Skip to main content

Full text of "The financial policy of corporations"

See other formats

Digitized by tine Internet Archive 

in 2007 with funding from 

IVIicrosoft Corporation 

The Financial Policy 
OF Corporations 



Assistant Professor of Economics, Harvard University; author of 

"Corporate Promotions and Reorganizations," "History of the 

National Cordage Company," etc. 



Second Printing 




Copjnight, 1920, by 
The Ronald Press Company 

All Rights Reserved 


Chapter Page 

I Underyling Motives and Principles 3 

Problem defined, 3 ; Two fundamental problems involved, 
4; Motives leading to expansion, 4; Ambition, 4; Creative 
impulse, 5; Profits, 6; Speculation, 6; Procedure of the 
present study, 7. 

II The Law of Balanced Return 9 

Statement of the Problem, 9; Law of diminishing re- 
turns, 10; The scope of the law, 12; Application of dimin- 
ishing returns to manufacturing, 13; Quantity factors in 
production, 14; Illustrations from shoe industry, 16; 
Tentative conclusions, 19; The law of balanced return 
expounded, 21 ; Illustrations of the operation of the law, 25. 

III Industrial Combinations 33 

The problem of industrial incorporations, 33; Historical 
survey of industrial consolidations, 34; Reasons for cessa- 
tion of industrial consolidation, 38; The failure of the 
industrial consolidation, 41 ; The present-day problem, 52 ; 
Importance of extremes of ability, 53 ; Four modern suc- 
cessful types of consolidation, 54; Automatic industries 
likely to succeed in large-scale production, 54; Integrated 
industries, 54; Chain stores, 57; Export companies, 64. 

IV The Expansion and Consolidation of Railroads . . 69 

Methods of treating subjects, 69; Analysis of forms, 71; 
The lease, 74; Trafific leases, 76; Gross earnings leases, 76; 
Net earnings leases, ^^ ; Fixed rental leases, 79 ; Stock con- 
trol by purchases, 83 ; Stock control by exchange, 85 ; Stock 
control by collateral trust bond, 86; Outright purchase, 
92; Historical period of railway consolidation, 94; First 
period of end-to-end consolidations, 96; Second period, 
100; Third period, 106. 


Chapter Page 

V The Public Utility Holding Company 109 

Means of control over many small companies, 109; Early 
history, no; Four advantages, 113; Superior technical effi- 
ciency, 114; Economy in purchase of equipment, 118; Ad- 
vantage in business dealings with public, 118; Advantages 
in financing, 122; Financial structure of the public utility 
holding company, 128; Special types of holding com- 
pany, 134. 

VI The Community of Interests 137 

Problem of business organization a balance between 
unity and diversity, 137; A balance involving advantages 
of each, 139 ; Trade associations, 145 ; District associations, 
146; Manufacturers' associations, 151; Community of in- 
terests, 154 ; Community of interests in production and dis- 
tribution, 155; Community of interests in stock owner- 
ship, 157. 

VII The Sources of Capital and Short-Term Borrowings 168 

^ Problem of new capital, 168; The investment of earn- 

ings, 168; Growth of short-term corporate borrowings, 
172; Evils of short-term notes, 174; Distinction between 
self-liquidating and fixed property, 176. 

VIII Expansion Through the Sale of Securities to 

Bankers 180 

Problems to be considered, 180; Advantages of issues of 
bonds rather than stock, 181 ; Advantages of stock issues, 
184; Advantages of sales through bankers, 188; Assur- 
ance of sales, 188; Widening of market for securities, 190; 
Relative economy, 193; Exchange, 195; Growing use of 
stocks rather than bonds, 196; Pretended safeguards from 
point of view of investor, 198. 

IX Privileged Subscriptions 202 

■^ Conditions of privileged subscription, 202; Terms of 

oflFer, 203; Value of the right, 210; Effect of the privileged 
subscription on the market price of the stock, 213 ; Methods 
of taking advantage of privileged subscription, 214; The 
profits from privileged subscription, 217; Underwriting 
privileged subscription, 218. 

Appendix 221 


The Financial Policy 
OF Corporations 




Problem defined, 3; Two fundamental problems involved, 4; 
Motives leading to expansion, 4; Ambition, 4; Creative impulse, 5; 
Profits, 6; Speculation, 6; Procedure of the present study, 7. 

A business corporation is either a success or a failure. 
Although a business may maintain, for a considerable time, 
a quiet existence showing no outward change, yet in the long 
run an observer will see clearly that it has gone either forward 
or backward. Many corporations go down-hill very rapidly 
and become failures within a few months after their promo- 
tion ;* with others the causes of disaster take longer to operate 
and may not precipitate failure for several years.^ The same 
thing is true of the success of a corporation. In fact, as the 
first few years are devoted to organization and to establishing 
a place in the trade, pronounced success is not likely to show 
itself so early as pronounced failure. Yet in the long run 
it is just as evident as failure, although the consequences may 
not, perhaps, be so dramatic* 

1 The failure of the old United States Shipbuilding Company, now the Bethlehem 
Steel Corporation, followed so quickly after its promotion that it is difficult to 
say that the company had any real existence of its own. 

' The causes behind the failure of the International Steam Pump Company in 
1914 were present from the organization of the company in 1899, yet by the aid 
of a bond issue and less obvious palliatives they were obscured from the outside 
until the autumn of 1913. 

•The remarkable but sporadic success which certain manufacturing companies 
obtained through foreign orders for munitions soon after the outbreak of the 
Great War is not an exception to this rule. The success in most cases was only 
apparent, not real, and vanished even before the contracts were executed. The 
vast majority of tnose corporations which profited greatly by_ the war were already 
successful or else had developed a highly efiicient productive organization before 
the war. 


There are two fundamental problems in regard to business 
expansion which require careful consideration. These are the 
problems of organization and of finance. The directors of a "1 
corporation who find themselves embarrassed by an increasing 
volume of business or are tempted by the prospects of larger 
profits through a larger business must plan the form and 
structure of their enlarged organization. It is important to 
note that the form of business organization that is suitable 
for a small business is not suitable for a large business of 
the same kind, and that the same form of organization is not 
suitable for all kinds of large businesses. But besides estab- 
lishing the general lines the business organization and cor- 
porate structure must follow, the directors of an expanding 
business must determine the sources whence they may derive 
the new capital required by their enlarged activities. A large 
business requires a great deal more capital than a small one, 
and the various means by which the increased capital may 
be obtained must be canvassed with a broad and far-sighted 
vision. A blunder in the method of obtaining the new capital 
would jeopardize the success of the expanded business. The 
financial structure of a large business, though different, must 
be no less sound than that of a small business. 

Four main motives have led men to expand business enter- 
prises. On the whole they are not economic, but rather 
psychological; they are the motives incident to the struggle 
for conquest and achievement — the precious legacy of man's 
"predatory barbarism." Primarily a man measures the success 
of a business by increased size, and secondarily by increased 

The most powerful motive that leads a man to expand a 
business is the illusion of valuing himself in terms of his 
setting. The bigger the business, the bigger the man^ A man 


prefers to direct a large business rather than a small one ; just 
as the borough president seeks the mayoralty and the mayor, 
the governorship. He likes to feel himself of influence in 
the sphere of his activity. He likes to be somebody, to occupy 
a "place in the sun" in the business world. 

