The evolution of shareholder voting rights: separation of ownership and consumption.

• Author: Hansmann, Henry
• Position: I. Corporate Ownership and Voting Rights in Early U.S. History B. Financial Infrastructure 2. Insurance through Conclusion, with appendix and footnotes, p. 981-1013

2. Insurance

Voting restrictions also appeared among early property and casualty insurance companies. (141) Maximum vote provisions were common, although not universal, in late eighteenth- and early nineteenth-century stock insurance companies in Pennsylvania and Massachusetts. (142) Approximately one third of stock insurance corporations chartered by special act in Connecticut through 1856 adopted restricted voting schemes. (143) By contrast, the overwhelming majority of New York finance and insurance companies (144) and New Jersey insurance companies (145) granted voting rights in direct proportion to share ownership. Our multi-state analysis shows 38% of insurance companies chartered between 1790 and 1859 adopting restricted voting.

A significant number of the early insurance corporations were, both in name and substance, mutual insurance companies. These firms were owned by their customers--the insured--and typically adopted one vote per member or another form of stringent voting restrictions. Early mutual insurance companies were particularly common in the fire insurance business. (146) The economies of scale in building an insurance pool gave many of these companies substantial monopoly power, and created a strong incentive for collective ownership by their customers. (147)

While many consumer-owned insurance companies were organized formally as mutuals, a number of insurance companies formed as joint stock corporations were also effectively mutuals, serving principally to insure their shareholders. In this sense, the history of insurance companies is essentially akin to, and closely related with, that of banks. (148) As described by Alfred Chandler in the context of marine insurance, "[b]y pooling resources in an incorporated insurance company, resident merchants, importers, exporters, and a growing number of specialized shipping enterprises were able to get cheaper insurance rates"; as a result, "[n]early all these companies handled only the business of local shippers and ship owners." (149) The local element of early insurance firms was made explicit in their charter provisions; state citizenship--or, in some cases, town residency--requirements for directors were common. (150)

Take, for example, the Insurance Company of North America, the first U.S. stock insurance company, which was chartered in Philadelphia in 1784. Historians attribute the decision to transform what was initially a failing tontine into a marine insurance company to John Maxwell Nesbitt, one of its founders and its future president who, as virtually all leading merchants at the time, had significant experience both as a policyholder and underwriter of marine insurance. (151) The company came to insure the ventures of many of its shareholders and directors--a situation expressly contemplated and permitted by the corporation's charter, provided that insiders did not receive special privileges. (152) However, not all prospective customers were able to become shareholders in the company. In fact, the Pennsylvania legislature granted a charter to another marine insurance company, the Insurance Company of the State of Pennsylvania, signed into law just four days after the charter of its predecessor, with the justification that "a number of the ship owners and traders of Philadelphia, from local circumstance, have not been able to obtain shares in [the Insurance Company of North America]." (153) Both insurance companies adopted a graduated voting scheme, subject to an absolute cap on the number of votes per shareholder. (154)

Leading merchants were also instrumental in establishing the first stock insurance corporation in Connecticut, the Hartford Fire Insurance Company, in 1810. According to P. Henry Woodward, "[a] sense of ever-present peril, a desire to avert the worst effects of calamity from the immediate sufferer by distributing the loss through the community, and a willingness to contribute fairly to the common fund, brought the company into existence"; even though its subscribers certainly intended to make a profit, "money-making was a secondary consideration." (155) Nevertheless, its shareholders and directors turned out not to be avid purchasers of insurance policies, and the company initially struggled for lack of a clientele. (156) The corporation's charter granted voting rights in proportion to share ownership. (157)

The inspiration for the establishment of another fire insurance company in Hartford came from merchants who were previously customers of the Hartford Fire Insurance Company. Interestingly, their main motivation for creating a competing business was allegedly not the firm's monopoly prices, but rather its slack customer service. The story goes that the office of Walter Mitchell, the secretary and sole salesman of the Hartford Fire Insurance Company, had a highly inconvenient location, erratic hours of operation, and no regard for agreed-upon appointments. A disgruntled group of merchants then "pooled their discontent in a general protest" and incorporated the Aetna Insurance Company in 1819. (158) Although originally a local endeavor, competition soon led the Aetna to expand to other localities and procure outside business through agents. (159) The company's original charter capped voting rights at fifty per shareholder, a rule that was, however, abandoned in favor of voting by shares in 1877. (160)

