Ryan Bubb


For most of the period associated with the Industrial Revolution in Britain, English law restricted access to incorporation and the Bubble Act explicitly outlawed the formation of unincorporated joint stock companies with transferable shares. Furthermore, firms in the manufacturing industries most closely associated with the Industrial Revolution were overwhelmingly partnerships. These two facts have led some scholars to posit that the antiquated business organization law was a constraint on the structural transformation and growth that characterized the British economy during the period. Importantly, however, the vast majority of manufacturing firms in the modern sector were partnerships. An easy explanation for the predominance of partnerships is that the legal restrictions on access to the joint stock form gave entrepreneurs no other choice of legal vehicle for their collective enterprises. It is not a large leap to then argue that these restrictions inhibited the development of the English economy. Those who make this argument implicitly envision a counterfactual in which legal restrictions on the joint stock form were absent, firms in the modern sector used the joint stock form to access external sources of funds to finance investment, and consequently capital accumulation and output accelerated more rapidly in the modern sector. The goal of this Essay is to challenge this view and to point towards other possible explanations for industrial entrepreneurs’ use of the partnership form. In short, the restrictions on access to the joint stock form lacked bite. While firms did not have general access to incorporation until 1844, creative businessmen and lawyers crafted an alternative legal form—the unincorporated joint stock company—that served as a functional replacement for the business corporation. Restrictions on unincorporated joint stock companies were unenforced and largely ignored. Thus, the use of the partnership by entrepreneurs in the modern sector must be understood as a choice; the law did not dictate their firms’ legal form. This Article proposes a resolution of this puzzle based on the pecking order theory of corporate finance. For the vast majority of firms in the modern sector it was optimal to use only debt, not equity, for any external financing. Industrial entrepreneurs chose the partnership form because it minimized the costs of debt financing. The unlimited liability of partners gave firm creditors additional collateral and provided better incentives against opportunism by partners, thereby lowering the cost of credit to the firm. Furthermore, the tighter nexus between control and residual financial claims in the partnership form resulted in better incentives for the owner-managers to exert effort and make efficient decisions in running the firm. Part II begins with a short overview of the early history of the joint stock form in England and then turns to the legal framework for business organization during the Industrial Revolution and explain that the supposed restrictions on organizing as a joint stock company were not binding. Part IV develops an explanation based on the pecking order theory of corporate finance for why industrial entrepreneurs nonetheless organized their businesses as partnerships.