Capital Lock-in Research Articles

From few large to many small investments: lessons for adaptive irrigation development in an uncertain world

Conventional approaches to irrigation development involve large lumpsum investments in big infrastructure that cannot adapt to changing climate and socio-economic conditions. There is an urgent need for alternative ways of investing in smallholder irrigation in Sub-Saharan Africa (SSA) that are adaptive and avoid capital lock-in. Adaptive Investment Pathways (AdIP), inspired by the Dynamic Adaptive Policy Pathways (DAPP) concept, proposes stepwise investments to support smallholder irrigation development. AdIP builds resilience to future shocks through dynamic and flexible investment plans instead of investing in single static solutions. To develop an empirical grounding for operationalizing AdIP, we draw lessons from three case studies representing different stages of irrigation development along shallow sand river aquifers in Kenya and Zimbabwe. We retrospectively analyse the nature of investments at farm and landscape scales, and the type of risks and opportunities that farmers respond to. We find that in face of risks, farmers diversify their livelihoods, make small investments incrementally especially in response to opportunities and risks created by external triggers, and pause or reorient activity when they reach saturation points, i.e., biophysical or socio-political limits to their development objective, here irrigation development. Governments and external agencies can support smallholder irrigation development in SSA through targeted landscape scale investments that address saturation points faced by smallholders. This requires a robust participatory monitoring framework to identify and respond to saturation points, and a re-thinking of financing mechanisms which do not measure progress against a fixed schedule of investments, but instead measure continuous progress towards the development objective.

Creating a New Legal Form: The GmbH

The most common business enterprise form in Germany today is the Gesellschaft mit beschränkter Haftung (GmbH). The GmbH offers entrepreneurs the flexibility of a partnership combined with limited liability, capital lock-in, and other traits associated with corporations. Authorized in 1892, the GmbH appeared during a period of ferment in German enterprise law and was an early example of the private limited-liability company prevalent in many economies today. The new form reflected challenges created by the corporation reform of 1884, problems in German colonial companies, and the view that British company law had put German firms at a competitive disadvantage. Significant sections of the financial and legal community harbored strong reservations about this legal innovation.

Creating a New Legal Form: The Gmbh

The most common business enterprise form in Germany today is the Gesellschaft mit beschrankter Haftung (GmbH). The GmbH offers entrepreneurs the partnership’s flexibility combined with limited liability, capital lock-in, and other traits associated with corporations. Earlier enterprise forms such as the partnership and corporation were codified versions of longstanding practice; the GmbH, on the other hand, was the lawgiver’s creation. Authorized in 1892, the GmbH appeared during a period of ferment in German enterprise law and was an early example of the “Private Limited-Liability Company” (PLLC) prevalent in many economies today. This paper traces the debates and the legislative process that led to the GmbH’s introduction. The new form reflected challenges created by the corporation reform of 1884, problems in German colonial companies, and the view that British company law had put German firms at a competitive disadvantage. Many new enterprises adopted the GmbH, but significant sections of the financial and legal community harbored strong reservations about this legal innovation.

Capital Lock-in, Liquidity, and the Separation of Ownership and Control

Who should own firm assets, the collection of investors or a distinct legal entity? In a partnership, individual investors own firm assets and retain the right to unilaterally withdraw their capital at will. If, instead, firm assets are owned by a distinct legal entity (the corporation), investors implicitly waive this right, locking capital in the firm. Capital lock-in facilitates long-term investments but carries a risk of inefficient continuation of unprofitable projects. Withdrawal at will can lead to the inefficient liquidation of profitable projects. In this paper I provide a theory of the capital lock-in and the choice of organizational form.

How Universal is the Corporate Form? Reflections on the Dwindling of Corporate Attributes in Brazil

The business corporation, a central pillar of modern capitalism, is deemed to have a set of defining features that are universal across different jurisdictions and ever more widely available. However, a close examination of legal developments in Brazil, one of the world’s largest economies, shows a surprisingly different picture. In the past decades, Brazil has significantly watered down all of the canonical elements of the corporate form, including limited liability and capital lock-in. After describing this phenomenon, I analyze it in view of efficiency and distributional considerations. In particular, I put forward the possibility that the blurring of the corporate attributes may be a second-best response to a weak institutional environment, which, among other things, fails to protect minority investors and curb externalities through regulation. The Article concludes by examining how the erosion of the corporate attributes in Brazil subverts our conventional understanding about the evolution of corporate law and the immutability of the corporate form.

Ernst Freund as precursor of the rational study of corporate law

AbstractThe rise of large business corporations in the late 19th century compelled many American observers to admit that the nature of the corporation had yet to be understood. Published in this context, Ernst Freund's little-knownThe Legal Nature of Corporations(1897) was an original attempt to come to terms with a new legal and economic reality. But it can also be described, to paraphrase Oliver Wendell Holmes, as the earliest example of the rational study of corporate law. The paper shows that Freund had the intuitions of an institutional economist, and engaged in what today would be called comparative institutional analysis. Remarkably, his argument that the corporate form secures property against insider defection and against outsiders anticipated recent work on entity shielding and capital lock-in, and can be read as an early contribution to what today would be called the theory of the firm.

