. Quite the contrary, the various interventions by the state in corporate governance, which occurred well before the twentieth century, are the rational by-product of the exercise of a sovereignty naturally subservient to a political régime, but also to requirements for revenue generation, military competition and defenses, and administrative organization. We recognize that the historical cases examined primarily provide emblematic value, and that therefore, they do not cover in any exhaustive way the complete evolution of the relationships between corporate enterprises and the state. Nevertheless, the cases are illustrative of the historical relationships between the state and corporate entities, which have often involved the creation of “measurement institutions”, including calculative accounting practices that facilitate economic regulation intended to protect and enhance the objectives of the state (Miller, 1990).

The three historical cases that will be examined are the Venetian Arsenal during the twelfth through to the eighteenth centuries, the East India Company during the fifteenth through to the nineteenth centuries, and the US federal government’s efforts to regulate capitalist activity due to abuses in the early years of the twentieth century. The analyses of the Venetian Arsenal and the East India Company illustrate the development of certain linkages and interdependencies between business elites and states, one a republic, the other a kingdom, with the mutually supportive objectives of increasing wealth through foreign trade and building state military and naval power. The US regulatory example of the early twentieth century illustrates government efforts directed towards the restoration of economic stability and viability as a vital step in resurrecting and sustaining national economic activity. It is important to note that the nature of the historical linkages and interdependencies between nation states and corporate enterprises has varied through time. This article highlights just a few informative episodes. However, whatever the form of government, the role of the state in corporate governance has always been there.

The remainder of the article is organized as follows. The next section discusses the notion of corporate governance in a general sense, contrasting the financially oriented shareholder perspective with a broader perspective which focuses on the state’s use of laws, rules and regulations to govern and control corporate activity (Miller, 1990; Gillan and Starks, 2003). The section after that discusses the definition of the “state” employed in this article, relying significantly on Miller’s (1990) notion of linkages and interdependencies between accounting practices and the state. We also discuss North’s (1991) concept of institutions, a concept which has many parallels with Miller’s notion of technologies (1990). In the fourth section, we present a historical discussion and analysis of three distinct ways in which the state has enacted its role in corporate governance. In organizing this historical analysis, we present in each sub-section, the theme of the analysis, the historical background of the institutions involved, and the management and accounting implications. This historical analysis and discussion will be followed by a summary and conclusion.

The notion of corporate governance

A growing interest in the topic of corporate governance developed in the United Kingdom in the early 1990s in the wake of revelations regarding the questionable practices of the press baron Robert Maxwell (Bower, 1992, 1996). These revelations produced evidence about undesirable corporate acts, which were subsequently added to concerns about the collapse of the Bank of Credit and Commerce International (BCCI) (Beaty and Gwynne, 1993). Such media thronged events influenced the work of the committee on Financial Aspects of Corporate Governance headed by Sir Adrian Cadbury (Cadbury Report, 1992). The recommendations of the Cadbury Committee focused on improving internal controls, increasing the independence of boards of directors, and enhancing the role of external auditors. While there was an implied critique of the decisions taken by managing directors, relatively little effort was made to control or govern such decisions (Stein, 2008). Moreover, the Cadbury Committee’s work was conducted in the private sector and it did not constitute “corporate governance” by the British state.

In a similar way, the Vienot I (1995) and Vienot II (1999) reports in France focused on establishing a balance between the role of managing directors, independent directors and shareholders. The parallels between the British and French reports did not end with the relatively weak recommendations regarding improvements in internal controls and external audit practices. The Vienot reports also illustrated that the views of corporate managers had been assimilated into the white papers; even if increasing the accountability of directors was at the heart of the recommendations, the reports did not disturb the predominant shareholder perspective of corporate governance. There was essentially no other purpose than to reassure shareholders that their interests were being cared for (Financial Reporting Council, 2008).

Prior academic research examining the effectiveness of the best practices approach to corporate governance has been similarly less than enlightening (Stein, 2008). Larcker et al. (2005) concluded that indicators of what is considered to be good corporate governance explain little about the effects of such practices on the behavior of managers or the economic performance of companies. Working with a database provided by Institutional Shareholders Services and several indices of good corporate governance, Brown and Caylor (2004) produced findings which revealed little connection between good corporate governance practices and economic performance. Shleifer and Vishny (1997) conducted a global review of corporate governance practices in advanced capitalism, and, in the end they admitted that their study remained at such a level of generality that it revealed little about the specifics of corporate governance; moreover, they did not address in any significant way, relationships between corporate governance and the state. As a result of the apparent inability of empirical research to provide definite conclusions regarding the relationship between corporate governance mechanisms and performance, some proponents of historical studies have suggested that the problems of computational efficiency inherent in scholarship that primarily employs mathematical analysis encourages reductionism. Quantitative studies do not sufficiently consider the influence of important socioeconomic factors that cannot be conveniently embedded in explanatory algorithms. Hence, there is need for a historical analysis of the role of the state in corporate governance.

