Published by EH.NET (April 2010)

Aldo Musacchio, Experiments in Financial Democracy: Corporate Governance and Financial Development in Brazil, 1882-1950. Cambridge: Cambridge University Press, 2009. xxv + 298 pp. $85 (hardcover), ISBN: 978-0-521-51889-5.

Reviewed for EH.NET by Anne Hanley, Department of History, Northern Illinois University.

I love Brazilian history of the nineteenth century up to World War I. This was an era of economic change, innovation, diversification, development, institution building, growth, opportunity, and creativity. Social and cultural historians would justifiably beg to differ since this was also a period when practices and prejudices from the days of slavery helped codify some of Brazil?s longest lasting and most reprehensible inequities. But for the economic historian, Brazil before World War I was all dynamism and promise. This promise is captured in Experiments in Financial Democracy by Aldo Musacchio, Assistant Professor of Business, Government, and International Economy at the Harvard Business School. Before the Great Depression, the Brazilian government passed good laws to protect investor rights and stimulate investment, corporations guaranteed protections that exceeded the legal mandate, and investors responded by funding a rapid growth in business formation. Disclosure laws and voting rights before 1930 gave the small investor both transparency and a real say in company decisions, prompting a rate of investment in stocks and bonds that was not again matched until the end of the twentieth century.

This dynamism runs contrary to the law and finance literature, which posits that inherited legal traditions determine financial development, and that common law countries fared better than civil law countries in this area. Modern Brazil, a civil law country, has weak financial institutions and poor investor protections. This presumably is the product of its legal tradition, meaning Brazil was doomed from independence to poor institutional development and economic growth. Musacchio undertook extensive archival research into sources related to financial development and shareholder protections to test this hypothesis for the Brazilian case. He reasoned that if this failure to thrive was the result of inherited legal traditions, weak financial institutions and poor investor protections must be observable at any point along Brazil?s historical path. Reconstructing government regulatory legislation, company statutes, valuations of the stock and bond exchanges, annual shareholder meeting minutes, and judicial bankruptcy cases he demonstrates that the relationship between legal tradition and financial development does not hold for Brazil. Before the 1930s, and especially before World War I, Brazil had strong financial institutions and all or most of the investor protections the law and finance literature said a country should have to promote growth.

What, then, caused Brazil to fall away from the dynamism of the early twentieth century? For Musacchio the answer rests in investor protections. After 1930 the rules that stimulated broad investor participation before World War I were changed to reverse, weaken, or eliminate protections. These changes were driven by the shortage of capital after 1930 that led to government investment in and ownership of large corporations, as well as by the new political environment in which Get?lio Vargas turned labor unions into a powerful political force. In this macroeconomic and the political setting, the rules were changed to privilege labor?s claims over investor claims in bankruptcy law. The rise of family-owned conglomerates was the response on the business side, eliminating transparency and the need to attract small investors and resulting in the stunted financial development we find in Brazil today. Political expediency, not legal tradition, determined Brazil?s modern fate.

This carefully and intelligently constructed book is the latest installment in detailed archival research by Brazilian economic historians that challenge conventional wisdom on the determinants of economic growth and development. Like the work by scholars including Zephyr Frank, Steve Haber, myself, Barbara Levy, Fl?vio Saes, Bill Summerhill, and Gail Triner, this book tests Brazil?s experience against hypotheses advanced about the relationship between institutions and economic growth. Musacchio confirms the research by myself, Haber, and Triner on the roles played by banks (a small one) and the stock market (an important one) in stimulating business development, diversification, and efficiency, but moves beyond our work to examine corporate governance as it was practiced and to tackle the thorny question of business and financial development in the dramatically changed post-1930 environment.

The criticisms I have of the book do not detract from its value, but they should be taken seriously because they involve the building blocks of the larger interpretation Musacchio develops. Take the argument that judges protected creditors? rights beyond legally mandated protections because they were shareholders themselves or that company directors adopted stronger investor protections than required by law because they were either foreign born or foreign educated and therefore predisposed to adopt tougher European protections. Both are a good assumption given what we know of the Brazilian elite, but the first is based on the profiles of just two judges as evidence and the second is true of perhaps some but not all directors. The archival work involved in testing these assertions is Herculean and beyond the scope of the book, but bear questioning. More important is Musacchio?s interpretation of the introduction of limited liability in Brazil. The 1882 law that reduced barriers to entry in company formations specified a liability calculation he reads as limited but that kept investors on the hook for shares they bought for five years after the date of purchase even if those shares had been traded away. Musacchio claims to overturn my interpretation that this provision was a disincentive to investment, but really just begs to differ with my reading because he finds an upsurge in Rio de Janeiro company formations after the law?s passage. No such upsurge is evidenced in S?o Paulo until the reforms of 1890 that definitively limited shareholder liability took effect. I urge readers to think through the implications of this law for themselves rather than accept either my or his interpretation as gospel truth.

With this book, Musacchio adds a rich new layer to our understanding of the forces behind both Brazilian dynamism and malaise. This book would make an excellent pairing with Mark Roe?s Political Determinants of Corporate Governance on the U.S. and Europe, and John French?s Drowning in Laws on the institutionalization of labor rights in Vargas?s Brazil. Like all good books, this one causes the reader to rethink assumptions and to challenge accepted wisdom.

Anne Hanley is Associate Professor of History at Northern Illinois University and author of Native Capital: Financial Institutions and Economic Development in S?o Paulo, Brazil, 1850-1920 (Stanford, 2005). Her current research is on municipal finance in Brazil from independence to 1930. E-mail: