Policy debates about business reforms invariably rely on one big assumption: the basic mechanism of the public company has malfunctioned, and corrective regulation will help safeguard the interests of shareholders and the public. Look no further than the current financial-reform bill, with its plethora of new rules aimed at correcting incentive mismatches that led to excessive risk taking at big, publicly traded Wall Street firms. Or the debates on health care reform, where the initial political impulse was to impose a government option to rein in “greedy” publicly traded health insurers.
An emphasis on regulating the behavior of public companies is understandable: their steady spread across the US business landscape since the 18th century, partly in response to the capital demands of widespread industrialization, conveys an impression that they are the natural form for large enterprises. Yet throughout much of modern corporate history, other ownership structures, such as mutuals, partnerships, and cooperatives, also played a prominent role, coexisting with the joint stock company. These structures represent an alternative for tailoring ownership and governance to the risks and operating profiles of specific economic sectors. They might offer regulators cheaper and more effective ways of limiting financial crises and industry implosions. Some entrepreneurs may even find them a better way to raise capital and manage the risks of new businesses.
The financial-services industry is a stunning example of recent and dramatic change in the prevailing corporate form. From the 18th century up through at least 1970, many savings and loans, investment banks, and insurance companies were organized as mutuals, partnerships, or joint stock–mutual hybrids (exhibit). The business models of insurers (fire, health, life, livestock, and marine) and of savings institutions (savings banks and societies, savings and loans) were characterized by long-term contracts and asymmetries between what proprietors and customers knew about the risks of doing business with one another. These conditions were well suited to mutual charters stipulating that customers should own the organization and often entrusting their aggregated interests to independent sales agents.
Similarly, policy makers in the late 18th and the 19th centuries forced many mercantile houses, broker–dealers, and investment banks to remain partnerships or sole proprietorships. They worried about “agency costs” in these businesses: skilled salaried managers with good information could defraud their companies, customers, and shareholders by trading on their own account and engaging in other forms of self-dealing. To keep the incentives of such firms aligned with those of society, managers had to be owners, and their ownership stakes had to be illiquid and constitute a large percentage of their net worth.
These views remained accepted wisdom until recently. In the 1970s and ’80s, however, mutuals lost their grip on the savings-and-loan and insurance industries, and by 2005 all the major US investment banks had gone public. This phenomenon was not confined to the United States. British building societies, for example, demutualized thanks to regulatory changes pursued by the Conservative governments of the 1980s. The transition’s causes, too complex to detail here, are no doubt related to largely positive shifts—toward a world of more liberal markets, more deeply integrated global financial systems, and faster, cheaper communications and information processing.
Yet subsequent challenges, including the US savings-and-loan crisis of the 1980s and the global financial crisis of 2008, raise the question of unintended consequences. The recently passed US financial-reform act suggests that there’s little appetite among policy makers for a broad restoration of organizational diversity. But more limited goals may be useful. Policy makers looking for sustainable ways to contain agency problems in the finance industry, for example, could design incentives that promote mutuals or partnerships when public companies divest units or form joint ventures. Life and property-and-casualty insurers that have struggled as joint stock companies could remutualize.
Private equity—which at its best is rooted in the beneficial alliance of management incentives and investor interests—also could play a role in encouraging diverse ownership structures. And at the grassroots level, would-be microfinanciers and community bankers should seriously consider mutual forms, such as credit unions, that accommodate social goals more readily than joint stock companies do. Modest steps such as these toward a broader portfolio of organizational forms might help rebalance risk and reward in these volatile times.