The concept of the state

The concept of the “state” has been extensively discussed in the social science literature (Lindblom, 1982). Max Weber famously defined the state as “an entity which possesses a monopoly on the legitimate use of physical force in a particular territory” (Weber, 1919). It can be argued, therefore, that states have always existed in one form or another. Going beyond Weber’s classic definition, Miller (1990: 316) characterizes the state as “an assemblage of practices, techniques, programs, rationales and interventions, employed in relation to the ‘arts of government’”. This latter definition provides certain insights into the role of the state in corporate governance, in that it can be argued that it is precisely through “arts of government” that the state has governed and controlled corporate enterprises through time.

North (1991) has also acknowledged the importance of the state in corporate governance. He maintained that there has been a continuous interplay between the state’s fiscal needs and its credibility with merchants and the citizenry in general. In particular the evolution of capital markets has been heavily influenced by certain policies of the state, in that the state has fostered the creation of financial institutions which are central to modern corporate governance (North, 1991: 107).

Miller (1990) also indicated that several distinct notions of the state have been articulated in the social science literature, including a functional model, a radical model, and an external model. A functional model focuses on the idea that states come into existence in order to coordinate and administer the functions of society as a whole (Lindblom, 1982). In contrast, a radical model defines the state as an expression of the interests of the ruling class in any particular society (Althusser, 1970; Tinker, 1984). From a third perspective, an external model seeks to identify causal explanations for the formation of states, with a tendency to focus on explanations related to military competition. Military competition often results in large, well organized states, which contend for territorial dominance and control of natural resources. According to the external model, taxation and public finance are seen as “technologies” directed towards the maintenance of military forces. Miller (1990) argued that these technologies incorporate calculative practices, such as accounting, which are routinely used to facilitate economic regulation for the purpose of defending and protecting the territory of the state.

Miller (1990) also observed that external factors cannot in and of themselves explain the formation of states. He therefore proposed a framework which differs from the functional and external models, focusing instead on linkages and interdependencies between the calculative practices of accounting and the state. These linkages and interdependencies constitute a loose assemblage of political rationalities (statements, claims, and prescriptions that set forth the objectives of government), and technologies (procedures and mechanisms of government, including laws, rules, and regulations, which are called upon to deliver various goals and objectives such as regulatory order, uniformity, and efficiency). In a similar way, North (1991: 97) defined “institutions” as “humanly devised constraints that structure political, economic and social interaction”. Miller’s (1990) notion of “technologies” and North’s (1991) concept of “institutions” are similar. In the discussion and analysis that follows, we illustrate several ways in which the state has enacted its role in corporate governance, focusing on the concepts of political rationalities and technologies/institutions derived from the theoretical definitions of Miller (1990) and North (1991).

Ways in which the state has enacted its role in corporate governance

The following historical analysis and discussion is divided into three sub-sections, each focusing on a particular way that the state has enacted its role in corporate governance. In organizing this historical analysis, we present in each sub-section, the theme of the analysis, the historical background of the institutions involved, and the management and accounting implications. We first consider the role of the state in corporate governance as enacted through direct ownership or control. This is exemplified by the Venetian Arsenal. Second, we consider the role of the state in corporate governance as enacted through the granting of monopoly trading privileges. This is exemplified by the British East India Company. The third sub-section focuses on the role of the state in corporate governance as a regulator of capitalism through rate regulation and other regulatory technologies and institutions. This is exemplified by the US government’s regulation of the American financial markets after the Great Depression of the 1930s.

The role of the state in corporate governance enacted through direct ownership and control

The theme of this sub-section is the role of the state in corporate governance as enacted through direct ownership and control. In approaching this theme it is important to note that while business enterprises have existed throughout history, the concept of the corporation as a primary organizational form for business enterprise is of much more recent origin. Moreover, the concept of a corporation did not always involve a business enterprise. The word “corporation” is derived from corpus, the Latin word for body, or a “body of people”. In Ancient Rome, corporate entities were created by law and they were often associated with guilds or social clubs. In medieval Europe, churches were incorporated, as well as local governments, such as the City of London Corporation. From the fifteenth century onward, many European nations chartered joint-stock companies (i.e. corporations) to engage in colonial ventures, such as the Dutch East India Company or the British East India Company. These types of corporations subsequently became highly implicated in the political and economic history of colonialism (Micklethwait and Wooldridge, 2003). Operating procedures and internal control practices of medieval merchant guilds were often set forth in the charters and by-laws of those entities. As a result, the role of the state in governing guild-like enterprises was relatively minimal as compared with state owned enterprises (Aron, 1981; Waymire and Basu, 2008). Consequently, the primary role of the state in corporate governance during the late medieval and early Renaissance periods involved the use of technologies and institutions, such as laws, rules, and regulations to control the operations of state-owned enterprises.

Historically, the Republic of Venice was a major naval power from the twelfth to the eighteenth century, as well as a center of maritime commerce and international trade (Lane, 1944; McNeill, 1963). One of the most important state-owned enterprises in Venice during the late medieval and Renaissance periods was the Arsenale di Venezia, a shipyard and armory founded in the twelfth century (Davis, 2007). The Arsenal was the largest industrial complex in Europe prior to the Industrial Revolution, spanning an area of about 45 ha (110 acres), or about 15 percent of Venice. It was surrounded by high walls which shielded the facility from public view, and armed guards protected its perimeter. The Arsenal produced most of Venice’s maritime trading vessels, which generated much of the city’s economic wealth and power until the fall of the Venetian Republic to Napoleon in 1797 (Davis, 2007).

