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«Working Paper 2010-29 November 2010 341 Mansfield Road, Unit 1063 Storrs, CT 06269–1063 Phone: (860) 486–3022 Fax: (860) 486–4463 ...»

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Department of Economics Working Paper Series

Business Groups and the Natural State

Richard N. Langlois

University of Connecticut

Working Paper 2010-29

November 2010

341 Mansfield Road, Unit 1063

Storrs, CT 06269–1063

Phone: (860) 486–3022

Fax: (860) 486–4463


This working paper is indexed on RePEc, http://repec.org/


Recent revisionist accounts of corporate governance in both business history

and finance are challenging the tradition narrative, associated with Berle and Means (1932) and Alfred Chandler (1977), in which the American model of diffuse ownership and coherent diversification is both an inevitable outcome of economic development and perhaps a normative standard for the world to follow.

This essay is an attempt to rethink that narrative in light of the continued significance of the pyramidal business group as a governance structure around the world. Drawing on the North, Wallis, and Weingast (2009) theory of the state, I argue that the evolution of corporate governance can be understood only in institutional terms and that institutional development is driven by the coalitional structure of the polity. This is true as much in open-access orders like the U. S. as in the natural states that rule most of the world. In the end, I endorse the view that the much-discussed and oft-misunderstood exceptionalism of the U. S. in corporate governance has its roots of the differential effect on the U. S. of the collapse of globalization during the middle years of the twentieth century.

Journal of Economic Literature Classification: G38, H10, K22, L22 Keywords: Business groups, corporate governance, diversification, pyramids, theory of the state.


Not too many years ago, our understanding of the evolution of corporate structure in the modern era fit within a dominant theoretical narrative. We learned early on from Berle and Means (1932) that, by the early twentieth century, the owner-managed firm had given way in the United States to a corporate form in which ownership was diffuse and inactive and in which control had effectively passed to managers. Then we learned from Alfred Chandler (1977) that this managerial revolution was both inevitable and desirable.1 The separation of ownership from control allowed managers to reorganize production along efficient bureaucratic lines, creating the modern multi-unit (vertically integrated) firm (Chandler 1977) and eventually the multidivisional corporation (Chandler 1962). The progression away from owner control and toward diffuse stock holdings and professional management took place first and proceeded most quickly in the United States, whereas the vestiges of what Chandler came to call “personal” capitalism persisted in Europe, especially Britain, preventing firms in those countries from taking full advantage of economies of scale and scope, and dooming Europe (apart from Germany) to relative industrial decline (Chandler 1990).

Although this account was certainly not without its critics, it long enjoyed the status of a comfortable conventional wisdom. The situation today is arguably rather different. The conventional wisdom still remains entrenched in scholarship generally; but among specialists in business history and corporate finance, a multi-faceted revisionism is in flower. Depending on how one looks at the data, it is no longer so clear that the


Indeed, Lamoreaux, Raff, and Temin (2004) go so far as to accuse Chandler of Whig history

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separation of ownership from control was (or is) quite so rampant in the United States as the Berle and Means account would lead us to believe (Desai, Dharmapala and Fung 2005; Holderness 2009; Holderness, Kroszner and Sheehan 1999). It is also not so obvious anymore that the separation of ownership from control was more advanced, or that personal capitalism was less characteristic, in the U. S. than in Britain in the early twentieth century (Hannah 2007a, b). In place of the linear, and perhaps even triumphalist, narrative of Chandler there is now emerging a more contingent story in which forms of corporate governance vary considerably across both time and geography.

Even in the United States, the vertically integrated managerial enterprise is arguably no longer the centerpiece of corporate organization (Lamoreaux, Raff and Temin 2003;

Langlois 2003). And, outside the U. S. and the U. K., the dominant form of governance is not the Chandlerian firm but the pyramidal business group, a form under which, far from ceding authority entirely to professional managers, owners retain effective control over large empires (La Porta, Lopez-de-Silanes and Shleifer 1999).

These new perspectives on corporate governance in the early twenty-first century call for a reexamination, and indeed a rewriting, of the Berle-Means-Chandler narrative.

In earlier work (Langlois 2003, 2007a) I have tried to rethink the issue of the latetwentieth-century vertical disintegration of the Chandlerian firm in what was essentially an American context. This essay is a preliminary attempt to widen the analysis to

–  –  –

consider corporate governance more generally and to look beyond the (real or imagined) American model of governance to alternatives that include the business group.2 Institutional analysis: comparative and historical.

The raw material for my argument will come from the New Institutional Economics in its broadest sense (Klein 2000; Langlois 1986). The economics of organization – what Williamson (1985) would call transaction-cost economics – has often been invoked to explain corporate governance. Its method calls upon what Coase in his later writings (Coase 1964) would call comparative-institutional analysis. Rather than comparing the world we observe against an


theoretical model (a practice Coase derided as “blackboard economics”), we should set two real-world institutions side-by-side and compare their respective costs and benefits. Implicitly in Coase, and explicitly in Williamson (1991), one explains an observed organizational form by comparing that form with hypothetical discrete alternatives in order to show that the observed form minimizes the sum of production costs and transaction costs.3 Although one can take advantage of this approach to compare specific kinds of arrangements, including those of corporate governance, the signal thought experiment in the literature is to compare “the market” as an organizational structure with “the firm” as


The term “business group” takes on a number of meanings in the literature, sometimes encompassing holding companies or loosely affiliated business networks (like Japanese keiretsu are supposed to be or have been). Following Colpan and Hikino (2010), however, I will consider the archetypical business group, which has three features: (1) pyramidal ownership structure; (2) unrelated diversification; and (3) family (or sometimes government) control.

