Description
This paper assesses the eects of Berle and Means' study of the separation of corporate ownership from control on cor-
porate ®nancial reporting theory, research and policy. Their focus on shareholders and managers provided a starting point
for the subsequent development of agency theory such that this relationship has come to dominate capital markets research
and policy, to the virtual exclusion of parallel issues involving other parties. Berle and Means' omission of the role of
investment funds led them to conclude that the separation of ownership from control problems was located between
shareholders and company managers. We document the inaccuracy of this conclusion using historical and contemporary
US evidence and contemporary evidence for Germany, Japan, South Africa, and Canada.
Where Berle and Means went wrong: a reassessment of
capital market agency and ®nancial reporting
Robert Bricker
a,
*, Nandini Chandar
b
a
Department of Accountancy, Weatherhead School of Management, Case Western Reserve University,
622 Enterprise Hall, Cleveland, OH 44120, USA
b
Department of Accounting Information Systems, Faculty of Management, Rutgers University, 94 Rockafeller Road, Piscataway,
NJ 08854, USA
Abstract
This paper assesses the e?ects of Berle and Means' study of the separation of corporate ownership from control on cor-
porate ®nancial reporting theory, research and policy. Their focus on shareholders and managers provided a starting point
for the subsequent development of agency theory such that this relationship has come to dominate capital markets research
and policy, to the virtual exclusion of parallel issues involving other parties. Berle and Means' omission of the role of
investment funds led them to conclude that the separation of ownership from control problems was located between
shareholders and company managers. We document the inaccuracy of this conclusion using historical and contemporary
US evidence and contemporary evidence for Germany, Japan, South Africa, and Canada. In contrast to Berle and Means,
we ®nd that investment fund in¯uence and control over companies is pervasive and probably a common characteristic of
modern capital markets. Our analysis shows how viewing the capital markets setting from a richer, two-tier perspective
involving investors, investment managers, and company managers results in quite di?erent and better perspectives on
®nancial reporting issues, particularly in terms of company reporting to funds, and fund reporting to investors. Conse-
quently, we suggest that our understanding of capital markets may be improved by studying and portraying more diverse
types of parties and their relationships than just managers and owners. This perspective subsumes the single-tier principal-
agent model and allows multiple relationships to be portrayed and studied. #2000 Elsevier Science Ltd. All rights reserved.
1. Introduction
During the past twenty-some years, agency
models have been widely used to portray eco-
nomic relationships between (among others)
shareholders and ®rm managers.
1
In these models,
®rm managers are commonly represented as the
agents of investors, while investment managers are
modeled as ®nancial intermediaries who facilitate
information transfers, investing and monitoring
activities.
2
These basic relationships, which per-
vade much theoretic and applied capital markets
research in accounting and ®nance, can be traced
back to the pioneering work of Berle and Means'
0361-3682/00/$ - see front matter # 2000 Elsevier Science Ltd. All rights reserved.
PI I : S0361- 3682( 99) 00050- 1
Accounting, Organizations and Society 25 (2000) 529±554
www.elsevier.com/locate/aos
* Corresponding author Tel.: +1-216-368-5355; fax: +1-
216-368-4776.
E-mail address: [email protected] (R. Bricker).
1
Watts and Zimmerman (1986) can be consulted for a
review of this literature.
2
For instance, Leland and Pyle (1977) and Ramakrishnan
and Thakor (1984).
Power without property: The rise of the modern
corporation (1932). Berle and Means studied the
development of the corporation and capital mar-
kets, characterized corporate ownership as con-
sisting of dispersed individual shareholders, and
found a separation between ownership and con-
trol functions within operating ®rms.
Berle and Means largely discounted or ignored
investment fund in¯uence and control of ®rms,
and largely for this reason, modern agency theory
3
focuses principally on the implications of the
agency relationship existing between dispersed
shareholders and ®rm managers. Although Berle
and Means can scarcely be faulted for failing to
anticipate the rise of the pension and mutual fund,
their recent emergence and prominence implies an
importance to reassessing the Berle and Means
thesis and the models of corporate in¯uence and
control that have been derived from it.
In this paper, we reassess both operating and
strategic in¯uence and control relationships invol-
ving individual investors, investment funds, and
operating ®rms, using an agency perspective, and
present related reporting and disclosure implica-
tions. To fully incorporate in¯uence and control
functions, we follow Mintz and Schwartz (1985),
among others, who de®ne in¯uence and control in
both strategic and operational terms.
4
We use the
terms ``investment fund'' and ``investment man-
ager'' interchangeably to refer to all sorts of funds
and investing institutions (including mutual funds
and pension funds) which invest aggregated
resources of investors, and their managers. The
term ``investor'' refers to noninstitutional parties,
typically individuals, who place ®nancial resources
in investment funds.
5
Our investigation studies in¯uence and control
over corporations in two time periods: from
approximately 1900 through 1932, and from
approximately 1970 through the present. This ana-
lysis describes the nature and extent of investment
managers' activities in aggregating the resources of
investors, in investing these resources in ®rms, and
in exerting in¯uence and control over these ®rms.
6
We ®nd numerous inconsistencies in the historical
record in terms of characterizations of managerial
control of ®rms and of investment funds as ®nancial
intermediaries, results echoed by contemporary,
empirical studies. These ®ndings show that the
separation of ownership from control does not
necessarily occur between stockholders and man-
agers, due to the presence of investment funds, but
also that a separation of ownership from control
may occur between investment funds and investors.
We conclude on this point that the underlying issue
is one of concentrated versus dispersed interests, and
not one of owners and managers per se. We use
these ®ndings and insights to portray the relation-
ships among individual investors, investment funds,
and company managers in a two-tier structure. In
one tier this involves individual investors and
investment funds, and in the other, investment funds
and ®rms.
7
This structure replaces the traditional
3
It is perhaps odd to realize that agency theory, as applied
to the capital markets, while developing out of Berle and
Means' study, has a quite di?erent solution than imagined by
Berle and Means. The authors imagined legislation and a
restructuring of corporate boards Ð such that board members
were trustees to a broad set of interest groups, while agency
theory identi®es a possible economic, market solution to the
separation problem.
4
This is a common view of in¯uence and control. Mintz and
Schwartz (1985, p. 8) de®ne strategic in¯uence and control by
owners as that ``in which the owners dominate decision making
while relieving themselves of the daily exercise of the power
they ultimately wield''. Other writers on this issue include Her-
man (1981, p. 115).
5
The capacity of individuals to be direct shareholders is well
understood and not considered further in this study.
6
We distinguish between property rights on one hand and
in¯uence and control on the other. Property rights relationships
refer to the legal right of ownership in property. However, the
de facto ability to exert in¯uence and control over property
may not arise from the legal ownership of such property. The
corporate form of organization is a classic example of how
property (ownership) rights can be separated from in¯uence
and control. Operating ®rm managers have the capacity to
exert substantial control over property owned by shareholders.
The point of our distinction is to emphasize an economic rather
than a legalistic perspective on in¯uence and control.
7
While it is well understood that the capital markets envi-
ronment includes relationships among many parties, considera-
tion of the relationships among capital managers, shareholders,
and company managers has increased signi®cance given the
prominent role of capital managers in the capital markets, and
the historical focus of accounting research (broadly conceived)
on direct operating-company reporting to investors. For these
reasons, focusing on these parties seems appropriate in this work.
530 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
perspective of investment managers as ®nancial
intermediaries. Furthermore, it separates the own-
ership±control issue into ones involving the rela-
tionship between investment funds and individual
investors, and the relationship between stockholders
and managers. Although the idea of a multi-tier
agency setting is not new, we note that it leads to
®nancial reporting and research implications that
di?er from those of the traditional single-tier
agency structure involving investors and ®rms that
now dominate ®nancial reporting research and
policy, speci®cally in terms of ®rm reporting to
funds, and fund reporting to investors. We
observe that excluding signi®cant capital market
parties in the interest of parsimony and simplicity
may result in analysis and policy that fails to address
the interests of the excluded parties. Our results,
therefore, pertain to other corporate claimholders,
including employees, consumers, communities
members, and other parties. While we do not assert
that studies of capital market relationships need to
portray all parties and relationships, we would argue
that such portrayals should depend upon the focus
and scope of each study, and not on arbitrary
maintenance of model simplicity.
The remainder of this paper is organized in the
following way. Section 2 reviews the Berle and
Means thesis of managerial control of ®rms. Sec-
tions 3 and 4 examine the in¯uence and control
exerted by investment funds and their managers
over ®rms during the ®rst quarter of the twentieth
century, during which time modern US capital
markets emerged, and the most recent quarter cen-
tury, during which time mutual and pension funds
emerged as important forms of investment funds.
Because the development of property and infor-
mation rights has been shaped by a complex and
dynamic interplay of factors over time, an histor-
ical analysis is exceptionally well suited as a
method. It provides a rich perspective for a deep
understanding of the many ways by which invest-
ment managers exert in¯uence over ®rms across
markedly di?erent economic environments. Fur-
thermore, our study uses historical methods and
evidence to critically assess two widely held
assumptions: ®rst, the Berle and Means mana-
gerial control thesis, and second the investment-
fund-as-®nancial-intermediary thesis. Our analysis
focuses on the in¯uence and control exerted by
investment managers over ®rms during both peri-
ods. While we principally study US evidence,
Section 5 addresses similar in¯uence and control
relationships observed in other countries. Follow-
ing presentation of this history, Section 6 discusses
and assesses the Berle±Means model and related
agency structures involving investors and man-
agers in a capital markets setting. We show how
replacing the agency model with a structure that
more richly portrays relationships involving
shareholders, investment managers and ®rm man-
agers leads to better understandings of ®nancial
reporting issues. Section 7 uses this perspective to
consider implications in terms of ®rm-to-invest-
ment manager reporting and fund-to-investor
reporting. We conclude in Section 8 by arguing for
greater ¯exibility in portraying capital markets
parties and relationships.
2. The Berle and Means thesis
In their classical work, The modern corporation
and private property (Berle & Means, 1932) Berle,
and Means sought to combine legal and economic
perspectives in explaining the development of the
``Modern Corporation''. Their main ``separation
of ownership from control'' thesis suggested that,
in the widely-held corporation, the risk-bearing
function of ownership and the managerial func-
tion of control were separate functions performed
by di?erent parties. They viewed the corporation
as ``a means whereby the wealth of innumerable
individuals has been concentrated into huge
aggregates and whereby control over this wealth
has been surrendered to a uni®ed direction''.
Berle and Means characterized management
of industrial corporations as powerful and
entrenched. Consequently, they argued that ``the
separation of ownership from control produces a
condition where the interests of owner and of
ultimate manager may, and often do, diverge, and
where many of the checks which formerly oper-
ated to limit the use of power disappears''. The
Berle and Means thesis became a focal point for
the subsequent development of capital markets
agency thinking. Particularly signi®cant was their
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 531
nearly exclusive focus on the relationship between
shareholders and managers. It is plausible that
Berle and Means merely con¯ated investment
funds and their managers with ®rms and ®rms'
managers, so closely were the two often portrayed
during this time. The failure to form this distinc-
tion, however, led to subsequent research and a
policy that focused on ®rm to shareholder dis-
closure issues, and virtually ignored investment
fund±investor issues.
This characterization of management as all-
powerful ``princes of industry'' could have been
intended to highlight dramatic social changes
wrought by the corporation rather than to accu-
rately portray the structure of economic relation-
ships at the time. In portraying the corporate
system as involving the divorce of ownership or
risk-taking from control, Berle and Means saw
managers as enjoying many of the fruits of capi-
talism, without themselves providing much capital
or undertaking proportionate risks. Instead, they
were organizers and administrators. The advan-
tages of the economies of scale that could be rea-
lized due to the technological revolution could
only be mobilized by the accumulation of vast
amounts of capital. For such large amounts of
capital outside sources were needed. This led to
the need for professional managers, who because
of the dispersed nature of ownership, exerted
e?ective operating control over ®rms. From this
perspective, Berle and Means' focus on owners
and managers might be regarded as a political or
rhetorical device designed to focus attention on
the problem of concentrated economic power in
conjunction with the absence of some counter-
vailing power. Indeed, as discussed later, Berle
and Means suggested broadening the responsi-
bility of a company's board of directors to a kind
of trusteeship to address the need for such a
countervailing power. Some regard the passage of
the Securities Acts as evidence of the success of
Berle and Means' arguments. While many believe
that the e?ects of the stock market crash and
depression far overshadowed any such e?ect
(Stigler & Friedland, 1983), the citation and word
choices of politicians and regulators at the time of
their enactment show that Berle and Means at
least provided the rationale for such legislation.
Empirically, Berle and Means studied the largest
200 non®nancial corporations of 1929±1930 and
found that management controlled 44%. Another
21% were controlled by a ``legal device'', so in total,
Berle and Means calculated that about 65% of these
large ®rms were nonowner controlled. To a large
extent, Berle and Means attributed this condition to
the emergence of widely dispersed ®rm ownership
that accompanied the development of the large
corporation. These ®ndings were viewed as empirical
con®rmation of several prior writers' observations
on the separation of corporate ownership from
control, including Veblen (1904), Veblen (1923) a
quarter century earlier, Ripley (1927), and the Pujo
Committee (1913). Writers such as Bell (1973), Gal-
braith (1967), Gordon (1945), Kaysen (1957), Marris
(1964), Simon (1966) and Fama and Jensen (1983)
have developed this thesis further. Furthermore,
Berle and Means' focus on the relationship existing
between retail investors and ®rms has resulted in
at least two important related theoretical con-
tributions. The ®rst of these is Chandler's man-
agerial capitalism (Chandler, 1977), which studies
the control of ®rms by their managers. The second
is Jensen and Meckling's (1976) application of
agency theory to capital markets settings, from
which modern Positive Accounting Research has
developed. The capital markets agency structure
incorporates a shareholder/principal, and a man-
ager/agent who is hired by the shareholder and to
whom the manager reports. This application of
agency theory to capital markets settings has been
embraced by accounting and ®nance academics and
policy makers, and has resulted in an emphasis in
contracting, capital structure, and reporting and
disclosure by ®rms to a dispersed group of owners.
The capital markets agency model may be inter-
preted as the economic markets theory response to
the issues raised by Berle and Means. Yet while
inspired by Berle and Means, the agency ``solution''
is far from the suggestions proposed by them.
Despite the widespread use and in¯uence of the
Berle and Means thesis, many writers continue to
question its descriptiveness. For example, while
Mintz and Schwarz (1985, p. 8) acknowledge that
``the acquisition of policymaking authority by the
chief executive is seen by managerial theorists as
more or less inevitable'', they view the control
532 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
issue as ``problematic''. This problem necessities
an analysis of ``the conditions under which outside
controllers can successfully establish and change
corporate direction''. Later in this paper we will
return to more thoroughly reassess the Berle and
Means thesis and related manager±investor agency
model in light of the evidence presented below.
3. The early corporate economy Ð the J.P. Morgan
era
3.1. Economic environment
We begin by tracing important business and
economic developments in the late nineteenth/
early twentieth century. We focus on the develop-
ment of US capital markets and the role of
investment funds, particularly investment bankers,
in conjunction with an assessment of the Berle and
Means thesis of a separation between ownership
and control.
The rise of the industrial giants in the United
States coincided with the peak of the country's
drive to industrialism after the 1880s (Chandler,
Bruchey & Galambos, 1968). Previously, the exis-
tence of innumerable small business ®rms resulted
in decentralized resource allocation decisions.
Centralized coordination and control of produc-
tion now replaced this approach. The US economy
was swiftly transformed from a strictly agrarian,
commercial and rural economy into an urban,
industrialized one. It experienced enormous
growth. While in the 1850s the industrial output of
the US was far below that of England, by 1894,
the value of American products almost equaled
the value of the combined output of the United
Kingdom, France, and Germany. By the First
World War, America produced more than one-
third of the world's industrial goods (Chandler
et al.).
Thus, within a relatively short span of time, there
was a dramatic transformation of an undi?er-
entiated economy to a di?erentiated and complex
one. It is not surprising, then, that the American
economy experienced fundamental structural
changes at the same time. As related to business
entities, the integration of ownership and control
that was characteristic of the nineteenth century
®rm gave way to their separation, initiated by the
development of railroads (Chandler, 1969).
It is well known that this enormous expansion
of the American economy occurred in conjunction
with a corresponding need for investment resour-
ces. Capital markets, as we understand them
today, did not exist. However, banking houses,
like J.P. Morgan (among many) did, and it is these
parties that we refer to as investment managers
and investment funds during this period. Bankers
like J.P. Morgan played a central role in this
expansion due to their ability to mobilize large
amounts of capital (DeLong, 1991). The capital
needed to develop railroads was provided in a
large part by the ¯otation of bonds, which, in
turn, led to the rise of the Wall Street investment
banks (Chandler & Tedlow, 1985) and, subse-
quently, to national and regional stock market
development.
3.2. Investment funds
The Berle and Means thesis, however, largely
overlooks the dominating presence of investment
managers during this early market. Investment
managers played a pivotal role in the development
of early capital markets, where they were important
in the resource allocation process. Firms such as J.P.
Morgan were instrumental in ®nancing corporate
acquisitions, mergers, and other activities (Bran-
deis, 1914; DeLong, 1991; Goldsmith, 1954; Pujo
Committee, 1913; Ramirez, 1995). Often, investing
activities extended to strategic and even opera-
tional in¯uence and control of ®rms. While the
source of the funds used for ®nancing these activ-
ities were typically bank deposits and insurance
funds held by ®rms controlled by Morgan or other
®nanciers, depositors, and insureds were probably
relatively uninformed of the use of their funds by the
investment managers (similar to many mutual fund
investors and pension plan participants of today
8
).
8
That is, both the depositor of the early twentieth century
and the mutual fund holder of the late twentieth century pro-
vided the ``atomic'' basis for resource aggregation, without, in
either case, having much of an idea about what was actually
done with their funds.
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 533
While the record of investment managers' con-
trol over ®rms is too broad to exhaustively review,
the illustrations below are characteristic of their
activities. Morgan's early major activities predate,
of course, the turn of the century (see Chandler &
Tedlow, 1985), and began with the railroads. By
way of background, an economic depression in the
1890s led to a series of railroad reorganizations. In
these transactions, the Morgan ®rms typically
acted as managers of large underwriting syndicates,
which normally agreed to purchase securities Ð
stock, convertible bonds, or convertible notes not
bought by the corporation's shareholders in an
o?ering. The general reorganization pattern con-
sisted of raising cash through the issue of new
securities, realigning ®xed charges by exchanging
new securities for old, predicated upon the earning
capacity of the corporation, and the creation of a
voting trust. The voting trusts, appointed by the
reorganization committee, were vested with full cor-
porate authority by the shareholders. Thus, Morgan
wielded signi®cant control over railroads, on behalf
of shareholders, through the vehicle of the voting
trust. These trusts served to separate the voting and
ownership rights inherent in common stocks.
The Morgan company was omnipresent
throughout the early development of American
capital markets. Between 31 December 1897 and
22 January 1913, J.P. Morgan & Co. was the sole
underwriter for 11 interstate railroad issues of
stock and convertible bonds totalling almost $63
million. In another 4 instances, the ®rm managed
underwriting syndicates totalling over $204 mil-
lion. In 122 instances, it acted as initial subscribers
for bonds and notes totalling $846 million, and in
another 61 instances, it managed subscription syn-
dicates which placed securities totalling over $485
million (Chandler & Tedlow, 1985, p. 272). As
managers of syndicates, J.P. Morgan & Co. sold
securities of the syndicate either through private
placement or public subscription for an additional
commission and share of pro®ts. These functions
were of central importance in an economic system
with relatively undeveloped capital markets.
The syndicate operations were based on faith,
reputation, and character, all of which were essential
factors in the development of early capital markets.
The growth of the railroads led to innovations in the
techniques of creating and managing large private
business enterprises. Modern ®nance and adminis-
tration techniques, labor relations and government
regulation changed dramatically. The demand for
capital to feed the immense growth in America's big
business led to the institutionalization of the
nation's money market in New York.
Morgan turned his attention to other industrial
enterprises around the turn of the century. From
1902 to 1912, J.P. Morgan & Co. was directly
responsible for marketing almost $2 billion of
interstate securities. It also ran a large commercial
banking business, with aggregate deposits in 1912
of $162 million. The Morgan Company became
best known for its roles in organizing ®ve ®rms:
General Electric, American Telephone and Tele-
graph, Federal Steel, United States Steel, and
International Harvester. In these cases, the need
for capital and the fragmentation of the industry
(particularly in the case of AT&T) resulted in a
close relationship between the company and its
bankers. Morgan involvement in a ®rm or indus-
try required extensive re®nancing, including the
¯otation of new securities in the New York market
(Sobel, 1965). Investment bankers of this time,
believing that small investors were prone to pan-
ics, turned to other banks, trust companies and
insurance companies as new sources of funds.