In terms of operational management, the historical record indicates that the production methods at the Venetian Arsenal were quite modern and well in advance of ship building methods in other parts of Europe at the time. The high production capacity at the Arsenal resulted from the large number of workers employed (about 16,000), and the streamlining of production processes. Ship production was divided into three main stages: framing, planking and cabins, and assembly. Each stage employed its own workers who specialized in that area of production. Standardized parts were used in an assembly-line process using a canal through which the ships moved into different stages of production. Partially completed ships were brought to the workers, instead of workers and parts going to the ships. This type of industrial production was not seen again until the early twentieth century when Henry Ford developed the assembly line for automobile production (Kaon Consulting, 2012).

In terms of accounting technologies, Zambon and Zan (2007) examined the Venetian Arsenal as a case study of the emergence of accounting as a control mechanism in complex pre-industrial settings. They argue that the accounting system at the Arsenal mirrored the production process. The authors studied archival records of the 1586 deliberations by the Venetian Senate, which mandated that a periodic inventory count be conducted at the Arsenal along with the maintenance of ship production records in double-entry format. These accounting records reflected the movement of raw materials and work-in-process between units. The records were kept both in physical quantities and monetary amounts. Prior to the implementation of these accounting technologies, the Venetian state controlled the operations of the Arsenal primarily by limiting the funds allocated to activities (wages, raw materials, timber, etc.) without focusing on the substance of the operations. The implementation of these accounting technologies permitted a sophisticated calculation of the production costs of ships.

Zambon and Zan (2007) argue that this sophisticated cost measurement system actually emerged as by-product of the Venetian state’s efforts to obtain greater control over the operations of the Arsenal. The political rationalities of the Venetian state were focused on the control of shipping and commerce throughout the Eastern Mediterranean, often in military competition with the Ottoman Empire and other Italian city states. These political rationalities involved the use of calculative practices focusing on cost controls in state owned enterprises. The linkages between these political rationalities and accounting technologies facilitated control over the state-owned corporate enterprise and supported the dominance of the Venetian state as a naval and commercial power.

Another role for the Venetian state in corporate governance involved support and financing for sea voyages (Lane, 1944). Merchants who needed sea-borne transportation would form companies called colleganza, which bid competitively to lease ships owned by the Venetian state. The voyages were financed through the issuance of shares purchased by merchants and other investors. The shareholders elected a captain who was responsible for outfitting and managing the voyage. The Venetian state protected the merchant vessels (which it owned) against attack by the naval forces or pirates of other military powers (Baskin and Miranti, 1997). Consequently, a series of technologies and institutions, involving both the calculative practices of accounting and legal technologies such as ship leasing, facilitated the political rationalities of the Venetian state, which focused on military competition and naval dominance in the eastern Mediterranean area.

In his biography of Andrea Barbarigo, the economic historian Frederic Lane (1944) has provided an interesting illustration of the trading activities conducted under the auspices of the Venetian state in the fifteenth century. Barbarigo began his trading career in 1418 with a capital of 200 ducats given to him by his mother. He was able to gain a knowledge of bookkeeping and commercial law by serving apprenticeships on various Venetian merchant ships and then as an attorney in the Venetian government. In contrast to other merchants at the time who often mixed politics and business affairs, Barbarigo’s focus was entirely on trade. At the end of his career he was worth more than 10,000 ducats (Morrisson, 2002). Through an examination of Barbarigo’s letters and ledgers, Lane was able to compile a list of his commercial transactions from 1430 to 1433. Lane also discussed accounting methods used by Barbarigo indicating that double entry was in use in Venice at least by the early fifteenth century (Carus-Wilson, 1947).

Barbarigo was primarily an entrepreneur, shifting rapidly from one branch of trade to another as opportunities arose. These opportunities could involve the Egyptian cotton market, the Italian grain market or the northern cloth market, as well as the Senate’s ship building and leasing activities. Such speculative transactions demanded quick decisions, but they were often difficult to complete. Of 26 sacks of cotton bought in Egypt early in 1432, only two had reached Venice by the end of the year and 10 never arrived (Carus-Wilson, 1947). Risks from piracy and naval battles were considerable. The rival Genoese fleet was a constant threat, as well as the Castilian fleet. In addition, English cloth could often be transported safely across Germany by making it legally the property of a Munich merchant. As a result the Venetian state needed to invest heavily in armaments and naval ships in order to protect the activities of its merchant class (Carus-Wilson, 1947). Lane’s biography of Barbarigo provides additional support for Miller’s (1990) argument that technologies incorporating calculative practices, such as accounting, have been regularly used to facilitate economic regulation and for the purpose of defending and protecting the economic interests of the state.

