Yet sober second thought must have convinced him that he was hardly that. Only in a very limited sense did he enjoy the prerogatives or responsibilities which usually accompany ownership, and which in the earlier days of corporations had actually accompanied the ownership of shares. The average stockholder realized that the administration of the company was far beyond his reach. If he found the company to be engaged in lawless or nefarious business practices, he did not regard himself as in any way responsible. If he believed that he was not getting his fair share of its profits, he almost never thought of fighting out the issue. He knew, in short, that for practical purposes what he had bought was not a certificate of part ownership, but a certificate of his right to receive such dividends as the directors saw fit to declare, and of his right to take a profit if the price of the stock went up on the market. Not that the average stockholder felt badly about this. What he wanted was the dividends (or the profits). If they failed to come, he could sell out; and of course in those days they usually came. He accepted implicitly the truth that in this supposed corporate democracy an oligarchy reigned securely.
7
The power and responsibility of the stockholder who was not an insider were diminished not only by the sheer size and unwieldiness of the enterprise, but frequently by various specific devices through which the management could effectively shoulder him aside or disfranchise him. Some of these were old devices, some were new; but most of them came into wider and more confident use in the seven fat years than ever before.
Some of them, it must be said, were only incidentally useful in keeping the stockholder in his place; they were primarily invented for other purposes. For instance, some companies had established their nominal headquarters in small villages in order to avoid property taxes which would be levied in a city; but it also was presumably convenient to have to hold the annual meeting of the stockholders in a place so inaccessible that few of them would be likely to attend and ask questions. One chain-store organization, for instance, with over a million shares of stock outstanding, held its annual meeting in the post-office building in the village of Eddyville, New York. Here—in a small bare room furnished with a couple of wooden benches and a few chairs and a desk—a group of insiders, holding proxies for a million shares or more, could transact the necessary business of the day. Other devices were deliberately invented in order to permit power to be concentrated.
For example, there was the voting trust: an old device by which a small group of men were empowered, by the terms on which the stock was issued, to elect directors annually for a certain term of years, When first used, the voting-trust device had been much criticized as involving virtual disfranchisement of the stockholders. But Morgan the Elder had used it freely—and had defended it strenuously, as you may recall, before the Pujo Committee. It was still in use in the nineteen-twenties, though perhaps not as popular as in previous years.
Then there was the issuing of non-voting stock. For a considerable period the right of the promoters of a company to issue non-voting preferred stock had been generally recognized, but the frank disfranchisement of common stockholders was a comparative novelty. Yet it was widely resorted to in the seven fat years, though always it was under criticism. For example, when the Dodge Brothers automobile concern was reorganized in 1925, not only the preferred stock but four-fifths of the common was deprived of any vote; the result was that the New York banking house of Dillon Read & Co., which performed the reorganization, was able to control a company representing a total investment valued at 130 millions by taking 2½ million dollars’ worth of Class B common stock.
There was the somewhat similar device of vesting a disproportionate voting power in one class of stock. For instance, in 1929 the Cities Service Company (the capstone of a pyramid of utility companies) issued a special class of preferred stock to H. L. Doherty & Company, and this preferred stock had twenty times the voting power of the common stock; a fact which enabled Mr. Doherty, as it were, to hold control of Cities Service and its subordinate companies with one hand, although the Doherty concern paid only one dollar a share for its twenty-vote stock, while new common stockholders were paying from twenty to sixty-eight dollars a share for their one-vote stock!
Another device was the outright extension of the legal powers of the directors of a company, by the passage of new incorporation laws which gave them the right to do things which had hitherto been banned (as infringing upon the rights of the owners of the corporation). It was the State of Delaware, under the political suzerainty of the wealthy duPonts, the powder and munitions manufacturers, which in the seven fat years took a long lead in the race among the states to secure incorporation fees by accommodating their laws to the wishes of company promoters. A generation earlier the rush of promoters had been to New Jersey; it was in Hoboken that the corporations which they formed had preferred to hang their hats. In the latter nineteen twenties the rush was to Delaware, and the corporate hats were hung in Wilmington.
In a single building in Wilmington, the Industrial Trust Building, some ten thousand corporations made their legal homes. It was not a large building; it was only ten stories high and ten windows wide on the front—in New York or Chicago it would be considered rather small. Nor did the ten thousand corporations occupy the whole of it. On the contrary: they all had their headquarters on the tenth floor (though there were stenographers and clerks available for their use on two or three lower floors).