This, in conjunction with the merger movement,
the growth of larger enterprises, and the need for
large-scale ®nancing, resulted in ``a complex of
investment commercial banks together with life
insurance trust companies . . . with enough
resources to control the market under almost any
circumstances. . .'' (Sobel, p. 184). Thus, the
merger movement that began with the railroads
in the 1880s, and which thereafter spread to the
industrial ®rms, was facilitated to a large extent by
a small group of private bankers including J.P.
Morgan. These ®nanciers fostered combinations
in capital intensive industries with the purpose of
bringing the market under control.
Morgan's restructuring of the steel industry into
the United States Steel Corporation, the ®rst bil-
lion-dollar ®rm, illustrates the operational in¯u-
ence and control exerted by investment managers
of the period. This combination, considered by many
to be the greatest merger of the era (Sobel, 1965),
534 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
resulted in a union of eleven major ®rms and
contained what were once 170 independent ®rms.
The ®rm was formed in 1901, and soon after its
incorporation, Morgan announced the formation of
a syndicate to underwrite new securities. The cir-
cular noted that ``the entire Plan of Organization
and Management of the United States Steel Cor-
poration shall be determined by J.P. Morgan &
Co.'' (Chandler & Tedlow, 1985, p. 282). Not only
did Morgan orchestrate the creation and ®nancing
of US Steel, he also handpicked its manager. It is
known that George Perkins, a Morgan partner,
served on its ®nance committee and designed the
company's innovative employee stock purchase
and bonus plans, and that Morgan himself was
involved in mediating labor disputes. Carosso (1987,
p. 473) writes ``As sole managers, with complete
authority over all its operations [Morgan's ®rm] was
responsible for every aspect of the steel corpor-
ation's organization.'' Furthermore, Morgan & Co.
made a 200% return on the funds advanced during
the merger, received substantial fees, and created a
®rm which controlled a majority of the various
businesses that made up the steel industry.
The formation of International Harvester also
illustrates investment banker strategic and opera-
tional control of a ®rm. Formed in 1902 in a mer-
ger of ®ve companies, the stock of International
Harvester was placed in a voting trust controlled
by the Morgan Company (Garraty, 1957). Carosso
(1987, p. 480) notes ``[The Morgan Firm] alone
would determine the structure of the merged com-
pany and who had the right to choose its ocers
and directors. . .'' The company was e?ectively run
by Morgan partner George Perkins, who wrote to
Morgan, ``The new company is to be organized by
us; its name is to be chosen by us; the state in which
it shall be incorporated is left to us; the Board of
Directors, the Ocers, and the whole out®t left to
us Ð nobody has any right to question in any way
any choice we make'' (Chernow, 1990, p. 109).
Carosso (1987, pp. 490±941) concludes that Perkins'
position in the company ``allowed him great
power, which he used to make personnel decisions,
de®ne the authority of various oces, and deter-
mine some of the corporation's basic policies. . .''
Morgan and Company's activities were not
limited to US Steel sized companies. For example,
the company organized and underwrote 145,000
preferred shares and 72,500 common shares of
American Bridge, organized under a ®ve-year
voting trust, and loaned working capital or
subscribed for shares of Associated Merchants,
Harper & Brothers, Hartford Carpet Corp., and
Virginia±Carolina Chemical Co. After 1907,
among other transactions, Morgan managed an $8
million bond subscription of US Rubber Co., and
purchased securities of ®rms as part of issues
managed by another ®rm, Lee, Higinson, & Co.
(Chandler & Tedlow, 1985, p. 280). His work with
Rockefeller's Standard Oil involved the formation
of a series of horizontal and vertical combinations
that controlled about 90% of the domestic industry
(Galambos & Pratt, 1988). Smith and Sylla (1993,
pp. 3±4) write: ``Morgan and other Wall Street
bankers became intimately involved with not only
the creation but also the shaping and governance
of big business enterprise.''
A common vehicle for instituting and perpetu-
ating control over companies was the investment
trust (which should be distinguished from its
1920s period progeny, investment and holding
companies). Investment trusts commonly involved
placing the voting securities of one or more cor-
porations under the control of a voting trust, the
trustees of which were, invariably, investment
bankers. Morgan's Northern Securities is instruc-
tive in this regard, being the vehicle used to exer-
cise control over Great Northern, Northern
Paci®c, and other railroad company stock. This
form of investment trust was the basis of popular,
progressive criticism and led to the Supreme
Court's breakup of Northern Securities under the
Sherman Antitrust Act. Subsequent investigations
and accounts provided by former ®nanciers such
as Thomas Lawson (1904) regarding the control
by ``organized ®nance'' over insurance and other
large corporations showed the pervasiveness of
control exerted by such organized groups over
companies.
From today's perspective, the early corporate
economy consisted of a comparatively small num-
ber of large corporations, and small groups of
®nanciers, the ``Money Trust'', who in turn,
mobilized the savings of a large number of individ-
uals and made resource allocation decisions. This
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 535
money trust had a large and important presence in
the capital markets that formed the context of
Berle and Means' analysis of the corporation. They
performed vital functions in the economy, which
resulted in a concentration of economic power in
their hands. However, Berle and Means did not
address the role of investment bankers, insurance
companies and underwriters as agents of managerial
capitalism. Their analysis, therefore, did not fully
portray in¯uence and control relationships, particu-
larly in terms of either acknowledging this role, the
relationship of the investment bankers to ®rms or
individual investors, or in distinguishing between
®rm managers and their investment bankers.
3.3. The money trust
The Pujo hearings on the ``money trust'' are
illustrative in assessing the position of investment
managers in the capital markets of the period.
These hearings were held with a view to determin-
ing whether something in the nature of a ``money
trust'' existed, and whether, as a result, a small
group of Wall Street Bankers dominated the econ-
omy. The majority report issued in February 1913
asserted ``a high degree of ®nancial con-
centration. . . and a close alliance between the heads
of a few New York City banks and the principal
users and suppliers of capital'' (Carosso, 1973).
This control over the resources of the investor was
e?ected through gaining representation on corpor-
ate boards, controlling through stock ownership
the savings represented in life insurance compa-
nies, savings banks and trust companies, and by
developing a syndicate system, which consisted of
various techniques of originating, underwriting,
and distributing new securities. There existed a
complex network of economic relationships at the
center of which was the ``money trust''.
The investment managers of the period scarcely
denied and, in fact, argued for the necessity of
such involvement (Pujo, 1913, p. 106). This involve-
ment went far beyond what is commonly asso-
ciated with ``®nancial intermediation'', but rather
better mirrored what Mintz and Schwartz (1985)
describe as strategic and operational in¯uence and
control. DeLong (1991, p. 217) asserts that ``[t]he
forty-®ve employees of Morgan and Company
approved and vetoed proposed top managers,
decided what securities they would underwrite,
and thus implicitly decided what securities would
be issued and what lines of business should receive
additional capital.'' Following Morgan's death in
1907, Pratt (1913) wrote, ``no man ever controlled
the money of other people in such sums as [Morgan]
did. . . His power is not to be found in the number of
his own millions, but in the billions of which he
was the trustee.'' Chernow summarizes the extent of
this in¯uence and writes:
Some 78 major corporations, including many
of the country's most powerful holding com-
panies, banked at Morgan. Pierpont and his
partners, in turn, held 72 directorships in 112
corporations, spanning the worlds of ®nance,
railroads, transportation and public
utilities. . .'' (Chernow, 1990, p. 152).
Even following the Northern Securities decision,
the Morgan Company remained a powerful force
in corporate ®nance, underwriting $6 billion in
securities between 1919 and 1933 (Chernow, 1990,
p. 257) and the ®rm continued to be involved in
both strategic and operational in¯uence and con-
trol over ®rms. Notable among its activities was its
1920 collaboration with the DuPonts to wrest con-
trol of General Motors Corporation from William
Crapo Durant. Morgan partners remained in¯u-
ential members of the boards of directors of major
corporations and were active participants in the
major strategic and operating decisions of many
others, including AT&T. Even at the time of the
Pecora hearings, during the 1930s, it was revealed
that Morgan partners sat on the boards of direc-
tors of 89 corporations. Pecora asserted that this
represented ``the greatest reach of power in private
hands in our entire history'' (Pecora, 1939, p. 36).
3.4. Investment trusts and holding companies
As the ``retail'' market for corporate securities
developed, other forms of institutionalized invest-
ment evolved. The 1920s saw the rise of invest-
ment trusts and holding companies, typically
sponsored by banks (or their subsidiaries) and
investment and brokerage houses. Small investors
536 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
invested money in these ®rms much as individuals
today invest in mutual funds [although the lines
between banks and investment trusts were su-
ciently vague that many individuals undoubtedly
believed they were putting their money in the banks
themselves (Galbraith, 1955, pp. 48±70)]. By 1927,
Wall Street investment trusts sold $400 million of
securities, and in 1929, they marketed securities
amounting to $3 billion, or about a third of all
issues. By the autumn of 1929, their total assets were
estimated to exceed $8 billion. This constituted an
elevenfold increase between 1927 and 1929 (Gal-
braith, 1955, p. 55). By 1929, a number of di?erent
kinds of concerns were bringing these trusts into
existence. Investment banking houses, commercial
banks, brokerage ®rms, securities dealers, and
most importantly, other investment trusts, were
``sponsoring'' the formation of new trusts.
What were the bene®ts of sponsorship? The
sponsoring ®rm in general executed a management
contract with the investment trust it sponsored.
The sponsor also administered the trust, invested its
funds, and was paid a fee based on capital or earn-
ings. If the sponsor was a stock exchange ®rm, it
received, in addition, commission on the purchase
and sale of securities. Many of the sponsors were
investment banking ®rms. The sponsoring of trusts
ensured that they had a steady source of business.
The investment bankers that sponsored these trusts,
including Morgan, o?ered themfor sale to friends at
depressed ``bargain'' prices, which practically
ensured a high pro®t in the markets soon after.
Galbraith (1955, p. 56) observed: ``that such agree-
able incentives greatly stimulated the organization
of new investment trusts is hardly surprising''.
It is apparent that in the early capital markets, a
premium was paid for ®nancial entrepreneurship.
The market value of the outstanding securities of
investment trusts and holding companies was far
higher than the sum of the values of the individual
securities owned. The property of these organiza-
tions consisted solely of common and preferred
stocks and debentures, mortgages, bonds, and cash.
Sometimes, their securities were worth twice the
value of the property owned. The premium was, in
Galbraith's view (1955, p. 59) ``the value an admir-
ing community placed on professional ®nancial
knowledge, skill, and manipulative ability.''
Trusts and holding companies also sought to
di?erentiate themselves by leveraging their capital
structure (Galbraith, 1955, pp. 61±69). Investment
trust's leverage in this regard was achieved by
issuing bonds, preferred stock, and common stock
to purchase almost exclusively, a portfolio of
common stocks. This ``intermediation'' system-
atically a?ected the control of property (capital stock
and bonds) in the markets. ``The magic of leverage''
(Galbraith, 1955, p. 62) also provided the common
stockholders of these trusts with the potential for
unlimited gains, which was compounded geome-
trically as trusts invested in other trusts. It was pos-
sible, using networks of investment trusts, for single
individuals to control disproportionately large parts
of the capital markets. For example, Harrison
Williams was thought by the SEC to have control
over a combined investment trust and holding
company system with a market value in 1929 at
close to a billion dollars (Galbraith, 1955, p. 64).
So called ``super holding companies'', such as
Morgan and Bonbright's; United Corporation, con-
trolled utilities providing 27% of the nation's elec-
trical output [Federal Trade Commission (FTC),
1935]. Other immense Morgan sponsored and con-
trolled holding companies included Standard
Brands, for food-producing companies, and Alle-
ghany Corporation, for railroads and real estate. The
line between a holding company and an investment
trust (presumed not to have direct control) was often
nebulous. The risks of leverage were not apparent
before 1929,
9
and numerous businesses including
American Founders Group and Goldman Sachs
turned to leveraging themselves to achieve remark-
able growth.
10
In their analysis of the corporation in terms of
the separation of ownership and control, Berle
and Means did not address the role of investment
funds in the patterns of corporate ownership,
9
By 1930, of course, the unraveling of this leveraging was
painfully apparent.
10
It is interesting to compare the excessive use of leverage in
the 1920s with that of the 1980s. There are clearly some di?er-
ences Ð the earlier case representing what was essentially a
pyramid scheme, while the latter (ostensibly) related to scale,
agency, and tax issues. More cogent to this paper is the obser-
vation that both required the active participation of the invest-
ment banking community.
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 537
in¯uence and control. As outlined above, mana-
gerial control of corporations was diluted by the
complex nature of various institutionalized struc-
tures including investment banks, holding compa-
nies, and trusts, which led to signi®cant control of
operations by the investment bankers and ®nan-
ciers. In turn, the funds used by these investment
managers were provided, wittingly or not, by indi-
viduals through direct investment in trusts, or
through insurance companies, or banks.
The basis of Berle and Mean's analysis is per-
haps best understood by considering that they
wrote during a period in which the ``retail'' market
for corporate securities developed, in part due to
the energies of Merrill Lynch and other emerging
brokerage ®rms. This highly visible growth in the
``retail market'' for corporate securities provides a
perspective for understanding Berle and Means'
focus on individual investors and the corporation.
Despite, however, the dramatic appearance of the
individual investor, the bulk of investment in cor-
porate securities continued to occur through
investment funds.
Berle and Means' analysis of corporate owner-
ship/control relations leads them to conclude that
the balance of control shifted entirely in favor of
the professional manager. Yet, while most small,
individual investors of this era did not have much
direct ®nancial control, one view on the presence
of the bankers is that they provided countervailing
power against managerial control over ®rms.
Another is that they operated at the expense of
individual investors and the public.
It is unclear whether Berle and Means viewed
the investment bankers as distinguishable from
®rm managers. While Berle and Means' analysis is
correct in identifying the control attained by pro-
fessional managers with respect to individual inves-
tors per se, their conclusions are limited by the
omission of institutionalized forms of corporate
control in their analysis. The scope of activities of
investment managers took them well beyond the
function of ®nancial intermediation. They were
orchestrators of the managerialist corporate system,
involved in exercising both strategic and opera-
tional in¯uence and control over ®rms. To the
extent that they proved to be of greatest bene®t to
owner±managers through their ability to provide
the ®nancial support and climate conducive to the
long-term viability of their enterprises, they could
be considered to be ``proprietor capitalists.'' From
this perspective, the agent of the individual was not
always, in fact, corporate management, but often the
investment bankers and trust managers. Indeed, the
bankers, at least, proved to be important monitoring
agents against opportunistic behavior by corporate
management (Carosso, 1973). The investment bank-
ers also had vested interests in the success of these
corporations, providing them with new avenues for
investment and fee income. The growth and
development of the investment banks therefore
paralleled that of corporations during this period.
4. The modern fund era Ð post 1970
4.1. Economic environment
In this section we ®rst reviewthe development and
extent of modern institutional ownership of ®rms.
Then we document investment funds' contemporary
in¯uence and control over ®rms with empirical evi-
dence and cases. While there are fundamental di?er-
ences between the American economy in the ®rst and
second periods studied, the ubiquity of investment
managers and institutionalized forms of capital of
various sorts continues, and indeed has even
grown, in the modern forms of pension funds,
mutual funds, insurance companies, and other
institutional vehicles. It is these parties that we refer
to as ``investment funds'' during this second period.
Banks, in contrast, had a dramatically di?erent
relationship with ®rms following the passage of
Glass±Steagall, and we consider their continuing
in¯uence and control abilities over ®rms only brie¯y.
Following the stock market crash of 1929, the
disastrous results of bank involvement with hold-
ing companies and investment trusts became evi-
dent, and beginning in the 1930s, Glass±Steagall
and other securities acts and regulations restricted
bank investing activities. It was thus from this
point through the 1950s that the Berle and Means
world of dispersed ownership was most nearly true.
At one point during the 1950s, it is estimated that
investment funds owned something less than 10%
of corporate equities. But during the prosperous
538 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
period following the end of the Second World War,
a number of nonbanking and nondepository insti-
tutions such as insurance companies, pension funds,
and mutual funds became important securities
holders. Even in the 1950s, and all the way up
through 1980, the Securities and Exchange Com-
mittee (cited in Allen, 1985) estimates show that a
quarter to a third of all US shares were held by
investment funds.
4.2. Investment funds
Between 1980 and 1990, fund ownership of
equities dramatically increased to more than 50%
(Brancato & Gaughan, 1991). By 1990 more than
half of the Business Week's Top 1000 ®rms had
greater than 50% ownership by institutional
investors (Brancato & Gaughan). Furthermore,
this institutional ownership was highly con-
centrated; for example, the largest 20 pension
funds represented nearly a quarter of all pension
fund assets in 1990 (Brancato & Gaughan).
Investment funds now hold more than half the
value of publicly traded US equity, and account
for more than 70% of the volume of US traded
equities.
11
Between the 1965 and the 1990, ``large
block'' trades rose from just 3% of all trades to
roughly half (Smith & Sylla, 1993). Also, the
number of noninstitutional parties investing
directly in corporations has declined dramatically
over the past decade. As reported in the Economist
(1990) American private investors reduced the
net value of their equity holdings by about $550
billion between the end of 1983 and the end of
1989, which is equivalent to 40% of their portfolios
in 1983. ``Were these trends to continue, the last
American to own shares directly would sell his last
one in the year 2003'' (Economist, 1990).
Pension funds emerged as principal owners of
American equity capital in the early 1970s
(Drucker, 1991). Employees became owners
through the medium of a fairly small number of
large ``trustees''. While these pension funds tradi-
tionally viewed themselves as investors (punters),
with a short-term focus, they found themselves
increasingly thrust into the position of owners
(proprietors) simply due to their sheer size (Econ-
omist, 1990). Table 1 shows the increase in ®nan-
cial assets held by pension funds from 2.5 to 4.2
trillion dollars between 1990 and 1995. The most
dramatic increase, however, occurred in mutual
funds. As mentioned in the paper's introduction,
the number of mutual funds has grown from
about 1000 in 1983 to about 5000. By 1995 mutual
funds held about 23% of all US ®nancial assets
[Organisation for Economic Co-ordination and
Development (OECD), 1997]. Mutual fund own-
ership of stock rose from about 3.1% in 1980, to
12.8% in 1996, and the total value of their ®nan-
cial assets reached over 2.7 trillion dollars in 1996
(OECD, 1997). Table 1 summarizes the ®nancial
asset holdings of major types of investment funds
between 1990 and 1995.
4.3. The regulatory environment
Changes in administrative and regulatory rules,
particularly in the form of corporate governance
mechanisms, investor communications, and block
trading, have increased the ability of investment
Table 1
Value of US institutional holdings of ®nancial assets (billions of dollars)
a
Insurance companies Mutual funds Pension funds Other institutions
b
Total
1990 1091 1155 2531 1409 6996
1991 2081 1376 2848 1589 7894
1992 2212 1624 3152 1664 8652
1993 2427 2045 3429 1811 9712
1994 2565 2191 3565 1881 10,202
1995 2829 2727 4156 2160 11,871
a
Constructed from OECD data (OECD, 1997).
b
``Other institutions'' include bank trusts, ®nance companies, real estate investment trusts, and security brokers and dealers.
11
In addition to being signi®cant debt owners.
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 539
funds to in¯uence ®rms. Important rule changes
included provisions related to proxy solicitations
and voting, shareholder communications, share-
holder proposals (Rule 14A-8) and the 1992 relaxa-
tion of communication rules for larger shareholders
(in part due to pressure from The California Public
Employees Retirement Systems Ð ``Calpers''). Blair
(1995, p. 72) relates the 1993 use by institutional
investors of these new communication rules, speci®-
cally in communicating with one another and in
coordinating their in¯uence over Medical Care
America. In addition, the federal government
encouraged, and even required, investment fund
involvement in ®rms whose securities they hold. For
example the Labor Department has ruled that pen-
sion funds must vote their shares as a part of their
®duciary duty in the ``economic best interest of a
plan's participants and bene®ciaries'' (Department
of Labor, 1989). Federal encouragement of pension
fund involvement in ®rm activities continued to
increase through the late 1990s.
Other rule changes, such as the SEC's rule 144a,
adopted in 1990, has made it easier for large ®rms to
sell their securities to large ``quali®ed'' buyers,
de®ned as institutions with at least $100 million
invested in securities. Rule 144a exempts many pri-
vately placed deals from SEC registration require-
ments. In 1992 changes to 144a were approved
allowing institutions seeking to meet the $100 mil-
lion requirement to include government securities in
their portfolios. As a result, it is now possible for
bank and pension trust funds and some insurance
accounts to buy unregistered bonds and stocks,
expanding the scope of institutional in¯uence.
Capital market structures have also evolved in a
manner favoring investment funds. Partly as a
result of competitive pressures from regional
exchanges, electronic networks such as INSTI-
NET and o?-exchange markets, the NYSE in
1992 adopted the ``clean-cross rule'' allowing large
institutional investors to sidestep ¯oor trading on
trades of 25,000 or more shares furthering the
development of a two-tier stock market.