The role of the state in corporate governance enacted through the granting of trade monopolies

The theme of this sub-section is the role of the state in corporate governance as enacted through the granting of trade monopolies. After the discovery of the Americas in 1492, various European kingdoms began granting trading monopolies to sea captains and adventurers who were willing to take on the risks of long-distance overseas trade. This was a way to increase the revenues of the crown at relatively little risk. Elizabeth I of England began granting letters of marque¹ to ship captains who would in trade in the Americas and also attack Spanish shipping. The profits from these enterprises were shared with the Queen (Durant, 1953). Subsequently, the granting of trade monopolies became one of the primary ways that Great Britain constructed its overseas empire.

One of the oldest British trading monopolies was the Honourable East India Company, a joint-stock company formed for the purpose of engaging in trade with East Asia. The original charter of the East India Company was granted by Queen Elizabeth I on 31 December 1600. This charter granted 220 adventurers the legal right to be ‘one body corporate’ under the name of the Governor and Company of Merchants of London trading into the East Indies. It also gave the company the right to admit and expel members; to receive, hold and grant property; and to sue and be sued in the corporate name. This organized group of merchants was granted monopoly rights to trade in the countries east of the Cape of Good Hope and west of the straits of Magellan (Baladouni, 1983; Chaudhuri, 1965).

While the joint-stock company had emerged in England in the second half of the sixteenth century as a form of business enterprise, it was not until the creation of the East India Company that this type of business form became more widely used. Shares of the East India Company were owned primarily by wealthy merchants and aristocrats. The English Crown owned no shares and had only indirect control. The Company was led by a Governor and 24 directors. They, in turn, reported to the Court of Proprietors (shareholders) (Baladouni, 1983; Chaudhuri, 1965).

From a management perspective, the joint-stock company form was a response to the dual problems of adequacy of capital and management competence. Costly overseas trading ventures required large amounts of capital. Unlike trade with the Continent where only working capital was needed, in long-distance overseas commerce it was necessary to commit considerable funds for military defense and for fixed assets in the form of buildings and warehouses. The need to invest in long-lived assets, or “dead stock”, has been regarded as one of the key factors in stimulating the use of the joint-stock company form for business enterprises (Heckscher, 1955).

Along with the need for large amounts of capital, it was also necessary to have managing directors who could manage the affairs of the Company on behalf of the shareholders and divide the proceeds equitably. As specified in its charter, the East India Company was led by a Governor and a Court of Directors. This body had a twofold function: to establish business and policy decisions and to perform various operating functions such as preparations for voyages, unloading of goods from the incoming ships, and the sale of commodities. Another court, known as the General Court, comprised all shareholders with an investment of at least 500 pounds. This court exercised ultimate supervisory control and had the power to overrule decisions (Baladouni, 1983; Chaudhuri, 1965).

Baladouni (1983) points out that the structure and operations of the East India Company addressed a number of management problems including the problem of high risk in long-distance overseas trade due to piracy, wars between maritime nations, and the hostility and violence of native rulers and people. Second, there was a demand for large amounts of capital which individuals were unable to provide. Third, there was the necessity of committing a high proportion of the capital for defense and for long-lived assets such as trading posts. Finally, there was the need for incorporation as a condition of obtaining a monopoly from the Crown (Baladouni, 1983: 66).

Initially, the East India Company struggled in the spice trade because of competition from the Dutch East India Company. The British East India Company opened a factory in Bantam (Island of Java) on its first voyage in 1601, and imports of pepper from Java became an important part of the Company’s trade for many years. In 1608 the Company built its first factory in the Bay of Bengal. The high profits reported by the Company after opening trade with India prompted King James I to grant licenses to other trading companies. However, in 1609, King James I renewed the charter given to the East India Company for an indefinite period, including a clause which specified that the charter would cease to be in force if the trade turned unprofitable for three consecutive years. Nevertheless, there was a second Asia trading company chartered by the British government later in the seventeenth century during the English Civil War that was sponsored by the Puritan government. A unified East India Company did not come about until the late seventeenth century, and this seems to have paralleled the end of the Glorious Revolution and the stabilization of the English state. During this period, the ships and foreign trading forts of the East India Company augmented state power in various battles with competing European powers for trading rights in Asia, particularly the Dutch, who competed with the British for control of world trade (Chaudhuri, 1965).

The economic success of the East India Company was the result of a systematic process of decision-making, communication, and control. The primary objective of the management control system was to reduce the complexities arising from the difficult trading conditions and the long distance between England and Asia (Chaudhuri, 1965: 33). The management control system involved three sub-systems: Subsystem I included the Court of Directors in London, along with the Accountant General’s Department, and the Committee on Warehouses; Subsystem II included the Company’s factories and locations in various places in Asia; Subsystem III included the docks and warehouses of the Company in London which received and ultimately transported goods and commodities in both England and other parts of Europe and North America. Subsystem I was responsible for planning and coordination, as well as financial operations, including accounting and auditing. Subsystem II was the largest in scale and involved large numbers of laborers to load and unload ship cargoes. System III also involved considerable number of laborers to unload and distribute commodities in England and elsewhere. Strategic and operational planning was based on the forecasted demand for commodities originating from London in Subsystem I, which were communicated through orders to various factories in Subsystem II, resulting in imports and sale of commodities through Subsystem III (Chaudhuri, 1965: 35).