This motive is much more fundamental than is usually 
realized. A man who operates successfully a corner drug 
store may be content with the business as it is, provided he 
finds the field of his primary interests outside of his business — 
home, sport, or an avocation. In such a case, which is com- 
mon, the business is an insignificant means to an end. It is 
not a part of the real life of the man, but merely an attendant 
circumstance in the problem of extracting a livelihood out of 
a competitive and unsentimental world. But such men are 
not true business managers in the sense that the economist 
uses the word "manager" or "entrepreneur." Their field 
of achievement is not business. Men who can be even broadly 
classified as business managers and who value success in 
productive enterprise as something worth while in itself — 
rather than as an insignificant means to a greater end — want 
their business undertaking to bear the outward signs of suc- 
cessful achievement. Increasing size is the most obvious of 
these signs. The race-old instinct of conquest becomes trans- 
lated in our twentieth century economic world into the prosaic 
terms of corporate growth. Business expansion is the spirit 
of a modern Tamerlane seeking new markets to conquer. It 
is a pawn for hu man ambition . 

The second motive, less significant, one Is led to believe, 
is the creative impulse. A business manager has an aversion 
to stagnation ; he wishes to be constructive. He wishes to make 
actual the vague images of progress. The only field with 
which he is familiar is his business, and in the fortunes of 
his business he sees the realization of his ideals. It is a 


commonplace of psychology, current since the brilliant in- 
trospective studies of the elder Mill and Reid, that somewhere 
in the mental structure of all of us lies the impulse to build, 
to see our ideas take form in material results. The impulse 
to build is at the same time an important element in inventive 
and artistic genius and in skilful craftsmanship. The particular 
form in which it finds expression is, among men of ordinary 
ability, certainly a matter of accident. And the particular 
form close at hand to the business manager is his business. 
A distinguished business manager, at sixty-nine years of age, 
to whom wealth had ceased to have a significance, was heard 
to outline in detail for an already well-rounded and world- 
wide business, steps in reconstruction and enlargement which 
would ordinarily take a lifetime to achieve. An expanding 
business affords a sphere for the kind of creative expression 
demanded by our twentieth century industrialism. 

The third motive is the .e conom ic. My own observation 
is that the vast majority of business men who plan enlarge- 
ments, consolidations, and extensions of their business are 
not actuated primarily by the impulse to make more money, 
although they unquestionably place this motive uppermost 
when they need to present plans for enlargement to directors 
and stockholders. Since increased profits have so obvious and 
direct an appeal, and since no other motive can sufficiently 
justify the investment of other people's money, it is natural 
to place the motive of increased profits foremost. And it 
appears foremost in every business manager's mind when he 
attempts to justify a business policy which may have been in 
the first instance subconsciously prompted by less obvious and 
more basal motives. 

The fourth motive is the satisfaction in taking speculative 
chances. Business managers like to be dealing with a future 


full of concrete uncertainties. They like to apply direct em- 
pirical tests to business policies, the results of which are at 
best uncertain. A successful business manager is invariably 
a man of imagipation. Invariably the man of imagination 
revels in uncertainties. He is by nature a speculator — if we 
use the term in its broadest significance and without disparage- 
ment. The development of constructive plans partakes of the 
nature of a game. All men enjoy the game they think theyj 
can play. 

Other motives undoubtedly influence the policy of business 
expansion in specific cases, but the four just outlined are, 
one is led to believe, the controlling motives. But it is not 
sufficient that business managers feel an inarticulate desire to 
expand and broaden their businesses. They must have and 
must put into execution definite and clear-cut methods; they 
must overcome obstacles — legal, financial, and economic. It 
is the purpose of this volume to discuss these. 

It is the purpose of this volume also to discuss the means 
and conditions presented in business expansion. They concern 
themselves primarily with organization and finance. Subse- 
quently in the succeeding volume the purpose is to discuss 
the causes of failure and the methods of corporate reorganiza- 
tion — the problems resulting from adversity — and also how 
financial failure may be temporarily and permanently relieved. 

It was pointed out in the opening paragraphs of this 
chapter that a business expansionist was presented with two 
sets of problems: the one, the problems of poUcy and methods 
of procedure; and the other, the problems of finance. In 
the following chapter an attempt is made to lay down a general 
rule to test the wisdom and economic expediency of business 
expansion. In the succeeding chapters different methods of 
expansion, extension, and consolidation are outlined as they 
apply to various types of business enterprises. In the last 


three chapters the financial problems incident to obtaining 
money for extensions are discussed in some detail, with special 
reference to the sources of new capital. 

But throughout the entire study, it must be remembered 
that motives other than economic are at play, and the reasons 
for men's actions can but seldom be reduced to the simple 
prerogatives. The impelling springs of human action are 
difficult to fathom. As business managers are human beings, 
their solutions of the difficult problems of business expansion 
cannot be dissolved into economic elements nor forecasted in 
accordance with the canons of economic expediency. 



Statement of the problem, 9; Law of diminishing returns, 10; 
The scope of the law, 12; Application of diminishing returns to man- 
ufacturing, 13; Quantity factors in production, 14; Illustrations from 
shoe industry, 16; Tentative conclusions, 19; The law of balanced 
return expounded, 21 ; Illustrations of the operation of the law, 25. 

The central problem for a corporation contemplating the 
expansion of its business is the simple one of the effect on 
profits. It is merely the question whether the increase in the 
size will bring about a corresponding increase in the net profits 
— or enough of an increase to make the move worth while. 
It was pointed out in the preceding chapter that the motives 
leading corporate managers to seek the extension of their 
businesses are fundamentally personal — the direct result of a 
personal ambition turned toward business enterprise; never- 
theless they justify all plans for business extension by the 
simple economic sanction of increased profits. It behooves 
managers of corporate enterprises to consider well the ques- 
tion whether the enlarged business is going to be more profit- 
able than the smaller business. It does not always pay to 
expand. In fact there is probably no other one policy which \ 
brings disaster to the old-established business more often than I 
the putting into practice of the fallacious principle that profits 
necessarily expand as the business expands. Net profits do J 
not always increase proportionately to the volume of gross 
sales, and if the increased volume is made with the help of 
large borrowings it is even less certain that the balance remain- 
ing after charges will be proportionately larger. 



It is the purpose of this present chapter to discuss a simple, 
inexact, but effective rule for distinguishing between those 
kinds of enterprises which are obviously susceptible of profit- 
able expansion and those which are not ; a working rule, more- 
over, which indicates the point at which expansion of any 
kind of business ceases to be profitable. It has been called the 
"law of balanced return." * 

For many years English students of economic theory have 
pointed out that the increase in the products derived from 
the cultivation of land is not always commensurate with the 
amount of labor and improvements expended on the land. A 
more intensive cultivation of a specific plot of land, a larger 
number of acres brought under cultivation, additional improve- 
ments, more and better farming tools, a more liberal use 
of fertilizers, do not always, in the strict business sense, pay. 
Even in the United States, where farming has been carried 
on in a slipshod manner — always, however, with an economy 
of hired labor — the farmer understands that a more careful 
and economical cultivation of land is not warranted because 
of the prohibitive increase it would bring in costs of labor. 
As formulated by the English economists, long ago, there was 
a point in the intensive cultivation of land beyond which addi- 
tional equal investments of labor and improvements did not 
bring equivalent returns in agricultural products. The returns 
from land diminished, relatively, as increases of capital and 
labor were invested in it. This principle, of far-reaching 
significance in the history of critical economic thought, is 
[ known as the "law of diminishing returns." 

