Information, institutions and agency: the crisis of railroad finance in the 1890s and the evolution of corporate oversight capabilities

Accounting History,  Jul 2005  by Chandar, Nandini,  Miranti, Paul J

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By the 1920s virtually all of the institutional and informational innovations favoured by Progressive reformers had gained permanence in US railroad oversight. The system of governance that had emerged perceived the central problem of railroad management largely in terms of the probity and competence of its leaders and its allied professional groups. From an economic perspective the regulators also favoured the income redistribution inherent in its crosssubsidisation of rates from the wealthy, industrial East to the poorer agrarian South and West. Yet the intricate structure of institutions and information built up over a half century that supported the agency in advancing its mission did not seem particularly effective in preventing the recurrence of extensive bankruptcy during the course of the Depression of the 1930s. Although close federal monitoring doubtless was effective in assuring greater financial probity and rate equity, it did little to cushion the effects of a deep and lengthy industrial collapse. Moreover, the railroads could not be insulated from the serious disruption of heavy industry, a primary customer sector. The baseline of what constituted "safe" finance shifted radically during these years. The financing plans approved by the ICC during the 1920s frequently could no longer accommodate to the requirement of a radically changed economic environment. This eventually led as in 1893 to a resurgence in bankruptcies. The new focus of policy shifted from micro concerns about the ethical failure of business leaders to macro concerns about the failure to maintain aggregate demand.

Conclusion

What then does the preceding analysis reveal about the evolution of institutions and financial agency? How does it inform theoretical perspectives about the nature of their relationships?

This paper evaluates agency issues in a manner that differs considerably from the logico-mathematical studies that have been prominent in the extension of this paradigm in finance and economics. As argued earlier, these latter approaches necessarily focus on short run firm-specific factors by holding the dynamic environmental factors constant. By contrast, the methodology employed in this study stresses the dynamic process of institutional change and its interplay with firm-specific variables over long time horizons. Focusing primarily on a crisis among dominant firms in a leading industry in the 189Os it explains why the diminishment of agency risk and the restoration of financial equilibrium depended not only on the adaptation of an existing array of legal conventions but also on the innovation of regulatory institutions to collect and to disseminate new bodies of information and to monitor corporate agents. Moreover, the study makes clear that institutional innovation did not come about immediately but often took considerable time. This study thus focuses on the dynamics involved in moving from one equilibrium position to another - an issue that is "black-boxed" in the logico-mathematical studies of agency relationships. Although the pathway for reforming the use of accounting information to achieve better governance over rail financing seemed clear in the 189Os, it took three decades for the proposed changes to be fully embraced in the corporate governance system. Innovation was slow because it affected the economic interests of many stakeholder classes and, consequently, required the formation of broad political coalitions that through a protracted process of negotiation and compromise reconciled the inevitable conflicts that arose.