Saturday, October 11, 2008

Origins of the joint-stock corporation

The modern joint-stock corporation has many sources in medieval Europe. First among these was corporate law itself. Although the era is commonly referred to as "feudalism," for the hierarchy of individually owned "fiefs" of land and control of serfs as fixtures of that land, large amounts of wealth in Europe were actually controlled by corporate entities. Chief among these were church lands, the corporate entities being dioceses, religious orders and the Roman Church itself. These entities controlled a substantial fraction of the land in Western Europe. Furthermore cities (with varying degrees of political independence), merchant guilds, craft guilds, and many charitable entities (such as hospitals) were legal "corporations," i.e. artificial and perpetual legal persons under law. Some basic issues in corporate law (for example, when are officers individually liable for acts of the corporation, and when the corporation is liable for acts of its agents) had already been solved in canon law and urban law long before the joint-stock corporation.

Another source of the joint-stock corporation was the tradition of dividing ownership over tangible things into "shares." For example, it was common in Italian maritime states fund the construction and operation of ships by dividing them into a certain number of shares (24 and 64 were common divisions). Share owners were responsible for funding voyages (not including cargo, which was typically paid for by trading partnerships called commenda) as well as the initial construction capital, and divided up the profits (fees paid by the merchants less costs). This tradition faded away in Venice when that republic's government took over ship ownership, but thrived across the Italian penninsula in Genoa. Ship shares became embedded into maritime law all over Europe and even survived the British Empire (today in Canada when you register a boat the government still registers 64 shares in it for its owner). The only organization controlled by the shareholders, however, was the captain and crew of the ship.

The medieval organizations that most resembled later joint-stock corporations were the Genovese maone. These bore some strong resemblances to the publicani tax farming corporations of the Roman Republican era, although it is not clear how they could have survived the intervening Late Empire and Dark Ages other than as very obscure (and perhaps now lost) written descriptions. In form and function maone also bore strong resemblances to some early joint-stock companies such as the Bank of Amsterdam, Bank of England, and the Dutch and English East India Companies.

The Italian cities often sold off their tax receivables to wealthy merchants at a discount as a way to borrow funds. (Discounting was one of the many ways late medieval financiers avoided the rather lax and narrow usury restrictions). The debts were divided into equal shares called loca or partes. Legally, these shares were personal property (chattels) and could be freely traded.

Technically, no organization was created when the city sold its tax receivables to merchants. However, to effectively collect the taxes, the holders of loca formed an organization called a maona or societas comperarum. This organization would then subcontract to tax farmers to collect the taxes. By the fourteenth century, Genovese maone also engaged in military conquest and colonization. These were, quite literally, corporate raiders.

Normally, maone were temporary, but some of them ended up lasting for a long time. In 1346 the Maona di Chio e di Focea (a company for managing the taxes of Chios and Focea) was formed. This organization's members obtained from Genoa the exclusive right to collect taxes from Chios (an Aegean island) and Phocaea (a port on the Anatolian coast). But first the company would have to conquer them! Although technically a temporary organization, it lasted until 1566.

Rather than going to buy receivables from Genoa, subscriptions to the di Chio e di Focea's loca shares (still legally debt, but to be paid out in dividends as taxes and trading revenues were collected) went to fund 29 galleys to conquer Chios and Phocaea. The Genovese Republic, for a fee, granted the organization exclusive rights to collect taxes from the conquered territories as well as special trading privileges. The conquests, taxes, and trading were at least partially successful, and by the 16th century more than 600 persons owned loca of the maona. This function and some of this structure would later be emulated by the Dutch and English India Companies, but with a basic legal difference -- "shares" in these later joint-stock companies would constitute ownership (like ship shares) not debt as with the maona.

The most famous Genovese maona was the Officium procuratorum San Giorgio, later the Banco di San Giorgio. Founded in 1407, this bank (and a later Genovese bank along the same lines, the Bank of Genoa) would be the inspiration for later central banks such as the Bank of Amsterdam and the Bank of England. Banco di San Giorgio came to administer most of the Genovese Republic's debts. Dividends were paid out of tax collections (less directly than with earlier maona, but still more directly than the later Bank of England). The maona business was becoming more monopolistic, as it had become in Venice and would become with later central banks.

At the same time, however, the ship share system spread to northern Europe and branched out beyond ships. In Italy and Germany by the 16th century a wide variety of mines were divied up into ownership shares. During the Reformation, a pious follower of Martin Luther gave him some kuxen, shares in a mine in Saxony. Luther complained that he did not know what to do with them. (Indeed, since as with ship shares the mine managers could call on investors to pay up more capital, ownership was not for the financially naive).

Martin Luther

Ship shares and mine shares like these were issued in small numbers (usually between 24 and 640) and thus were not typically traded on exchanges. The number of employees was also small, usually no more than a few dozen. Kuxen were reportedly sometimes traded at the Leipzig fairs. Indeed, illiquidity was the rule in the first century of English joint-stock companies. It was not until the Vereenigde Oostindische Compagnie (the Dutch East India Company, founded out of a merger of smaller colonial companies in 1602) that volume existed to trade company shares on exhanges (which up to that time traded state and municipal bonds and commodities).

Interestingly, the first joint-stock companies chartered by the English Crown (starting in 1553) were companies involved in trading (the Muscovy and Levant companies), mining (the Royal Mines and the Mineral and Battery), and trading combined with conquest (the India Companies, the Virginia and Plymouth companies, etc.) The two mining companies borrowed not only shares but managers and engineers (presumably along with their techniques) from Germany. The Genovese for their part would have felt at home with the trading and conquest companies.

References include:

Harold Berman, Law and Revolution.

Guido Ferrarini, "Origins of Limited Liability Companies and Company Law Modernisation in Italy: A Historical Outline", Centro di Diritto e Finanza WP 5-2002.

Meir Kohn, "The Capital Market Before 1600", working paper 99-06, February 1999.

Emergency economics

For those of you who didn't catch me on econ-law a few months ago [2005] during the hurricanes, here is an expanded version of what I posted there:

Here are some alternative ways of rationing in an emergency. At least some of these have been written about by Yoram Barzel. We have witnessed all of them during hurricane Katrina [and also this summer (2008) during Ivan]:

(1) market prices ("price gouging")
(2) waiting in line
(3) centrally planned rationing
(4) don't ration: just let the resource run out
It's not clear that, even with perfect knowledge, with or without an emrgency, centrally planned rationing could operate without using one of the other methods of rationing. In any case, our very poor knowledge about each others' needs is sufficient to ensure that, short of a perfect price system, we can't get what we want without waiting in line, and sometimes we just can't get what we want (or even, the Rolling Stones notwithstanding, what we need). The worse the price system -- in other words, the higher the transaction costs -- the more we wait in line or do without, as East Germany once demonstrated (cf. West Germany) and as North Korea continues to demonstrate. Luckily for those of us in largely market price based economies, we need only wait in line when trying to do business with the government, call a toll-free service line, go to a hot movie on opening night, or during an emergency -- i.e. in the remaining situations where prices don't operate very well or at all, due to transaction costs imposed by law or otherwise.

Mises and Hayek long ago demonstrated the weakness of centrally planned economies such as the old Soviet Union (or today's North Korea) -- the lack of knowledge the government has about peoples' needs and desires. Similarly, lack of the requisite detailed rknowledge of the needs of others, especially at specific times of crisis when they need our help most, is a huge problem even if we were perfectly charitable. Not even the local governments exhibited much knowledge of the needs of their neighbors, especially in New Orleans. Much less did the state or Feds (FEMA being only the most glaring example) exhibit even a tiny fraction of the knowledge that would be required for an optimal outcome. This is not the fault of the people in the government agencies to not act as knowlegeably as they are capable of acting, but rather the fault is in their implied promises and our expectations. For example, TV commentators, watching pictures of some Coast Guard helicopters, seem to have come to expect that government agencies will swoop down from the sky and rescue everybody and take on other attributes of God. Such as, for example, being able to knowledgeably evacuate people and distribute other scarce goods and services in a disaster.

Per Mises and Hayek, even if the Soviet Union had been run by an perfectly beneficient dictator, people would have, short of a matching omniscience of said dictator (and of enough of his underlings to receive and act on the knowledge) still have waited in bread lines. When price controls hit gasoline in the United States in the 1970s, people similarly waited in gas lines.

In emergencies rationing becomes extreme: people wait in long lines, pay "extortionate" prices, or, even worse, do without. We are thrown into economically unfamiliar territory and transaction costs balloon. Goods will always be rationed in one or more of the above four ways, and in an emergency the rationing can be quite severe. Our charitable spirit can temporarily overcome self-interest, but it can't overcome the knowledge problem or the scarcity of goods.

Given that waiting in line, or doing without, are very painful (even sometimes deadly) alternatives, and that allowing the charge of very high prices can largely prevent use of these extreme and wasteful forms of rationing, why do we have price gouging laws?

Can price gouging laws be explained as follows? In a zero transaction cost world, consumers would successfully negotiate with retailers for an insurance policy that caps prices in case of emergency. This may be, for example, because retailers are better able to bear the risk of emergency supply shortages than consumers are, or because consumers don't want to bear the risk of having to have an unusually large amount of money at hand during an emergency. (Katrina may be a good example of this -- it reportedly struck just before many paychecks were due, leaving many people who live from paycheck to paycheck without funds). However, the transaction costs for negotiating with consumers for such contracts are too high. Therefore, the default retail sales contract should include such insurance. Price gouging laws are a convenient way to do this. More generally, if it weren't such a bother almost all of us would like to purchase insurance against volatile prices in order to make our budgets more predictable.

Whether and when wholesale contracts include such price caps provisions would provide interesting evidence in favor of or against this hypothesis, and under what conditions it would have been rational to for consumers and retailers to have made such a contract.

As we have seen, there is a strong economic argument against price gouging laws. Consistent application of market pricing during an emergency would minimize the other inefficient, and occasionally deadly, rationing methods above, especially (4)actually running out of emergency supplies. Consumers could be confident that supplies will not run out, so stocking up on excess supplies based on fear of imminently running out of the supply (such as we've seen consumers do in some areas recently with gasoline) would be minimized. Given modern technology, perhaps we should work on improving the availability of credit and liquidity in emergencies via always-up wireless devices and immediately payable liquidity insurance policies instead of price gouging laws.

Furthermore, the promise of very high prices might motivate retailers to fly in special deliveries of emergency supplies at otherwise prohibitive transportation rates. On can even imagine for-profit organizations doing many of the tasks that the National Guard, Red Cross, and similar organizations are doing now. Of course, the moral indignation would be enormous. People, at least in political discussion, tend to be extremely averse to "windfall profits" and seem to have a strong psychological preference for an implicit insurance policy that puts a price cap during emergencies on retail contracts.