4.4. Evidence on in¯uence and control
The regulatory and administrative changes
described above, coupled with the huge growth in
pension and mutual funds, have dramatically
increased the ability of investment funds to in¯u-
ence ®rms. What is now characterized as ``fund
activism'' has increased since 1970. Numerous
sources report increased levels of shareholder
activism, including increases in shareholder pro-
posals. For instance The Investor Responsibility
Research Center reported increases in shareholder
activism in terms of shareholder proposals from 55
in 1986 to 294 in 1990 (Brancato & Gaughan, 1991).
Anand (1997), in ``Funds ¯exing muscles early in
proxy battles'', reported that ``in dozens of instan-
ces, companies agreed to make concessions to
shareholders. . . Even top performing companies are
no longer immune from shareholder activism. . .''
From their comprehensive study of institutional and
capital markets, Brancato and Gaughan conclude
that:
. . .while [institutional investors] may be
diverse, a high concentration of economic
power resides among a relatively small and
extraordinarily stable group of institutions.
. . . the very largest of these institutions, by
virtue of their concentrated economic power,
are increasingly in a position to exert sub-
stantial in¯uence on the shape of corporate
governance in this country (p. 1).
Indeed, it is so widely acknowledged that
investment funds in¯uence ®rms that empirical
studies of fund in¯uence examine patterns and
e?ects, rather than the existence, of activity and
in¯uence. Gordon and Pound (1993) study, in part,
various institutional shareholder voting alignments
and found that the outcomes of shareholder spon-
sored proposals varied as a function of ownership
by institutions and outside blockholders. They
assert:
Previously the province of ``gad¯y'' activists,
governance proposals have become a tool used
by a variety of large professional investors,
including large ®duciary institutions. . . (p. 697).
Smith (1996) studies the e?ects of 51 share-
holder activism programs by institutional inves-
tors from 1987 to 1993. Agrawal and Mandelker
540 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
(1992) examine ``whether the monitoring activities
of institutional investors, and their in¯uence on
the management of the ®rm, are related to the size
of their investment in a corporation and/or the
proportion of equity owned by them''. Using anti-
takeover proposals, investment fund ownership,
and abnormal return data from 1979 to 1985, their
®ndings are consistent with an ``active investor''
hypothesis. Other studies, such as Brous and Kini
(1994) provide evidence on the ability of invest-
ment funds to e?ectively monitor ®rms.
One line of investment fund research has explored
fund activism and ®rm pro®tability.
12
While these
studies do not study fund in¯uence per se,
13
their
design and analysis nonetheless provide evidence
about fund in¯uence. For example, in a study of
corporate ``refocusing'' programs and ®rm pro®t-
ability, Berger and Ofek (1997) found that about
39% of such programs were associated with a new
outside blockholder or fund activism. In other
pro®tability studies, Wahal (1996) and Opler and
Sokobin (1996) document the occurrence and e?ects
of fund in¯uence in the management of nearly 200
®rms.
In addition to the empirical and theoretical
work, a plethora of cases are described in various
investment-related publications that compellingly
convey the in¯uence exerted by funds over ®rms.
Large pension funds that have de®ned and struc-
tured shareholder activism programs have been
quite active (see Wahal, 1996). Calpers, which
pioneered public pension fund activism and foun-
ded the Council of Institutional Investors in 1984,
is highly visible in terms of such activities. The
1984 Texaco greenmail case involving that ®rm's
repurchase of the Bass brothers' 9.9% stake for
$1.3 billion (28% above market value) sparked a
response from Calpers, which was one of Texaco's
largest shareholders. Dale Hanson, the CEO of
Calpers and the founder of its shareholder acti-
vism program, asserts the importance of this case
in the development of institutional activism.
Other widely publicized cases involved ITT,
GM, American Express, IBM, Westinghouse,
Apple Computer, Eli Lilly, Kodak, Scott Paper,
and Borden. In 1990, shareholders targeted ITT
for excessive executive compensation. Pressures
from institutional shareholders, who owned about
43% of GM and who were frustrated as a result of
the third straight year of huge losses under current
management, resulted in the 1992 ousting of Gen-
eral Motors Chairman Robert Stempel. Following
Stempel, James Robinson of American Express,
John Akers of IBM, and Paul Lego of Westing-
house Electric, were all ousted, all principally as a
result of institutional pressure (Smith & Sylla,
1993). Others asked to step down in 1993 included
the chiefs at such large, well-known corporations
as Apple Computer, Eli Lilly, Kodak, Scott Paper,
and Borden, again under pressure from invest-
ment managers. Smith and Sylla write:
By 1993, however, institutional activism was
directly responsible for instigating reforms in
the nation's largest companies. It was pres-
sure from institutional shareholders that led
to the ousters of chief executives at General
Motors, IBM, and American Express, each
one a company in need of reform, each one a
traditional bastion of managerial control. The
news of the day was that corporate boards
had to take more seriously the concerns of
their institutional investors, who in turn
found it more pro®table, over the long run, to
behave more like owners rather than mere
holders of stock (p. 56).
4.5. The banks
Despite the legal separation of commercial and
investment banking resulting from Glass±Steagall,
writers such as Fitch and Oppenheimer (1970)
present a theory of bank in¯uence and control
over corporations. Certainly, bank capacity to
in¯uence companies continues. Herman (1981, p.
130) shows that 66% of the largest 200 non-
®nancial corporations and 76% of the largest 100
industrials had bankers on their board of directors
in 1975. Baum and Stiles (1965, p. 30) show that
60% of all pension fund assets were managed by
12
The results of these studies are mixed. Whether fund acti-
vism is e?ective in improving ®rm performance is, however,
irrelevant to their ability to in¯uence ®rms.
13
Most of these studies address the e?ect of fund activism
on company performance and are premised on the assumption
that funds can and do in¯uence ®rms.
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 541
banks, while in 1972, just 71 bank trust depart-
ments managed 72% of all trust assets (Herman
1975, p. 20).
14
In addition, investment bank repre-
sentatives sat on 42% of the largest 100 industrials'
boards of directors.
Speci®c evidence also demonstrates bank in¯u-
ence, although such activities tend to occur with
®rms in ®nancial trouble. Gogel (1977, p. 50)
asserts ``the largest American corporations form
an interconnected network which is dominated by
®nancial institutions, especially commercial
banks. . .'' Mintz and Schwartz (1985) cite bank
in¯uence and control over 39 major US cor-
porations between 1977 and 1981 alone, exten-
sively recounting the details of banker
involvement with Brani? Airlines in 1979 and
1980 and International Harvester in 1981. They
conclude (Mintz, & Schwarts, 1985, p. 35) that
``capital shortages may result in the loss of
corporate autonomy and the transfer of control to
lenders''. Banker in¯uence over companies is
reinforced by the huge dollar amount of pension
funds managed by banks as well as trust funds
controlled by banks. Of particular interest, Mintz
and Schwartz illustrate the continuing existence of
interlocking directorates involving managers of
leading ®nancial institutions, including Morgan
Guarantee, one of the ``House of Morgan'' suc-
cessor ®rms.
4.6. A comparison
Previts and Bricker (1994) discuss the dangers of
applying contemporary thought to historical peri-
ods. Yet despite di?erences between the socio-
economic settings of the US in the 1990s and the
early 1900s, it is interesting to compare investment
managers of the 1990s with those of the Morgan
era. One important di?erence, the implications of
which we will return to later, relates to the princi-
pal interests of the investment managers of the
two periods. The investment managers of the ear-
lier era were principally focussed on company
operations, and only secondarily interested in
share price and stockholder returns. In contrast,
modern investment managers are principally
interested in share price and returns, and secon-
darily interested in company operations. Thus, the
bankers of the early twentieth century often
wanted to act like owners (Morgan saw himself as
rationalizing chaotic industries and markets)
while contemporary investment managers gen-
erally do not.
Regardless of the management inclinations of
investment managers of the two periods, the mere
size of investment funds makes costless exit from
ownership ®rm shares dicult (Taylor, 1990).
Today funds are increasingly forced into being
``proprietors'' rather than ``punters''. While proxy
®ghts and shareholder proposals and resolutions
represent one of active control mechanisms that
can be exercised, a second that is receiving
increased attention and that again hearkens back
to the earlier period is the so-called ``quiet in¯uence''
exerted by investment funds involved in what many
have termed ``relational investing'' (see Hawley &
Williams 1996). In ``Political voice, ®duciary acti-
vism, and the institutional ownership of U.S. cor-
porations'', Hawley (1995) examines the shift of
ownership from predominantly individual to
institutional. He argues that pension funds, as
important institutional owners, will become,
increasingly, ``relational investors''. To the extent
that this does not exist, the result is fund managers
that are less concerned with ®rms' long-term
prospects or interested in the long term growth
and survival of ®rms. Rather, they may focus on
short-term operating results.
Overall, the modern investment fund manager is
remarkably similar to that of the Morgans of the
early period in two important respects. First, both
are important agents involved in aggregating and
allocating economic resources. Like the Morgans
of the past, investment funds aggregate the
resources of individual investors and are centers of
®nancial power having abilities to in¯uence ®rms
and markets. Second, despite di?erent inclinations
about doing so, both exert in¯uence and control
over ®rms, and in this way, extend the realm of
their activities well beyond that described by
®nancial intermediation.
14
Interested readers may wish to consult Soldofsky (1971)
for a description of investment fund holding of stock between
1930 and 1970.
542 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
5. An international perspective
The in¯uence exerted by fund managers over US
companies described in the preceding section is
echoed internationally. Below, we brie¯y review
studies of institutional in¯uence and control in
Germany, Japan, South Africa, and Canada. While
these countries re¯ect patterns of investment quite
di?erent from that of the US (see Barr, Gerson &
Kantor, 1995; Prowse 1995), they nonetheless
illustrate the extensive in¯uence of institutions
over ®rms.
In Japan and Germany, corporate in¯uence
and control has traditionally been concentrated
in the hands of ®nancial institutions, much as it
was in the United States prior to the 1920s,
with individual investors generally playing a rela-
tively insigni®cant role in capital markets. Walter
(1993) asserts that ``Japan's industrial and ®nan-
cial communities have historically been interlinked
more closely than in any other advanced econ-
omy.'' Prior to the Second World War, banks
monopolized the underwriting of corporate secu-
rities and through the institutionalized structure
of the keiretsu exercised considerable in¯uence
over such ®rms. Despite US e?orts after the war,
this structure remains largely in place. Walter
observes:
A unique form of corporate control has been
integral to the Japanese model of industrial
development. . . the focus was on continuous
surveillance and monitoring of management
performance by the managements of aliated
®rms and bank. . .
In 1990, Japanese banks and other investment
funds held about 40% of Japanese equity, with
another 30% held by other operating ®rms (Porter,
1992, p. 42). German ®rms have similar associations
with their bankers. Walter (1993) writes:
[The] Hausbank relationship has, as its basis,
a business ®rm's reliance on only one princi-
pal bank as its primary supplier of all forms
of ®nancing. The Hausbank, in turn, is deeply
involved in its corporate client's business. . . If
the client ®rm faces collapse, the Hausbank
may well convert its debt into equity and take
control of the client. . .
In comparison with Japan and Germany, where
control is exercised by banking institutions, a
small number on holding ®rms owning shares in
subsidiary operating ®rms dominates the South
African stock exchange. Barr et al. (1995) ®nd that
``companies comprising the six largest groups on
the JSE presently account for over 70% of the
value of all the shares quoted on the exchange''.
In contrast to the preceding countries, the
Canadian experience closely parallels that of the
United States. In both, investment fund involve-
ment in capital markets has increased to the point
of comprising three-quarters of securities trading
(Cohen, 1995). Increases in security ownership by
investment funds has been accompanied by
declines in direct, individual ownership (Andrews,
1991). In contrast to the US, activity by depository
institutions has increased dramatically following
relaxation of restrictions on bank ownership of
securities (Johnson, 1994). As in the US, many
writers have addressed the issue of corporate gov-
ernance as it relates to institutional in¯uence over
®rms (Montgomery, 1996; Yalden, 1996), and
pension fund activism is promoted by trade
groups such as the Pension Investment Associa-
tion of Canada (Star, 1994). The extent of invest-
ment fund holdings in Canadian securities and the
corresponding extent of Canadian individual
holdings of investment funds motivated the Cana-
dian Institute of Chartered Accountants to study
the issue of fund reporting to investors and to
issue Financial reporting by investment funds
[Canadian Institute of Chartered Accountants
(CICA), 1997].
The preceding literature strongly suggests the
international character of institutional in¯uence
over companies. As Prowse (1995) argues, the dif-
ferences in the speci®c forms of capital market rela-
tionships have resulted from di?ering legal and
regulatory environments (neither Japan or Ger-
many has Glass±Steagall type laws); yet remarkably,
each of these countries re¯ect the important, and
even dominant, role played by institutionalized
capital. Indeed, Prowse concludes, ``corporate gov-
ernance systems based on the concentrated holding
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 543
of ®nancial claims. . . may be more ecient means
of resolving corporate agency problems. . .''
6. Discussion
6.1. Reassessing Berle and Means
Berle and Means' study, described in Section 2
above, drew criticism virtually from the time of its
publication [see Crum1934; Securities and Exchange
Commission (SEC) 1940; Burch, 1972; Mintz &
Schwartz, 1985; Stigler & Friedland, 1983, among
others], largely, as noted by Mintz and Schwartz (p.
18) because of the importance of ``the connection
between stock dispersal and the argument for
managerial control''. Regarded to this day as par-
ticularly curious was their failure to fully consider
the role of ®nancial institutions such as banks and
other investment funds in in¯uencing and con-
trolling corporations. For example, Brandeis's
Other people's money and how the bankers use it
(Brandeis, 1914), the National Resource Commit-
tee's The structure of the American economy
(National Resources Committee, 1939) and the
US Congress's ``Patman Report'' (1968) have
consistently observed, over multiple time periods,
the in¯uence and control over ®rms exerted by
banks and other institutions. Herman (1981, p. 65)
writes, ``It is a curiosity that Berle and Means
never employed such a category [of ®nancial con-
trol], for the potential con¯ict of interest between
owners and controlling bankers or speculators in
the late 1920s would seem important enough to
have warranted special attention.'' In reassessing
Berle and Means' analysis, Herman (p. 64) adds a
``®nancial control'' category and determines that
only about 40% of Berle and Means' ®rms were
controlled by management in 1929. Drucker's
``pension fund socialism'' (1976), Porter's ``institu-
tionalization of equity'' (1992), and Hawley and
Williams's ``®duciary capitalism'' (1996) also argue
that ownership (at least) of public ®rms is not dis-
persed. Demsetz and Lehn (1985) empirically show
that ownership concentration varies widely across
companies.
Given the prominent role of investment bankers
such as Morgan in the creation and ®nancing of
®rms of this early period, as described below,
Berle and Means' inattention to this issue is con-
sidered rather surprising by many. Perhaps, as
suggested earlier, they merely con¯ated investment
funds and their managers with operating ®rms and
their managers, as was common for the period.
Not only did the theory of Financial Capitalism
re¯ect this view, but also Lenin's Imperialism
(1926). It is clear that Berle and Means viewed a
great inequity in power between the ultimate,
individual shareholder and operating ®rm man-
agers, and that they sought to bring attention to
this situation and encouraged a solution. As Stig-
ler and Friedland (1983, p. 242) write, ``the time
was ripe to view corporate directors as trustees,
not only for stockholders but for other interested
groups such as consumers and laborers''. Along
this same line many contemporaneous accounts
addressed the concentration of ®rms' control
through investment bankers, their intimacy with
®rm management, and their use of investor funds.
Certainly Lawson (1904), who chronicled the misuse
of investor funds by insurance companies and the
``money kings,'' Brandeis (1914), several US
government investigations, including those of the
Pujo Committee (1913) and Pecora (1939), re¯ect
this thinking and may have contributed to Berle and
Means not drawing a distinction between the two.
In any case, Berle and Means did not consider
the role of investment managers in the in¯uence
and control over ®rms, and they locate the
separation of ownership from control ``problem''
squarely between ®rm managers and stockholders.
In their view, managerial control of ®rms occurs
speci®cally because of dispersed ownership inter-
ests (stockholding) in comparison with con-
centrated managerial interests. Whether or not
they intended to overlook the investment funds,
acceptance of the Berle and Means thesis led, iron-
ically, to elaborations in the forms of managerial
capitalism and agency theory which, in conjunc-
tion with two other elements, had important
results for accounting research and policy.
6.2. Capital markets agency theory
Before considering these e?ects, we ®rst turn to
the development of agency theory as it is applied
544 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
to the capital markets setting. Drawing on Coase
(1937) and Berle and Means (1932), Jensen and
Meckling's (1976) agency view of the ®rm in a
capital markets setting has been widely applied in
both accounting and ®nance research. In theory,
``the relationship of agency is one of the com-
monest codi®ed modes of social interaction''
(Ross, 1973). The Jensen and Meckling agency
model portrays and analyzes an abstracted set of
economic relationships, grounded in theories of
economic organization, involving ®rm managers
and investors. In accounting capital markets
research (both empirical and analytical), agency
models succinctly portray a single principal who is
the owner and residual claimant, who hires
another party, an agent, to manage the principal's
resources. In the corporate setting the principal is
the ``representative shareholder'' who has entrus-
ted wealth to the agent who is the ``representative
manager'' [for example, in Baiman (1982) and
Watts & Zimmerman (1986)]. When investment
managers are incorporated in such structures, it is
commonly in the form of a ®nancial intermediary
whose presence does not fundamentally alter the
basic agency relationship between shareholder and
®rm manager (for example, Ramakrishnan &
Thakor, 1984). Thus, the Berle and Means world
of dispersed shareholder principals and manager
agents has become the characteristic perspective
from which to view capital markets agency rela-
tionships, while those involving investment funds
(and other parties) are disregarded. To the extent
that such a focus obscures the characteristics of
capital markets agency relationships there is a
value to incorporating investment funds in
accounting contracting, reporting, and disclosure
studies. In terms of the issues discussed in this
paper Ð that is, the relationships among indivi-
dual investors, investment managers, and operat-
ing ®rm managers Ð the traditional agency model
typically depicts the following:
Principal
Investor
!
Agent
FirmManager
This perspective relegates investment managers
(among other parties) to the role of mere ®nancial
intermediaries. While it can also be criticized for
failing to convey much of the richness of the capi-
tal market environment, it has the advantages of
simplicity and strong parallels to Berle and
Means; both focus on the relationship between
investors and creditors.
Another aspect to this issue is that the identi®-
cation of the parties to be included in a model
inevitably has political implications, because the
chosen parties' interests and relationships are
addressed to the exclusion of other parties. Thus
the choice for simplicity and parsimony carries
such implications, because restricting the model to
investors and creditors excludes the consideration
of other parties. Such exclusions are important,
and unfortunate results can occur, such as the
erroneous con¯ating, obscuring, or obliterating of
signi®cant ®nancial reporting issues involving the
excluded parties and their relationships.
6.3. E?ects on ®nancial reporting research and policy
As it turned out, the Berle and Means thesis and
the simple, single-tier agency model that evolved
from it carried ®nancial accounting research and
policy far from the condition of contemporary
capital markets. Two elements fueled this result:
federal regulation and the growth of investment
funds as a vehicle for individual investors.
First, the passage of Glass±Steagall and the
Investment Company Holding Acts e?ectively
crippled the ability of investment funds to exert
in¯uence and control over operating ®rms. This
substantially increased managerial control of ®rms
from the 1940s through the 1970s. However, in
recent years regulatory changes and federal revisiting
of the role of investment funds in corporate gov-
ernance have dramatically changed the landscape,
as described in earlier sections of this paper. Sec-
ond, the end of the twentieth century witnessed the
phenomenal and unparalleled growth of investment
funds (see Table 1). As individual investors increas-
ingly place their ®nancial assets in investment
funds (see Table 2) their holdings in institutions is
approaching 50% of household ®nancial assets.
These three elements: the Berle and Means
managerial control thesis and subsequent single-
tier agency perspective of the capital markets,
regulatory changes that increased the in¯uence
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 545
and control ability of investment funds, and the
substantial growth of investment funds, have led
to a remarkable situation. The intellectual accep-
tance of the Berle and Means thesis and single-tier
agency perspective has resulted in accounting and
®nancial reporting research and policy that is
focussed on corporation reporting to individual
investors. The assumption of dispersed share-
holders and the disregard of investment funds
leads to research and policy that tends to overstate
the power of managers with respect to owners. It
correspondingly overstates the unobservability
problem between managers and owners, and fails to
fully recognize di?erent agency relationship char-
acteristics involving operating ®rms and investment
funds. Second, the focus on the agency relationship
involving operating ®rms and investors results in
inattention to the separation of ownership from
management problem as it relates to investors and
investment funds, which has become relatively invi-
sible both in policy and research.
The capital markets landscape implies many
®nancial reporting priorities and issues beyond
those implied by the simple, single-tier agency
model. These implications are discussed in more
detail below. But before addressing those, it is
useful to reconsider the role of Agency Theory in
studying capital markets relationships.