The Emergence of the Corporate Form

The Dutch East India Company (VOC) is generally viewed as the first modern corporation, yet its 1602 charter did not introduce all features of legal personality. A detailed historical analysis reveals how its statute proved inadequate to sustain the massive military investment needed to secure a strong trade position in Asia. In response, legal innovations were introduced in the subsequent twenty years. In 1612, state intervention overruled shareholder rights and created capital lock-in. The associated loss of control by shareholders was ultimately compensated by long-term profits, as the escalated commitment to Asia allowed the VOC to outperform its competitors. Once capital became permanent, VOC directors needed and gained the final corporate feature of general limited liability in 1623. We argue that this transition could be achieved while preserving private interests because the Dutch Republic’s limited form of government protected long term private capital, while autocratic colonial powers maintained a royal monopoly on colonial trade. The English East India Company adopted the much-admired Dutch model only half a century later, as the crown became subject to parliamentary control. By then the Dutch grip on South-East Asia had become entrenched, leading its competitors to focus elsewhere.

Ernst Freund as Precursor of the Rational Study of Corporate Law

The rise of business corporations in the late nineteenth century compelled many American observers, including leading economists and lawyers, to admit that the nature of corporations had yet to be understood. In this context, Ernst Freund’s (1897) little-known The Legal Nature of Corporations represented not just an original attempt to come to terms the a new legal and economic reality but also what can best be described, to paraphrase Oliver Wendell Holmes, as the earliest example of the “rational study” of corporate law. This paper proposes the first systematic assessment of Freund’s corporate theory, showing that Freund had the mind of an institutional economist and engaged in what today would be called comparative institutional analysis. Remarkably, Freund’s argument that the corporate form secures property both against insider defection and against outsiders anticipated recent work on entity shielding and capital lock-in associated with Henry Hansmann, Margaret Blair and others.

Capital reduction case law decisions and the development of the capital maintenance doctrine in late-nineteenth-century England

Incorporation with limited liability enabled companies to ‘lock-in’ their financial capital’ and then invest in the long-term, highly specific investments on which the modern industrial economy would be based. The level of benefit varied from country to country, according to the way that the concept of capital lock-in, or maintenance, was defined in the legal systems concerned.In the UK, the concept was not well defined in early company legislation and challenges were raised through the courts during the late nineteenth century. Some of these, the ‘dividend cases’, have been quite widely considered in the literature but direct reductions of share capital, or capital reduction schemes, have received far less attention, even though they raised fundamental issues concerning long-term dividend positions, the accounting treatment of accumulated losses, depreciation and asset values and had important effects on the development of the capital maintenance doctrine and on shareholder class rights.The purpose of this paper is to question whether this literature adequately captures judicial influences on the development of the capital maintenance doctrine in England during the latter part of the nineteenth century, given the limited attention that has been paid to date to the leading capital reduction cases.

Uncorporating the Large Firm

This article examines private equity firms as an example of partnership-type, or uncorporate, structures in the governance of large firms. Other examples include publicly traded partnerships, real estate investment trusts, hedge funds and venture capital funds. These firms can be seen as an alternative to the corporate form in dealing with the central problem of aligning managers' and owners' interests. In the standard corporate form, shareholders monitor powerful managers by voting on directors and corporate transactions, suing for breach of fiduciary duty and selling control. These mechanisms deal with managerial agency costs by relying on other agents, including auditors, class action lawyers, judges, independent directors and shareholder intermediaries such as mutual and pension funds. Uncorporations substitute other devices for corporate-type monitoring, including more closely tying managers' economic well-being to the firm's fortunes and greater assurance of distributions to owners. Continued concerns with managerial agency costs, the inadequacy of regulatory responses such as the Sarbanes-Oxley Act, changing costs and benefits of public ownership, leverage and capital lock-in all contribute to the rise of uncorporate structures in large firms. Political considerations may, however, constrain these developments.

Firm Governance as a Determinant of Capital Lock-In

This paper has two main components: methodological and substantive. Methodologically, it develops a new way of measuring and coding contractual, statutory, and regulatory variables through series of Monte-Carlo simulations. Substantively, it tests whether the extent to which a firm locks in its capital is related to the level of agency costs. In a study of lock-in choices of venture capital funds, I find that the degree of capital lock-in is inversely related to several measures of expected agency costs. Better venture organizations (the ones with fewer failed and more succeeded companies) lock their capital more tightly, as do funds where managers' compensation is more heavily based on performance and funds that employ alternative governance devices.

Should History Lock in Lock-In?