The law of diminishing returns was originally worked out 
in connection with agriculture. This was because agriculture 
constituted the great fundamental industry in the eyes of 

1 This chapter is a reproduction and condensation of a study printed elsewhere. 
Dewing, A. S., "The Law of Balanced Return," 7 Am. Econ. Rev. 755 (Dec. 1917). 
See also a very enlightening criticism by Mixter, C. W., 8 Am. Econ. Rev. 74s 
(Dec. 1918). 


the English students of economic theory and because the 
conditions of agricultural production had remained unchanged 
for centuries. But it was soon discovered that the underlying 
principle could be extended to other forms of enterprise and 
that a decreasing rate of productiveness would be found by 
experience to pertain to other industries besides agriculture. 
It was noted, for illustration, that it took relatively little labor 
and very little equipment to catch fish near the shore. But 
if larger quantities of fish were required than the shore areas 
would afford, then more labor and more equipment must be 
used to secure similar quantities of fish from greater depths. 
And the further one must go out to catch fish, the greater 
must be the expenditure and the greater the cost of the pro- 
duct; so that the relative quantity of fish obtainable from a 
fixed expenditure of labor and capital diminishes as the volume 
of the fish increases. 

Furthermore, the same principle was observed to apply to 
all the so-called extractive industries, such as mining, lumber- 
ing, and quarrying. Ore dug from the upper layers of a mine 
cost less to procure than from deeper levels, and the deeper 
the workings the smaller the amoimt of product obtainable 
from a fixed expenditure. No matter how rich ore may be, 
there comes a point in depth beyond which it does not pay 
to go. The expenditure for labor and equipment equals or 
exceeds the value of the product. And though the price of 
the metal may be raised to absorb the increased cost of produc- 
ing the ore — and thus render profitable the deeper workings 
of a mine — still the fact remains that sooner or later the 
cost of production will reach, and ultimately exceed, the value 
of the product. Lumbering operations return a product on a 
diminishing scale the further they are removed from streams 
and railroads ; and although the timber on far mountainsides 
can be harvested — provided the price of the manufactured 
lumber is sufficiently high — the product is conspicuously smaller 


than that derived from using the same capital and labor to cut 
timber near streams. All this is merely objective evidence to 
show that in industries concerned with the production of raw 
products from nature — the extractive, in distinction from the 
manufacturing industries — a single principle obtains. 

The law of diminishing returns — that the amount of the 
product obtainable from increasing investments of labor and 
capital in the exploitation of natural resources yields decreas- 
ing rates of product — says nothing regarding an increasing 
or a decreasing rate of profit to the business. It may be 
profitable, owing to the liberal prices obtainable for increased 
quantities of product, to continue to increase the size of a 
business long after it has become obvious that the rate of 
production is decreasing. But, on the other hand, the law 
of diminishing returns suggests at least the presumption that 
beyond a certain very moderate size the large business unit 
is relatively less profitable than the smaller one. Among the 
extractive industries it establishes a presumption in favor of 
the small business unit 

Students of economic theory have restricted the application 
of the law of diminishing returns to agriculture and the ex- 
tractive industries. And it must be admitted that the law, 
if such a name can be applied to a principle so vague and 
inexact, is best illustrated, empirically, by examples taken from 
these fields of industry. This is evident. It requires no wide 
knowledge of agriculture to observe that to double the labor, 
or to double the fertilizer, does not necessarily mean a double 
crop of potatoes or wheat or mushrooms. But another ques- 
tion, much more difficult to understand, is whether or not the 
principle of diminishing returns with increasing size applies 
to other businesses than agriculture and the extractive indus- 
tries. This is not a question easily answered. The big store 
is, apparently, more profitable than the small one; the large 


Steel works than the small foundry. On the other hand, there 
are almost innumerable businesses which have been successful 
as small, relatively confined and restricted enterprises, which, 
when extended and nationalized, have become failures. The 
question cannot, therefore, be answered from any casual in- 
spection of the available empirical evidence. 

There have been many efforts by students of economics 
to extend the application of the law of diminishing returns 
to banks, railroads, public service corporations, and manufac- 
turing businesses. Likewise there have been many efforts to 
show that the principle is, by its very nature, confined in its 
application to agriculture and the extractive industries. The 
difficulties in all these attempts at generalization lie in the 
great variety of the conclusions to be drawn from different 
businesses. And this variety of conclusions, leading to hope- 
less confusion, results from the simple fact that it has been 
found impossible to compare, in terms of a common de- 
nominator of quantity, the labor and capital expended in a 
given case and the product obtained. The following paragraphs 
discuss the relations subsisting between these factors and their 
respective products. 

Many facts connected with present-day manufacture in- 
dicate conditions which might be associated with the law of 
diminishing returns, were it possible to phrase it differently — 
were it possible to get a clearer idea of the meaning of 
quantity as it must be applied to the factors, labor and capital, 
in industrial production. The presuppositions of the law 
require that labor and capital be compared, quantitatively, with 
each other and with the product under varying combinations. 
The difficulty is to do this empirically. But this difficulty 
is not nearly as unsurmountable in modern manufacturing as 
in agriculture and the other extractive industries. Economists 
have noted, especially within the last ten or fifteen years, 


that the economies of large-scale production, particularly when 
spread over many widely separated plants, have not been real- 
ized to anything like the extent that was anticipated.^ In 
some notorious instances they were not realized at all. The 
product was so much smaller, relatively, in the large-scale than 
in the small-scale production, that the entire business resulted 
in a financial loss. This suggests the presumption that the 
law of diminishing returns, heretofore applied to those kinds 
of production in which a natural resource is the constant 
factor and labor and capital the variables (like agriculture 
and mining), can be applied to manufacture if only varying 
quantities of the factors of production can be empirically 
studied in their effects on the quantity of production. To do 
this the problem becomes a study of the effect of changes in 
the quantity of the factors upon the quantity of the product 
in different types of manufacturing businesses. 

In isolating the factors, in order to test the effect on the 
product of varying their quantity, it is neither necessary nor 
illuminating to distinguish between that portion of the capital 
factor that is invested in land and that in structures and 
equipment. If the manufacturer had a certain amount of 
money to be invested in "plant account," it would rest merely 
with his construction engineer to determine how much should 
be expended in land and how much in structures and 
machinery. Very commonly a few hundred dollars of un- 
improved land gives sufficient area to erect a plant costing 
hundreds of thousands of dollars. Especially is this true if 
the establishment does not require land in or near a city. As 
soon as the land is acquired, its original cost is irretrievably 
merged with the cost of the foundations and the structures, 
the whole representing a fixed capital investment which, aside 
from depreciation on the one hand and improvements on the 

'This general subject is discussed at length in the next chapter. 


Other, remains relatively constant for considerable periods of 
time. It is, indeed, the most constant factor of production 
that economic theory can isolate, far more constant than the 
land of the agriculturalist, which is always subject to differ- 
ences in soil content and the varying conditions of weather. 
On the other hand, the labor factor can be subjected to direct 
and quantitative controls, impossible in the case of agricul- 
tural production. For it is certain that the economic value 
of agricultural labor varies with the seasons. The worth 
of a day's work at hoeing in early June is distinctly different 
from the same objective quantity in August — hoeing or any- 
thing else. But in manufacturing, on the other hand, the 
economic value of the same quantity of labor is more nearly 
constant whenever applied to the same equipment. Similarly, 
the ratio of economic values of varying quantities of manu- 
facturing labor approximates the ratio of the quantities. One 
day's labor and two days' labor at a stitching machine are 
more easily compared with each other and their product than 
one and two days' labor on a farm. 

