Corporate Ownership and Control in the UK: The Tax Dimension
| Published date | 01 September 2007 |
| Date | 01 September 2007 |
| DOI | http://doi.org/10.1111/j.1468-2230.2007.00663.x |
Corporate Ownership and Control in the UK:
TheTax Dimension
Brian R. Che⁄ns
n
and Steven A. Bank
nn
While generally the impact tax has on patterns of corporate ownership and control has received
little attention in the relevant academic literature, this paper argues that tax is potentially an
important determinant of ownershippatterns in large companies.The paper focuses on historical
developments in Britain, where an ‘outsider/arm’s-length’ system of corporate governance took
shape during the twentieth century and became fully entrenched by the end of the 1970s. Taxes
imposed on corporate pro¢ts, taxation of managerial and investment income and inheritance
taxes help to explainwhy during this period blockholders sought toexit a ndwhy there was su⁄-
cient demand for shares among investors to permit ownership to s eparatefrom control.
In the United Kingdom, large bus iness enterpris es typically are quoted on the stock
market, have widely dispersed share ownership and are run by professionally
trained managers.This ‘separation of ownership and control’
1
in larger public com-
panies has dictated the tenor of debate on corporate governance in Britain.When
share ownership in a company is widely dispersed, shareholders generally have
good reason to refrain from incurring the costs of activism since the company is
likely to be only a small part of a diversi¢ed portfolio of shares, the equity can be
sold if things begin going wrong and potential bene¢ts from intervention will
accrue primarily to investors opting to remain passive. Executives thus will poten-
tially havelatitude to act in an ill-advised or self-serving manner and impose ‘agency
costs’ on investors. Concerns about low standards of managerial accountabil ityand
rising executive pay were su⁄ciently serious to prompt the establishment of the
trilogy of committees ^ Cadbury, Greenbury and Hampel ^ that set the agenda
for corporate governance reform in the UK in the 1990s.
2
These themes continue
to in£uence heavily debates about corporate governance in Britain.
3
The dominance of the widely held company in Britain was not inevitable. Other
developed countri es typically have a considerably smaller nu mber of publicly quoted
companies per capita and among those ¢rms traded on the stock market, block-
n
Faculty of Law,University of Cambridge.
nn
UCLA Schoolof Law.The authors are grateful for feedback from Marco Bigelli, Mihir Desai, two
anonymous referees and participantsat seminars at Bologna, Georgetown, the University of Toronto
and at a symposium of tax on corporate governance in Munich.
1 The phrase was ¢rst used in the corporate context byA. A. Berle and G. C. Means,The Modern
Corporationand PrivateProperty(New Brunswick, NJ:Transaction Publishers,1997, originally pub-
lished in 1932 by Harcourt, Brace & World)5.
2 Cadbury Committee, Reportof the Committeeon the Financial Aspects ofCorporateGovernance (Lon-
don: Gee,1992);Greenbury Committe e,Directors’Remuneration: Reportof a Study GroupChaired by
SirRichardGreenbury(London: Gee, 1995);Hampel Committee, Reportof the Committeeon Corporate
Governance (London: Gee,1998).
3 D. Higgs, Reviewof the Roleand E¡ectiveness of Non-Executive Directors (London:Stationery O⁄ce,
2003) 11^12; Department of Tradeand Industry,‘‘‘Rewards for Failure’’: Directors’Remuneration ^
Contracts, Performa nce and Severance: A Consul tative Document’ (2003) URN 03/652,5 ^7.
r2007 The AuthorsJournal Compilation r2007 The Modern Law ReviewLimited.
Published by BlackwellPublishing, 9600 Garsington Road,Oxford OX4 2DQ,UK and 350 Main Street, Malden, MA 02148, USA
(2007) 70(5) MLR778^811
holders are much more common.
4
Over the past decade academics have written at
length about why national systems of corporategovernance might, or might not, be
characterised by a separation ofownership and control, with explanations based on
law and politics proving particularly popular.
5
Theprevailingtheoriesdonot
account readily, however, for the separation of ownership from control in Britain.
6
This paper argues the con¢guration of ownership and control in UK public
companies canbe explained at least partly by a variable largely overlooked in the
relevant academic literature, namely tax. Some others have suggested such a link.
In the late1950s,Walter Brudno, a US law professor writing about the e¡ects of
tax on business in theUK, speculated that tax was contributing to the separation
of ownershipand control occurringat the time.
7
Morerecently, economists Alex-
ander Dyck and Luigi Zingales have shown thatamong factors likely to in£uence
private bene¢ts ofco ntrol ^ a key incentive for blockholding in public companies ^
tax, measured by compliance rates, has considerable explanatory power.
8
Generally, though, little has been said about the impact tax regulation has on the
con¢guration of share ownership in large ¢rms.
9
Tax in fact helps to explain how ownership separated from control in the UK
when conditions, theoretically speaking, were notparticularly favourable. In par-
ticular, tax factors help to answer three core questions that must be addressed to
understand whyownership separates from control in a particular country: Firstly,
why did those owning large blocks of shares want to exit; secondly why were
investors willing to buy the shares available for sale? and thirdly why did the
new investors fail to exercise controlthemselves? Tax does not in isolation explain
whyownership separated fromcontrol in the UK. It was, however, a signi¢cant
enough part of t he story to merit further a nalysis.
The ¢rst two sections of the paper set the scene, with the ¢rst providing the
relevant chronologyand the second indicating that the current literature on com-
parative corporate governance doesnot explain satisfactorily why the widely held
company became dominant in Britain. The third section outlines how tax pro-
vided blockholdersin the UKwith incentivesto exit, the fourthdiscusses how tax
in£uenced the demand for shares from potential investors and the ¢fth describes
how tax potentially might have deterred activismby Britain’s institutional inves -
tors.The concluding section argues the paper’s insights concerning tax and own-
ership structure are potentiallyof general application rather than being restricted
to a particular historical context.
