“While I think a securities act is very essential, it is, in a total program of social control over high finance, quite secondary. That is why I am particularly intrigued with your proposal for federal incorporation, as I think that only by some such beginning can genuine progress toward protection of investors get under way.”December 2, 1933 Reply to Jerome Frank from William O. Douglas on federal incorporation proposal
It took the Great Depression of the 1930s to put reform of corporate governance on the federal legislative agenda. The New Deal approach to the problem set the trend that continued for the rest of the century, favoring incremental over sweeping change, and focusing on disclosure rather than direct supervision.
In 1932, the conflict between shareholders and management received its most enduring depiction in The Modern Corporation and Private Property. Authors Adolf Berle, Jr. and Gardiner Means argued that millions of shareholders had surrendered their property to entrenched, unelected managers who were lightly supervised and had little personally at stake. The system, which Berle and Means noted “bids fair to be as all-embracing as was the feudal system in its time,” had created enormous concentrations of wealth and power that they believed could conceivably rival that of the nation state.5
Berle and Means insisted that the corporate system had endured only by grace of relatively honest, competent managers, and, were they ever truly to abuse their power, shareholders would be unable to do anything about it. With the American and world economy in turmoil, Berle and Means feared that management would not remain honest. With shareholders unable to exert corrective control, the nation state would have to step in.
The Modern Corporation and Private Property appeared at the onset of a great wave of liberal legislation, but in the end, federal reform initiatives did not supersede state law. The Securities Act of 1933 called for some limited disclosure of articles of incorporation, as well as officer and director compensation and shareholdings. Emphasis on disclosure carried over into the Securities Exchange Act of 1934, which boosted the amount of disclosure required of registered companies.
The Securities Exchange Act notably extended federal involvement in proxy regulation. In hearings prior to the passage of the Act, one economist noted that stockholders could not “get together or get up courage enough to assert their rights unless they have some opportunity of knowing who their fellows in interest are.”6
The 1934 Act gave the Securities and Exchange Commission broad powers, which it used to write rules requiring submission of proxy materials for review, prohibiting false or misleading statements, and providing guidance to shareholders seeking to have proposals included in the proxy statement. The SEC revisited proxy rules in 1937, 1942 and 1957, but with minimal results. Nevertheless, these steps pioneered a new frontier for the federal government – extending shareholder democracy.
One reason why the 1933 and 1934 Acts lacked more powerful governance provisions was the expectation that the Acts would soon be supplemented by a federal incorporation law. The idea of a law regulating large corporations involved in interstate commerce had been discussed since 1885 and had gathered sporadic support. As the 1934 Act worked its way through Congress, President Roosevelt called on experts to consider federal incorporation. During testimony, several witnesses clearly expected a federal incorporation act to deal with issues such as accounting standards and the role of directors.
In 1936, U.S. Senators Joseph O’Mahoney (D-WY) and William Borah (R-ID) put legislation before Congress. A fierce critic of what he perceived as overly-lax incorporation laws, O’Mahoney included in his bill standards for boards of directors, shareholder voting for directors, increased accountability of management to shareholders, and a guarantee of voting rights for corporate stock. The O’Mahoney-Borah bill went through several iterations, but, weighed down by unpopular antitrust provisions, it was never enacted.
New Deal reform for corporate governance stalled as the United States prepared to enter World War II. Proponents of corporate governance had achieved greater corporate disclosure, as well as moderate reform of the proxy system. The failure of the federal incorporation bill, however, meant that any comprehensive federal reform of corporate structures would have to wait. As the focus shifted to the struggle for world, rather than corporate, democracy, momentum passed to the exchanges.