The Formation of the East India Company as a Cooperation-Enhancing Institution

Abstract

The transition from personal to impersonal cooperation was essential for the economic rise of Europe. To date, the few studies of the transition to impersonal cooperation which went beyond basic barter or cash exchange, analyzed bilateral credit and agency transactions. This article analyzes the creation of cooperation in a more complex context: that of sustained, multilateral, impersonal, investment cooperation in the context of business organization. This is a micro-study of the formation of the English East India Company [EIC] in 1600. Though it is a study of a single business enterprise, it has far-reaching implications, first because the EIC itself played an important role in a major economic transformation - Europe's take-over of Eurasian trade, and second, because the EIC was the first publicly-held business corporation and a model for later adopters of this organizational form. The article argues that the formation of the EIC can be understood as a means to achieve cooperation between entrepreneurs who aimed at establishing oceanic trade with Asia, and outsider investors who would only cooperate within an institutional framework that would protect their interests vis-a-vis the insiders. The institutional framework had to surmount the need for a long-term enterprise, for a large number of investors, the considerable informational asymmetry, the high risks involved in such oceanic trade and the absence of a share market infrastructure. The EIC offered its outside investors full participation in governance. It obliged insiders to provide information to outsiders on a regular basis. It offered outsiders an exit option at the end of every voyage. By doing so, it shaped the interaction between insiders and outsiders as repeated relations rather than a one-shot contract. This allowed them to restore reputation mechanisms that were lost in the passage from personal to impersonal cooperation. The fine organizational details of the design of the EIC fits the explanation offered here. They do not fit the prevailing public choice explanation, according to which the EIC reflects a deal between the state and the entrepreneurs, of monopoly for money and political service. The EIC was a privately ordered institution. In order to create the corporate entity to be used as a platform for the institution, a charter, rather than a simple contract, was needed from the state. The charter was also a device through which the insiders credibly conveyed to the outsiders their commitment not to unilaterally alter the institutional design.