Academic journal article Washington and Lee Law Review

Dividends as a Substitute for Corporate Law: The Separation of Ownership and Control in the United Kingdom/Comment on Brian R. Cheffins, Dividends as a Substitute for Corporate Law: The Separation of Ownership and Control in the United Kingdom

Academic journal article Washington and Lee Law Review

Dividends as a Substitute for Corporate Law: The Separation of Ownership and Control in the United Kingdom/Comment on Brian R. Cheffins, Dividends as a Substitute for Corporate Law: The Separation of Ownership and Control in the United Kingdom

Article excerpt

Brian R. Cheffins*

I. Introduction

As the twentieth century drew to a close, corporate law scholarship "found the market" as "contractarian" analysis became the dominant mode of analysis. A key underlying presumption of this economically oriented school of thought was that market dynamics define primarily how directors, shareholders, and others associated with companies interact. Corporate law, the thinking went, had only a supplementary and supportive role to play, namely facilitating efficient contracting. No sooner had legal academics started to push law to the margins when economists began to assert that the extent to which law provides protection for investors is a key determinant of the configuration of corporate governance structures around the world. The claim made was that the "quality" of corporate and securities law does much to determine whether a country will have strong securities markets and a corporate economy dominated by firms with widely dispersed share ownership.

The "law matters" thesis economists have advanced has important normative implications because it suggests countries will not develop a robust stock market or escape from potentially backward family capitalism unless laws are in place that provide suitable protection for investors. Not surprisingly, the thesis has attracted much attention from legal academics.1 But is "investor friendly" corporate and securities law in fact a necessary condition for a country to develop strong securities markets and a corporate economy where large firms are generally widely held? The experience in the United Kingdom suggests not.

Currently, Britain has an "outsider/arm's-length" system of ownership and control, so called because most U.K. public companies lack a shareholder owning a large block of equity, and those owning shares (typically institutional investors) generally refrain from taking a "hands-on" approach to the management of companies. This system became entrenched between the 1940s and the 1980s, as company founders and their heirs exited and institutional investors rose to prominence. By the end of this period, the widely held company so often identified as the hallmark of corporate arrangements in the United States had moved to the forefront in the United Kingdom. The law matters thesis implies that Britain should have had laws in place that were highly protective of shareholders as the transition occurred. In fact, from the perspective of investor protection, Britain had "mediocre" corporate and securities legislation during the relevant period.

If corporate and securities law did not provide the foundation for the separation of ownership and control in U.K. public companies, what did? A number of possibilities have been canvassed in the literature, including regulation by the privately run London Stock Exchange, which supplemented the protection investors had under corporate and securities legislation, and takeover activity, which acted as a catalyst for the reconfiguration of existing ownership patterns.2 This paper identifies a new candidate: the dividend policy of publicly quoted firms.

Essentially, dividends contributed to the unwinding of share ownership structures in U.K. public companies by mimicking the role that the law matters thesis attributes to corporate and securities law, namely, constraining corporate insiders and providing investors with information flow about companies with publicly traded shares. Regulation of dividend policy by corporate law was minimal in the United Kingdom as ownership separated from control. Hence, while economists have been stressing the importance of law as a determinant of corporate governance systems, at least in Britain, corporate behavior lightly constrained by legal rules played a significant role. The paper does not claim that the payment of dividends by U.K. public companies was a sufficient condition for a separation of ownership and control to occur because it was the norm for publicly traded firms to pay dividends in the decades before dispersed ownership became standard. …

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