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The Effect of the Bubble Act on the Market for Joint Stock Shares

Published online by Cambridge University Press:  03 March 2009

Margaret Patterson  and
David Reiffen
David Reiffen
Affiliation:
Margaret Patterson is a graduate student in the Department of Economics at University of California, Los Angeles, CA 90024. David Reiffen is an economist at Capital Economics, 1730 Pennsylvania Avenue, NW, Washington, D. C. 20006. The authors would like to thank David Glasner and Randy Kroszner for their insightful commentary.
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Type
Notes and Discussion
Information
The Journal of Economic History , Volume 50 , Issue 1 , March 1990 , pp. 163 - 171
Copyright
Copyright © The Economic History Association 1990

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References

1 It was, more precisely, “An Act to Restrain the Extravagant and Unwarrantable Practice of Raising Money by Voluntary Subscription for Carrying on Projects Dangerous to the Trade and Subjects of the Kingdom”. DuBois, A. B., The English Business Company After the Bubble Act, 1720–1800 (New York, 1938), p. 2.Google Scholar

2 See Amsler, Christine E., Bartlett, Robin L., and Bolton, Craig J., “Thoughts of some British economists on early limited liability and corporate legislation”, History of Political Economy, 13 (Winter 1981), p. 776Google Scholar; Malkiel, Burton G., A Random Walk Down Wall Street (1st edn., 1973; 4th edn., New York, 1985), p. 37Google Scholar; Shannon, H. A., “The Coming of General Limited Liability”, Economic History, 2 (01 1931), p. 268.Google Scholar

3 Butler, Henry N., “General Incorporation in Nineteenth Century England: Interaction of Common Law and Legislative Processes”, International Review of Law and Economics, 6 (12 1986), p. 172. Also see fn. 39 below.CrossRefGoogle Scholar

4 Mirowski, Philip, “The Rise (and Retreat) of a Market: English Joint Stock Shares in the Eighteenth Century”, this JOURNAL, 41 (09 1981), pp. 559–77.Google Scholar

5 Ibid., p. 577.

6 While Mirowski acknowledges that the decline in the market coincides with the duration of the Bubble Act, he contends that the Act was not responsible for it. He supports this view by citing the lack of enforcement of the Act and concludes, “One cannot have it both ways: an ineffectual Bubble Act cannot sabotage a dynamically expanding market”.Google ScholarIbid.

7 For Acts of Parliament, see Holdsworth, William, A History of English Law (New York, 1922–1926), vol. 8, pp. 211,212, 218Google Scholar; and for royal charters, see ibid., p. 209.

8 Examples of direct payments to the Crown and Parliament abound in Scott's, W. R.The Constitution and Finance of English, Scottish, and Irish Joint Stock Companies to 1720 (Cambridge, 1912), see vol. 1, pp. 242, 324, 366, 408; vol. 2, pp. 156–57; vol. 3, p. 315.Google Scholar In addition to initial payments and specified royalties, both Parliament and the Crown extracted loans from corporations (ibid., vol. 1, p. 237). The government also borrowed heavily during the protectorate (ibid., vol. 1, p. 258). Other examples of payments for charters are cited in Butler “General Incorporation in Nineteenth Century England”, p. 171; and Holdsworth, A History of English Law, pp. 208–9.Google Scholar

9 Scott, Constitution and Finance of … Joint Stock Companies, vol. 3, p. 332; see also fn. 7.Google Scholar

10 Scott, Constitution and Finance of … Joint Stock Companies, vol. 3, p. 344.Google Scholar

11 More generally, as discussed below, the grantor of corporate status could be the Crown or Parliament. At the loss of some accuracy but to avoid cumbersome language, we use the term Parliament to signify the grantor of corporate status.Google Scholar

12 The exception to this was “Letters Patent and grants of privileges for terms not exceeding fourteen years, for the working or making of new manufactures within the realm, in favor of the true and first inventors thereof” (Jenks, Edward, A Short History of English Law [Boston, 1913], p. 129). That is, the Act specifically made exceptions of new patents and nondomestic commerce. In both cases the exceptions encouraged innovation—either technological or geographical—but did not create monopolies in otherwise competitive industries.Google Scholar