6.4. Expanding perspectives
While Agency theory is not the only perspective
that can be employed to study relationships
between parties, it provides a useful economic tool
for portraying them. However, it does not seem
intuitively appealing to necessarily restrict capital
markets agency theory to the simple form princi-
pally used in contemporary research. Indeed,
Agency Theory can be thought of from several
perspectives. From the broadest perspective, it
represents a conceptual way of describing rela-
tionships between two or more parties. In terms of
the way that it is used in modern empirical, archi-
val capital markets research and related analytical
work, it is typically restricted (aÁ la Jensen and
Meckling) to two parties, investors and managers,
ostensibly to make the model tractable to mathe-
matical analysis. While typical in accounting
research, neither this sort of mathematical simpli-
®cation nor traditional empirical archival methods
are necessary; economic studies such as DeLong
(1991), for example, use agency-type models in
conjunction with historical methods. Writers such
as Blair (1995, pp. 31, 47) have presented elabora-
tions of the ``Basic Berle±Means Model'' to more
fully portray investment fund activities in capital
markets; however such elaborations have not yet
been explicitly applied to accounting and ®nancial
reporting. If capital markets agency theory is not
thought of as a way to present a highly stylized
and simpli®ed relationship between investors and
managers, but instead as a way of identifying and
portraying relationships among two or more par-
ties in the capital markets setting, then the agency
modeling goal becomes to portray these parties (as
parsimoniously as possible) and their relation-
ships. Many such relationships exist, and studies
need not identify and portray them all, but neither
do they need to be restricted to investors and
managers. Instead, studies need to portray those
parties and relationships that are pertinent to their
own focus.
Because our paper focuses on the role of invest-
ment funds with respect to operating ®rm man-
agers and investors, a possible alternative
structure might be portrayed as:
Principal
Investor
!
Agent ÀPrincipal
Investment
Manager
!
Agent
Firm
Manager
Table 2
Household holdings in investment funds (% of total household
®nancial assets)
a
Insurance
companies
Mutal
funds
Pension
funds
Other
institutions
b
Total
1990 7.4 6.3 18.0 6.2 37.9
1991 7.4 6.6 18.2 6.8 39.0
1992 7.8 7.0 19.1 7.1 41.0
1993 8.3 8.0 19.5 7.5 43.3
1994 8.4 8.1 19.6 7.1 43.2
1995 8.5 8.7 20.2 7.9 45.3
a
Constructed from OECD data (OECD, 1997).
b
``Other institutions'' include bank trusts, ®nance companies,
real estate investment trusts, and security brokers and dealers.
546 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
This formulation retains the concept of princi-
pals and agents.
15
In it, investors, as principals,
aggregate resources in an investment fund. Their
agent, the investment manager, invests these
resources in ®rms and has an agency relationship
with ®rm managers. Investors are de®ned more
broadly, and are comprised not only of mutual
fund owners, but holders of insurance policies
with cash values, investors in money market
funds, pension fund participants, and ®nancial
institution depositors, among others. As Berle and
Means emphasize, it is where ownership disper-
sion occurs that in¯uence and control is lost.
From this perspective contracting and ®nancial
reporting/disclosure issues occur at two levels and
vary depending upon the nature of ownership
concentration/dispersion.
7. Financial reporting implications
7.1. Overview
This two-tier structure has ®nancial reporting
implications
16
of two sorts. First, it leads to ®nancial
reporting issues in terms of ®rm reporting to invest-
ment funds (and investors
17
), investment fund
reporting to investors, and ®rm reporting through
investment funds to investors. Whereas histori-
cally accounting research, the accounting profes-
sion, and ®nancial reporting standard setters have
concentrated on ®rm reporting to investors, the
volume of investment activity that occurs via
institutional processes implies a need for greater
attention to these additional issues. Some recent
work, such as the Jenkins Committee Report
[American Institute of Certi®ed Public Accountants
(AICPA), 1994], which proposes a ``Business
Reporting'' model based largely on studies of infor-
mation uses and needs of professional investors,
seemingly re¯ects a greater awareness of these issues.
Second, and more broadly, our ®ndings suggest
that the single-tier agency relationship commonly
used as the basis of ®nancial research and policy
tends to obscure the information and ®nancial
reporting needs of many types of claimholders (see
Bricker & Previtts, 1999). That multiple agency
relationships exist in capital markets settings is
already widely accepted. It is well understood that
capital markets are (and have been) characterized
by complex and dynamic structures of relationships
that have evolved in changing political, social,
regulatory, and economic environments. Their
complexity has been portrayed by historical work
such as McCraw (1984). However, while accounting
and economic research recognizes the existence of
multi-tier agency relationships in theory (Antle,
1982), the simple, abstracted manager±shareholder
structure remains a principal foundation for
accounting research and ®nancial reporting con-
siderations, both at academic and policy levels.
This is useful for considering many issues and
promotes analytical computational eciencies, yet
also may result in some of the problems described
above. A broadened perspective on formulating
agency models and the application of more diverse
research methods in conducting accounting research
may result in better portrayals of capital markets
relationships and richer understandings of ®nancial
reporting issues. Below we focus on ®nancial
reporting implications related to the two-tier struc-
ture proposed in the following areas:
. di?erential reporting, e?ects of institutional
ownership on information about ®rms,
15
However, it is not necessary that a formal mathematical
``agency'' setting be imposed. Rather, the important point is to
identify the separate parties and identify their relationships, as
discussed elsewhere in this paper.
16
One objection to extending the basic agency setting to
portray ®nancial reporting as a two-tier relationship is that
many more such relationships could also be envisioned. As we
discuss elsewhere, this is a desirable result, in our view. Judgment
as to the importance of such portrayals given the context being
studied must be exercised to avoid a web of such relationships
so complex as to render analysis intractable. Given the promi-
nence of capital funds both today and historically, a two-tier
model seems reasonable to consider the principal and agent roles
of capital managers vis-aÁ -vis shareholders and management, and
to highlight the limitations of the traditional agency model.
Indeed, Walter (1993) characterizes corporate control systems in
terms of individuals, banks, investment institutions, and indus-
trial companies; in all of the stylized corporate control structures
he presents, individual investment through institutions (banks or
investment institutions) is always an important component.
Nonetheless, there are many other relationships and claimholders
to whom generalization of our ®ndings would appear warranted.
17
In recognition that individuals still invest directly invest in
®rms.
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 547
. managers' choice of accounting methods,
investment managers' reporting to investors,
. investors' assessment of fund risk, and con-
¯icts of interest,
. insider-type trading activities related to
investment managers and investors, and
. reporting to claimholders generally
7.2. Di?erential reporting
An extensive body of research (including Kim,
1997; Lev, 1988) suggests the importance of con-
sidering investor classes in regards to ®rm report-
ing. The two-tier structure suggests that investment
funds, because of their size, can ameliorate the
observability problem commonly associated with
an agency structure involving dispersed owners,
and helps focus on di?erential information needs
of investment funds and noninstitutional investors
as di?erent investor classes. Investment fund size
makes monitoring and information gathering eco-
nomically practical, and the size and in¯uence of
the fund's holding of a ®rm's shares makes ®rm
managers more willing to communicate directly
with fund managers.
Theoretical and empirical evidence supports
treating noninstitutional investors and investment
funds as di?erent investor classes. Shleifer and
Vishny's (1986) ``Large Shareholders and Cor-
porate Control'' shows how agency monitoring
problems are a?ected by the existence of large
shareholders, and how large shareholders are
able to monitor ®rms and in¯uence ®rm policy.
Kim (1997) shows that institutional ownership
a?ects price and volume responses to earnings.
Other studies have shown that investment funds
anticipate earnings surprise and trade accord-
ingly, ahead of the announcement. Fund ¯ows
suggest that this trading occurs with smaller
investors (Ali & Durtschi, 1997). Overall, this
evidence with our characterization of invest-
ment funds and noninstitutional investors as
separate classes of investors with di?erent infor-
mation needs, and modeling them as such helps
re®ne research questions about the ®nancial
reporting needs related to these separate classes of
investors.
7.3. Information e?ects of investment fund
ownership of securities on individual investors
Furthermore, the proportion of securities owned
by investment funds may a?ect information avail-
able to individual investors about ®rms, particu-
larly when such investors rely upon ®nancial
analysts for information about ®rms. Financial
analyst coverage of ®rms is inversely related to
proportion of institutional ownership (Grant &
Rogers, 1998), when controlling for ®rm size.
Firms with higher levels of institutional ownership
may generate less information for individual
investors. Porter's (1992) ®nding that ®rms with
high institutional ownership proportions had lar-
ger abnormal returns on earnings announcement
dates is consistent with this conjecture. The two-
tier structure provides a basis for rationalizing
di?erential ®rm reporting to investors depending
upon the ownership structure of the ®rm.
7.4. Firm managers' accounting and economic
choices
The two-tier structure a?ects interpretations
involving the ®ltering of information from ®rms to
investment funds to individual investors and, pos-
sibly operating ®rm accounting and economic
choices. Myopic managerial choices have been
studied extensively in business research, and it has
been conjectured that institutional ownership of
companies may aggravate this tendency (for
example, see Laderman, 1992).
The two-tier structure provides a perspective for
understanding the possible incentives. Investment
manager compensation depends, to a large extent,
on fund size, which in turn is driven by investor
assessment of past fund performance and their
formation of expectations regarding future fund
performance. Mutual funds invest in large num-
bers of operating ®rms. The ®ltering of informa-
tion that occurs when operating ®rms report to
investment funds which in turn report to individ-
ual investors may lead investors to evaluate funds
on the basis of relatively simpler, short-term
aggregate measures, such as annual returns. Then
an increased focus on short-term earnings max-
imizing decisions may be re¯ected in investment
548 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
managers' accounting choices and economic
resource allocation (investing) choices. That such
®ltering occurs is suggested by the numerous
ranking and rating reports of fund performance that
appear regularly in popular business publications.
Operating ®rm managers' compensation is often
partially a function of the ®rm's cost of capital. If
this cost is a?ected by investment managers' invest-
ing choices, then ®rm managers' accounting and
economic choices may correspondingly focus on
maximization of short-term ®rm pro®tability. For
example, investment managers may choose
income increasing accounting methods in valuing
certain restricted and Section 144a securities which
are not market-determinable, choose to invest in
®rms with high short-term earnings prospects, and
make economic choices about asset disposals so as
to maximize compensation (Chandar, 1997). On
the other hand, if investors focus on multi-year,
instead of most-recent year investment fund
results, then the opposite may occur. Investment
fund monitoring and in¯uence of ®rms would then
lead to accounting and economic choices max-
imizing long-term pro®tability (see Hansen, 1991;
Kochhar, 1996).
7.5. Fund reporting to investors
Traditionally ®nancial reporting focuses on the
relationship and reporting between operating
®rms and investors, and there is consequently little
published work assessing the adequacy of invest-
ment fund reporting to investors for facilitating
mutual-fund and pension-fund resource allocation
decisions. Only recently, for example CICA's
(1997) Financial reporting by investment funds,
have serious attempts been made to address
investment fund reporting issues. The two-tier
structure proposed here facilitates study of fund
reporting to investors as conceptually distinct
from ®rm reporting to investors or ®rm reporting
to investment funds.
The failure to focus on fund reporting to inves-
tors has had several results. It is known that
investment fund reporting is less comprehensive
than ®rm reporting, although this situation is cer-
tainly ameliorated by services such as Morningstar
and the many ®nancial press publications which
analyze and rate various mutual funds. Reviews of
the ®nancial reports of investment funds suggests
that information is provided by funds on a less
timely basis and with far greater variability in dis-
closure content than is found in corporate report-
ing (Chandar, 1997; Henriques, 1994c). For
example, disclosure related to investment asset
cost, transaction pro®tability, fund risk, and the
valuation of some securities vary widely. Some of
these di?erences are merely in amount while oth-
ers re¯ect apparently di?erent methods. It is not
clear whether fund reporting enables investors to
compare funds. Funds ®le ®nancial information
semiannually, revealing only snapshots of their
investment holdings. Unlike corporations, funds
are not required to ®le supplemental disclosures
even when signi®cant events occur that could
change an investor's perception of the risk of the
investment. For example if the investment man-
ager is replaced, or if new investment strategies
with signi®cantly di?erent risk pro®les are initi-
ated (as discussed in more detail below). Some
funds include their portfolios in their pro-
spectuses; others include them in statements of
additional information that must be ordered
separately. The dearth of information encourages
investors to make investment decisions based on
information obtained at the point of sale, often
from funds' sales sta?, or from brokers. Many
investors also rely on fund ratings and rankings
provided by publications of varying quality in
making fund investment choices.
7.6. Investor assessment of fund risk
The single-tier structure implies an importance
to consideration of operating ®rm risk. In con-
trast, the two-tier structure implies an importance
to assessing both operating ®rm and investment
fund risk, another matter addressed in the CICA
(1997) report. However, fund reports contain very
little information about risk.
Investment managers' compensation contracts
provide them with incentives that may similarly
a?ect their choices regarding investment portfolio
risk. They face intense competitive pressures to
achieve at-or-above benchmark returns, which
may motivate them to make risky investments, for
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 549
example in derivatives, in order to outperform
competitors. This motivation results from their
incentivized compensation contracts, which
reward them according to measures of fund return
achieved, and the low observability of a fund's
level of risk. Even relatively conservative funds
face this problem. McGough (1994) asserts that
``managers' desire to win incentive pay is a major
reason that the worst damage to mutual funds
from derivatives is falling on the most con-
servative types Ð money market and bond funds.
In these funds, the competition is toughest,
because their investments are so similar.'' While it
has been illegal for individual investment advisers
dealing with small clients to base pay on perfor-
mance, mutual funds are exempt from that statute,
even though most mutual fund holders are individual
investors.
The diculty in assessing fund risk can be illu-
strated by considering the impact of derivatives,
which are not commonly described in fund
reports. Contracts like interest-rate options and
foreign currency contracts are not only used to
hedge against risk, but also to increase risk. Apart
from derivatives, funds may engage in transac-
tions such as short selling, margin purchasing, and
investing in other exotic ®nancial instruments.
SEC commissioner Richard Roberts [quoted by
McGough (1994) in the Wall Street Journal]
asserts that stock and bond mutual funds ``should
be able to invest in whatever they want to, with
the caveat that the risk of those investments
should be fairly and fully disclosed to investors''.
However, the issue of what constitutes fair and
full disclosure of risk by funds has not been fully
studied. It is not known whether investors can
distinguish among funds on the basis of risk.
7.7. Con¯icts of interest and insider-type trading
While the historic focus on company reporting
to investors has highlighted operating ®rm con-
¯ict-of-interest and insider trading abuses,
researchers or policy makers have not carefully
studied such activities involving investment man-
agers. It is known that investment managers can
engage in business dealings with parties in whose
®rms funds have invested. For example, Henriques
(1994a) has identi®ed cases in which investment
managers, with little regulatory oversight, invest in
®rms that employ executives, advisers, or under-
writers with whom they have close ties. The
®nancial and popular press reports cases of high
pro®le investment managers who have purchased
stock that enriched a family member. Henriques
(1994a) identi®es instances of investment man-
agers investing privately in deals promoted by a
broker from whom they had bought stocks for
their funds. The risk that investment managers
have a close relationship with their investees is
comparable with a similar allegation in the case of
its precursor, the publicly traded investment trust,
earlier this century.
Some of the funds promising the highest growth
rates invest in start-up ®rms in the US or in
loosely regulated markets abroad. They also invest
in small ®rms or purchase penny stocks, in their
attempts to beat competitor and benchmark
returns. These are markets that are typically thinly
traded and followed, and reliable information is
often scarce. Portfolio managers therefore rely on
``professional `stock boosters,' aggressive brokers
and ®rm insiders Ð whose chief goals are to sell
stock, collect fees, or increase the value of the
shares they already own'' (Henriques, 1994b). The
operating ®rm bene®ts from this ``stamp of cred-
ibility'' that is a?orded to it by an investment by a
large mutual fund, and the investment managers
in turn anticipate prospects of considerable gains.
Particularly in thinly traded markets, the very act
of sale by a mutual fund may in¯uence market
prices, making it dicult to determine fair market
prices for fund assets.
Some of these transactions are simply illegal, as
the Investment Company Act of 1940 prohibits
investment managers from purchasing stocks
publicly underwritten by, or formally aliated
with, their ®rms. Others, while not violations of
law, are of obvious and legitimate interest to fund
investors, and have clear reporting implications
that correspond to similar disclosure requirements
for operating ®rm managers. Certainly, the
apparent low visibility of these transactions and
relationships leads to research questions as to fund
investor reactions should such information be
readily available.
550 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
7.8. Other claimholders
Just as focusing on investors and company
managers obscures both the nature of the ®nancial
reporting ``problem'' and implications with respect
to investors, fund managers, and company man-
agers, so also the single-tier agency model
obscures ®nancial reporting issues involving other
kinds of claimholders, including customers,
employees, and communities. In this way, the sin-
gle-tier model has political implications as it
removes the interests of other parties from con-
sideration. Each of these parties has information
rights of the sort commonly associated with
shareholding (ownership). As Bricker and Previts
(1999) write, ownership investment carries with
it implicit contracts (as opposed to the explicit
contracts of agency theory), among them being the
right to know about that which is owned Ð that
is, an information right. They argue further that
the ``investments'' made by other parties, such as
employees, the community, and other parties
(including their investment from bearing the cost
of company operations, such as pollution) give
these parties a similar claim in the company, and a
corresponding information right. From this per-
spective, the agency or other structural relation-
ships among parties are not limited to those who
are shareholders, and there are certain property
rights, and consequently information rights, accru-
ing to these other classes of claimholders. As pre-
viously discussed, Berle and Means apparently held
the view companies should be held responsible to
broader constituencies, and argued that company's
board of directors should have trusteeship responsi-
bilities to these parties. More ¯exible agency models
can facilitate portraying and studying such models
and their implications, as we do with respect to
investment fund managers using a two-tier model.
The di?erent goals of investment fund managers
today also have implications for reporting to other
classes of claimholders. As previously discussed, a
principal goal of the Morgans of the earlier era
were operational Ð they sought to achieve eco-
nomic goals that, secondarily, a?ected ®rm share
value. In contrast, investment fund managers of
today are principally concerned with share value
and returns, and despite the in¯uence they exert
over operating ®rms, only secondarily (and reluc-
tantly) focused on ®rm economic goals and oper-
ating activities. It is the cost ``punting'' that makes
them act as proprietors. In contrast, other claim-
holders have far more interest in ®rm operating
activities, and these interests can be addressed by
broadened reporting to address them.
8. Concluding comments
In this paper, using the historical record from
two time periods, we identi®ed in¯uence and con-
trol relationships involving investors, investment
funds, and ®rms beyond those addressed by Berle
and Means, and showed that investment managers
have important in¯uence and control capabilities
beyond ®nancial intermediation. Brief considera-
tions of Germany, Japan, South Africa, and
Canada suggested that similar roles are played by
investment funds, including banks and other
institutions, in those countries. Overall, the evi-
dence suggests the importance of investment funds
in in¯uencing and controlling ®rms, across time
and countries. To more fully portray these
observed relationships among investors, invest-
ment funds, and ®rms we presented a two-tier
capital markets structure interposing investment
managers as agents of investors and principals of
®rm managers. This structure more clearly separates
and illuminates the contracting and ®nancial report-
ing issues involving these parties, particularly in
terms of ®rm reporting to investment funds, and
fund reporting to investors. Particularly, in con-
junction with our historical analysis, it highlights a
hierarchy of investing relationships in which the dis-
persion or concentration of ownership interests may
vary. While Berle and Means point to the dispersion
of ownership interests with respect to ®rmmanagers,
the evidence suggests that the dispersion of indivi-
dual ownership interests with respect to investment
funds may also be an important issue to consider.
We do not want the reader to conclude that our
principal argument is for replacing the single-tier
agency model with a two-tier one to study capital
markets, per se. Instead, our point is that in trying
to portray and study capital markets parties
and relationships from an agency perspective,
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 551
researchers should balance model parsimony with
descriptiveness. For the purposes of this paper, a
two-tier model is useful. Investment funds are an
important type of participant in US and interna-
tional capital markets, and incorporating them
improves our view of ®nancial reporting issues.
From a broader perspective, we conclude that
models of capital markets relationships should be
contingent on the issue under study. To more fully
understand the accounting and ®nancial reporting
issues of contemporary capital markets, it is
important to portray the signi®cant parties and
relationships. While richer models may render
them less tractable to mathematical analysis, they
may o?er fruitful areas of application for historical
and ®eld research methods, as well as archival
empirical research.
Understanding the structure of in¯uence and
control relationships in modern capital markets is
both useful and timely. The recent activities of the
AICPA, FASB, and CICA suggest the importance
of a theoretical structure from which ®nancial
reporting implications can be derived for investors
in mutual funds as well as direct shareholding
investors. Traditional ®nancial reporting policy
has focused on the latter of these, leaving fund
reporting issues and those of reporting to other
claimholders largely unaddressed. Our results
imply that ®nancial reporting research and policy
issues should be reconsidered in light of this two-
tier setting speci®cally, and in terms of a broader
set of claimholders, more generally. Such con-
siderations may provide a basis for improving
®nancial reporting both in process and in product.