The only readily visible sign of their legal tenancy of these modest offices was in the entrance lobby downstairs, where the visitor, expecting perhaps to see the usual moderate-sized framed panel containing the directory of tenants (with the names in white letters on a black background), saw, instead, panels on every side of him reaching almost from floor to ceiling and containing tier upon tier of names in small print. And what names! The Standard Oil Company of New Jersey, the Radio Corporation of America, the United Corporation, the National Dairy Products Corporation, the Pullman Company, and so on. (Indeed, some of these tenants appeared on the list not singly but in squad formation, followed by their subsidiaries: a visitor to the building in 1934 noted the names of 30 different corporations in the McKesson squad, of 18 in the Warner Brothers squad, of 13 in the Publix squad. The vast General Motors Corporation had its technical residence across the street, in the duPont Building, but a squad of its subsidiaries were listed here.)
Why this eagerness to take up legal residence in Wilmington? Because, in the first place, it need be only a very casual residence. According to the Delaware laws, none of the directors of a Delaware corporation need live in the state; it was not necessary to hold the directors’ meetings or even the stockholders’ meetings in the state; and the corporation might do its actual business anywhere on the globe. But also because, in the second place, the Delaware laws gave to directors such privileges as these:
They need not own any stock whatever in the company which they directed.
They might issue stock, not only in return for cash or for property, but, if they preferred, in return for “services rendered”—the value of which they would of course fix.
They might arrange the voting rights of various classes of stock as they saw fit.
And, what was more, they might at any time dilute the stockholders’ share in the ownership of the company by issuing new stock without offering it first to the existing stockholders or even getting these stockholders’ permission; and to such new stock they might give such voting privileges as they saw fit.
In short, the stockholders of a Delaware corporation which took full advantage of its legal opportunities were shorn of many of the traditional prerogatives of ownership. (Strong to survive, however, are ancient ways of thought: if you had suggested to one of these stockholders that a Federal incorporation law might be to his advantage, he probably would have opposed such an innovation as “threatening the rights of property.” And of course he would have opposed it as undermining “states’ rights”—that rugged prin
ciple of local self-rule which enables New Yorkers to do business in California under the laws of Delaware.)
Still another device was the banker-controlled reorganization. If a company went into receivership or was for some other reason to be reorganized, it had become the custom for bankers not only to put up the money necessary to finance the financial operations which were required, but to dictate the terms of the whole reorganization. In theory such transactions were completely under the supervision of the courts, in order that the bondholders and other creditors and the stockholders and other interests involved might be fairly treated. What sometimes happened in practice has been clearly brought out by Max Lowenthal in his analysis of the reorganization of the St. Paul Railroad, the biggest of all such rearrangements of capital during the seven fat years.
This reorganization was managed by the Wall Street private banking firm of Kuhn, Loeb & Co. This banking firm, seeing that a receivership was inevitable, selected a “friendly” creditor and suggested that it ask for the receivership. (Incidentally, this creditor was a coal company—and one of the heads of this coal company, on its being selected, at once obeyed a natural impulse and sold a thousand shares of St. Paul short!) The banking firm selected the judge before whom the creditor was to appear; consulted the judge in advance about whom to appoint receivers, and got a satisfactory group of three; selected the heads of the committees who were to represent the various classes of bonds and stock in the negotiations; and selected most of the members of the committees, including, as members, various eminent bankers who owned none of the securities whose interests they were supposed to represent. The banking firm further selected the trustees for the bondholders and the lawyers who were to represent various groups of security holders; and they secured the adoption by these committees of a complicated and lengthy agreement which maintained Kuhn, Loeb’s hold on the situation. Not only did the fees allowed to the banks and trust companies and corporation lawyers and to the firm of Kuhn, Loeb & Co. itself, for their services in reorganizing the railroad, run into the millions—which had to be paid out of the resources of this bankrupt road before the regular creditors got a penny—but naturally the plan of reorganization which was adopted left the control of the road firmly within the sphere of influence of Kuhn, Loeb & Company.
Indeed it was very generally the custom, when reorganizations took place, not only to levy large fees but also to make up the new board of directors in such a way that the control rested wherever the bankers wished it to rest. Once more the investor who was not an insider found himself at the mercy of those who held the reins of power.
Sometimes the bankers and corporation lawyers at the center of things exercised this power of theirs scrupulously and beneficently, sometimes they exercised it scandalously; the point which I am making here is simply that the power was theirs to exercise as they pleased.
There were still other devices by which insiders could acquire or protect their control. For example pyramiding, which we have already discussed, undoubtedly deserves mention here again.
It must be understood that often the men who put these devices to use had no sense that they were wielding power to which they were not entitled. The custom of taking such power had grown up through a long series of corporation lawyers’ inventions, and there were many arguments in favor of these inventions. They made for speed, for efficiency, for harmony; they did away with red tape; and they put the affairs of the corporation in question in what the insiders naturally considered to be the most capable and deserving hands—to wit, their own hands and those of their friends. Seldom did investors protest audibly; as we have seen, the investor, loudly as he might defend his rights of property in the abstract, was quite reconciled to relinquishing many of them in the concrete. And in the enthusiasm of Coolidge prosperity he was inclined to accept anything and everything which the masters of capital chose to do as superlatively wise and right.