13 In Selected Charters of Trading Companies (London, 1913), Cecil Carr details 22 non. monopoly charters granted between 1660 and 1707 (and 19 charters granted before 1660). Of the 22, 6 were trading companies, and I was involved in a domestic activity requiring a charter. Most of the remainder involved either new technology or mining. Carr notes that his study of 41 charters “omits many interesting charters that have already been printed” (p. i). These include the East India Company, some of the Levant charters, and many of the American plantation charters. It appears that most of the omitted charters involved overseas trade.Google Scholar

14 DuBois, The English Business Company, p. 91, notes that 21 years was a common fixed life span for corporate charters. In Selected Charters, Carr states that “there are exceptions to the rule that a corporation is ‘immortal’ … there were cases where exclusive powers were conceded of such an unusual or experimental nature as to require periodic revision … where it was felt necessary to keep a tight hand over the company, charters which imposed no time limit often contained provisions for termination upon warning from the Crown” (p. 15).Google Scholar

15 Another explanation for short-term charters relates to Parliament's ability to commit to a long-term charter. That is, once a payment is made for a charter that is thought to be exclusive, Parliament could turn around and issue additional charters to competing firms, at some lower price. This means that unless Parliament could credibly commit itself to limiting the number of charters, a rational petitioner would not pay a price reflecting the perpetual right to, for example, a particular trade route. It seems unlikely that Parliament, being an elected body, would be in a position to make such a commitment. For example, following the Glorious Revolution of 1688 Parliament ignored the charter of the East India Company and auctioned the rights to a monopoly of trade with East India to anyone who was willing to subscribe to a loan of £2,000,000 to the state; see Scott, The Constitution and Finance of … Joint Stock Companies, vol. 1, p. 324. Even the Crown could not make such a commitment, as it was not uncommon for one monarch to revise or ignore the promises made in a charter by a predecessor. Indeed, when faced with changed circumstances a monarch might reverse him- or herself. The experiences of the Civil War, the Protectorate, the Restoration, and the Glorious Revolution no doubt convinced companies that promises made in corporate charters were only as durable as the regimes that created themGoogle Scholar; see ibid., pp. 238, 247, 321–24; vol. 2, pp. 112–14. See also Coase, Ronald, “Durability and Monopoly”, Journal of Law and Economics, 15 (04 1972), pp. 143–49CrossRefGoogle Scholar; and Bulow, J. I., “An Economic Theory of Planned Obsolescence”, Quarterly Journal of Economics, 10 (11 1986), pp. 729–49, for analyses of the issue of the credibility of the commitment in the context of a durable-good monopolist.CrossRefGoogle Scholar

16 Holdsworth, A History of English Law, vol. 9, p. 55.Google Scholar

17 Ibid., p. 48.

18 Gower, L. C. B., Principles of Modern Company Law (London, 1979), p. 22.Google Scholar

19 Ibid., p. 28, fn. 28.

20 Butler, “General Incorporation in Nineteenth Century England”, p. 171.Google Scholar

21 Ibid.

22 DuBois, The English Business Company, p. 34.Google Scholar

23 Butler, “General Incorporation in Nineteenth Century England”, p. 171. DuBois, The English Business Company, p. 2, claims that in fact unincorporated joint-stock companies entering the bull market were more numerous than either incorporated companies or companies seeking corporate status. That unincorporated joint-stock companies found it to their liking to raise new issues in this bull market bears emphasis, as investors in such companies were subject to unlimited liability for the debts of their companies.Google ScholarCooke, C. A., Corporation, Trust and Company (Cambridge, MA, 1951), notes that in the wake of the stock manipulations by the Board of the South Sea Company, “it seemed suddenly to become a widely held belief that to subscribe to a capital fund was to become rich. The belief was based more on the upward movement of the stock markets than on any thoughts of probable earning powers. When merely to hold shares was to become richer, money was available for any sort of scheme” (p. 18). The problems associated with the threat of dissolution inherent in partnership was apparently mitigated by the rise of the trustee device, under which ownership rights to the property of the partnership were vested in trustees.Google Scholar