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doc_475592778.pdf
This paper assesses the eects of Berle and Means' study of the separation of corporate ownership from control on cor-
porate ®nancial reporting theory, research and policy. Their focus on shareholders and managers provided a starting point
for the subsequent development of agency theory such that this relationship has come to dominate capital markets research
and policy, to the virtual exclusion of parallel issues involving other parties. Berle and Means' omission of the role of
investment funds led them to conclude that the separation of ownership from control problems was located between
shareholders and company managers. We document the inaccuracy of this conclusion using historical and contemporary
US evidence and contemporary evidence for Germany, Japan, South Africa, and Canada.
Where Berle and Means went wrong: a reassessment of
capital market agency and ®nancial reporting
Robert Bricker
a,
*, Nandini Chandar
b
a
Department of Accountancy, Weatherhead School of Management, Case Western Reserve University,
622 Enterprise Hall, Cleveland, OH 44120, USA
b
Department of Accounting Information Systems, Faculty of Management, Rutgers University, 94 Rockafeller Road, Piscataway,
NJ 08854, USA
Abstract
This paper assesses the e?ects of Berle and Means' study of the separation of corporate ownership from control on cor-
porate ®nancial reporting theory, research and policy. Their focus on shareholders and managers provided a starting point
for the subsequent development of agency theory such that this relationship has come to dominate capital markets research
and policy, to the virtual exclusion of parallel issues involving other parties. Berle and Means' omission of the role of
investment funds led them to conclude that the separation of ownership from control problems was located between
shareholders and company managers. We document the inaccuracy of this conclusion using historical and contemporary
US evidence and contemporary evidence for Germany, Japan, South Africa, and Canada. In contrast to Berle and Means,
we ®nd that investment fund in¯uence and control over companies is pervasive and probably a common characteristic of
modern capital markets. Our analysis shows how viewing the capital markets setting from a richer, two-tier perspective
involving investors, investment managers, and company managers results in quite di?erent and better perspectives on
®nancial reporting issues, particularly in terms of company reporting to funds, and fund reporting to investors. Conse-
quently, we suggest that our understanding of capital markets may be improved by studying and portraying more diverse
types of parties and their relationships than just managers and owners. This perspective subsumes the single-tier principal-
agent model and allows multiple relationships to be portrayed and studied. #2000 Elsevier Science Ltd. All rights reserved.
1. Introduction
During the past twenty-some years, agency
models have been widely used to portray eco-
nomic relationships between (among others)
shareholders and ®rm managers.
1
In these models,
®rm managers are commonly represented as the
agents of investors, while investment managers are
modeled as ®nancial intermediaries who facilitate
information transfers, investing and monitoring
activities.
2
These basic relationships, which per-
vade much theoretic and applied capital markets
research in accounting and ®nance, can be traced
back to the pioneering work of Berle and Means'
0361-3682/00/$ - see front matter # 2000 Elsevier Science Ltd. All rights reserved.
PI I : S0361- 3682( 99) 00050- 1
Accounting, Organizations and Society 25 (2000) 529±554
www.elsevier.com/locate/aos
* Corresponding author Tel.: +1-216-368-5355; fax: +1-
216-368-4776.
E-mail address: [email protected] (R. Bricker).
1
Watts and Zimmerman (1986) can be consulted for a
review of this literature.
2
For instance, Leland and Pyle (1977) and Ramakrishnan
and Thakor (1984).
Power without property: The rise of the modern
corporation (1932). Berle and Means studied the
development of the corporation and capital mar-
kets, characterized corporate ownership as con-
sisting of dispersed individual shareholders, and
found a separation between ownership and con-
trol functions within operating ®rms.
Berle and Means largely discounted or ignored
investment fund in¯uence and control of ®rms,
and largely for this reason, modern agency theory
3
focuses principally on the implications of the
agency relationship existing between dispersed
shareholders and ®rm managers. Although Berle
and Means can scarcely be faulted for failing to
anticipate the rise of the pension and mutual fund,
their recent emergence and prominence implies an
importance to reassessing the Berle and Means
thesis and the models of corporate in¯uence and
control that have been derived from it.
In this paper, we reassess both operating and
strategic in¯uence and control relationships invol-
ving individual investors, investment funds, and
operating ®rms, using an agency perspective, and
present related reporting and disclosure implica-
tions. To fully incorporate in¯uence and control
functions, we follow Mintz and Schwartz (1985),
among others, who de®ne in¯uence and control in
both strategic and operational terms.
4
We use the
terms ``investment fund'' and ``investment man-
ager'' interchangeably to refer to all sorts of funds
and investing institutions (including mutual funds
and pension funds) which invest aggregated
resources of investors, and their managers. The
term ``investor'' refers to noninstitutional parties,
typically individuals, who place ®nancial resources
in investment funds.
5
Our investigation studies in¯uence and control
over corporations in two time periods: from
approximately 1900 through 1932, and from
approximately 1970 through the present. This ana-
lysis describes the nature and extent of investment
managers' activities in aggregating the resources of
investors, in investing these resources in ®rms, and
in exerting in¯uence and control over these ®rms.
6
We ®nd numerous inconsistencies in the historical
record in terms of characterizations of managerial
control of ®rms and of investment funds as ®nancial
intermediaries, results echoed by contemporary,
empirical studies. These ®ndings show that the
separation of ownership from control does not
necessarily occur between stockholders and man-
agers, due to the presence of investment funds, but
also that a separation of ownership from control
may occur between investment funds and investors.
We conclude on this point that the underlying issue
is one of concentrated versus dispersed interests, and
not one of owners and managers per se. We use
these ®ndings and insights to portray the relation-
ships among individual investors, investment funds,
and company managers in a two-tier structure. In
one tier this involves individual investors and
investment funds, and in the other, investment funds
and ®rms.
7
This structure replaces the traditional
3
It is perhaps odd to realize that agency theory, as applied
to the capital markets, while developing out of Berle and
Means' study, has a quite di?erent solution than imagined by
Berle and Means. The authors imagined legislation and a
restructuring of corporate boards Ð such that board members
were trustees to a broad set of interest groups, while agency
theory identi®es a possible economic, market solution to the
separation problem.
4
This is a common view of in¯uence and control. Mintz and
Schwartz (1985, p. 8) de®ne strategic in¯uence and control by
owners as that ``in which the owners dominate decision making
while relieving themselves of the daily exercise of the power
they ultimately wield''. Other writers on this issue include Her-
man (1981, p. 115).
5
The capacity of individuals to be direct shareholders is well
understood and not considered further in this study.
6
We distinguish between property rights on one hand and
in¯uence and control on the other. Property rights relationships
refer to the legal right of ownership in property. However, the
de facto ability to exert in¯uence and control over property
may not arise from the legal ownership of such property. The
corporate form of organization is a classic example of how
property (ownership) rights can be separated from in¯uence
and control. Operating ®rm managers have the capacity to
exert substantial control over property owned by shareholders.
The point of our distinction is to emphasize an economic rather
than a legalistic perspective on in¯uence and control.
7
While it is well understood that the capital markets envi-
ronment includes relationships among many parties, considera-
tion of the relationships among capital managers, shareholders,
and company managers has increased signi®cance given the
prominent role of capital managers in the capital markets, and
the historical focus of accounting research (broadly conceived)
on direct operating-company reporting to investors. For these
reasons, focusing on these parties seems appropriate in this work.
530 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
perspective of investment managers as ®nancial
intermediaries. Furthermore, it separates the own-
ership±control issue into ones involving the rela-
tionship between investment funds and individual
investors, and the relationship between stockholders
and managers. Although the idea of a multi-tier
agency setting is not new, we note that it leads to
®nancial reporting and research implications that
di?er from those of the traditional single-tier
agency structure involving investors and ®rms that
now dominate ®nancial reporting research and
policy, speci®cally in terms of ®rm reporting to
funds, and fund reporting to investors. We
observe that excluding signi®cant capital market
parties in the interest of parsimony and simplicity
may result in analysis and policy that fails to address
the interests of the excluded parties. Our results,
therefore, pertain to other corporate claimholders,
including employees, consumers, communities
members, and other parties. While we do not assert
that studies of capital market relationships need to
portray all parties and relationships, we would argue
that such portrayals should depend upon the focus
and scope of each study, and not on arbitrary
maintenance of model simplicity.
The remainder of this paper is organized in the
following way. Section 2 reviews the Berle and
Means thesis of managerial control of ®rms. Sec-
tions 3 and 4 examine the in¯uence and control
exerted by investment funds and their managers
over ®rms during the ®rst quarter of the twentieth
century, during which time modern US capital
markets emerged, and the most recent quarter cen-
tury, during which time mutual and pension funds
emerged as important forms of investment funds.
Because the development of property and infor-
mation rights has been shaped by a complex and
dynamic interplay of factors over time, an histor-
ical analysis is exceptionally well suited as a
method. It provides a rich perspective for a deep
understanding of the many ways by which invest-
ment managers exert in¯uence over ®rms across
markedly di?erent economic environments. Fur-
thermore, our study uses historical methods and
evidence to critically assess two widely held
assumptions: ®rst, the Berle and Means mana-
gerial control thesis, and second the investment-
fund-as-®nancial-intermediary thesis. Our analysis
focuses on the in¯uence and control exerted by
investment managers over ®rms during both peri-
ods. While we principally study US evidence,
Section 5 addresses similar in¯uence and control
relationships observed in other countries. Follow-
ing presentation of this history, Section 6 discusses
and assesses the Berle±Means model and related
agency structures involving investors and man-
agers in a capital markets setting. We show how
replacing the agency model with a structure that
more richly portrays relationships involving
shareholders, investment managers and ®rm man-
agers leads to better understandings of ®nancial
reporting issues. Section 7 uses this perspective to
consider implications in terms of ®rm-to-invest-
ment manager reporting and fund-to-investor
reporting. We conclude in Section 8 by arguing for
greater ¯exibility in portraying capital markets
parties and relationships.
2. The Berle and Means thesis
In their classical work, The modern corporation
and private property (Berle & Means, 1932) Berle,
and Means sought to combine legal and economic
perspectives in explaining the development of the
``Modern Corporation''. Their main ``separation
of ownership from control'' thesis suggested that,
in the widely-held corporation, the risk-bearing
function of ownership and the managerial func-
tion of control were separate functions performed
by di?erent parties. They viewed the corporation
as ``a means whereby the wealth of innumerable
individuals has been concentrated into huge
aggregates and whereby control over this wealth
has been surrendered to a uni®ed direction''.
Berle and Means characterized management
of industrial corporations as powerful and
entrenched. Consequently, they argued that ``the
separation of ownership from control produces a
condition where the interests of owner and of
ultimate manager may, and often do, diverge, and
where many of the checks which formerly oper-
ated to limit the use of power disappears''. The
Berle and Means thesis became a focal point for
the subsequent development of capital markets
agency thinking. Particularly signi®cant was their
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 531
nearly exclusive focus on the relationship between
shareholders and managers. It is plausible that
Berle and Means merely con¯ated investment
funds and their managers with ®rms and ®rms'
managers, so closely were the two often portrayed
during this time. The failure to form this distinc-
tion, however, led to subsequent research and a
policy that focused on ®rm to shareholder dis-
closure issues, and virtually ignored investment
fund±investor issues.
This characterization of management as all-
powerful ``princes of industry'' could have been
intended to highlight dramatic social changes
wrought by the corporation rather than to accu-
rately portray the structure of economic relation-
ships at the time. In portraying the corporate
system as involving the divorce of ownership or
risk-taking from control, Berle and Means saw
managers as enjoying many of the fruits of capi-
talism, without themselves providing much capital
or undertaking proportionate risks. Instead, they
were organizers and administrators. The advan-
tages of the economies of scale that could be rea-
lized due to the technological revolution could
only be mobilized by the accumulation of vast
amounts of capital. For such large amounts of
capital outside sources were needed. This led to
the need for professional managers, who because
of the dispersed nature of ownership, exerted
e?ective operating control over ®rms. From this
perspective, Berle and Means' focus on owners
and managers might be regarded as a political or
rhetorical device designed to focus attention on
the problem of concentrated economic power in
conjunction with the absence of some counter-
vailing power. Indeed, as discussed later, Berle
and Means suggested broadening the responsi-
bility of a company's board of directors to a kind
of trusteeship to address the need for such a
countervailing power. Some regard the passage of
the Securities Acts as evidence of the success of
Berle and Means' arguments. While many believe
that the e?ects of the stock market crash and
depression far overshadowed any such e?ect
(Stigler & Friedland, 1983), the citation and word
choices of politicians and regulators at the time of
their enactment show that Berle and Means at
least provided the rationale for such legislation.
Empirically, Berle and Means studied the largest
200 non®nancial corporations of 1929±1930 and
found that management controlled 44%. Another
21% were controlled by a ``legal device'', so in total,
Berle and Means calculated that about 65% of these
large ®rms were nonowner controlled. To a large
extent, Berle and Means attributed this condition to
the emergence of widely dispersed ®rm ownership
that accompanied the development of the large
corporation. These ®ndings were viewed as empirical
con®rmation of several prior writers' observations
on the separation of corporate ownership from
control, including Veblen (1904), Veblen (1923) a
quarter century earlier, Ripley (1927), and the Pujo
Committee (1913). Writers such as Bell (1973), Gal-
braith (1967), Gordon (1945), Kaysen (1957), Marris
(1964), Simon (1966) and Fama and Jensen (1983)
have developed this thesis further. Furthermore,
Berle and Means' focus on the relationship existing
between retail investors and ®rms has resulted in
at least two important related theoretical con-
tributions. The ®rst of these is Chandler's man-
agerial capitalism (Chandler, 1977), which studies
the control of ®rms by their managers. The second
is Jensen and Meckling's (1976) application of
agency theory to capital markets settings, from
which modern Positive Accounting Research has
developed. The capital markets agency structure
incorporates a shareholder/principal, and a man-
ager/agent who is hired by the shareholder and to
whom the manager reports. This application of
agency theory to capital markets settings has been
embraced by accounting and ®nance academics and
policy makers, and has resulted in an emphasis in
contracting, capital structure, and reporting and
disclosure by ®rms to a dispersed group of owners.
The capital markets agency model may be inter-
preted as the economic markets theory response to
the issues raised by Berle and Means. Yet while
inspired by Berle and Means, the agency ``solution''
is far from the suggestions proposed by them.
Despite the widespread use and in¯uence of the
Berle and Means thesis, many writers continue to
question its descriptiveness. For example, while
Mintz and Schwarz (1985, p. 8) acknowledge that
``the acquisition of policymaking authority by the
chief executive is seen by managerial theorists as
more or less inevitable'', they view the control
532 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
issue as ``problematic''. This problem necessities
an analysis of ``the conditions under which outside
controllers can successfully establish and change
corporate direction''. Later in this paper we will
return to more thoroughly reassess the Berle and
Means thesis and related manager±investor agency
model in light of the evidence presented below.
3. The early corporate economy Ð the J.P. Morgan
era
3.1. Economic environment
We begin by tracing important business and
economic developments in the late nineteenth/
early twentieth century. We focus on the develop-
ment of US capital markets and the role of
investment funds, particularly investment bankers,
in conjunction with an assessment of the Berle and
Means thesis of a separation between ownership
and control.
The rise of the industrial giants in the United
States coincided with the peak of the country's
drive to industrialism after the 1880s (Chandler,
Bruchey & Galambos, 1968). Previously, the exis-
tence of innumerable small business ®rms resulted
in decentralized resource allocation decisions.
Centralized coordination and control of produc-
tion now replaced this approach. The US economy
was swiftly transformed from a strictly agrarian,
commercial and rural economy into an urban,
industrialized one. It experienced enormous
growth. While in the 1850s the industrial output of
the US was far below that of England, by 1894,
the value of American products almost equaled
the value of the combined output of the United
Kingdom, France, and Germany. By the First
World War, America produced more than one-
third of the world's industrial goods (Chandler
et al.).
Thus, within a relatively short span of time, there
was a dramatic transformation of an undi?er-
entiated economy to a di?erentiated and complex
one. It is not surprising, then, that the American
economy experienced fundamental structural
changes at the same time. As related to business
entities, the integration of ownership and control
that was characteristic of the nineteenth century
®rm gave way to their separation, initiated by the
development of railroads (Chandler, 1969).
It is well known that this enormous expansion
of the American economy occurred in conjunction
with a corresponding need for investment resour-
ces. Capital markets, as we understand them
today, did not exist. However, banking houses,
like J.P. Morgan (among many) did, and it is these
parties that we refer to as investment managers
and investment funds during this period. Bankers
like J.P. Morgan played a central role in this
expansion due to their ability to mobilize large
amounts of capital (DeLong, 1991). The capital
needed to develop railroads was provided in a
large part by the ¯otation of bonds, which, in
turn, led to the rise of the Wall Street investment
banks (Chandler & Tedlow, 1985) and, subse-
quently, to national and regional stock market
development.
3.2. Investment funds
The Berle and Means thesis, however, largely
overlooks the dominating presence of investment
managers during this early market. Investment
managers played a pivotal role in the development
of early capital markets, where they were important
in the resource allocation process. Firms such as J.P.
Morgan were instrumental in ®nancing corporate
acquisitions, mergers, and other activities (Bran-
deis, 1914; DeLong, 1991; Goldsmith, 1954; Pujo
Committee, 1913; Ramirez, 1995). Often, investing
activities extended to strategic and even opera-
tional in¯uence and control of ®rms. While the
source of the funds used for ®nancing these activ-
ities were typically bank deposits and insurance
funds held by ®rms controlled by Morgan or other
®nanciers, depositors, and insureds were probably
relatively uninformed of the use of their funds by the
investment managers (similar to many mutual fund
investors and pension plan participants of today
8
).
8
That is, both the depositor of the early twentieth century
and the mutual fund holder of the late twentieth century pro-
vided the ``atomic'' basis for resource aggregation, without, in
either case, having much of an idea about what was actually
done with their funds.
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 533
While the record of investment managers' con-
trol over ®rms is too broad to exhaustively review,
the illustrations below are characteristic of their
activities. Morgan's early major activities predate,
of course, the turn of the century (see Chandler &
Tedlow, 1985), and began with the railroads. By
way of background, an economic depression in the
1890s led to a series of railroad reorganizations. In
these transactions, the Morgan ®rms typically
acted as managers of large underwriting syndicates,
which normally agreed to purchase securities Ð
stock, convertible bonds, or convertible notes not
bought by the corporation's shareholders in an
o?ering. The general reorganization pattern con-
sisted of raising cash through the issue of new
securities, realigning ®xed charges by exchanging
new securities for old, predicated upon the earning
capacity of the corporation, and the creation of a
voting trust. The voting trusts, appointed by the
reorganization committee, were vested with full cor-
porate authority by the shareholders. Thus, Morgan
wielded signi®cant control over railroads, on behalf
of shareholders, through the vehicle of the voting
trust. These trusts served to separate the voting and
ownership rights inherent in common stocks.
The Morgan company was omnipresent
throughout the early development of American
capital markets. Between 31 December 1897 and
22 January 1913, J.P. Morgan & Co. was the sole
underwriter for 11 interstate railroad issues of
stock and convertible bonds totalling almost $63
million. In another 4 instances, the ®rm managed
underwriting syndicates totalling over $204 mil-
lion. In 122 instances, it acted as initial subscribers
for bonds and notes totalling $846 million, and in
another 61 instances, it managed subscription syn-
dicates which placed securities totalling over $485
million (Chandler & Tedlow, 1985, p. 272). As
managers of syndicates, J.P. Morgan & Co. sold
securities of the syndicate either through private
placement or public subscription for an additional
commission and share of pro®ts. These functions
were of central importance in an economic system
with relatively undeveloped capital markets.
The syndicate operations were based on faith,
reputation, and character, all of which were essential
factors in the development of early capital markets.
The growth of the railroads led to innovations in the
techniques of creating and managing large private
business enterprises. Modern ®nance and adminis-
tration techniques, labor relations and government
regulation changed dramatically. The demand for
capital to feed the immense growth in America's big
business led to the institutionalization of the
nation's money market in New York.
Morgan turned his attention to other industrial
enterprises around the turn of the century. From
1902 to 1912, J.P. Morgan & Co. was directly
responsible for marketing almost $2 billion of
interstate securities. It also ran a large commercial
banking business, with aggregate deposits in 1912
of $162 million. The Morgan Company became
best known for its roles in organizing ®ve ®rms:
General Electric, American Telephone and Tele-
graph, Federal Steel, United States Steel, and
International Harvester. In these cases, the need
for capital and the fragmentation of the industry
(particularly in the case of AT&T) resulted in a
close relationship between the company and its
bankers. Morgan involvement in a ®rm or indus-
try required extensive re®nancing, including the
¯otation of new securities in the New York market
(Sobel, 1965). Investment bankers of this time,
believing that small investors were prone to pan-
ics, turned to other banks, trust companies and
insurance companies as new sources of funds.
This, in conjunction with the merger movement,
the growth of larger enterprises, and the need for
large-scale ®nancing, resulted in ``a complex of
investment commercial banks together with life
insurance trust companies . . . with enough
resources to control the market under almost any
circumstances. . .'' (Sobel, p. 184). Thus, the
merger movement that began with the railroads
in the 1880s, and which thereafter spread to the
industrial ®rms, was facilitated to a large extent by
a small group of private bankers including J.P.