According to Baladouni (1983), the East India Company was highly aware of the importance of accounting in all of its operations. The Lawes or Standing Orders of the East India Company published in 1621, comprising 82 volumes, contained a wide range of regulations governing the affairs of the Company. These regulations specified the duties of the Company’s officers, clerks and committees in charge of various operations, including the organization of the accounting and auditing function. The Accountant General was one of the more important officers of the East India Company. Assisted by bookkeepers, the Accountant General was responsible for maintaining “the great Bookes”. Transactions were entered into the books after they were audited by the Auditor General. Under the supervision of the Accountant General, the bookkeepers reviewed the audited accounts to make sure that there were no omissions or errors. Where an omission or error was found, it was to be immediately corrected. The bookkeepers were also required to report any uncorrected errors made by officers or auditors to higher level officials. Once a year, the Accountant General prepared a balance sheet for the Court of Directors. Thus, the accounting technologies used to control operations in the East India Company were extensive and these technologies facilitated the management systems in an effort to achieve coordinated communication of Company operations between Europe and Asia (Baladouni, 1983; Chaudhuri, 1965).

Chaudhuri (1965) has calculated that the average return on equity of the East India Company was approximately 9 percent per annum from 1710 to 1745, with a high of 22 percent in 1713 and only two years of negative return during that period. The profitability of the East India Company was important to the British Crown because this led to various types of financial payments to the Crown. Beyond customs duties paid on imports, the Company was required to make large financial contributions to the British government. After 1709, the entire permanent capital of three million pounds was required to be lent to the Crown. Effectively, from the point of view of the British government, the East India Company was a significant source of revenues. The Company accepted the fact that it was politically dependent on the Crown for its monopoly status, but the heavy rates of duty imposed on imports together with the fixed cost of settlements in Asia were such that the Directors felt that they operated more for the benefit of the British state than for itself (Chaudhuri, 1965: 120).

While the focus of the British Crown with respect to the East India Company was initially on trading profits and the revenues that could be garnered by the Crown as a result of these profits, this focus evolved during the latter half of the eighteenth century into a political rationality focusing on military competition and territorial expansion of the British Empire (Buchan, 1994; Sutherland, 1952). Buchan (1994) argues that this was due in part to certain changes taking place in the Court of Directors towards a policy of military confrontation with the Portuguese, Dutch, and French and the eventual military control of Calcutta, Madras, and Bombay. This second phase of East India Company development came through a rivalry between Laurence Sullivan who wanted to preserve the firm’s primary status as a trading enterprise and Clive who wanted to take a more active part in politics with the local princely states. As Sutherland (1952) points out, Clive’s policies eventually prevailed. This result extended the role of the Company as a de facto agency of the Crown. The East India Company raised a large army and it was deeply involved in administration of the India subcontinent for over a century. This came to an end in 1855 with the Sepoy Mutiny. The changes in political rationalities that took place during the second half of the eighteenth century led to the expansion of the role of the British state in the governance of the East India Company, leading ultimately to the nationalization and dissolution of the Company and the incorporation of all of the Indian sub-continent into the British Empire.

The role of the state in corporate governance as a facilitator of capitalist development

The focus of this sub-section is the role of the state in corporate governance as a facilitator of capitalist development. Braudel (1985) maintains that the existence of a capitalist economy presupposes certain positive acts on the part of the state, because only the state can enact legislation to assure the rights of private property which are essential to capitalist activity. Consequently, even though there was a significant need for capital during the industrial revolutions of the late eighteenth and early nineteenth centuries, the difficulty of using the corporate form hindered its use as a common way of organizing business activity (Johnston, 2005). In effect, there was a need for certain positive acts by the state in order to encourage capitalist development.

While the role of the state differed between Great Britain and the United States (US) during the nineteenth and early twentieth centuries, many of the underlying corporate forms were essentially identical. Therefore, we will first discuss in a brief way the creation of the Companies Acts in Great Britain, which were passed in the mid-nineteenth century as a way of encouraging capitalist development. We will then discuss in somewhat greater detail the regulatory form of corporate governance pursued in the United States during in the late nineteenth and early twentieth centuries.

In pursuing this discussion we rely on two important references by Miranti (1986, 1989). Miranti (1989) addresses how accounting was employed by the state to regulate competition and to provide investor transparency for railroad finance in the United States. This was significant because it was the first large industry regulated by the US federal government. Miranti (1986) discusses the background of the emergence of the New Deal governance structures for corporate regulation. In the United States there were two competing regulatory models that the government could have embraced. In effect, the government could have followed the type of legislation that created the Interstate Commerce Commission (ICC), which used accounting to tightly regulate rates and competition. This is what Louis Brandeis tried to achieve in formulating the Clayton Act in 1915 (McCraw, 1984). The other model of regulation involved the creation of, and support for, an independent profession that would provide assurance regarding the reliability of financial statements of corporate enterprises, following the example of the British Chartered Accountancy profession. What eventually emerged was a blend of these two approaches.

