Working Knowledge
Business Research for Business Leaders
17 Aug 2006Working Paper Summaries

Corporate Governance and Networks: Bankers in the Corporate Networks of Brazil, Mexico, and the United States circa 1910

by Aldo Musacchio
Brazil today looks like a typical case in which business groups and close relations between companies and banks play an important role to overcome information and monitoring problems. This was not always the case. To study how the development of financial markets can change the interaction between banks and corporations, Musacchio compared the importance of interlocking boards of directors between corporations and banks in Brazil, Mexico, and the United States at the turn of the twentieth century. This paper and previous research support Musacchio's hypothesis that financial markets in Brazil were sustained by an institutional framework that protected investors, enforced credit contracts, and promoted regular financial disclosure of company accounts. The development of bond and stock markets, and the relatively good corporate governance practices in Brazil before 1930, made connections with bankers less necessary. Key concepts include:
  • Even though Brazil, Mexico, and the United States had very different network structures, all three achieved rapid industrial growth before 1910.
  • Connections with bankers might be good in an environment where access to credit is limited or where close relations help to reduce asymmetries of information. But once financial markets develop, these connections to lenders are less necessary.
  • The development of good disclosure and corporate governance practices in Brazil circa 1910 allowed companies to depend less on connections with banks in the form of corporate bond interlocks.
  • In Brazil, bankers were less central in the network of corporate board interlocks than in Mexico and the United States.
  • In Mexico, foreign companies had access to financial markets abroad and fewer connections with banks. This strong, dense network in Mexico substituted for some of the institutions that promoted financial development and growth in Brazil.
  • While most people see networks and financial markets as substitutes, networks in the United States functioned as complements to financial markets. Networks may successfully substitute for some institutions and generate the credible commitments that are necessary for the expansion of markets.

Author Abstract

How does the development of financial markets change the interaction between banks and corporations? This paper compares the importance of interlocking boards of directors between corporations and banks in Brazil, Mexico, and the United States circa 1909. The hypothesis tested is that the development of financial markets and the institutions that accompany it (e.g., financial disclosure rules, investor protections, etc.) allows corporations to rely less on connections to banks. There are two specific hypotheses tested in this work. First, given the development of disclosure and corporate governance standards in Brazil, I expect bankers to have been less central than in Mexico and, perhaps, the United States. Second, I test if the availability of financing alternatives, like a well-developed bond market in Brazil, reduced the average importance of corporate connections to commercial banks compared to Mexico. I test these hypotheses using network analysis and a simple multivariate regression that explains bank connections. I use comparable business directories to create databases with names of directors and financial information for all major corporations in Mexico and Brazil in 1909. The findings show that using different centrality measures, connections between banks and corporations were less important in Brazil than in Mexico and the United States. Also, in Brazil, the availability of bonds as a way to obtain financing allowed corporations to have a lower average number of connections to banks when compared to their Mexican counterparts. In Mexico, foreign companies, which had access to financial markets abroad, had also lower average connections with banks. I conclude by arguing that even though the Brazil, Mexico, and the United States had very different network structures, rapid industrial growth was achieved by these three countries. In Mexico, a strong and dense network replaced for some of the institutions that promoted financial development and growth in Brazil.

Paper Information

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