Morgan. These ®nanciers fostered combinations
in capital intensive industries with the purpose of
bringing the market under control.
Morgan's restructuring of the steel industry into
the United States Steel Corporation, the ®rst bil-
lion-dollar ®rm, illustrates the operational in¯u-
ence and control exerted by investment managers
of the period. This combination, considered by many
to be the greatest merger of the era (Sobel, 1965),
534 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
resulted in a union of eleven major ®rms and
contained what were once 170 independent ®rms.
The ®rm was formed in 1901, and soon after its
incorporation, Morgan announced the formation of
a syndicate to underwrite new securities. The cir-
cular noted that ``the entire Plan of Organization
and Management of the United States Steel Cor-
poration shall be determined by J.P. Morgan &
Co.'' (Chandler & Tedlow, 1985, p. 282). Not only
did Morgan orchestrate the creation and ®nancing
of US Steel, he also handpicked its manager. It is
known that George Perkins, a Morgan partner,
served on its ®nance committee and designed the
company's innovative employee stock purchase
and bonus plans, and that Morgan himself was
involved in mediating labor disputes. Carosso (1987,
p. 473) writes ``As sole managers, with complete
authority over all its operations [Morgan's ®rm] was
responsible for every aspect of the steel corpor-
ation's organization.'' Furthermore, Morgan & Co.
made a 200% return on the funds advanced during
the merger, received substantial fees, and created a
®rm which controlled a majority of the various
businesses that made up the steel industry.
The formation of International Harvester also
illustrates investment banker strategic and opera-
tional control of a ®rm. Formed in 1902 in a mer-
ger of ®ve companies, the stock of International
Harvester was placed in a voting trust controlled
by the Morgan Company (Garraty, 1957). Carosso
(1987, p. 480) notes ``[The Morgan Firm] alone
would determine the structure of the merged com-
pany and who had the right to choose its ocers
and directors. . .'' The company was e?ectively run
by Morgan partner George Perkins, who wrote to
Morgan, ``The new company is to be organized by
us; its name is to be chosen by us; the state in which
it shall be incorporated is left to us; the Board of
Directors, the Ocers, and the whole out®t left to
us Ð nobody has any right to question in any way
any choice we make'' (Chernow, 1990, p. 109).
Carosso (1987, pp. 490±941) concludes that Perkins'
position in the company ``allowed him great
power, which he used to make personnel decisions,
de®ne the authority of various oces, and deter-
mine some of the corporation's basic policies. . .''
Morgan and Company's activities were not
limited to US Steel sized companies. For example,
the company organized and underwrote 145,000
preferred shares and 72,500 common shares of
American Bridge, organized under a ®ve-year
voting trust, and loaned working capital or
subscribed for shares of Associated Merchants,
Harper & Brothers, Hartford Carpet Corp., and
Virginia±Carolina Chemical Co. After 1907,
among other transactions, Morgan managed an $8
million bond subscription of US Rubber Co., and
purchased securities of ®rms as part of issues
managed by another ®rm, Lee, Higinson, & Co.
(Chandler & Tedlow, 1985, p. 280). His work with
Rockefeller's Standard Oil involved the formation
of a series of horizontal and vertical combinations
that controlled about 90% of the domestic industry
(Galambos & Pratt, 1988). Smith and Sylla (1993,
pp. 3±4) write: ``Morgan and other Wall Street
bankers became intimately involved with not only
the creation but also the shaping and governance
of big business enterprise.''
A common vehicle for instituting and perpetu-
ating control over companies was the investment
trust (which should be distinguished from its
1920s period progeny, investment and holding
companies). Investment trusts commonly involved
placing the voting securities of one or more cor-
porations under the control of a voting trust, the
trustees of which were, invariably, investment
bankers. Morgan's Northern Securities is instruc-
tive in this regard, being the vehicle used to exer-
cise control over Great Northern, Northern
Paci®c, and other railroad company stock. This
form of investment trust was the basis of popular,
progressive criticism and led to the Supreme
Court's breakup of Northern Securities under the
Sherman Antitrust Act. Subsequent investigations
and accounts provided by former ®nanciers such
as Thomas Lawson (1904) regarding the control
by ``organized ®nance'' over insurance and other
large corporations showed the pervasiveness of
control exerted by such organized groups over
companies.
From today's perspective, the early corporate
economy consisted of a comparatively small num-
ber of large corporations, and small groups of
®nanciers, the ``Money Trust'', who in turn,
mobilized the savings of a large number of individ-
uals and made resource allocation decisions. This
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 535
money trust had a large and important presence in
the capital markets that formed the context of
Berle and Means' analysis of the corporation. They
performed vital functions in the economy, which
resulted in a concentration of economic power in
their hands. However, Berle and Means did not
address the role of investment bankers, insurance
companies and underwriters as agents of managerial
capitalism. Their analysis, therefore, did not fully
portray in¯uence and control relationships, particu-
larly in terms of either acknowledging this role, the
relationship of the investment bankers to ®rms or
individual investors, or in distinguishing between
®rm managers and their investment bankers.
3.3. The money trust
The Pujo hearings on the ``money trust'' are
illustrative in assessing the position of investment
managers in the capital markets of the period.
These hearings were held with a view to determin-
ing whether something in the nature of a ``money
trust'' existed, and whether, as a result, a small
group of Wall Street Bankers dominated the econ-
omy. The majority report issued in February 1913
asserted ``a high degree of ®nancial con-
centration. . . and a close alliance between the heads
of a few New York City banks and the principal
users and suppliers of capital'' (Carosso, 1973).
This control over the resources of the investor was
e?ected through gaining representation on corpor-
ate boards, controlling through stock ownership
the savings represented in life insurance compa-
nies, savings banks and trust companies, and by
developing a syndicate system, which consisted of
various techniques of originating, underwriting,
and distributing new securities. There existed a
complex network of economic relationships at the
center of which was the ``money trust''.
The investment managers of the period scarcely
denied and, in fact, argued for the necessity of
such involvement (Pujo, 1913, p. 106). This involve-
ment went far beyond what is commonly asso-
ciated with ``®nancial intermediation'', but rather
better mirrored what Mintz and Schwartz (1985)
describe as strategic and operational in¯uence and
control. DeLong (1991, p. 217) asserts that ``[t]he
forty-®ve employees of Morgan and Company
approved and vetoed proposed top managers,
decided what securities they would underwrite,
and thus implicitly decided what securities would
be issued and what lines of business should receive
additional capital.'' Following Morgan's death in
1907, Pratt (1913) wrote, ``no man ever controlled
the money of other people in such sums as [Morgan]
did. . . His power is not to be found in the number of
his own millions, but in the billions of which he
was the trustee.'' Chernow summarizes the extent of
this in¯uence and writes:
Some 78 major corporations, including many
of the country's most powerful holding com-
panies, banked at Morgan. Pierpont and his
partners, in turn, held 72 directorships in 112
corporations, spanning the worlds of ®nance,
railroads, transportation and public
utilities. . .'' (Chernow, 1990, p. 152).
Even following the Northern Securities decision,
the Morgan Company remained a powerful force
in corporate ®nance, underwriting $6 billion in
securities between 1919 and 1933 (Chernow, 1990,
p. 257) and the ®rm continued to be involved in
both strategic and operational in¯uence and con-
trol over ®rms. Notable among its activities was its
1920 collaboration with the DuPonts to wrest con-
trol of General Motors Corporation from William
Crapo Durant. Morgan partners remained in¯u-
ential members of the boards of directors of major
corporations and were active participants in the
major strategic and operating decisions of many
others, including AT&T. Even at the time of the
Pecora hearings, during the 1930s, it was revealed
that Morgan partners sat on the boards of direc-
tors of 89 corporations. Pecora asserted that this
represented ``the greatest reach of power in private
hands in our entire history'' (Pecora, 1939, p. 36).
3.4. Investment trusts and holding companies
As the ``retail'' market for corporate securities
developed, other forms of institutionalized invest-
ment evolved. The 1920s saw the rise of invest-
ment trusts and holding companies, typically
sponsored by banks (or their subsidiaries) and
investment and brokerage houses. Small investors
536 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
invested money in these ®rms much as individuals
today invest in mutual funds [although the lines
between banks and investment trusts were su-
ciently vague that many individuals undoubtedly
believed they were putting their money in the banks
themselves (Galbraith, 1955, pp. 48±70)]. By 1927,
Wall Street investment trusts sold $400 million of
securities, and in 1929, they marketed securities
amounting to $3 billion, or about a third of all
issues. By the autumn of 1929, their total assets were
estimated to exceed $8 billion. This constituted an
elevenfold increase between 1927 and 1929 (Gal-
braith, 1955, p. 55). By 1929, a number of di?erent
kinds of concerns were bringing these trusts into
existence. Investment banking houses, commercial
banks, brokerage ®rms, securities dealers, and
most importantly, other investment trusts, were
``sponsoring'' the formation of new trusts.
What were the bene®ts of sponsorship? The
sponsoring ®rm in general executed a management
contract with the investment trust it sponsored.
The sponsor also administered the trust, invested its
funds, and was paid a fee based on capital or earn-
ings. If the sponsor was a stock exchange ®rm, it
received, in addition, commission on the purchase
and sale of securities. Many of the sponsors were
investment banking ®rms. The sponsoring of trusts
ensured that they had a steady source of business.
The investment bankers that sponsored these trusts,
including Morgan, o?ered themfor sale to friends at
depressed ``bargain'' prices, which practically
ensured a high pro®t in the markets soon after.
Galbraith (1955, p. 56) observed: ``that such agree-
able incentives greatly stimulated the organization
of new investment trusts is hardly surprising''.
It is apparent that in the early capital markets, a
premium was paid for ®nancial entrepreneurship.
The market value of the outstanding securities of
investment trusts and holding companies was far
higher than the sum of the values of the individual
securities owned. The property of these organiza-
tions consisted solely of common and preferred
stocks and debentures, mortgages, bonds, and cash.
Sometimes, their securities were worth twice the
value of the property owned. The premium was, in
Galbraith's view (1955, p. 59) ``the value an admir-
ing community placed on professional ®nancial
knowledge, skill, and manipulative ability.''
Trusts and holding companies also sought to
di?erentiate themselves by leveraging their capital
structure (Galbraith, 1955, pp. 61±69). Investment
trust's leverage in this regard was achieved by
issuing bonds, preferred stock, and common stock
to purchase almost exclusively, a portfolio of
common stocks. This ``intermediation'' system-
atically a?ected the control of property (capital stock
and bonds) in the markets. ``The magic of leverage''
(Galbraith, 1955, p. 62) also provided the common
stockholders of these trusts with the potential for
unlimited gains, which was compounded geome-
trically as trusts invested in other trusts. It was pos-
sible, using networks of investment trusts, for single
individuals to control disproportionately large parts
of the capital markets. For example, Harrison
Williams was thought by the SEC to have control
over a combined investment trust and holding
company system with a market value in 1929 at
close to a billion dollars (Galbraith, 1955, p. 64).
So called ``super holding companies'', such as
Morgan and Bonbright's; United Corporation, con-
trolled utilities providing 27% of the nation's elec-
trical output [Federal Trade Commission (FTC),
1935]. Other immense Morgan sponsored and con-
trolled holding companies included Standard
Brands, for food-producing companies, and Alle-
ghany Corporation, for railroads and real estate. The
line between a holding company and an investment
trust (presumed not to have direct control) was often
nebulous. The risks of leverage were not apparent
before 1929,
9
and numerous businesses including
American Founders Group and Goldman Sachs
turned to leveraging themselves to achieve remark-
able growth.
10
In their analysis of the corporation in terms of
the separation of ownership and control, Berle
and Means did not address the role of investment
funds in the patterns of corporate ownership,
9
By 1930, of course, the unraveling of this leveraging was
painfully apparent.
10
It is interesting to compare the excessive use of leverage in
the 1920s with that of the 1980s. There are clearly some di?er-
ences Ð the earlier case representing what was essentially a
pyramid scheme, while the latter (ostensibly) related to scale,
agency, and tax issues. More cogent to this paper is the obser-
vation that both required the active participation of the invest-
ment banking community.
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 537
in¯uence and control. As outlined above, mana-
gerial control of corporations was diluted by the
complex nature of various institutionalized struc-
tures including investment banks, holding compa-
nies, and trusts, which led to signi®cant control of
operations by the investment bankers and ®nan-
ciers. In turn, the funds used by these investment
managers were provided, wittingly or not, by indi-
viduals through direct investment in trusts, or
through insurance companies, or banks.
The basis of Berle and Mean's analysis is per-
haps best understood by considering that they
wrote during a period in which the ``retail'' market
for corporate securities developed, in part due to
the energies of Merrill Lynch and other emerging
brokerage ®rms. This highly visible growth in the
``retail market'' for corporate securities provides a
perspective for understanding Berle and Means'
focus on individual investors and the corporation.
Despite, however, the dramatic appearance of the
individual investor, the bulk of investment in cor-
porate securities continued to occur through
investment funds.
Berle and Means' analysis of corporate owner-
ship/control relations leads them to conclude that
the balance of control shifted entirely in favor of
the professional manager. Yet, while most small,
individual investors of this era did not have much
direct ®nancial control, one view on the presence
of the bankers is that they provided countervailing
power against managerial control over ®rms.
Another is that they operated at the expense of
individual investors and the public.
It is unclear whether Berle and Means viewed
the investment bankers as distinguishable from
®rm managers. While Berle and Means' analysis is
correct in identifying the control attained by pro-
fessional managers with respect to individual inves-
tors per se, their conclusions are limited by the
omission of institutionalized forms of corporate
control in their analysis. The scope of activities of
investment managers took them well beyond the
function of ®nancial intermediation. They were
orchestrators of the managerialist corporate system,
involved in exercising both strategic and opera-
tional in¯uence and control over ®rms. To the
extent that they proved to be of greatest bene®t to
owner±managers through their ability to provide
the ®nancial support and climate conducive to the
long-term viability of their enterprises, they could
be considered to be ``proprietor capitalists.'' From
this perspective, the agent of the individual was not
always, in fact, corporate management, but often the
investment bankers and trust managers. Indeed, the
bankers, at least, proved to be important monitoring
agents against opportunistic behavior by corporate
management (Carosso, 1973). The investment bank-
ers also had vested interests in the success of these
corporations, providing them with new avenues for
investment and fee income. The growth and
development of the investment banks therefore
paralleled that of corporations during this period.
4. The modern fund era Ð post 1970
4.1. Economic environment
In this section we ®rst reviewthe development and
extent of modern institutional ownership of ®rms.
Then we document investment funds' contemporary
in¯uence and control over ®rms with empirical evi-
dence and cases. While there are fundamental di?er-
ences between the American economy in the ®rst and
second periods studied, the ubiquity of investment
managers and institutionalized forms of capital of
various sorts continues, and indeed has even
grown, in the modern forms of pension funds,
mutual funds, insurance companies, and other
institutional vehicles. It is these parties that we refer
to as ``investment funds'' during this second period.
Banks, in contrast, had a dramatically di?erent
relationship with ®rms following the passage of
Glass±Steagall, and we consider their continuing
in¯uence and control abilities over ®rms only brie¯y.
Following the stock market crash of 1929, the
disastrous results of bank involvement with hold-
ing companies and investment trusts became evi-
dent, and beginning in the 1930s, Glass±Steagall
and other securities acts and regulations restricted
bank investing activities. It was thus from this
point through the 1950s that the Berle and Means
world of dispersed ownership was most nearly true.
At one point during the 1950s, it is estimated that
investment funds owned something less than 10%
of corporate equities. But during the prosperous
538 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
period following the end of the Second World War,
a number of nonbanking and nondepository insti-
tutions such as insurance companies, pension funds,
and mutual funds became important securities
holders. Even in the 1950s, and all the way up
through 1980, the Securities and Exchange Com-
mittee (cited in Allen, 1985) estimates show that a
quarter to a third of all US shares were held by
investment funds.
4.2. Investment funds
Between 1980 and 1990, fund ownership of
equities dramatically increased to more than 50%
(Brancato & Gaughan, 1991). By 1990 more than
half of the Business Week's Top 1000 ®rms had
greater than 50% ownership by institutional
investors (Brancato & Gaughan). Furthermore,
this institutional ownership was highly con-
centrated; for example, the largest 20 pension
funds represented nearly a quarter of all pension
fund assets in 1990 (Brancato & Gaughan).
Investment funds now hold more than half the
value of publicly traded US equity, and account
for more than 70% of the volume of US traded
equities.
11
Between the 1965 and the 1990, ``large
block'' trades rose from just 3% of all trades to
roughly half (Smith & Sylla, 1993). Also, the
number of noninstitutional parties investing
directly in corporations has declined dramatically
over the past decade. As reported in the Economist
(1990) American private investors reduced the
net value of their equity holdings by about $550
billion between the end of 1983 and the end of
1989, which is equivalent to 40% of their portfolios
in 1983. ``Were these trends to continue, the last
American to own shares directly would sell his last
one in the year 2003'' (Economist, 1990).
Pension funds emerged as principal owners of
American equity capital in the early 1970s
(Drucker, 1991). Employees became owners
through the medium of a fairly small number of
large ``trustees''. While these pension funds tradi-
tionally viewed themselves as investors (punters),
with a short-term focus, they found themselves
increasingly thrust into the position of owners
(proprietors) simply due to their sheer size (Econ-
omist, 1990). Table 1 shows the increase in ®nan-
cial assets held by pension funds from 2.5 to 4.2
trillion dollars between 1990 and 1995. The most
dramatic increase, however, occurred in mutual
funds. As mentioned in the paper's introduction,
the number of mutual funds has grown from
about 1000 in 1983 to about 5000. By 1995 mutual
funds held about 23% of all US ®nancial assets
[Organisation for Economic Co-ordination and
Development (OECD), 1997]. Mutual fund own-
ership of stock rose from about 3.1% in 1980, to
12.8% in 1996, and the total value of their ®nan-
cial assets reached over 2.7 trillion dollars in 1996
(OECD, 1997). Table 1 summarizes the ®nancial
asset holdings of major types of investment funds
between 1990 and 1995.
4.3. The regulatory environment
Changes in administrative and regulatory rules,
particularly in the form of corporate governance
mechanisms, investor communications, and block
trading, have increased the ability of investment
Table 1
Value of US institutional holdings of ®nancial assets (billions of dollars)
a
Insurance companies Mutual funds Pension funds Other institutions
b
Total
1990 1091 1155 2531 1409 6996
1991 2081 1376 2848 1589 7894
1992 2212 1624 3152 1664 8652
1993 2427 2045 3429 1811 9712
1994 2565 2191 3565 1881 10,202
1995 2829 2727 4156 2160 11,871
a
Constructed from OECD data (OECD, 1997).
b
``Other institutions'' include bank trusts, ®nance companies, real estate investment trusts, and security brokers and dealers.
11
In addition to being signi®cant debt owners.
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 539
funds to in¯uence ®rms. Important rule changes
included provisions related to proxy solicitations
and voting, shareholder communications, share-
holder proposals (Rule 14A-8) and the 1992 relaxa-
tion of communication rules for larger shareholders
(in part due to pressure from The California Public
Employees Retirement Systems Ð ``Calpers''). Blair
(1995, p. 72) relates the 1993 use by institutional
investors of these new communication rules, speci®-
cally in communicating with one another and in
coordinating their in¯uence over Medical Care
America. In addition, the federal government
encouraged, and even required, investment fund
involvement in ®rms whose securities they hold. For
example the Labor Department has ruled that pen-
sion funds must vote their shares as a part of their
®duciary duty in the ``economic best interest of a
plan's participants and bene®ciaries'' (Department
of Labor, 1989). Federal encouragement of pension
fund involvement in ®rm activities continued to
increase through the late 1990s.
Other rule changes, such as the SEC's rule 144a,
adopted in 1990, has made it easier for large ®rms to
sell their securities to large ``quali®ed'' buyers,
de®ned as institutions with at least $100 million
invested in securities. Rule 144a exempts many pri-
vately placed deals from SEC registration require-
ments. In 1992 changes to 144a were approved
allowing institutions seeking to meet the $100 mil-
lion requirement to include government securities in
their portfolios. As a result, it is now possible for
bank and pension trust funds and some insurance
accounts to buy unregistered bonds and stocks,
expanding the scope of institutional in¯uence.
Capital market structures have also evolved in a
manner favoring investment funds. Partly as a
result of competitive pressures from regional
exchanges, electronic networks such as INSTI-
NET and o?-exchange markets, the NYSE in
1992 adopted the ``clean-cross rule'' allowing large
institutional investors to sidestep ¯oor trading on
trades of 25,000 or more shares furthering the
development of a two-tier stock market.