Reduced, then, to the simplest terms and the terms most 
nearly consonant with actual conditions, it appears that the 
product of a modem manufacturing establishment is the direct 
result of a relatively constant factor in the form of fixed ^.t\»'"'* 
capital investment and a variable factor in the form of human 
labor, the whole administered by an intangible economic value 
called entrepreneur ability — the role of which in the present 
discussion may be omitted for the moment. The immediate 
problem of the quantitative relations between factors and 
products in manufacturing — the problem of the application 
of the law of diminishing returns — is, then, the problem of 
the effect of variations in the quantity of equipment and the 
quantity of labor on the quantity of the manufactured goods. 
To subject this problem to specific empirical tests there would 
be two mutually related experiments or rather sets of observa- 


tions: (i) Assume a constant quantity of labor (a constant 
labor cost), vary the quantity of fixed capital (the capital 
cost), and note the effect on the quantity of product. (2) 
Assume a constant quantity of fixed capital (a constant capital 
cost), vary the quantity of labor (the labor cost), and note 
the effect on the quantity of product. It is obviously impos- 
sible to isolate cases where the conditions may be controlled, 
as is often possible among the physical sciences; but there 
are groups of economic phenomena which so nearly approxi- 
mate those just defined that the conclusions to be drawn from 
them are at least of tentative value. 

The shoe industry affords niunerous illustrations of vary- 
ing costs of fixed capital under a constant of labor costs.' 
The following case is highly instructive. A certain man had 
had long training in the business. He had acciunulated enough 
money to operate a small factory with rather antiquated and 
inefficient equipment. In this he was highly successful. 
Spurred on by his success he built a modern factory to manu- 
facture the same grade of shoes. Indeed, so complete and 
perfect of its kind was the new factory that it was distinctly 
a "show establishment" among those making that particular 
grade of shoe. The output or quantity of product was very 
much greater than in the previous factory although the same 
scale of piece-work wages prevailed. He failed, losing in a 
short space of time practically all that he had made under 
the previous conditions. He exercised the same entrepreneur 
ability in both factories. The labor costs per unit of product 
remained as constant as a set of actual conditions would 
permit. The fixed capital costs only varied. But in the second 
case they were so much greater proportionally to the cost of 

*The labor clement In the shoe industry is easy to isolate and deal with, as 
the industry is conducted on a piece-work basis now carefully systematized. The 
scales of payment are approximately equal in different localities for the same grades 
of labor. 


labor that the total cost of the product exceeded the com- 
petitive price value determined by other smaller and technically 
less efficient factories. In brief, the fixed capital cost was 
too great for that particular line of product. 

And the manufacturers of the different grades of shoes 
illustrate varying quantities of products produced under condi- 
tions of varying quantities of capital investment. The highest 
grades of shoes are "fine turns," ladies' wooden heel "fancies," 
and gentlemen's fine custom lasts. These industries are con- 
fined to the small personally superintended shops of Haverhill, 
Brooklyn, and Newark. They are the nearest approach to 
the old-fashioned custom shops where a few dollars' worth 
of tools was all the shoemaker required. At the other extreme 
are the large capitalistic establishments of Brockton, Man- 
chester, and St. Louis, manufacturing the cheapest kind of shoes 
in immense quantities. These companies had introduced very 
many economies of large-scale production, but at enormous 
cost of equipment. It would be as impossible for a Newark 
shop to make low-grade men's shoes economically as it would 
for a factory devoted to cheap shoes to turn out a Newark 
shoe. Each is successful in its own line because it has solved 
the problem of the balance between the labor cost and the 
fixed capital cost. But the balance is determined by the size 
of the output, or rather by the quantity of product most 
economically produced. Should the Newark shop introduce 
the large-scale efficiency methods in the endeavor to increase 
the quantity of its product it would turn out so many "seconds" 
as to ruin first its reputation and then itself. Should the 
large-scale factory try to reduce its fixed capital expenditure 
by substituting more labor for costly equipment, either its 
labor costs would rise higher in proportion — thereby increas- 
ing the cost of its product— or else the quantity of its product 
would be reduced — thereby increasing the pro rata costs of 
the fixed capital and "overhead" and therefore the costs of 


the product. In other words, the Haverhill, Brooklyn, and 
Newark manufacturers (at least those who are permanently 
successful) have discovered that nice and delicate balance be- 
tween the ratio of labor and capital costs on the one hand 
and the quantity of their output on the other. They have 
discovered that with small capital costs proportional to the 
total value of the product they must adopt small-scale produc- 
tion. And the great highly organized factories manufacturing 
cheap shoes have also discovered their own proper balance — 
that with a large proportion of fixed capital costs in the total 
cost of the shoe they can adopt large-scale production. The 
manufacturer described in the preceding paragraph, who was 
successful with a small, cheaply equipped, inefficient shop, but 
unsuccessful with a large, expensively and efficiently con- 
structed shop, had not discovered the proper balance for his 
particular grade of product — the proper scale of production 
for the most economical ratio of capital and labor required 
by his particular grade of shoe — therefore he failed. 

The conclusions to be deduced from these observations 
of the shoe industry are in brief as follows : 

1. Given a constant quantity of labor, constant as evidenced 
by its costs, in the manufacture of a given grade of product, 
the quantity or cost of the fixed capital to which it is applied 
affects the quantity of the product that can be economically 
produced. (Economical production is evidenced by rising or 
falling costs, and, in the long nm, failure or success in the 
competitive market.) 

2. In the production of any given grade of product there 
is "an exactly right" scale of production; a change in the 
scale, either increase or decrease, is reflected in a diminution 
of the quantity of the product — a diminution evidenced by 
rising costs. (By scale of production is meant the size of 
the unit combination of labor and capital conducted as a single 
establishment or unified group of establishments.) 


3. If the grade of product demands a proportionally large 
quantity of capital corresponding to a small quantity of labor 
(that is, low labor cost), then the "exactly right" scale of 
production is large. And, conversely, if the grade of product 
demands proportionally a small quantity of capital to a given 
quantity of labor (that is, high labor costs), then the "exactly 
right" scale of production is small. 

We turn now to the other set of observations, dealing 
with cases where the costs of capital remain constant but the 
quantity or cost of labor varies. A highly instructive series 
of such cases is afforded by those metal and munition manu- 
facturers who accepted large-scale orders from belligerent 
governments at the outbreak of the Great War. The American 
manufacturers, especially in the metal industries, were lured 
into taking foreign government orders by high prices and 
the expectation of liberal profits. They were forced to use 
their existing plants, although in some cases additions were 
hurried forward even by searchlight. Increases in equipment 
were not, however, important in the first hectic rush; so that 
we are dealing with a rather unusual condition of a constant 
quantity of fixed capital yielding a product under markedly 
varying quantities of labor. In many cases the labor was 
doubled, in some cases even trebled, changing from one ten- 
hour shift to three eight-hour shifts. Labor was increased 
intensively. More helpers were assigned to each master; there 
was greater division of labor and elimination of special work. 
The results were a disappointment to the managers. The 
product was not increased proportionally. Three shifts did not 
produce 2.4 times as much as a single ten-hour shift; the 
increased intensification of labor within the shop did not make 
a corresponding increase in the quantity of the product, as- 
suming that the other factors remained approximately constant 