The enactment of the Joint Stock Companies Act 1844 in Great Britain greatly increased the ability of business enterprises to form as joint-stock companies. Prior to this legislation, the formation of joint-stock companies was required to be done via Royal Charter or an Act of Parliament (Hickson and Turner, 2005). Limited liability for joint-stock companies was subsequently introduced by the Limited Liability Act 1855. The British system of corporate governance was revised again through the Joint Stock Companies Act 1856. Unlike other parliamentary acts before it, the 1856 Act provided a simple administrative procedure through which any group of seven individuals could register a limited liability company as a joint-stock company. While the mid-nineteenth century legislation in the Great Britain reflected a certain set of political rationalities oriented towards the promotion of capitalist development and economic liberalism, this legislation also had direct implications for investors in terms of reducing risk for creditors because it was possible for corporate debtors to default without suffering long-term penalties. Consequently, much of the debate about limited liability in the 1850s was about corporate liability rather than economic liberalism. This represented a political confrontation, perhaps for the first time in history, regarding the proper role of the state in corporate governance.²

It should also be noted that for most of the nineteenth century, European states were engaged in military confrontations and competitions with other European states. These confrontations were linked to the expansion of railroads, the creation of a steel and coal industry, support for textile manufacturers, and colonial trade, all of which were enhanced through the use of limited liability joint-stock companies. Removal of restrictions on the formation of joint-stock companies, and various other positive acts on the part of the state (Braudel, 1985), produced linkages and interdependencies between political rationalities, largely focused on military competition and capitalist economic development, which were supported by legal technologies/institutions, like the Companies Acts in Great Britain. Corporate governance was therefore a means of facilitating the political rationalities of the state.

Similar to the European setting in the mid-nineteenth century, the United States began facilitating the development of infrastructure and economic development through the encouragement of capitalist investment. One of the most significant industrial engineering achievements in the United States during the nineteenth century was the construction of the transcontinental railroad. In 1864, the US federal government chartered the Union Pacific Railroad for the purpose of completing a rail line westward from the Missouri River to meet another rail line that was being constructed from California. The construction of a transcontinental railroad was based on a political rationality focusing on unifying the country in order to protect against military incursions from other nation states, particularly the British Empire to the north and Spain and Mexico to the south.

The US federal government provided a loan of $60,000,000 to the Union Pacific Railroad and a land grant of 20,000,000 acres, worth between $50,000,000 and $100,000,000 (Ambrose, 2000). One of the conditions of this grant was that the Union Pacific had to engage an independent contractor to construct the railroad rather than build the railroad itself. In order to avoid this independent contractor requirement, the officers and directors of the Union Pacific, formed the Crédit Mobilier of America (not to be confused with Crédit Mobilier of France) in order to give the appearance that an independent corporate enterprise had been selected. In actuality the shareholders and officers of the Union Pacific were the shareholders of Crédit Mobilier (Heier, 2009). The Union Pacific was able to conceal the Crédit Mobilier scandal until 1872 because the officers of the Company had bribed members of the US Congress who were responsible for approving the construction loans and land grants. When the fraud was revealed, the ensuing financial crisis led to congressional hearings which revealed accounting and reporting practices that had obscured the fraud (Heier, 2009). The significance of the Crédit Mobilier scandal was that it revealed the existence of corrupt acts by members of the US government which prevented transparency in corporate governance. Thirty members of the US Congress accepted bribes during the scandal, as well as two Vice-Presidents of the United States. While this scandal was important at the time, it did not immediately lead to reforms in corporate governance practices and structures. It was not until later in the nineteenth century that the federal government began to take a more active role in corporate governance and regulation.

Because of restrictions imposed by the United States Constitution, the federal government was proscribed from becoming involved in any significant way in corporate governance before the latter part of the nineteenth century. In Trustees of Dartmouth College v. Woodward, 17 US 518 (1819), the United States Supreme Court established the basic nature of the American corporation as an entity formed through a nexus of private contracts among shareholders and directors as opposed to being a quasi-public entity. After the Dartmouth decision, individual states began regulating corporations by enacting laws giving them the right to alter or revoke corporate charters. The courts mandated, however, that the alteration or revocation of a corporate charter must be reasonable and could not cause harm to shareholders (Miller v. State, 82 US 478, 1872), thus leading to the predominat shareholder perspective of corporate governance prevailing throughout the United States.

The federal government eventually began to address the pernicious aspects of large concentrations of corporate power towards the end of the nineteenth century. The Sherman Antitrust Act was passed by the US Congress in 1890. The purpose of this Act was to control trusts and other corporate entities that had created cartels and monopolies. For the most part, however, the Sherman Antitrust Act was not implemented until the presidency of Theodore Roosevelt (1901–1909). Anti-trust enforcement became more vigorous during the administration of President William Howard Taft (1909–1913). During Taft’s presidency lawsuits were brought against American Tobacco, Standard Oil, du Pont, and the Aluminum Company of America (Alcoa). Taft’s aggressive trust busting was one factor that persuaded Theodore Roosevelt to challenge Taft in the 1912 presidential election. The split between regular and progressive Republicans made possible Woodrow Wilson’s election as President.³