“The underlying viewpoint that informs the comparative study of issues of economic organization is this: Transaction costs are economized by assigning transactions (which differ in their attributes) to governance structures (the adaptive capacities and associated costs of which differ) in a discriminating way” (Williamson 1985, p. 18).

–  –  –

an organizational structure (Coase 1937). To an extent not often appreciated, however, the imperfect “market” in the economics of organization is actually a relatively wellfunctioning structure as real-world markets go. The underlying assumption, normally unspoken, is that relevant background institutions — things like respect for private property, contract law, courts — are all in place. Whatever transaction costs then arise are thus the result of properties inherent in “the market” itself, not of inadequacies in background institutions.4 There is generally a tacit factual or historical assumption as well: that the relevant markets exist thickly or would come into existence instantaneously if called upon.5 In the economics of organization, then, firms arise because, under certain circumstance, they are inherently superior to markets — even when those markets exist thickly and are well supported (albeit in ways normally unspecified) by background institutions.

One could actually make a similar argument about Chandler. Chandler certainly can’t be accused of ignoring history: to a far greater extent than the economics of organization, he understood that markets take time to develop and that, in part at least, real-world firms often integrated vertically because markets were initially thin and


As I will argue in due course, the imperfections that the economics of organization tends to discover in “markets” are not in fact inherent but are the result of the historical state of the market (market thickness or extent) or of institutions, especially those intermediate-level institutions I will describe as market-supporting institutions.

Williamson (1975, p. 20) is fond of assuming that “in the beginning there were markets.” He means this as a heuristic dictum not a historical claim: let’s assume that markets and firms are both equally capable – that both (and other forms, too, perhaps) exist and have at their disposal the same productive capabilities. This makes it easy to conduct a (static) comparative-institutional analysis.

We can compare firms and markets as discrete institutional choices and then explain observed forms strictly on the basis of differences in transaction costs (and perhaps also production costs as understood in neoclassical terms).

–  –  –

organization, Chandler believed in the inherent superiority of the firm — that is, of the large managerial corporation — over markets (and over other kinds of firms) at their realworld best. Steeped in Max Weber via Talcott Parsons, he saw the modern corporation much as Weber saw bureaucracy: as a modern and efficient attractor toward which developed economies were naturally tending (Langlois 2007a). And, whereas Chandler is most attentive to history, background institutions are conspicuous by their absence from his explanatory framework (if not always from his narrative). In his account, the rise of the large multi-unit enterprise in the United States was driven by impersonal economic forces: the lowering of transportation and communications costs attendant on the railroad and telegraph, along with increases in per capita income, that made it economical to produce or package goods centrally and in volume. This imperative required careful professional management to assure high throughput and thus lower costs (Chandler 1977). As the managerial firm matured, its (Weberian) advantage began to show, and the large multi-unit enterprise was able to adapt existing capabilities and develop new ones in a manner superior to older networks of owner-managed firms (Chandler 1990). Although the adoption of the managerial corporation took different


“[I]ntegration … should be seen in terms of the enterprise's specific capabilities and needs at the time of the transaction. For example, Williamson (1985, p. 119) notes that: ‘Manufacturers appear sometimes to have operated on the mistaken premise that more integration is always preferable to less.’ He considers backward integration at Pabst Brewing, Singer Sewing Machine, McCormack [sic] Harvester, and Ford ‘from a transaction cost point of view would appear to be mistakes.’ But when those companies actually made this investment, the supply network was unable to provide the steady flow of a wide variety of new highly specialized goods essential to assure the cost advantages of scale. As their industries grew and especially as the demand for replacement parts and accessories expanded, so too did the number of suppliers who had acquired the necessary capabilities. … The point is that an understanding of the changing boundaries of the firm required an awareness of the specific capabilities of the firm and the characteristics of the industry and market in which it operates at the time the changes were made.” (Chandler 1992, pp. 88-89.)

–  –  –

paths in Europe and Japan, those differences seem more a matter of historical accident, managerial decisions, or even national culture.7 Antitrust policies, corporate law, or the state of development of financial markets seem to matter little. To put it another way, neither the economics of organization nor Chandler makes much analytical use of institutions in the wider sense treated in other regions of the New Institutional Economics (Greif 2006; Hayek 1967; North 1990).

All of this stands in sharp contrast to the literature on business groups, especially business groups outside the developed world, and to the related literature on the multinational corporation. Although much in these literatures draws upon both transaction-cost economics and the work of Alfred Chandler, the central explanatory focus lies not on a comparison of existing institutions with ideal or “optimal” ones in the abstract but rather on the roles of history and institutions in shaping organizational structure. At center stage here is an institution that most often lurks as the ignored elephant in the room of organizational economics: the state. One cannot sensibly talk about the differences in structures of corporate governance through time and around the world without talking about the evolution of the political institutions that enable and constrain choice of governance structure.

The natural state.

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