If the matter were allowed to remain there, the failure 


of our manufacturers to meet the sudden and very unusual 
demands put upon them by the war would be attributed to 
the role of the law of diminishing returns in modern industry. 
But the experiences of the munition and metal manufacturers 
were different. In some cases, as with the manufacturers 
of timing devices for shrapnel shells and of other materials 
requiring fine handwork, the disaster which befell the con- 
tractors was worse than that of other larger establishments 
taking contracts for the kind of war material that could be 
turned out largely by machinery. The little Connecticut or 
Vermont shop that undertook the handwork subcontract was 
ruined, whereas the Bethlehem Steel Corporation, the West- 
inghouse Electric, and Remington companies merely made less 
money than was anticipated. The handwork shops attempted 
large-scale production by merely increasing the quantity of 
labor, and disaster overcame them immediately. The estab- 
lishments already committed to the manufacture of products 
in which the cost is largely one of fixed capital, plants already 
large-scale in comparison with the others, were able to increase 
yet further their scale of operations without serious loss. It 
is notable that the particular steel company which suffered 
at the beginning the largest relative curtailment of anticipated 
profits, the Crucible Steel Company, has, more than any other 
of the large steel companies, a considerable labor element in 
the cost of its product. 

The conclusions to be drawn from these unusual cases of 
the manufacture of war materials are similar to those outlined 
before as applicable to the shoe industry, only here there are 
varying quantities and costs of labor with a relatively constant 
investment of capital. 

I. Given a constant quantity of fixed capital, varying quan- 
tities of labor affect the quantity of the product that can be 
economically produced. (Economical production is indicated 
by rising and falling costs of the product — the outward evi- 


dence of rising or falling costs being the failure or the success 
in the competitive market.) 

2. There is reached, easily, a point of excessive costs of 
production as the proportion of labor is increased with respect 
to a given quantity of fixed capital. 

3. If the grade of product demands proportionally a small 
quantity of labor to a given quantity of capital (that is, low 
labor costs), then the most profitable scale of production is 
relatively large. Conversely, if the product is such as to 
demand a large quantity of labor with respect to a given 
quantity of capital (that is, high labor costs), then the most 
profitable scale of production is relatively small. 

These conclusions are identical with those reached from 
using data drawn from the shoe industry. The first two of 
them may be passed over, for the moment, as representing 
merely the consequences that would follow were some form 
of the law of diminishing returns applicable to manufacturing 
businesses. As to the extent to which this is true it is not the 
present purpose to dwell. But the third conclusion, alike under 
both conditions of varying capital investment and varying 
applications of labor, is of importance in throwing a new light 
on the conditions of production in manufacturing businesses. 

It appears that when the quantity of labor to be applied 
to a given constant of fixed capital is varied, different types 
of industry respond differently to the changes. If the industry 
manufactures a product in which the labor element is large, 
the quantity of that product cannot be increased by increasing 
the quantity of labor, except at a very large increase in the 
cost of production. If, on the other hand, the product is one 
in which fixed capital is far and above the larger element 
in the final cost, then a sudden increase in the quantity of 
labor working upon the capital invested will not so seriously 
affect the cost of the product. 


This result, deduced from a study of data drawn from 
the shoe and the war materials industries, is not a mere coin- 
cidence. Both the unreflective business man and tlie economist 
observing present-day industry have long felt that somehow 
there must be some general principle underlying the apparent 
confusion in our observations of large- and small-scale produc- 
tion. The practical business man, with what he calls "horse- 
sense," discriminates among manufacturing businesses accord- 
ing to differences in the quantity of labor that goes to make 
up the product. He says, "If you have little capital, go into 
a business with a good deal of handwork." At first sight 
the truth of this bald, uncritical statement would appear to 
be based merely on the assumption that such businesses are 
the only ones available to limited capital. Yet if this negative 
reason were all there was to this advice then the man with 
little capital would be eliminated by the competition of larger 
capitalistic organizations. But, in truth, the practical business 
man acknowledges in this simple aphorism of the street that 
the man with little capital survives in those businesses where 
labor predominates in the cost of production, whereas he can- 
not survive with his small plant in those industries in which 
machinery predominates in the production costs. This is 
another way of saying that sufficient special economies to 
enable the producer to sell in a free competitive market can 
be attained in a small-sized shop if labor predominates in 
the cost of production, whereas if the labor costs are relatively 
small only the shop capable of manufacturing large quantities 
of the product can survive. 

And this rule-of-thumb of the practical business man is 
in strict accord with the conclusions previously drawn from 
the shoe and war munitions businesses. It is, moreover, fre- 
quently tacitly assumed in the discussions of economic theory 
employing the concept of the law of diminishing, returns in 
its classic form. The economists admit that the law does 


not operate at every point of intensive production, not even 
in the field of agriculture. It is certainly probable, for 
illustration, that within ranges of very meager cultivation two 
days' labor might produce more than twice as much product 
as one day's labor. If a man spent one day plowing a plot 
of land and carelessly planting it, there is a very strong 
probability that it would not produce half the product it would 
produce if he spent two days' labor in plowing, harrowing, and 
carefully planting. Obviously, the law of diminishing returns 
begins to operate only after some labor and some capital have 
been expended on land beyond the irreducible minimum. Ob- 
viously, there is a point in agricultural production up to which 
the returns increase more than in proportion to the increases 
in labor and capital. Beyond this point the returns decrease. 
There must, therefore, be a point where increasing returns 
cease and diminishing returns begin, a point of perfect equilib- 
rium. From this point either a decrease or an increase of 
labor or capital results in a decline in the relative quantity 
of the products. 

A study of the position of this point of equilibrium in 
various forms of industry has never seemed significant to the 
student of economic theory for two very good reasons. In 
the first place, as has been said, our minds have become 
accustomed, both from the literature of the subject and the 
ease of exposition, to deal with the law of diminishing returns 
as a phenomenon essentially connected with agriculture, or at 
most as confined to extractive industries. The comparison 
of its operation in agriculture with its possible working in 
other industries has seemed, therefore, neither pertinent nor 
of practical moment. And, again, the conditions under which 
labor and capital are applied to land vary so with locality, 
soil, and custom that any single practical demonstration of 
this point would have little or no significance beyond the 
isolated case. But if the law of diminishing returns is recog- 


nized throughout industry, then the understanding and com- 
parison, in different fields, of this point of equilibrium becomes 
one of the most significant of strictly theoretical economic 
problems. It is also of great practical importance because it 
indicates whether a business is better adapted to large- or 
small-scale production. 

It is this comparison which leads to the conclusion, drawn 
from various industries, that there is a point of maximum 
productivity as the quantity of labor and of capital is in- 
creased, but that this point varies in position according to the 
relative proportions of capital and labor represented in the 
final product. If the product is fine shoes, representing a 
large ratio of labor to invested capital, the point is reached 
in a relatively small scale of production; if it is inexpensive, 
low-grade men's shoes, it is reached only under conditions 
of very large-scale production. Clearly the position of this 
point at which increasing returns cease and decreasing returns 
begin, a point found somewhere in every industry, varies 
according to the relative proportion of labor and capital repre- 
sented by the final product. This connection between the two 
can be stated in the form of a new law ; or, better, a general 
principle approaching the rigor of a law as near as the flexi- 
bihty of economic phenomena permits. It is this: The ratip 
between the quantitative values of labor and fixed capital in 
any unit of product determines the point at which increase in 
the scale of total production ceases to he economical ; i.e., it 
determines the point of maximum productivity beyond which 
further investments of fixed capital and further increments 
of labor cease to yield the same proportionate quantity of 
product. This may be called the law of maximum balanced 
return, or simply th€4aw_nf balanced retujn. It represents 
a more abstract statement of the third conclusion previously 
drawn from the shoe and the munitions industries. 