In sum, a unique concept of the role of the state in corporate governance developed in the United States during the late nineteenth and early twentieth centuries, which took the form of regulatory technologies/institutions that were used to control corporate activity. This type of legislation was frequently based on the use of accounting technologies to restrict the profitability of corporate enterprises, either through direct price controls or through the imposition of maximum rates of return on capital. Additional laws were enacted against the creation of interlocking corporate ownership (anti-trust), restraints of trade (anti-monopoly), and price and rate controls in industries like water distribution and sewerage, urban lighting and transportation, interstate railroads and shipping, telecommunications, and electricity and gas production (Cooke, 1950). Many of these laws were prompted by corporate abuses and financial crises such as the stock market collapse of 1929 and the New Deal legislation of the 1930s. The significance of the New Deal was the massive intervention of the state into the governance of the financial markets especially with respect to the accounting technologies of public companies. These regulatory structures emerged in the midst of an economic crisis and at a time when there was concern about the preservation of capitalistic institutions. These years witnessed a significant shift of governance responsibilities from private to public institutions. Although there has been significant modification of the system since the 1930s the main features of the regulatory structure remain intact.

In fact, one of the most important interventions by the state in corporate governance in the United States was the passage of the Securities Acts of the 1930s. The Securities Act of 1933 was the first federal legislation to regulate the sale of corporate securities. Prior to the 1933 Act, regulation of the sale of corporate securities was controlled by state laws or not controlled at all. The 1933 Act required that corporate securities offered for sale to the public must be registered with the federal government. The Act prescribes the information that must be included in a registration statement, including financial statements prepared in accordance with “generally accepted accounting principles” and audited by independent accountants (Douglas and Bates, 1933). This was the first time that audited financial statements were required by law in the United States for publicly traded securities.

The Securities Exchange Act of 1934 governs the secondary trading of corporate securities. The 1934 Act also created the Securities and Exchange Commission (SEC), which is responsible for enforcement of the federal securities laws. Among other things, the 1934 Act requires corporations to file annual audited financial statements with the SEC and to issue audited financial statements to shareholders. This was a highly significant legal technology/institution enacted by the state with respect to corporate governance in that it fundamentally changed the relationship between shareholders, boards of directors and corporate management. One important provision of the 1934 Act was the anti-fraud provision, which specifies that it is “unlawful for any person, directly or indirectly, to use or employ, in connection with the purchase or sale of any security registered on a national securities exchange any manipulative or deceptive device or contrivance”. This provision allows the US Government, through the SEC, to pursue corporate fraud wherever it occurs (Cox et al., 2009).

Justice Felix Frankfurter of the US Supreme Court was highly influential in the development of the Securities Acts (Parrish, 1970). Frankfurter thought of the capital market as involving the mutually interdependent functions of many specialists groups – accountants, brokers, underwriters, lawyers, etc. Market efficiency was therefore dependent on assuring the competency and probity of all market participants. The Securities Acts became major vehicles for investors seeking redress from the malfeasance of company management and directors. The emphasis in the finance and accounting literatures on the shareholder model of corporate governance can therefore be traced to the ideas embodied in the Securities Acts.

McCraw (1982) points out that the requirement in the Securities Acts to issue audited financial statements in accordance with “generally accepted accounting principles” evolved during the 1930s into a system of joint governance of the accounting profession involving both government regulation and self-regulation through a national professional body (i.e. the American Institute of CPAs). Unlike other federal regulatory agencies, such as the Interstate Commerce Commission, which sought to use accounting as a tool for directly regulating prices and rates of return on capital, the Securities Acts sought to protect consumers by assuring more reliable and timely information for investors.

The Public Utility Holding Company Act of 1935 (PUHCA), was another law passed by the United States Congress in which the US government intervened in a significant way in corporate governance. The electrical generation and distribution system in the United States was initially created by a diverse group of entrepreneurs, including Thomas Alva Edison, during the late nineteenth and early twentieth centuries. By the 1920s, the electrical industry had become highly concentrated due to mergers between various generating companies throughout the country, leading to what were referred to as public utility holding companies. In addition, electrical generation companies often owned other enterprises, such as electrified urban street railroads and radio stations, as a way of extending their monopoly in the generation and use of electricity (Baskin and Miranti, 1997). The federal PUHCA law restricted the scope of operations of electrical companies to a single state, and also subjected them to a complex set of accounting technologies based on a fixed maximum rate of return on equity. In addition, no electrical generating companies could be engaged in other types of business. This led to the dismantlement of the public utility holding companies as well as the electrified urban street railroad system in the United States.

Throughout the 1930s, 1940s and 1950s, many corporations in the United States began to be regulated by federal or state governments through legally constituted commissions or boards which set prices, either according to a fixed rate of return on capital or through maximum prices. Among the industries regulated in this way were electrical generation, telecommunications, railroads, marine transportation, water distribution, securities brokerage, and banking. This system began to dissolve in the 1980s, when a trend towards neo-liberalism, during the presidencies of Jimmy Carter and Ronald Reagan, led to deregulation in many industries. This trend towards neo-liberalism continued through the 1990s and into the early twenty-first century. Many of the most highly regulated industries in the United States (e.g. banking, electricity, airlines, and telecommunications) were no longer governed or controlled by the state.