One further fact should be made clear. Not all directors of corporations were necessarily insiders in any real sense. A director might concern himself with only some limited phase of the corporation’s activities, or he might be ornamentally inactive; he might actually know almost as little as the outside stockholders about what was going on in the enterprise which he was supposed to supervise. When one man held 45 directorships, as did Albert H. Wiggin, chairman of the Chase National Bank, in the heyday of his career—or 52, as did Percy Rockefeller, or even 66, as did Charles Hayden—what were the chances that he would be able to devote time and care to a study of each corporation’s work? Many financiers, when blamed in later years for scandals in the companies of which they had been directors, testified quite truly that they had been ignorant of what was happening. Often the real authority was lodged in one or two men. Decisions involving not only the fortunes of stockholders but the livelihood of employees, and affecting the whole economic destiny of an industry or a region, could be made by such men subject to only the flimsiest sort of check from either the ostensible owners of the property or their ostensible representatives.
8
To be an insider could on occasion be very profitable. There were many ways—ranging all the way from the reasonably defensible to the utterly indefensible—of making money by reason of one’s inside position. John T. Flynn has remarked that very few Americans have made as much as a million dollars merely by saving their salaries, even by saving hundred-thousand-dollar salaries. It is probable that most of the self-made millionaires and multi-millionaires—and there were thousands of them—won their fortunes by exercising the prerogatives of insidership: by being awarded stock for services (either with or without quotation marks), or by being awarded bonuses by their fellow-directors, or by using their inside knowledge to speculate in the stock market, or by engaging in personal transactions with their companies, or by investing in concerns to which they threw company business, or by siphoning the money of their companies into holding companies in which they held an interest, or otherwise.
As far back as 1904, Thorstein Veblen had called attention, in The Theory of Business Enterprise, to the divergence between the pecuniary interest of the insiders and that of the ordinary stockholders. He had noted, for example, that the easiest way for an insider to make money was to trade in the shares of his own company, buying these shares when he knew the company was doing better than the proxy-signers supposed, and selling them when he knew it was not doing so well; and that, once this insider’s position at the center of things was secure, it was less to his pecuniary interest that the enterprise should prosper than that there should be a discrepancy, one way or the other, between the market value of its shares and their real value. As the corporate giants grew and their shares were more generally listed and more actively traded in, and the devices which we have been discussing came into common use, this divergence of interest became a much more widespread and more striking characteristic of American business than it had been in 1904.
The more dubious of the exploits by which insiders took their private profits seldom became widely known. Even if they became widely known they were usually regarded with considerable tolerance in the business world. Indeed, one of the most flagrant of all which came to light during this period—the Continental Trading Company deal, in which a group of officers of various oil companies drew off a profit of over three million dollars on an inter-company sale of oil (a profit which would otherwise have gone to one or more of their companies)—would hardly have caused the removal of Colonel Stewart from his position at the head of the Standard Oil Company of Indiana, if John D. Rockefeller, Jr., had not employed all the voting power of the large blocks of stock which he controlled, and all the great financial and moral influence which he possessed, to push Colonel Stewart out.
There were insiders of the most scrupulous integrity in big corporations, of course, but there were others to whom a position on the inside was a legitimate opportunity to draw off the gravy from the dish; and for these latter there were opportunities in plenty.
But far more important for our consideration than the profits made by insiders at the expense of other participants in business is the effect which the growing concentration of a large part of American business into the control of a few corporations, and of the power over these corporations into the hands of groups of insiders, had upon the economic organization of the country. It is difficult to escape these three conclusions:
1. Some of the devices which were now permitted and were used on a large scale made for general financial instability. This was conspicuously true of the holding-company pyramid, and to a lesser degree was true of holding-companies in general, of investment trusts, and of other financial superstructures of the new-era model. Companies at the top of holding-company pyramids, for example, could not even pay the interest on their debt—let alone pay dividends—unless the companies in which they held stock could pay common-stock dividends. These financial superstructures were built for fair weather. If a storm should come, they were in danger of outright bankruptcy. They would not be able to afford to let the companies which they controlled pass dividends; in fact, they were under the most severe temptation to milk these companies of funds in order to protect themselves, and the banks which were involved with them, from disaster. The maintenance of prices or of rates was essential to their life; the maintenance of employment was not essential, at least not immediately; thus the almost inevitable thing for them to do under the pressure of fear would be to save money on labor and to try to hold their wobbly financial structures intact. But almost nobody foresaw foul weather then. The skies were clear, confidence ran high, and so capital built its superstructures high and handsome—and not nearly wide enough. The tumble was to come later.
Lords of Creation Page 25