This principle can be expressed in various forms. It means 


merely that there is a direct connection between the scale of 
economical production, the point of equilibrium when increas- 
ing returns cease and diminishing returns begin, and the 
proportion of labor and machinery that goes into the manu- 
facture of an article. Imagine the cost of producing a certain 
pair of shoes to be $1.50, of which 50 cents represents the 
interest, depreciation, and obsolescence of all the machinery, 
factory, plant and power system, together with the rentals 
of hired equipment, that can be borne by this one pair of 
shoes. Imagine that $1 represents the wages of labor and 
superintendence. We may assume, therefore, a ratio of one 
to two between capital and labor costs for this particular article. 
Imagine another pair of shoes of which the total cost is also 
$1.50 but of which the capital costs are 75 cents and the labor 
costs 75 cents; obviously the ratio here is one to one. Now, 
if the principle outlined above is correct, it will follow that 
these two ratios give the key to the scale at which production 
may be carried on for the two classes of shoes. This scale 
will be larger for the second class than for the first. One 
would like, following the ideal of quantity which all general 
principles strive for, to say the scale will be twice as great. 
But one must freely admit that the rigor of quantitative exact- 
ness is a remote ideal for economic theory. The principle 
is at least true that a direct connection exists between the ratio 
of capital and labor costs on the one hand, and the scale of 
production permitting the lowest costs, on the other hand. To 
what extent their connection may be reduced to rigid quanti- 
tative terms is, at best, a matter of empirical evidence. 

Nimierous instances having to do with large- and small- 
scale production seem to justify this principle in our actual 
experience. The most significant revelation of the history 
of industrial consolidation that followed the depression of 
the middle nineties was that the anticipated economies of large- 


scale production were not forthcoming. In certain industries, 
such as the steel industry, the divergence between theory and 
practice was not as marked as in others. But, nevertheless, 
in spite of exceptions, the fact remains that the industrial con- 
solidations based on the fundamental presimiption of the 
economies of large-scale production were a profound disap- 
pointment to the student of economics and the practical busi- 
ness man alike."* And the error in the judgment of both 
was the same — the tmintelligence and limitations of human 
labor. Its economic efficiency is not increased by mere quan- 
titative additions. On the contrary it is decreased. Conse- 
quently, an increase in the quantity of capital did not produce 
a corresponding increase in the quantity of the product because 
the productivity of the labor element could not be increased 
by mere quantitative accretions. A sudden increase in the real 
quantity of capital and the apparent quantity of labor carried 
the scale of production in the vast majority of industrial con- 
solidations beyond the point of balance, to where the increas- 
ing returns ceased and diminishing returns began. There is 
this fundamental contrast between labor and capital, a failure 
to realize which blinded the promoters of the industrial con- 
solidations. In those types of industry where the human ele- 
ment is of small importance in the final product an increase 
in the quantity of labor applicable to capital could be made 
to keep pace with an increase in the capital even up to a point 
of an extremely large scale of production. This is now true 
of the steel industry. The fixed capital has become enormously 
large, but less and less does labor play a part in the final 
product. The very purpose behind the increase in fixed capital 
has been the substitution of mechanistic production for human. 
And as the ratio between the quantity of capital applicable to 
each unit of labor has increased, the scale upon which produc- 
tion can occur economically has increased correspondingly. In 

* See Appendix to this voltime. 


fact, so far has the successful substitution of machinery for 
labor been carried in the steel business that it affords to the 
minds of many students the best example in modern industry 
of economical large-scale production. It has been reported 
by four entrepreneur steel-makers, of wide experience and acute 
understanding, that no thoroughly economical establishment 
for the" manufacture of steel and its simpler products can be 
built short of $10,000,000, Coupled with this large scale of 
production is the fact that in the value of the final product, 
the pro rata share of the fixed capital is enormous, while the 
direct labor costs are exceedingly small. That the labor costs 
are proportionately the smallest of any industry would be 
difficult to prove, but it is a matter of personal judgment that 
this is true. It explains, as nothing else can, why the American 
steel-makers, paying higher nominal wages than are paid in any 
steel industry of the world, can undersell their foreign com- 
petitors in neutral markets. Although the total wage received 
by each man is very high, the labor costs per ton of fabricated 
steel are very low, due to the extended use of machinery. 
The cotton manufacturing industry is one of the oldest 
in the United States. By the close of the nineteenth century 
there were a great many cotton-mills scattered over the eastern 
states. They were particularly numerous in certain regions 
of New England, the vicinity of Baltimore, and in parts of 
the South. This concentration of many small units in certain 
localities was a circumstance which in many industries 
promoted the combination of small competitors into large in- 
dustrial combinations. But in the cotton industry only three 
combinations have been attempted, and all of these proved 
failures." No combination was attempted in the fine and 
medium fine branches of the industry where the labor cost. 

»The Mount Vernon-Woodberry Cotton Duck Corporation. For account, see 
Dewing, A. S., Corporate Promotions and Reorganizations, Chaps. XIII and XIV 
(1914); The New England Cotton Yarn Company, Ibid. Chap. XII. The Parker 
Mills Company. 


per pound of yam or yard of cloth, exceeded the unit labor 
costs in the production of the coarser grades of textiles. 
Cotton manufacturers predicted at the time each of these 
combinations was formed that the anticipated economies due 
to consolidation would not be realized. Some manufacturers 
predicted financial disaster for any combination of cotton-mills 
which sought to introduce large-scale methods of production. 
In the case of the Mount Vernon- Woodberry consolidation 
which manufactured only coarse goods using chiefly heavy 
looms and low-intelligence labor it was admitted that the 
chance of success was greater than if a combination of New 
England medium-goods mills had been attempted. The reason 
given was invariably that all the economies of mere size of 
output could be obtained in a "medium-sized" mill,* and that 
problems of maintaining a high rate of production presented 
almost insuperable difficulties in larger tmits or combinations 
of units. This judgment is so generally acknowledged among 
textile operators that it represents almost a consensus of ex- 
perts. So far as actual experience is concerned the history of 
the three companies which attempted to secure the economies 
of large-scale production is highly instructive. The Mount 
Vemon-Woodberry consolidation of coarse goods mills was 
consistently a failure for upwards of fifteen years, during which 
time other smaller duck mills of Baltimore County proved suc- 
cessful. After three successive reorganizations it was divided 
into two separate parts. Each part then passed under the 
control of a different and independent management. The New 
England Cotton Yam Company failed twice. Ultimately one 

•The "exactly right size" for a cotton-mill varies, apparently, with the size 
of the yarn. Using medium counts as a basis, there is a fairly uniform judgment 
that a mill of 70,000 spindles can secure all the economies of mere size. Copeland, 
M. T., Cotton Manufacturing Industry in the United States, places the point at 
100,000 spindles (page 155). In lectures on mill construction in the Massachusetts 
Institute of Technology, 50,000 spindles was mentioned as the most efficient size. 
Undoubtedly for coarse numbers this is true. In another connection the author 
canvassed a number of prominent cotton manufacturers in Boston. The consensus 
of opinion seemed to be that 30,000 spindles for coarse goods and 60^000 for 
medium goods would give the maximum efficiency. Dewing, A. S., Corporate 
Promotions and Reorganizations, 374 (1914). 


mill after another was sold to independent textile operators. 
It is important to note that the separate dismembered parts 
of the consolidation under separate and independent managers 
were all conspicuously successful, whereas in combination 
these mills had failed. The Parker Mills Company, a con- 
solidation of southern mills, proved unsuccessful after two 
or three years and was divided into two parts each of which 
was thereafter operated by separate managements quite inde- 
pendent of each other. No combination of New England 
fine goods mills has ever been attempted. These fine goods 
mills are small, independent, and on the whole successful 
enterprises. While all this may not throw much light on 
the exact point at which large-scale production in the textile 
industry ceases to be profitable, still it does indicate that the 
industry is one in which small-scale units are able, apparently, 
to obtain sufficiently low costs of production to enable them 
to ward off any actual or potential competition from large- 
scale units of production. 

