The Economist has some important recognition of the uncorporation, written by its Schumpeter columnist, who is Adrian Wooldridge. Wooldridge co-wrote with John Micklethwait an important little book called The Company. The article begins, in the spirit of Wooldridge’s book, by noting that “for most of the past 150 years public companies have swept all before them.” But then it asks: “is the sun finally setting on the public company?”:
Private partnerships are . . . on the march. A succession of legal changes in the United States—starting with a law in Wyoming in the 1970s and culminating in an Internal Revenue Service ruling in 1996—made life easier for them. * * *
The result has been a revolution among small and mid-sized businesses in America. Larry Ribstein, a professor of law at the University of Illinois, calculates that about a third of American businesses large enough to file tax returns are now organised as partnerships or what he calls “uncorporations”. Plenty of big businesses, too, are shunning the stockmarket, with its costly reporting requirements and impatient investors. Publicly traded partnerships and real-estate investment trusts mix and match features from corporations and uncorporations. * * *
The most fashionable investment vehicles—leveraged buy-out firms, hedge funds and venture-capital funds—are spearheading the “uncorporate” revolution. * * * Corporate raiders often raise money by creating funds in the form of partnerships. Their targets are often restructured as partnerships. This makes managers behave like owners rather than hired hands * * * Venture capitalists make money in the long term by lending their names and expertise to start-ups. Hedge funds and venture-capital firms also make money in their different ways by getting fund managers to behave more like partners, with “skin in the game”, as the modish phrase puts it.
So where does this leave the public company? * * *
[P]rivate companies have disadvantages that will hamper their growth. They lack public firms’ rigorous systems of corporate governance and financial reporting. They depend too heavily on borrowing: many drank themselves silly during the credit boom and now have throbbing heads. * * *
In fact, the public and private models of ownership have a symbiotic relationship. The reward for those who take a company private often comes when, having revived it, they take it public again. * * * Public companies may have had their confidence shaken in the past few years and their territory shrunken a little. But the organisations that were launched on an unsuspecting world in the mid-19th century still have a healthy spark of life in them.
This article has many of the same ideas as my book, The Rise of the Uncorporation, which my co-blogger Jay Verret kindly put on his list of top ten corporate governance books (no, I didn’t tell him to!). Of course the conclusion suggests that Wooldridge is not ready to let his Company go.
I disagree a bit with Wooldridge’s view of the uncorporation’s disadvantages. Leverage is a corporate, not an uncorporate, problem. As I discuss in my book, large firms borrow in part because most of them can’t get uncorporate tax treatment. So the U.S. tax system basically feeds business to its bankruptcy courts. While non-public uncorporations are subject to lower financial reporting standards, as I discuss in my book, this represents a tradeoff between uncorporate disciplines (like those Wooldridge notes) and corporate-style monitoring mechanisms.
But I agree with Wooldridge that the future will make room for both of these business forms. In the heart of the financial crisis I wrote a symposium article, just now published, called The Uncorporation’s Domain, which reflects on this future. Here’s the abstract:
This Article describes firms’ current choice between the corporate and uncorporate governance forms. This choice depends on firms’ demand for flexibility, the effectiveness in particular situations of corporate-type monitoring, and the suitability of uncorporate mechanisms of controlling agency costs. The Article suggests that, although the corporation likely will continue to be important for many large firms, uncorporate business forms are likely to become more important for a wide variety of firms. Tax, regulatory, and economic developments will determine the speed but not the existence of the trend.
Dodd-Frank imposed some constraints on uncorporations, particularly including hedge fund registration. I anticipated that sort of thing in the article and my book, written around the same time. However, I concluded that the uncorporation’s flexibility and the problems with corporate governance will make it difficult to keep a lid on the uncorporation. I haven’t seen anything so far to make me question this conclusion.
Brown Brothers Harriman did not get into trouble in the real estate bubble, perhaps because they were investing their own money.
If more capital moves towards uncorporations, where does this leave the small investor? By preference or law, these uncorporations typically only accept investments from individuals with substantial net worth.
Does this mean the small investor will be stuck with publicly traded funds thatinvest in the uncorporations, with the attendant agency problems so clearly visible with fund managers?