4.4. Evidence on in¯uence and control
The regulatory and administrative changes
described above, coupled with the huge growth in
pension and mutual funds, have dramatically
increased the ability of investment funds to in¯u-
ence ®rms. What is now characterized as ``fund
activism'' has increased since 1970. Numerous
sources report increased levels of shareholder
activism, including increases in shareholder pro-
posals. For instance The Investor Responsibility
Research Center reported increases in shareholder
activism in terms of shareholder proposals from 55
in 1986 to 294 in 1990 (Brancato & Gaughan, 1991).
Anand (1997), in ``Funds ¯exing muscles early in
proxy battles'', reported that ``in dozens of instan-
ces, companies agreed to make concessions to
shareholders. . . Even top performing companies are
no longer immune from shareholder activism. . .''
From their comprehensive study of institutional and
capital markets, Brancato and Gaughan conclude
that:
. . .while [institutional investors] may be
diverse, a high concentration of economic
power resides among a relatively small and
extraordinarily stable group of institutions.
. . . the very largest of these institutions, by
virtue of their concentrated economic power,
are increasingly in a position to exert sub-
stantial in¯uence on the shape of corporate
governance in this country (p. 1).
Indeed, it is so widely acknowledged that
investment funds in¯uence ®rms that empirical
studies of fund in¯uence examine patterns and
e?ects, rather than the existence, of activity and
in¯uence. Gordon and Pound (1993) study, in part,
various institutional shareholder voting alignments
and found that the outcomes of shareholder spon-
sored proposals varied as a function of ownership
by institutions and outside blockholders. They
assert:
Previously the province of ``gad¯y'' activists,
governance proposals have become a tool used
by a variety of large professional investors,
including large ®duciary institutions. . . (p. 697).
Smith (1996) studies the e?ects of 51 share-
holder activism programs by institutional inves-
tors from 1987 to 1993. Agrawal and Mandelker
540 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
(1992) examine ``whether the monitoring activities
of institutional investors, and their in¯uence on
the management of the ®rm, are related to the size
of their investment in a corporation and/or the
proportion of equity owned by them''. Using anti-
takeover proposals, investment fund ownership,
and abnormal return data from 1979 to 1985, their
®ndings are consistent with an ``active investor''
hypothesis. Other studies, such as Brous and Kini
(1994) provide evidence on the ability of invest-
ment funds to e?ectively monitor ®rms.
One line of investment fund research has explored
fund activism and ®rm pro®tability.
12
While these
studies do not study fund in¯uence per se,
13
their
design and analysis nonetheless provide evidence
about fund in¯uence. For example, in a study of
corporate ``refocusing'' programs and ®rm pro®t-
ability, Berger and Ofek (1997) found that about
39% of such programs were associated with a new
outside blockholder or fund activism. In other
pro®tability studies, Wahal (1996) and Opler and
Sokobin (1996) document the occurrence and e?ects
of fund in¯uence in the management of nearly 200
®rms.
In addition to the empirical and theoretical
work, a plethora of cases are described in various
investment-related publications that compellingly
convey the in¯uence exerted by funds over ®rms.
Large pension funds that have de®ned and struc-
tured shareholder activism programs have been
quite active (see Wahal, 1996). Calpers, which
pioneered public pension fund activism and foun-
ded the Council of Institutional Investors in 1984,
is highly visible in terms of such activities. The
1984 Texaco greenmail case involving that ®rm's
repurchase of the Bass brothers' 9.9% stake for
$1.3 billion (28% above market value) sparked a
response from Calpers, which was one of Texaco's
largest shareholders. Dale Hanson, the CEO of
Calpers and the founder of its shareholder acti-
vism program, asserts the importance of this case
in the development of institutional activism.
Other widely publicized cases involved ITT,
GM, American Express, IBM, Westinghouse,
Apple Computer, Eli Lilly, Kodak, Scott Paper,
and Borden. In 1990, shareholders targeted ITT
for excessive executive compensation. Pressures
from institutional shareholders, who owned about
43% of GM and who were frustrated as a result of
the third straight year of huge losses under current
management, resulted in the 1992 ousting of Gen-
eral Motors Chairman Robert Stempel. Following
Stempel, James Robinson of American Express,
John Akers of IBM, and Paul Lego of Westing-
house Electric, were all ousted, all principally as a
result of institutional pressure (Smith & Sylla,
1993). Others asked to step down in 1993 included
the chiefs at such large, well-known corporations
as Apple Computer, Eli Lilly, Kodak, Scott Paper,
and Borden, again under pressure from invest-
ment managers. Smith and Sylla write:
By 1993, however, institutional activism was
directly responsible for instigating reforms in
the nation's largest companies. It was pres-
sure from institutional shareholders that led
to the ousters of chief executives at General
Motors, IBM, and American Express, each
one a company in need of reform, each one a
traditional bastion of managerial control. The
news of the day was that corporate boards
had to take more seriously the concerns of
their institutional investors, who in turn
found it more pro®table, over the long run, to
behave more like owners rather than mere
holders of stock (p. 56).
4.5. The banks
Despite the legal separation of commercial and
investment banking resulting from Glass±Steagall,
writers such as Fitch and Oppenheimer (1970)
present a theory of bank in¯uence and control
over corporations. Certainly, bank capacity to
in¯uence companies continues. Herman (1981, p.
130) shows that 66% of the largest 200 non-
®nancial corporations and 76% of the largest 100
industrials had bankers on their board of directors
in 1975. Baum and Stiles (1965, p. 30) show that
60% of all pension fund assets were managed by
12
The results of these studies are mixed. Whether fund acti-
vism is e?ective in improving ®rm performance is, however,
irrelevant to their ability to in¯uence ®rms.
13
Most of these studies address the e?ect of fund activism
on company performance and are premised on the assumption
that funds can and do in¯uence ®rms.
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 541
banks, while in 1972, just 71 bank trust depart-
ments managed 72% of all trust assets (Herman
1975, p. 20).
14
In addition, investment bank repre-
sentatives sat on 42% of the largest 100 industrials'
boards of directors.
Speci®c evidence also demonstrates bank in¯u-
ence, although such activities tend to occur with
®rms in ®nancial trouble. Gogel (1977, p. 50)
asserts ``the largest American corporations form
an interconnected network which is dominated by
®nancial institutions, especially commercial
banks. . .'' Mintz and Schwartz (1985) cite bank
in¯uence and control over 39 major US cor-
porations between 1977 and 1981 alone, exten-
sively recounting the details of banker
involvement with Brani? Airlines in 1979 and
1980 and International Harvester in 1981. They
conclude (Mintz, & Schwarts, 1985, p. 35) that
``capital shortages may result in the loss of
corporate autonomy and the transfer of control to
lenders''. Banker in¯uence over companies is
reinforced by the huge dollar amount of pension
funds managed by banks as well as trust funds
controlled by banks. Of particular interest, Mintz
and Schwartz illustrate the continuing existence of
interlocking directorates involving managers of
leading ®nancial institutions, including Morgan
Guarantee, one of the ``House of Morgan'' suc-
cessor ®rms.
4.6. A comparison
Previts and Bricker (1994) discuss the dangers of
applying contemporary thought to historical peri-
ods. Yet despite di?erences between the socio-
economic settings of the US in the 1990s and the
early 1900s, it is interesting to compare investment
managers of the 1990s with those of the Morgan
era. One important di?erence, the implications of
which we will return to later, relates to the princi-
pal interests of the investment managers of the
two periods. The investment managers of the ear-
lier era were principally focussed on company
operations, and only secondarily interested in
share price and stockholder returns. In contrast,
modern investment managers are principally
interested in share price and returns, and secon-
darily interested in company operations. Thus, the
bankers of the early twentieth century often
wanted to act like owners (Morgan saw himself as
rationalizing chaotic industries and markets)
while contemporary investment managers gen-
erally do not.
Regardless of the management inclinations of
investment managers of the two periods, the mere
size of investment funds makes costless exit from
ownership ®rm shares dicult (Taylor, 1990).
Today funds are increasingly forced into being
``proprietors'' rather than ``punters''. While proxy
®ghts and shareholder proposals and resolutions
represent one of active control mechanisms that
can be exercised, a second that is receiving
increased attention and that again hearkens back
to the earlier period is the so-called ``quiet in¯uence''
exerted by investment funds involved in what many
have termed ``relational investing'' (see Hawley &
Williams 1996). In ``Political voice, ®duciary acti-
vism, and the institutional ownership of U.S. cor-
porations'', Hawley (1995) examines the shift of
ownership from predominantly individual to
institutional. He argues that pension funds, as
important institutional owners, will become,
increasingly, ``relational investors''. To the extent
that this does not exist, the result is fund managers
that are less concerned with ®rms' long-term
prospects or interested in the long term growth
and survival of ®rms. Rather, they may focus on
short-term operating results.
Overall, the modern investment fund manager is
remarkably similar to that of the Morgans of the
early period in two important respects. First, both
are important agents involved in aggregating and
allocating economic resources. Like the Morgans
of the past, investment funds aggregate the
resources of individual investors and are centers of
®nancial power having abilities to in¯uence ®rms
and markets. Second, despite di?erent inclinations
about doing so, both exert in¯uence and control
over ®rms, and in this way, extend the realm of
their activities well beyond that described by
®nancial intermediation.
14
Interested readers may wish to consult Soldofsky (1971)
for a description of investment fund holding of stock between
1930 and 1970.
542 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
5. An international perspective
The in¯uence exerted by fund managers over US
companies described in the preceding section is
echoed internationally. Below, we brie¯y review
studies of institutional in¯uence and control in
Germany, Japan, South Africa, and Canada. While
these countries re¯ect patterns of investment quite
di?erent from that of the US (see Barr, Gerson &
Kantor, 1995; Prowse 1995), they nonetheless
illustrate the extensive in¯uence of institutions
over ®rms.
In Japan and Germany, corporate in¯uence
and control has traditionally been concentrated
in the hands of ®nancial institutions, much as it
was in the United States prior to the 1920s,
with individual investors generally playing a rela-
tively insigni®cant role in capital markets. Walter
(1993) asserts that ``Japan's industrial and ®nan-
cial communities have historically been interlinked
more closely than in any other advanced econ-
omy.'' Prior to the Second World War, banks
monopolized the underwriting of corporate secu-
rities and through the institutionalized structure
of the keiretsu exercised considerable in¯uence
over such ®rms. Despite US e?orts after the war,
this structure remains largely in place. Walter
observes:
A unique form of corporate control has been
integral to the Japanese model of industrial
development. . . the focus was on continuous
surveillance and monitoring of management
performance by the managements of aliated
®rms and bank. . .
In 1990, Japanese banks and other investment
funds held about 40% of Japanese equity, with
another 30% held by other operating ®rms (Porter,
1992, p. 42). German ®rms have similar associations
with their bankers. Walter (1993) writes:
[The] Hausbank relationship has, as its basis,
a business ®rm's reliance on only one princi-
pal bank as its primary supplier of all forms
of ®nancing. The Hausbank, in turn, is deeply
involved in its corporate client's business. . . If
the client ®rm faces collapse, the Hausbank
may well convert its debt into equity and take
control of the client. . .
In comparison with Japan and Germany, where
control is exercised by banking institutions, a
small number on holding ®rms owning shares in
subsidiary operating ®rms dominates the South
African stock exchange. Barr et al. (1995) ®nd that
``companies comprising the six largest groups on
the JSE presently account for over 70% of the
value of all the shares quoted on the exchange''.
In contrast to the preceding countries, the
Canadian experience closely parallels that of the
United States. In both, investment fund involve-
ment in capital markets has increased to the point
of comprising three-quarters of securities trading
(Cohen, 1995). Increases in security ownership by
investment funds has been accompanied by
declines in direct, individual ownership (Andrews,
1991). In contrast to the US, activity by depository
institutions has increased dramatically following
relaxation of restrictions on bank ownership of
securities (Johnson, 1994). As in the US, many
writers have addressed the issue of corporate gov-
ernance as it relates to institutional in¯uence over
®rms (Montgomery, 1996; Yalden, 1996), and
pension fund activism is promoted by trade
groups such as the Pension Investment Associa-
tion of Canada (Star, 1994). The extent of invest-
ment fund holdings in Canadian securities and the
corresponding extent of Canadian individual
holdings of investment funds motivated the Cana-
dian Institute of Chartered Accountants to study
the issue of fund reporting to investors and to
issue Financial reporting by investment funds
[Canadian Institute of Chartered Accountants
(CICA), 1997].
The preceding literature strongly suggests the
international character of institutional in¯uence
over companies. As Prowse (1995) argues, the dif-
ferences in the speci®c forms of capital market rela-
tionships have resulted from di?ering legal and
regulatory environments (neither Japan or Ger-
many has Glass±Steagall type laws); yet remarkably,
each of these countries re¯ect the important, and
even dominant, role played by institutionalized
capital. Indeed, Prowse concludes, ``corporate gov-
ernance systems based on the concentrated holding
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 543
of ®nancial claims. . . may be more ecient means
of resolving corporate agency problems. . .''
6. Discussion
6.1. Reassessing Berle and Means
Berle and Means' study, described in Section 2
above, drew criticism virtually from the time of its
publication [see Crum1934; Securities and Exchange
Commission (SEC) 1940; Burch, 1972; Mintz &
Schwartz, 1985; Stigler & Friedland, 1983, among
others], largely, as noted by Mintz and Schwartz (p.
18) because of the importance of ``the connection
between stock dispersal and the argument for
managerial control''. Regarded to this day as par-
ticularly curious was their failure to fully consider
the role of ®nancial institutions such as banks and
other investment funds in in¯uencing and con-
trolling corporations. For example, Brandeis's
Other people's money and how the bankers use it
(Brandeis, 1914), the National Resource Commit-
tee's The structure of the American economy
(National Resources Committee, 1939) and the
US Congress's ``Patman Report'' (1968) have
consistently observed, over multiple time periods,
the in¯uence and control over ®rms exerted by
banks and other institutions. Herman (1981, p. 65)
writes, ``It is a curiosity that Berle and Means
never employed such a category [of ®nancial con-
trol], for the potential con¯ict of interest between
owners and controlling bankers or speculators in
the late 1920s would seem important enough to
have warranted special attention.'' In reassessing
Berle and Means' analysis, Herman (p. 64) adds a
``®nancial control'' category and determines that
only about 40% of Berle and Means' ®rms were
controlled by management in 1929. Drucker's
``pension fund socialism'' (1976), Porter's ``institu-
tionalization of equity'' (1992), and Hawley and
Williams's ``®duciary capitalism'' (1996) also argue
that ownership (at least) of public ®rms is not dis-
persed. Demsetz and Lehn (1985) empirically show
that ownership concentration varies widely across
companies.
Given the prominent role of investment bankers
such as Morgan in the creation and ®nancing of
®rms of this early period, as described below,
Berle and Means' inattention to this issue is con-
sidered rather surprising by many. Perhaps, as
suggested earlier, they merely con¯ated investment
funds and their managers with operating ®rms and
their managers, as was common for the period.
Not only did the theory of Financial Capitalism
re¯ect this view, but also Lenin's Imperialism
(1926). It is clear that Berle and Means viewed a
great inequity in power between the ultimate,
individual shareholder and operating ®rm man-
agers, and that they sought to bring attention to
this situation and encouraged a solution. As Stig-
ler and Friedland (1983, p. 242) write, ``the time
was ripe to view corporate directors as trustees,
not only for stockholders but for other interested
groups such as consumers and laborers''. Along
this same line many contemporaneous accounts
addressed the concentration of ®rms' control
through investment bankers, their intimacy with
®rm management, and their use of investor funds.
Certainly Lawson (1904), who chronicled the misuse
of investor funds by insurance companies and the
``money kings,'' Brandeis (1914), several US
government investigations, including those of the
Pujo Committee (1913) and Pecora (1939), re¯ect
this thinking and may have contributed to Berle and
Means not drawing a distinction between the two.
In any case, Berle and Means did not consider
the role of investment managers in the in¯uence
and control over ®rms, and they locate the
separation of ownership from control ``problem''
squarely between ®rm managers and stockholders.
In their view, managerial control of ®rms occurs
speci®cally because of dispersed ownership inter-
ests (stockholding) in comparison with con-
centrated managerial interests. Whether or not
they intended to overlook the investment funds,
acceptance of the Berle and Means thesis led, iron-
ically, to elaborations in the forms of managerial
capitalism and agency theory which, in conjunc-
tion with two other elements, had important
results for accounting research and policy.
6.2. Capital markets agency theory
Before considering these e?ects, we ®rst turn to
the development of agency theory as it is applied
544 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
to the capital markets setting. Drawing on Coase
(1937) and Berle and Means (1932), Jensen and
Meckling's (1976) agency view of the ®rm in a
capital markets setting has been widely applied in
both accounting and ®nance research. In theory,
``the relationship of agency is one of the com-
monest codi®ed modes of social interaction''
(Ross, 1973). The Jensen and Meckling agency
model portrays and analyzes an abstracted set of
economic relationships, grounded in theories of
economic organization, involving ®rm managers
and investors. In accounting capital markets
research (both empirical and analytical), agency
models succinctly portray a single principal who is
the owner and residual claimant, who hires
another party, an agent, to manage the principal's
resources. In the corporate setting the principal is
the ``representative shareholder'' who has entrus-
ted wealth to the agent who is the ``representative
manager'' [for example, in Baiman (1982) and
Watts & Zimmerman (1986)]. When investment
managers are incorporated in such structures, it is
commonly in the form of a ®nancial intermediary
whose presence does not fundamentally alter the
basic agency relationship between shareholder and
®rm manager (for example, Ramakrishnan &
Thakor, 1984). Thus, the Berle and Means world
of dispersed shareholder principals and manager
agents has become the characteristic perspective
from which to view capital markets agency rela-
tionships, while those involving investment funds
(and other parties) are disregarded. To the extent
that such a focus obscures the characteristics of
capital markets agency relationships there is a
value to incorporating investment funds in
accounting contracting, reporting, and disclosure
studies. In terms of the issues discussed in this
paper Ð that is, the relationships among indivi-
dual investors, investment managers, and operat-
ing ®rm managers Ð the traditional agency model
typically depicts the following:
Principal
Investor
!
Agent
FirmManager
This perspective relegates investment managers
(among other parties) to the role of mere ®nancial
intermediaries. While it can also be criticized for
failing to convey much of the richness of the capi-
tal market environment, it has the advantages of
simplicity and strong parallels to Berle and
Means; both focus on the relationship between
investors and creditors.
Another aspect to this issue is that the identi®-
cation of the parties to be included in a model
inevitably has political implications, because the
chosen parties' interests and relationships are
addressed to the exclusion of other parties. Thus
the choice for simplicity and parsimony carries
such implications, because restricting the model to
investors and creditors excludes the consideration
of other parties. Such exclusions are important,
and unfortunate results can occur, such as the
erroneous con¯ating, obscuring, or obliterating of
signi®cant ®nancial reporting issues involving the
excluded parties and their relationships.
6.3. E?ects on ®nancial reporting research and policy
As it turned out, the Berle and Means thesis and
the simple, single-tier agency model that evolved
from it carried ®nancial accounting research and
policy far from the condition of contemporary
capital markets. Two elements fueled this result:
federal regulation and the growth of investment
funds as a vehicle for individual investors.
First, the passage of Glass±Steagall and the
Investment Company Holding Acts e?ectively
crippled the ability of investment funds to exert
in¯uence and control over operating ®rms. This
substantially increased managerial control of ®rms
from the 1940s through the 1970s. However, in
recent years regulatory changes and federal revisiting
of the role of investment funds in corporate gov-
ernance have dramatically changed the landscape,
as described in earlier sections of this paper. Sec-
ond, the end of the twentieth century witnessed the
phenomenal and unparalleled growth of investment
funds (see Table 1). As individual investors increas-
ingly place their ®nancial assets in investment
funds (see Table 2) their holdings in institutions is
approaching 50% of household ®nancial assets.
These three elements: the Berle and Means
managerial control thesis and subsequent single-
tier agency perspective of the capital markets,
regulatory changes that increased the in¯uence
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 545
and control ability of investment funds, and the
substantial growth of investment funds, have led
to a remarkable situation. The intellectual accep-
tance of the Berle and Means thesis and single-tier
agency perspective has resulted in accounting and
®nancial reporting research and policy that is
focussed on corporation reporting to individual
investors. The assumption of dispersed share-
holders and the disregard of investment funds
leads to research and policy that tends to overstate
the power of managers with respect to owners. It
correspondingly overstates the unobservability
problem between managers and owners, and fails to
fully recognize di?erent agency relationship char-
acteristics involving operating ®rms and investment
funds. Second, the focus on the agency relationship
involving operating ®rms and investors results in
inattention to the separation of ownership from
management problem as it relates to investors and
investment funds, which has become relatively invi-
sible both in policy and research.
The capital markets landscape implies many
®nancial reporting priorities and issues beyond
those implied by the simple, single-tier agency
model. These implications are discussed in more
detail below. But before addressing those, it is
useful to reconsider the role of Agency Theory in
studying capital markets relationships.