Another rather striking example is shown by the increas- 
ing scale of production for different forms of tobacco products. 
When the American Tobacco Company was organized it suc- 
ceeded immediately in securing a monopoly — upwards of at 
least 90 per cent of the production — of machine-made ciga- 
rettes. This is the branch of the tobacco business in which 
production is conducted on the largest scale. It requires com- 
plicated and expensive automatic machinery, but at the same 
time a minimum of hand-labor. And the old American 
Tobacco Company easily drove out the small competitors in 
this line through superior factory equipment, the result of 
liberal capital expenditures. Having secured a monopoly in 
this single form of product the company made it doubly sure 
by acquiring the patents covering the essential machinery. But 
the branch of the tobacco industry which the American 
Tobacco Company succeeded neither in monopolizing nor even 


gaining a dominant foothold in, in spite of uninterrupted 
efforts for upwards of twenty years and a large investment 
of capital, was the manufacture of cigars. This is the very 
branch of the industry in which hand-labor is everything and 
machinery nothing. A skilful entrepreneur with a few thou- 
sand dollars of capital, employing a few cigarmakers, buying 
his materials carefully, and personally supervising the work 
can produce a high-grade cigar actually cheaper than can a 
large establishment having unlimited capital at its disposal. 
In other words, the point of largest economy of production 
is reached very soon in the high-grade cigar industry, very 
late in the machine-made cigarette industry. 

All this is mere illustration of the principle, abstractly 
stated above in the italics, that the point at which the law of 
diminishing returns begins to operate as the scale of produc- 
tion is increased is determined by the ratio between the labor 
costs and the capital costs. Those industries which produce 
articles involving artistic handicraft or high technical skill 
must inevitably operate under conditions of small-scale pro- 
duction, because the point at which increasing returns end and 
diminishing returns begin occurs early. On the other hand, 
if the article does not require the intelligent attention of skilled 
labor, the operation of a law of diminishing returns may be 
postponed to the extent that capital investment in appliances 
may be substituted for skilled labor, that is, the cost of fixe<r>[ 
capital may replace the cost of labor in the finished product/ M 

» It has been presumed by economists, engineers, and practical business men that 
the central station electric light and power industry is of such a nature that the larger 
the central station the cheaper would be the cost of production of electricity, measured 
both at the switchboard and at the customer's meter. In other words, it has been pre- 
sumed that the law of diminishing returns does not apply to the central station industry 
and therefore there would be no point of balanced return. This theoretical presump- 
tion has gone unquestioned as there has been no reliable empirical evidence to prove 
or disprove it. 

Dr. Lincoln, a trained economist, prepared the statistics covering the financial and 
operating data for central stations for the year 1917 (published September, 1920). The 
statistics show that there is a constant decrease in the cost of production for kilowatt- 
hours sold, for steam stations up to about 20,000,000 kw.-hrs. annual output, after 
which the cost remains about constant. (Census Rep. Table 06, page 130.) The net 
income for kilowatt-hours sold is actually greater for the few very large stations, 
200,000,000 kw.-hrs. and over, than for steam stations of medium capacity, 20,000,000 


This law of balanced return, as it is called here, is merely 
a general working hypothesis for the corporation official, to 
indicate the extent to which a given type of business may be 
expanded. It is not exact. It is the balance between two 
opposing forces, a balance between the quantity of capital and 
labor on the one hand, and the quantity of product on the 
other hand. Economies are inevitable as the business in- 
creases in size. These economies are, specifically, different in 
different businesses, but in general are connected with those 
parts of the business which are not concerned with personal 
judgment or individual skill and attention to detail. The 
economies are incidental to the automatic phases of the busi- 
ness. On the other hand, as the business enlarges certain 
wastes creep in which increase with greater rapidity than do 
the economies. These wastes, in contrast to the economies, 
pertain to all phases of the business where personal skill is 
required. They pertain to what one might call the humanities 
of business. The critical point in the expansion of any busi- 
ness is reached when the wastes incident to mere size overcome 
the economies. Before this point is reached the economies in- 
crease more rapidly than do the wastes ; beyond this point the 
wastes exceed the economies. To determine the point is, as 
suggested before, a matter of very nice business judgment. 
Men who otherwise command that remarkable combination 
of shrewdness and courage, of unemotional judgment and in- 
tuitive daring, which distinguishes the truly great business 
executive, often fail in this very matter of perceiving the point 
of expansion beyond which their business suffers from the 
practical application of the law of balanced return. The control 
of this law over business enterprise is absolute, notwithstand- 
ing the fact that its concrete application in a given case is 
vague and inexact. Its destructive power, once the business 

to 50,000,000 kw.-hrs. annual output. (Ibid, page 129.) In other words, there is a 
point of balanced return. 


man has overstepped its limit, is certain and merciless. Yet 
if, on the other hand, by reason of good fortune, intuition, 
or judgment founded on experience, he can stop the expansion 
of his business at exactly the right point, the economy of 
operation due to this very fact alone is able to absorb great 
wastes in other directions. A business executive may make 
many mistakes in the routine conduct of his enterprise, but 
these will be fully compensated for if he correctly determines 
the proper size of his undertaking. 

The social aspect, too, of the law of balanced return has 
great importance. It has been contended by the socialists and 
those having a socialistic slant to their political philosophy 
that modern conditions of production inevitably tend toward 
large-scale units the ultimate outgrowth of which is govern- 
ment ownership and operation.* If the law of balanced return 
is true, though only in its general implications, this contention 
is not true. For the very heart of the principle is that in many 
industries large-scale production is not essential, indeed is 
not even so economical, as small-scale production. In those 
industries, clearly, economic conditions of production do not 
demand the large-scale unit. So that the social order cannot, 
jin the interest of increased economy of production, demand 
either the adoption of large-scale units throughout industry 
or a state control over industry predicated on the gradual sub- 
stitution of regulated monopolies instead of unregulated com- 
petition. Small-scale production with attendant unrestricted 
competition is, by the very nature of certain industries, 
destined to remain; and state operation of these industries, 
attempting to apply to them large-scale production, would 
inevitably lead to increased costs. Therefore the excuse of 
state control to justify the adoption, universally, of large-scale 
imits, loses entirely the force of its argument. 

■Obterve particularly passage quoted in Chapter III, note 22. 



The problem of industrial incorporations, 33; Historical survey 
of industrial consolidations, 34; Reasons for cessation of industrial 
consolidations, 38 ; The failure of the industrial consolidation, 41 ; 
The present-day problem, 52; Importance of extremes of ability, 53; 
Four modern successful types of consolidation, 54; Automatic in- 
dustries likely to succeed on large-scale production, 54; Integrated 
industries, 54; Chain stores, 57; Export companies, 64. 