3. Manufacturing

   In sharp contrast to the types of firms discussed above, one vote per share was from the outset the dominant voting rule in U.S. manufacturing corporations. Only one out of 135 manufacturing corporations chartered by special act in Connecticut through 1856 adopted voting restrictions. (161) Similarly, restricted voting schemes were present in only 2% of the manufacturing corporations chartered in New York between 1790 and 1825 and 5% of such firms incorporated in New Jersey between 1790 and 1867. (162) New York's path-breaking general incorporation act for manufacturing firms of 1811 provided a one-share-one-vote rule--a pattern that prevailed in most such statutes subsequently enacted by other states. (163)

   Our multistate analysis shows 31% of manufacturing firms chartered between 1790 and 2859 as having restricted voting, but this proportion is, almost certainly, misleadingly high. Manufacturing firms, in contrast to other types of firms, appear to have been formed under the period's new free incorporation statutes in substantial numbers from an early stage. (164) Indeed, the pioneering New York corporation statute of 1811 was limited to manufacturing firms. Consequently, manufacturing firms are probably underrepresented in these data, which exclude corporations chartered under free incorporation statutes. Moreover, there is good reason to believe that the omitted manufacturing corporations had a substantially higher ratio of one-share-one-vote rules than did the specially chartered manufacturing corporations included in the data. One reason is that the early statutes providing for free incorporation, such as the New York statute of 1811, were not only limited to manufacturing firms but also mandated a rule of one-share-one-vote. (165) Thus our multistate analysis presumably understates the disparities between the voting rules adopted by manufacturing corporations and those adopted by corporations in other industries. Nonetheless, the regression reported in Table 2 shows that the frequency of restricted voting was significantly smaller in manufacturing corporations than in corporations organized to provide banking, bridges, canals, insurance, or roads.

   The trend towards voting by shares in manufacturing firms was already apparent upon the incorporation of the pioneering Society for Establishing Useful Manufactures (S.U.M.) in New Jersey in 1791. The S.U.M. was a privately owned, but state-sponsored, corporation intended to foster the development of manufacturing in the United States. Even though the corporation was ultimately chartered and headquartered in New Jersey, most subscribers were New York capitalists and speculators. Unlike other contemporary corporations, which specified the object of the firm with considerable precision, the purposes clause of the S.U.M charter was exceedingly broad, providing that the corporation was to carry on "the Business of Manufactures in this State" and to employ its capital stock in "Manufacturing or making all such Commodities or Articles as shall not be prohibited by Law." (166) The S.U.M. charter granted one vote per share to private shareholders, while limiting the voting rights of the U.S. and state governments to one hundred votes each if they were to become shareholders in the firm. (167) Interestingly, Alexander Hamilton, who vigorously defended the adoption of voting restrictions in the First Bank of the United States, was one of the chief promoters of the S.U.M. (168)

   While many of the early corporations previously examined--such as bank, insurance, and transportation companies--were customer-owned local monopolies, shareholders of manufacturing corporations were almost always investors, not consumers. In contrast to the public utilities of the time, most manufacturing firms that required enough capital to employ the corporate form--which produced mostly textiles and, in smaller numbers, glass and metal (169)--were likely to be part of a reasonably broad market and thus face substantial competition. Moreover, the consumers of manufacturing firms were generally so dispersed, and purchased their products so sporadically, that they could not be efficiently organized to become owners of the enterprise. In this respect, they contrasted with the users of turnpikes, banks, and insurance companies, who would have continuously transacted with those service providers at a fairly constant rate of expenditure. Finally, as Donald Smythe observes, manufacturing firms required more active and innovative management than the early public utilities, and...