4 For data, see C.van der Elst, ‘TheEquity Markets, Ownership Structures and Control:Towards
an International Harmonization?’in K. J. Hopt and E.Wymeersch(eds), CapitalMarketsand Com-
panyLaw (Oxford: Oxford University Press,20 03)3, 7^16.
5 See, forexample, R. La Portaet al,‘InvestorProtection and Corporate Governance’(2000) 58 J Fin
Econ 3. (law); M. J. Roe, Political Determinants of Corporate Governance: Political Context, Corporate
Impact (Oxford:Oxford University Press,20 03)(politics).
6 J. Armour B. R. Che⁄ns and D.A. Skeel,‘CorporateOw nership Structurea ndthe Evolution of
Bankruptcy Law:Lessons from the United Kingdom’(2002) 55 Vanderbilt L Rev1699, 1714^1720.
7 W. W. Brudno,‘The E¡ects of Taxeson Business Policies and Practices in Great Britain’(1958) 13
J Fin 211, 236.
8 A. Dyck and L. Zingales,‘Private Bene¢ts of Control: An International Comparison’ (2004) 59
JFin537.
9 M. A. Desai etal,‘Theft and Taxes’(20 07) 84 J. Fin Econ. 591,592.
Brian Che⁄ns and Steven Bank
779
r2007 The Authors.Journal Compilation r2007 The Modern Law Review Limited.
(2007) 70(5)MLR 778^811
THE EVOLUTION OF OWNERSHIPAND CONTROL IN THE UK
The United Kingdom shares with theUnited States an‘outsider/arm’s-length’sys-
tem of ownership and control, with ownership in large companies typically
being dispersed among a large number of individuals and institutional interme-
diaries rather than being concentrated in the hands of ‘core investors’ (eg a family)
and with shareholders rarely being poised to intervene and take a hand in run-
ning a business.
10
Though nineteenth century railways anticipated the trend,
11
the UK’s outsider/arm’s-length system of ownership and control took shape pri-
marily during the twentieth century. The number of industrial and commercial
companies quoted on the London Stock Exchange re£ects this, as the ¢gure rose
from 70 in1885 to 571 in1907 and again to1,712 in 1939.
12
There were 4,409 com-
panies quotedon the London Stock Exchange in1963, a ¢gure that haddwindled
to just under 2,000 by 2000.
13
There was clearly some ownership dispersion prior toWorldWar I since there
were some examples of companies with a few thousand shareholders and since
companies seeking to have a class of shares quoted on the London Stock
Exchange had to o¡er a minimum of two-thirds of that class to the public.
14
The available empirical data suggests, however, that original proprietors of pub-
licly quoted companies typically retained signi¢cant blocks of shares and the
companies often continued to be managed and owned on a local basis.
15
The
investor base was usually composed of friends and regional business contacts,
likely in combinationwith wealthy clients of well-connected stockbrokers, such
as successfulmerchants and aristocratic landownersseeking to spread their invest-
ments due to falling rental incomes.
16
During the years between World War I and World War II share ownership
became commonplace among a considerably widercircle of investors, in particu-
10 Armour et al, n 6 a bov e 170 4, 1715 , 1750 ^17 52.
11 T. R. Gourvish, ‘Railways 1830^70: The FormativeYears’ in M. J. Freeman and D. H. Aldcroft
(eds),Transportin Victorian Britain (Manchester: Manchester University Press,1988) 57, 83.
12 J. Franks, C. Mayerand S. Rossi,‘Spending Less Time with the Family: The Decline of Family
Ownership in the United Kingdom’ in R. K. Morck (ed),A History ofCorporateGovernanceAround
theWorld (Chicago: Universityof Ch icago Press,20 05)581, 587^588.
13 ibid.
14 L. Hannah,‘The Divorce of Ownership from Control from 1900: Re-calibrating Imagined Glo -
bal Historical Trends’ (2007) CIRJE Discussion Paper20^26.
15 H.W.Macrosty,‘BusinessAspects of BritishTrusts’ (19 02) 12Econ J 3 47, 351,353 (of 51multi-¢rm
amalgamations carried out between 1896 and 1902 that issued shares to the public, the vendors
retained all of the voting shares in 22 instances and a third or more of the shares in 13 instances);
J. Franks, C. Mayer and S. Rossi,‘Ownership:Evolution and Regulation’ (2005) working paper
30^31,Tables 4,10(with a s ampleof 40 companies i ncorporated around1900, manyof which were
publicly traded by1920,the directors owned an average of 49per cent of the shares as of 1920 and
the proportion of ordinaryshareholders living within si x miles of the city ofi ncorporation as of
1910was 56 per cent).
16 J. B.Je¡reys, BusinessOrganisationin Great Britain1856^1914 (NewYork: Arno Press,1977) 329^330,
339^340,359^362, 373, 401,409^10; P. L. Cottrell, IndustrialFinance 1830^19 14 (Lo ndon:Methuen,
1980) 153^154; J. Armstrong,‘The Rise and Fall of the Company Promoterand the Financing of
British Industry’ in J. -J. van Helten and Y. Cassis (eds), Capitalism in a MatureEconomy: Financial
Institutions, Capital Exportsand British Industry,18 7 0 ^1939 (Aldershot UK: Edward Elgar, 1990) 115,
121^122.
Corporate Ownership and Control in the UK
780 r2007 The Authors. Journal Compilation r2007 The Modern Law ReviewLimited.
(2007) 70(5)MLR 778^811
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