The corporation does not allow owners, at least by default, to cash out their interests. This feature of facilitates durable and centralized management of corporate assets. It has been argued that capital lock-in is what has made the corporation the dominant business form and has enabled the modern firm. This argument for the historical significance of capital lock-in is intended to provide a rationale for rejecting reforms that would compromise lock-in. However, lock-in has costs, including inhibiting effective monitoring of managers. Moreover, the historical argument is inaccurate, since lock-in has always been available in the partnership form. Lock-in should be viewed as just one of many features of firms that evolve to meet business needs, not frozen in place by a dubious account of the past.

Property to Market: The Transformation of Business Investments in Emerging Markets

The transformation of business interests into liquid assets is a critical step in the development of a market economy. How ownership interests came to be commodified can be studied in 19th century American businesses and capital markets. This commoditization of ownership interest solved the twin problems of capital lock-in and liquidity that had heretofore dogged partnerships and small corporations. The bringing of these new property interests to market is the subject of this essay. This paper focuses on the transition from physical, tangible investments to intangible investments represented by stocks and bonds in American 19th century capital markets. At the beginning of the century, America was a nation largely of subsistence farmers and small businessmen. The businesses that were conducted were predominantly small affairs, usually sole proprietorships and partnerships. While, at law, partnerships interests are intangibles, the assets of the business, its operation, management, and liabilities were tangible indeed. That was one of the charms and, ultimately, one of the critical defects of such enterprises. Early 19th century investors, even corporate investors in mills and small factories, thought in tangible terms and saw themselves intimately connected with the business. That connection provided a sense of security, control and safety. It also severely limited size and sources of capital. Fortunately, as a consequence of sound fiscal and monetary policies, America possessed a strong government bond market. Wall Street provided liquidity and investor experience with intangible securities, the Hamilton 6s and other federal bonds. State changes in corporate laws permitted general incorporation (making incorporation relatively easy). The capital demands of railroads, required to link the agrarian hinterlands with the cities of the Atlantic Coast and Europe, necessitated the corporate form. Modern management pioneered by the Erie and the Boston & Albany railroads substituted for hands on control. Boston & Albany stockholders, and later investors in other railroads and gigantic businesses, quickly accepted the corporate form and widely dispersed holdings, notwithstanding the apparent loss of control. These venturers accepted the loss of control because the emerging markets provided paradoxically two additional critical features: a lock-in for capital, thus avoiding the partnership hold-up problem, and liquidity. These important features of the market gave investors greater confidence. This confidence, in turn, fueled greater investment, lowering the cost of capital, producing greater growth and strengthening the demand for more intangible investments.

On the Nature of Corporations

Legal experts traditionally distinguish corporations from unincorporated business forms by focusing on such corporate characteristics as limited shareholder liability, centralised management, perpetual life, and freely transferred shares. While this approach has value, this essay argues that the nature of the corporation can be better understood by focusing on a fifth, often-overlooked, characteristic of corporations: their capacity to “lock in” equity investors’ initial capital contributions by making it far more difficult for those investors to subsequently withdraw assets from the firm. Like a tar pit, a corporation is much easier for equity investors to get into, than to get out of. An emerging school of theorists has begun to explore the implications of this idea for corporate law and practice. The idea is still novel enough to lack a uniformly- accepted label—in addition to the phrase “capital lock-in,” scholars have described this aspect of incorporation as “affirmative asset partitioning,” “the absence of a repurchase condition,” and “asset separation from shareholders.” Whatever label one chooses, the idea shows great promise for illuminating a variety of thorny problems that have long troubled corporate scholars and practitioners. In illustration, this essay considers how the idea of capital lock-in sheds light on three corporate mysteries in the United States: the sui generis nature of corporate directors’ fiduciary duties; the rise of the large modern service partnership; and lawmakers’ enthusiasm for meddling with corporate governance rules.

On the Nature of Corporations

Legal experts traditionally distinguish corporations from unincorporated business forms by focusing on such corporate characteristics as limited shareholder liability, centralized management, perpetual life, and freely transferred shares. While this approach has value, this essay argues that the nature of the corporation can be better understood by focusing on a fifth, often-overlooked, characteristic of corporations: their capacity to lock in equity investors' initial capital contributions by making it far more difficult for those investors to subsequently withdraw assets from the firm. Like a tar pit, a corporation is much easier for equity investors to get into, than to get out of. An emerging school of theorists has begun to explore the implications of this idea for corporate law and practice. The idea is still novel enough to lack a uniformly-accepted label - in addition to the phrase capital lock-in, scholars have described this aspect of incorporation as affirmative asset partitioning, the absence of a repurchase condition, and asset separation from shareholders. Whatever label one chooses, the idea shows great promise for illuminating a variety of thorny problems that have long troubled corporate scholars and practitioners. In illustration, this essay considers how the idea of capital lock-in sheds light on three corporate mysteries: the sui generis nature of corporate directors' fiduciary duties; the rise of the large modern service partnership; and lawmakers' enthusiasm for meddling with corporate governance rules.