Discussion and conclusion

This article has examined the changing role of the state in corporate governance through time. In the cases of the Venetian Arsenal and the East India Company the connections between the state and business enterprise were quite close. The enterprises created during these periods were de facto subsidiaries of the state, and the state was a major stakeholder in the enterprises at multiple levels. The examinations of the Venetian Arsenal and the East India Company also illustrate interdependencies between business elites and governments, where the principal objectives were focused on increasing wealth through foreign trade and building state military and naval power.

In contrast, the Company Laws enacted in Great Britain during the nineteenth century were intended to encourage capitalist enterprise, albeit leading at times to corporate abuses and financial crises. The regulatory efforts occurring in the United States during the late nineteenth and early twentieth centuries also illustrate the efforts of the US federal government to restore and maintain confidence in the capitalist system. In this way, the state gradually became a monitor of corporate governance and sought to protect investors against management malfeasance or incompetency. At the same time the state benefited from the activities of the business sector, even though the scope of business activity eventually began to be so great that it was no longer practical for the government to exercise direct control over corporate enterprises, as was the case in Venice or the East India Company. The state continued to draw strength and power from its oversight of a vibrant business sector, but because of the enormous size and complexity of capitalist enterprises, new, more indirect methods had to be developed to provide effective corporate governance (Miranti, 1986, 1989).

In effect, the various modes of intervention by the state in corporate governance may be seen as consubstantial to a certain extent with the degree of sovereignty that a state possesses over its territory. During periods when sovereignty is challenged, the need to maintain armed forces requires substantial financial resources that are difficult to obtain through taxation alone. In this context, alternative sources of wealth creation become a strategic initiative for the state which seeks to intervene in business enterprises by practicing a kind of “deduction at the source” in a quasi-feudal logic.

In more recent periods, direct control of business enterprises appears to be considered to be no longer necessary when the recognized authority of the state guarantees a form of social stability that allows the development of a specialized administrative apparatus and a more elaborate system of taxation leading to a reliable source of revenue. In other words, in a period of relative peace, the regulation of business enterprises tends to be exerted through legislation rather than through the more uncertain means employed when there are direct “requisitions”, as in times of war or national emergency.

In the same way, the lifting of the governmental restriction against the formation of joint-stock companies cannot be ascribed solely to an irrepressible need for industrial capital, but undoubtedly answers to strategic considerations as well. During the nineteenth century the state freed the energy of capitalist entrepreneurs to enhance the sovereignty of the state through the development of militarily significant means of transportation and communication (e.g. railroads, the telegraph, and telephone). Thus, the state was able to equip its territory with fundamental infrastructure pertaining to which it could not in and of itself have ensured the financing without excessive burdens on the citizens of the territory.

Like the collective passions that prevail during gold rushes and other speculative bubbles, the rapid economic expansion and technological developments of the nineteenth and twentieth centuries promised profits which often relegated to a secondary position the protection of shareholders who doubtless were less concerned with prudence than enrichment. The 1929 crash revealed the excesses of that period and effectively constituted the starting point of our current system of regulation of corporate governance. It might therefore be argued that the fraudulent episodes of the early twenty-first century, such as Enron, and the later crises like the banking crisis of 2008, will follow a similar logic and will generate regulatory reforms to address the more recent perceived corporate abuses.

In this article we have also relied on certain theoretical frameworks provided by Miller (1990) and North (1991), who have described the creation of “measurement institutions” intended to protect and enhance the objectives of the state. Miller’s (1990) theoretical framework focused on linkages and interdependencies between calculative accounting practices and the state. These types of measurement institutions constitute an assemblage of political rationalities (statements, claims, and prescriptions that set forth the objectives of government), and technologies (procedures and mechanisms of government, including laws, rules and regulations, which are called upon to deliver various goals and objectives such as regulatory order, uniformity and efficiency). In a similar way, North (1991: 97) defined measurement institutions as “humanly devised constraints that structure political economic and social interaction”. Miller’s (1990) notion of “technologies” and North’s (1991) the concept of measurement “institutions” have been employed in this article to examine the role of state in corporate governance through time. What can be seen is that even though the state has benefitted from its control of business entities, the maintenance of corporate order has frequently necessitated the creation of new forms of regulation. While this article has dealt primarily with the evolution of corporate governance though time, the significance of measurement institutions within the overall framework of political economy should not be overlooked.

Footnotes

Acknowledgements

We would like to thank the Joint Editor of Accounting History, Garry Carnegie, for his helpful comments on this article, as well as the very useful comments of the anonymous reviewers.We would also like to thank the participants at numerous conferences and academic seminars including: Aston University Accounting Research Seminar, 2013; The World Congress of Accounting Historians 2012, Newcastle; American Accounting Association Annual Meeting, 2012, Washington, DC; Society for the Advancement of Socio-Economics, 2012, Madrid; and the Asia Pacific Interdisciplinary Perspectives on Accounting Conference (APIRA), 2011, Sydney.

Funding

This research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors.

Notes

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