6.4. Expanding perspectives
While Agency theory is not the only perspective
that can be employed to study relationships
between parties, it provides a useful economic tool
for portraying them. However, it does not seem
intuitively appealing to necessarily restrict capital
markets agency theory to the simple form princi-
pally used in contemporary research. Indeed,
Agency Theory can be thought of from several
perspectives. From the broadest perspective, it
represents a conceptual way of describing rela-
tionships between two or more parties. In terms of
the way that it is used in modern empirical, archi-
val capital markets research and related analytical
work, it is typically restricted (aÁ la Jensen and
Meckling) to two parties, investors and managers,
ostensibly to make the model tractable to mathe-
matical analysis. While typical in accounting
research, neither this sort of mathematical simpli-
®cation nor traditional empirical archival methods
are necessary; economic studies such as DeLong
(1991), for example, use agency-type models in
conjunction with historical methods. Writers such
as Blair (1995, pp. 31, 47) have presented elabora-
tions of the ``Basic Berle±Means Model'' to more
fully portray investment fund activities in capital
markets; however such elaborations have not yet
been explicitly applied to accounting and ®nancial
reporting. If capital markets agency theory is not
thought of as a way to present a highly stylized
and simpli®ed relationship between investors and
managers, but instead as a way of identifying and
portraying relationships among two or more par-
ties in the capital markets setting, then the agency
modeling goal becomes to portray these parties (as
parsimoniously as possible) and their relation-
ships. Many such relationships exist, and studies
need not identify and portray them all, but neither
do they need to be restricted to investors and
managers. Instead, studies need to portray those
parties and relationships that are pertinent to their
own focus.
Because our paper focuses on the role of invest-
ment funds with respect to operating ®rm man-
agers and investors, a possible alternative
structure might be portrayed as:
Principal
Investor
!
Agent ÀPrincipal
Investment
Manager
!
Agent
Firm
Manager
Table 2
Household holdings in investment funds (% of total household
®nancial assets)
a
Insurance
companies
Mutal
funds
Pension
funds
Other
institutions
b
Total
1990 7.4 6.3 18.0 6.2 37.9
1991 7.4 6.6 18.2 6.8 39.0
1992 7.8 7.0 19.1 7.1 41.0
1993 8.3 8.0 19.5 7.5 43.3
1994 8.4 8.1 19.6 7.1 43.2
1995 8.5 8.7 20.2 7.9 45.3
a
Constructed from OECD data (OECD, 1997).
b
``Other institutions'' include bank trusts, ®nance companies,
real estate investment trusts, and security brokers and dealers.
546 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
This formulation retains the concept of princi-
pals and agents.
15
In it, investors, as principals,
aggregate resources in an investment fund. Their
agent, the investment manager, invests these
resources in ®rms and has an agency relationship
with ®rm managers. Investors are de®ned more
broadly, and are comprised not only of mutual
fund owners, but holders of insurance policies
with cash values, investors in money market
funds, pension fund participants, and ®nancial
institution depositors, among others. As Berle and
Means emphasize, it is where ownership disper-
sion occurs that in¯uence and control is lost.
From this perspective contracting and ®nancial
reporting/disclosure issues occur at two levels and
vary depending upon the nature of ownership
concentration/dispersion.
7. Financial reporting implications
7.1. Overview
This two-tier structure has ®nancial reporting
implications
16
of two sorts. First, it leads to ®nancial
reporting issues in terms of ®rm reporting to invest-
ment funds (and investors
17
), investment fund
reporting to investors, and ®rm reporting through
investment funds to investors. Whereas histori-
cally accounting research, the accounting profes-
sion, and ®nancial reporting standard setters have
concentrated on ®rm reporting to investors, the
volume of investment activity that occurs via
institutional processes implies a need for greater
attention to these additional issues. Some recent
work, such as the Jenkins Committee Report
[American Institute of Certi®ed Public Accountants
(AICPA), 1994], which proposes a ``Business
Reporting'' model based largely on studies of infor-
mation uses and needs of professional investors,
seemingly re¯ects a greater awareness of these issues.
Second, and more broadly, our ®ndings suggest
that the single-tier agency relationship commonly
used as the basis of ®nancial research and policy
tends to obscure the information and ®nancial
reporting needs of many types of claimholders (see
Bricker & Previtts, 1999). That multiple agency
relationships exist in capital markets settings is
already widely accepted. It is well understood that
capital markets are (and have been) characterized
by complex and dynamic structures of relationships
that have evolved in changing political, social,
regulatory, and economic environments. Their
complexity has been portrayed by historical work
such as McCraw (1984). However, while accounting
and economic research recognizes the existence of
multi-tier agency relationships in theory (Antle,
1982), the simple, abstracted manager±shareholder
structure remains a principal foundation for
accounting research and ®nancial reporting con-
siderations, both at academic and policy levels.
This is useful for considering many issues and
promotes analytical computational eciencies, yet
also may result in some of the problems described
above. A broadened perspective on formulating
agency models and the application of more diverse
research methods in conducting accounting research
may result in better portrayals of capital markets
relationships and richer understandings of ®nancial
reporting issues. Below we focus on ®nancial
reporting implications related to the two-tier struc-
ture proposed in the following areas:
. di?erential reporting, e?ects of institutional
ownership on information about ®rms,
15
However, it is not necessary that a formal mathematical
``agency'' setting be imposed. Rather, the important point is to
identify the separate parties and identify their relationships, as
discussed elsewhere in this paper.
16
One objection to extending the basic agency setting to
portray ®nancial reporting as a two-tier relationship is that
many more such relationships could also be envisioned. As we
discuss elsewhere, this is a desirable result, in our view. Judgment
as to the importance of such portrayals given the context being
studied must be exercised to avoid a web of such relationships
so complex as to render analysis intractable. Given the promi-
nence of capital funds both today and historically, a two-tier
model seems reasonable to consider the principal and agent roles
of capital managers vis-aÁ -vis shareholders and management, and
to highlight the limitations of the traditional agency model.
Indeed, Walter (1993) characterizes corporate control systems in
terms of individuals, banks, investment institutions, and indus-
trial companies; in all of the stylized corporate control structures
he presents, individual investment through institutions (banks or
investment institutions) is always an important component.
Nonetheless, there are many other relationships and claimholders
to whom generalization of our ®ndings would appear warranted.
17
In recognition that individuals still invest directly invest in
®rms.
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 547
. managers' choice of accounting methods,
investment managers' reporting to investors,
. investors' assessment of fund risk, and con-
¯icts of interest,
. insider-type trading activities related to
investment managers and investors, and
. reporting to claimholders generally
7.2. Di?erential reporting
An extensive body of research (including Kim,
1997; Lev, 1988) suggests the importance of con-
sidering investor classes in regards to ®rm report-
ing. The two-tier structure suggests that investment
funds, because of their size, can ameliorate the
observability problem commonly associated with
an agency structure involving dispersed owners,
and helps focus on di?erential information needs
of investment funds and noninstitutional investors
as di?erent investor classes. Investment fund size
makes monitoring and information gathering eco-
nomically practical, and the size and in¯uence of
the fund's holding of a ®rm's shares makes ®rm
managers more willing to communicate directly
with fund managers.
Theoretical and empirical evidence supports
treating noninstitutional investors and investment
funds as di?erent investor classes. Shleifer and
Vishny's (1986) ``Large Shareholders and Cor-
porate Control'' shows how agency monitoring
problems are a?ected by the existence of large
shareholders, and how large shareholders are
able to monitor ®rms and in¯uence ®rm policy.
Kim (1997) shows that institutional ownership
a?ects price and volume responses to earnings.
Other studies have shown that investment funds
anticipate earnings surprise and trade accord-
ingly, ahead of the announcement. Fund ¯ows
suggest that this trading occurs with smaller
investors (Ali & Durtschi, 1997). Overall, this
evidence with our characterization of invest-
ment funds and noninstitutional investors as
separate classes of investors with di?erent infor-
mation needs, and modeling them as such helps
re®ne research questions about the ®nancial
reporting needs related to these separate classes of
investors.
7.3. Information e?ects of investment fund
ownership of securities on individual investors
Furthermore, the proportion of securities owned
by investment funds may a?ect information avail-
able to individual investors about ®rms, particu-
larly when such investors rely upon ®nancial
analysts for information about ®rms. Financial
analyst coverage of ®rms is inversely related to
proportion of institutional ownership (Grant &
Rogers, 1998), when controlling for ®rm size.
Firms with higher levels of institutional ownership
may generate less information for individual
investors. Porter's (1992) ®nding that ®rms with
high institutional ownership proportions had lar-
ger abnormal returns on earnings announcement
dates is consistent with this conjecture. The two-
tier structure provides a basis for rationalizing
di?erential ®rm reporting to investors depending
upon the ownership structure of the ®rm.
7.4. Firm managers' accounting and economic
choices
The two-tier structure a?ects interpretations
involving the ®ltering of information from ®rms to
investment funds to individual investors and, pos-
sibly operating ®rm accounting and economic
choices. Myopic managerial choices have been
studied extensively in business research, and it has
been conjectured that institutional ownership of
companies may aggravate this tendency (for
example, see Laderman, 1992).
The two-tier structure provides a perspective for
understanding the possible incentives. Investment
manager compensation depends, to a large extent,
on fund size, which in turn is driven by investor
assessment of past fund performance and their
formation of expectations regarding future fund
performance. Mutual funds invest in large num-
bers of operating ®rms. The ®ltering of informa-
tion that occurs when operating ®rms report to
investment funds which in turn report to individ-
ual investors may lead investors to evaluate funds
on the basis of relatively simpler, short-term
aggregate measures, such as annual returns. Then
an increased focus on short-term earnings max-
imizing decisions may be re¯ected in investment
548 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
managers' accounting choices and economic
resource allocation (investing) choices. That such
®ltering occurs is suggested by the numerous
ranking and rating reports of fund performance that
appear regularly in popular business publications.
Operating ®rm managers' compensation is often
partially a function of the ®rm's cost of capital. If
this cost is a?ected by investment managers' invest-
ing choices, then ®rm managers' accounting and
economic choices may correspondingly focus on
maximization of short-term ®rm pro®tability. For
example, investment managers may choose
income increasing accounting methods in valuing
certain restricted and Section 144a securities which
are not market-determinable, choose to invest in
®rms with high short-term earnings prospects, and
make economic choices about asset disposals so as
to maximize compensation (Chandar, 1997). On
the other hand, if investors focus on multi-year,
instead of most-recent year investment fund
results, then the opposite may occur. Investment
fund monitoring and in¯uence of ®rms would then
lead to accounting and economic choices max-
imizing long-term pro®tability (see Hansen, 1991;
Kochhar, 1996).
7.5. Fund reporting to investors
Traditionally ®nancial reporting focuses on the
relationship and reporting between operating
®rms and investors, and there is consequently little
published work assessing the adequacy of invest-
ment fund reporting to investors for facilitating
mutual-fund and pension-fund resource allocation
decisions. Only recently, for example CICA's
(1997) Financial reporting by investment funds,
have serious attempts been made to address
investment fund reporting issues. The two-tier
structure proposed here facilitates study of fund
reporting to investors as conceptually distinct
from ®rm reporting to investors or ®rm reporting
to investment funds.
The failure to focus on fund reporting to inves-
tors has had several results. It is known that
investment fund reporting is less comprehensive
than ®rm reporting, although this situation is cer-
tainly ameliorated by services such as Morningstar
and the many ®nancial press publications which
analyze and rate various mutual funds. Reviews of
the ®nancial reports of investment funds suggests
that information is provided by funds on a less
timely basis and with far greater variability in dis-
closure content than is found in corporate report-
ing (Chandar, 1997; Henriques, 1994c). For
example, disclosure related to investment asset
cost, transaction pro®tability, fund risk, and the
valuation of some securities vary widely. Some of
these di?erences are merely in amount while oth-
ers re¯ect apparently di?erent methods. It is not
clear whether fund reporting enables investors to
compare funds. Funds ®le ®nancial information
semiannually, revealing only snapshots of their
investment holdings. Unlike corporations, funds
are not required to ®le supplemental disclosures
even when signi®cant events occur that could
change an investor's perception of the risk of the
investment. For example if the investment man-
ager is replaced, or if new investment strategies
with signi®cantly di?erent risk pro®les are initi-
ated (as discussed in more detail below). Some
funds include their portfolios in their pro-
spectuses; others include them in statements of
additional information that must be ordered
separately. The dearth of information encourages
investors to make investment decisions based on
information obtained at the point of sale, often
from funds' sales sta?, or from brokers. Many
investors also rely on fund ratings and rankings
provided by publications of varying quality in
making fund investment choices.
7.6. Investor assessment of fund risk
The single-tier structure implies an importance
to consideration of operating ®rm risk. In con-
trast, the two-tier structure implies an importance
to assessing both operating ®rm and investment
fund risk, another matter addressed in the CICA
(1997) report. However, fund reports contain very
little information about risk.
Investment managers' compensation contracts
provide them with incentives that may similarly
a?ect their choices regarding investment portfolio
risk. They face intense competitive pressures to
achieve at-or-above benchmark returns, which
may motivate them to make risky investments, for
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 549
example in derivatives, in order to outperform
competitors. This motivation results from their
incentivized compensation contracts, which
reward them according to measures of fund return
achieved, and the low observability of a fund's
level of risk. Even relatively conservative funds
face this problem. McGough (1994) asserts that
``managers' desire to win incentive pay is a major
reason that the worst damage to mutual funds
from derivatives is falling on the most con-
servative types Ð money market and bond funds.
In these funds, the competition is toughest,
because their investments are so similar.'' While it
has been illegal for individual investment advisers
dealing with small clients to base pay on perfor-
mance, mutual funds are exempt from that statute,
even though most mutual fund holders are individual
investors.
The diculty in assessing fund risk can be illu-
strated by considering the impact of derivatives,
which are not commonly described in fund
reports. Contracts like interest-rate options and
foreign currency contracts are not only used to
hedge against risk, but also to increase risk. Apart
from derivatives, funds may engage in transac-
tions such as short selling, margin purchasing, and
investing in other exotic ®nancial instruments.
SEC commissioner Richard Roberts [quoted by
McGough (1994) in the Wall Street Journal]
asserts that stock and bond mutual funds ``should
be able to invest in whatever they want to, with
the caveat that the risk of those investments
should be fairly and fully disclosed to investors''.
However, the issue of what constitutes fair and
full disclosure of risk by funds has not been fully
studied. It is not known whether investors can
distinguish among funds on the basis of risk.
7.7. Con¯icts of interest and insider-type trading
While the historic focus on company reporting
to investors has highlighted operating ®rm con-
¯ict-of-interest and insider trading abuses,
researchers or policy makers have not carefully
studied such activities involving investment man-
agers. It is known that investment managers can
engage in business dealings with parties in whose
®rms funds have invested. For example, Henriques
(1994a) has identi®ed cases in which investment
managers, with little regulatory oversight, invest in
®rms that employ executives, advisers, or under-
writers with whom they have close ties. The
®nancial and popular press reports cases of high
pro®le investment managers who have purchased
stock that enriched a family member. Henriques
(1994a) identi®es instances of investment man-
agers investing privately in deals promoted by a
broker from whom they had bought stocks for
their funds. The risk that investment managers
have a close relationship with their investees is
comparable with a similar allegation in the case of
its precursor, the publicly traded investment trust,
earlier this century.
Some of the funds promising the highest growth
rates invest in start-up ®rms in the US or in
loosely regulated markets abroad. They also invest
in small ®rms or purchase penny stocks, in their
attempts to beat competitor and benchmark
returns. These are markets that are typically thinly
traded and followed, and reliable information is
often scarce. Portfolio managers therefore rely on
``professional `stock boosters,' aggressive brokers
and ®rm insiders Ð whose chief goals are to sell
stock, collect fees, or increase the value of the
shares they already own'' (Henriques, 1994b). The
operating ®rm bene®ts from this ``stamp of cred-
ibility'' that is a?orded to it by an investment by a
large mutual fund, and the investment managers
in turn anticipate prospects of considerable gains.
Particularly in thinly traded markets, the very act
of sale by a mutual fund may in¯uence market
prices, making it dicult to determine fair market
prices for fund assets.
Some of these transactions are simply illegal, as
the Investment Company Act of 1940 prohibits
investment managers from purchasing stocks
publicly underwritten by, or formally aliated
with, their ®rms. Others, while not violations of
law, are of obvious and legitimate interest to fund
investors, and have clear reporting implications
that correspond to similar disclosure requirements
for operating ®rm managers. Certainly, the
apparent low visibility of these transactions and
relationships leads to research questions as to fund
investor reactions should such information be
readily available.
550 R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554
7.8. Other claimholders
Just as focusing on investors and company
managers obscures both the nature of the ®nancial
reporting ``problem'' and implications with respect
to investors, fund managers, and company man-
agers, so also the single-tier agency model
obscures ®nancial reporting issues involving other
kinds of claimholders, including customers,
employees, and communities. In this way, the sin-
gle-tier model has political implications as it
removes the interests of other parties from con-
sideration. Each of these parties has information
rights of the sort commonly associated with
shareholding (ownership). As Bricker and Previts
(1999) write, ownership investment carries with
it implicit contracts (as opposed to the explicit
contracts of agency theory), among them being the
right to know about that which is owned Ð that
is, an information right. They argue further that
the ``investments'' made by other parties, such as
employees, the community, and other parties
(including their investment from bearing the cost
of company operations, such as pollution) give
these parties a similar claim in the company, and a
corresponding information right. From this per-
spective, the agency or other structural relation-
ships among parties are not limited to those who
are shareholders, and there are certain property
rights, and consequently information rights, accru-
ing to these other classes of claimholders. As pre-
viously discussed, Berle and Means apparently held
the view companies should be held responsible to
broader constituencies, and argued that company's
board of directors should have trusteeship responsi-
bilities to these parties. More ¯exible agency models
can facilitate portraying and studying such models
and their implications, as we do with respect to
investment fund managers using a two-tier model.
The di?erent goals of investment fund managers
today also have implications for reporting to other
classes of claimholders. As previously discussed, a
principal goal of the Morgans of the earlier era
were operational Ð they sought to achieve eco-
nomic goals that, secondarily, a?ected ®rm share
value. In contrast, investment fund managers of
today are principally concerned with share value
and returns, and despite the in¯uence they exert
over operating ®rms, only secondarily (and reluc-
tantly) focused on ®rm economic goals and oper-
ating activities. It is the cost ``punting'' that makes
them act as proprietors. In contrast, other claim-
holders have far more interest in ®rm operating
activities, and these interests can be addressed by
broadened reporting to address them.
8. Concluding comments
In this paper, using the historical record from
two time periods, we identi®ed in¯uence and con-
trol relationships involving investors, investment
funds, and ®rms beyond those addressed by Berle
and Means, and showed that investment managers
have important in¯uence and control capabilities
beyond ®nancial intermediation. Brief considera-
tions of Germany, Japan, South Africa, and
Canada suggested that similar roles are played by
investment funds, including banks and other
institutions, in those countries. Overall, the evi-
dence suggests the importance of investment funds
in in¯uencing and controlling ®rms, across time
and countries. To more fully portray these
observed relationships among investors, invest-
ment funds, and ®rms we presented a two-tier
capital markets structure interposing investment
managers as agents of investors and principals of
®rm managers. This structure more clearly separates
and illuminates the contracting and ®nancial report-
ing issues involving these parties, particularly in
terms of ®rm reporting to investment funds, and
fund reporting to investors. Particularly, in con-
junction with our historical analysis, it highlights a
hierarchy of investing relationships in which the dis-
persion or concentration of ownership interests may
vary. While Berle and Means point to the dispersion
of ownership interests with respect to ®rmmanagers,
the evidence suggests that the dispersion of indivi-
dual ownership interests with respect to investment
funds may also be an important issue to consider.
We do not want the reader to conclude that our
principal argument is for replacing the single-tier
agency model with a two-tier one to study capital
markets, per se. Instead, our point is that in trying
to portray and study capital markets parties
and relationships from an agency perspective,
R. Bricker, N. Chandar / Accounting, Organizations and Society 25 (2000) 529±554 551
researchers should balance model parsimony with
descriptiveness. For the purposes of this paper, a
two-tier model is useful. Investment funds are an
important type of participant in US and interna-
tional capital markets, and incorporating them
improves our view of ®nancial reporting issues.
From a broader perspective, we conclude that
models of capital markets relationships should be
contingent on the issue under study. To more fully
understand the accounting and ®nancial reporting
issues of contemporary capital markets, it is
important to portray the signi®cant parties and
relationships. While richer models may render
them less tractable to mathematical analysis, they
may o?er fruitful areas of application for historical
and ®eld research methods, as well as archival
empirical research.
Understanding the structure of in¯uence and
control relationships in modern capital markets is
both useful and timely. The recent activities of the
AICPA, FASB, and CICA suggest the importance
of a theoretical structure from which ®nancial
reporting implications can be derived for investors
in mutual funds as well as direct shareholding
investors. Traditional ®nancial reporting policy
has focused on the latter of these, leaving fund
reporting issues and those of reporting to other
claimholders largely unaddressed. Our results
imply that ®nancial reporting research and policy
issues should be reconsidered in light of this two-
tier setting speci®cally, and in terms of a broader
set of claimholders, more generally. Such con-
siderations may provide a basis for improving
®nancial reporting both in process and in product.
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