24 Some of the purposes for which capital funds were raised at that time were “to make salt water fresh”, “for fatting of hogs”, “for a wheel of perpetual motion”, “for importing Jackasses from Spain”, and “for an undertaking which shall in due time be revealed”. Cooke, Corporation, Trust, p. 81.Google Scholar

25 Limited liability could be acquired only by Special Act of Parliament, and hence not all corporations had limited liability. It was only later in the eighteenth century that legal opinions evolved to the point where corporations possessed limited liability unless Parliament specified unlimited liability.Google Scholar

26 Scott, The Constitution and Finance of … Joint Stock Companies, vol. 1, p. 304. The government would be unlikely to permit the widespread issuance of debt instruments that could compete with their own bonds.Google Scholar

27 Scott (ibid., pp. 305, 381, 477) notes the dearth of failures due to problems with debt financing. Usury laws offered one important constraint on the use of debt financing. If the legal maximum interest rate was below the risk-adjusted rate for a specific firm, it would be difficult to write contracts that did not violate the usury laws, yet were sophisticated enough to guarantee the right risk-adjusted rate. Not surprisingly, the development of debenture bonds for the financing of fixed capital has been traced to the quarter century after the 1855 introduction of general limited liability and the 1854 repeal of usury laws. See Jeffrey, James B., Business Organization in Great Britain, 1856–1914 (New York, 1977), pp. 241, 251–52.Google Scholar

28 During the seventeenth century the extent to which liability was truly limited for an incorporated, profit-making venture was at best uncertain. Shareholders typically invested in corporations “on subscription”, with initial payments equal to as little as I percent of the nominal value of a share. Their subscription purchase obligated them to provide the balance upon the corporation's call and thus could be attached by creditors of the firm. This meant that the identity of other shareholders was important even for limited liability companies. While it seems curious that companies did not simply limit their liability by setting nominal value equal to their initial payment, such a strategy could be costly. If the company subsequently decided to increase capitalization, a new charter would be required. Hence the distinction between limited and unlimited liability in the seventeenth century was not the crisp one associated with modern companies.Google Scholar

29 Holdsworth, A History of English Law, vol. 8, p. 215.Google Scholar

30 Ibid. Holdsworth documents a variety of corporate charters appropriated in this manner: the York Buildings Company abandoned the business for which it had received a charter in 1691 and in 1719 began a different business; the charter of a company formed in 1691 was sold at least twice in the resale market; a mining company charter was sold to an insurance company.

31 Ibid., p. 220.

32 DuBois, The English Business Company, p. 3.Google Scholar

33 Holdsworth, A History of English Law, vol. 8, p. 220.Google Scholar

34 By this time it was understood that a charter or act of incorporation conveyed limited liability unless unlimited liability was explicitly stipulated; see ibid. and Dubois, The English Business Company, pp. 34, 236. Also, at p. 40, DuBois notes that at about this time, restraints in the articles of association of unincorporated joint-stock companies with regard to transfer of shares became less common. One interpretation of this is that the Crown recognized that large partnerships required increased alienability of shares to work effectively.

35 DuBois, The English Business Company, p. 236. Although DuBois's work is limited to the period from 1720 to 1800, the conditions he described for the second half of the eighteenth century appear to have persisted until the repeal of the Bubble Act in 1825.Google Scholar

36 Ibid., p. 11.

37 Pengelley was consulted in relation to the Act's scope in connection with at least 27 organizations in the year immediately following the Act's passage. See ibid., p. 4.

38 Even those undertakings established prior to June 24, 1718, were not safe from legal action; see Holdsworth, A History of English Law, vol. 3, p. 220.Google Scholar Corporations trading under obsolete charters, or those trading in a manner not allowed by their charters prior to that date, were still liable to legal proceedings under the common law. Indeed, in 1720 the South Seas Company instigated legal proceedings against some of those companies (ibid., p. 216).

39 Cooke, Corporauon, Trust, p. 83. Cooke notes that forcing certain firms out of business may have caused the collapse of the market which occurred subsequent to the Act's passage. Ascertain firms' stock became valueless, “in many cases … loans [were] raised on that stock. Other stocks came on the market to meet this indebtedness and a general wave of selling followed”.Google Scholar

40 DuBois, The English Business Company, p. 4.Google Scholar