It was suggested in the preceding chapter that the point | 
of size at which a business operates at its greatest efficiency i,*x-''%l r ^^ 
is determined by the balance between two opposing forces, y.^ ^^ 
On the one hand, economies of large-scale production arise L^M-'J^^^^^d^ 
through the extended use of mechanical processes. On the ' V*~*^"^ 
other hand, the wastes of large-scale production are due to } 
the limitations of human labor and human administration. ; 
Man stands in contrast to the machine. It follows therefore \ 
that the greater the proportion of the cost of finished product 
represented by interest, depreciation, and engineering costs 
— in brief by charges due to the widely extended use of 
machinery — ^the further the point of normal equilibrium may 
be pushed. Stating the same principle in other words, the 
larger the part machinery can be made to play in production, 
the larger the business unit may become before the law of 
diminishing returns begins to operate. This principle was 
called the "law of balanced return." In the next few chapters 
the practical questions of business expansion will be discussed. 

The specific application of the law of balanced return to 
concrete cases is extremely difficult. Still, practical results 
in a variety of different types and conditions of business enter- 



prises have brought together a vast deal of specific facts which 
throw light on the empirical answer to the question — does it 
pay to expand ? This is a field where the human factors play 
roles so important that theory serves as a very uncertain and 
illusive guide. Economists as well as practical and experienced 
business men have made serious blunders in forecasting 
whether or not a specific business expansion or combination 
would be profitable. It is a sphere in which unrestrained 
optimism and imbridled ambition obscure the comparatively 
few safeguards founded on individual experience. 

It is the purpose of the present chapter to discuss large 
manufacturing units. These are usually spoken of as indus- 
trial consolidations, since most of the large manufacturing 
businesses have arisen through the bringing together of many 
small competing businesses into a single, widely extended 
operating unit.^ From the point of view of business enterprise 
it is the problem of industrial expansion; from the point ol^ 
view of the science of economics it is the problem of the 
economy and wisdom of large-scale production ; and from the 
point of view of social theory it is the "trust" problem. 

The large manufacturing corporation is of very recent 
development in the industrial organization of society. The 
great combinations of manufacturing establishments — the 
"trusts" so called — appeared suddenly during the closing years 
of the nineteenth century, with comparatively little warning. 
The movement quickly reached its climax, and then shrunk to 
inconspicuous proportions. In 1880 there was nothing 
analogous to an industrial trust or consolidation in the sense 
that the term was used later.^ By 1888 several industries 

* The literature on industrial consolidations, or "trusts," is voluminous. No 
attempt is made to present a bibliography. Two such bibliog^raphies exist and are 
easily accessible (Bullock, C. J., and the Library of Congress). Two brief books 
covering in outline many aspects of the subject without preaching any specific 
solution to the "trust problem" are Stevens, W. S., Industrial Combinations and 
Trusts, and Haney, L. H., Business Organization and Combination. 

* About 1882 the professor of political economy in one of the eastern uniyersities 


were dominated by large consolidations such as the Standard 
Oil "trust." By 1890 the tendency had reached such propor- 
tions that public opinion, thoroughly aroused against a move- 
ment in industry which seemed to threaten the stability of 
democratic institutions, brought about the passage of the 
Sherman Anti-Trust Act. The movement toward industrial 
consolidations stopped abruptly with the panic of May, 1893, 
and remained dormant during the depression of the succeeding 
three years. It started in afresh, with renewed vigor, in 1897, 
when the first pulsations of returning prosperity began to 
quicken business enterprise. It again reached a climax about 
1 90 1, and again ceased altogether with the industrial depres- 
sion of 1903. Since 1905 there have been sporadic instances 
of industrial consolidations but no general movement analogous 
in magnitude or significance to the consolidations of the clos- 
*ng years of the last century. 

The stupendous wave of industrial consolidations which 
began in the late eighties and closed with the depression of 
1903 has been divided in another connection into two cycles.' 
Each cycle began with the prosperity succeeding a depression, 
each culminated at the climax of feverish speculation and each 
was abruptly terminated by conditions verging on a panic. 
The earlier, or minor cycle, so called because the consolidations 
were fewer in ntunber and smaller in size, began in the years 
immediately following the depression of the middle eighties — 
a depression caused by the failure of numerous overextended 
railroads. The consolidations formed at this time were of 
the typical trust form of organization in which a board of 
trustees assumed ownership of the corporate shares of numer- 

is reported to have been much concerned over a combination of thread mills in 
Connecticut, with a capitalization of $1,000,000. He is said to have remarked to 
his classes that the formation of a manufacturing enterprise of this mag^nitude was 
an unprecedented event in the industrial world. Perhaps it was. This was in 
the early eighties. Within ten years combinations had been formed with capital 
in excess of a hundred million dollars and within twenty years a combination of 
steel plants had been formed with a total capitalization in excess of a thousand 
million dollars. 

* Dewing, A. S., Corporate Promotions and Reorganizations, 532 (1914). 


ous small, previously competing concerns. The trusts stifled 
competition effectually, but in so doing thoroughly aroused 
public opinion against them. The trusts were seen in the 
garb of a social menace. They became the dominating social 
and political "problem" demanding a legislative solution, and 
the Sherman Anti-Trust Act of 1890 was the response of a 
feverishly aroused Congress. Engrossing the act on the 
federal statute books had, it is true, little immediate effect. 
Two state court decisions, one in New York* and the other 
in Ohio,'' were adverse to the trust form of organization, and 
in consequence most of the consolidations formed after 1890 
were organized as holding companies. Yet neither the pro- 
hibiting federal statute nor the anti-trust court decisions de- 
creased the rate at which consolidations were forming. These 
continued with increasing frequency imtil the spring of 1893, 
and attained even greater size. Then occurred the scandalous 
failure of the National Cordage Company, the bankruptcy of 
several great transcontinental railroads, and the evil conse- 
quences of the bimetallic legislation. The panic of 1893 fol- 
lowed quickly and with it the promotion of industrial con- 
solidations ceased. 

The later or major cycle of industrial consolidations began 
in 1897. It was among the first outward signs of the return- 
ing prosperity following the stagnation consequent upon the 
panic of 1893. At first the consolidations were few in number, 
but the movement, once begun again, quickly reached far 
beyond anything thought of in the preceding period. Every 
conceivable line of manufacturing had its trust. Conservative 
bankers, shrewd business men, and doctrinaire economists 
became infected with the virus of large-scale production. 
People condemned the trusts one moment and bought their 
securities in the next. It was the harvest-time of promoters. 

* People Y. North River Sugar Refining Co., 121 N. Y. 582 (1890). 
» Sute V. Standard Oil Co., 49 Ohio 137 (1892). 



By the end of 1899 more than a hundred and thirty con- 
solidations of considerable magnitude had been organized, all 
for the sole purpose of suppressing competition and increasing 
the scale of production.* During 1900 and 1901 the move- 
ment continued, but the new promotions were fewer in number, 
owing to the fact that most opportunities for the formation 

* Compilations of the exact number and capitalization of Industrial consolidations 
incorporated during any one period are inaccurate. In the first place it is often 
difficult to distinguish between an industrial consolidation, in the sense that the 
term is usually employed, and a mere recapitalization of an enlarged business. 
Furthermore many incorporations were mere "paper corporations," which never 
endured beyond the initial stages of promotion. The records of incorporations, 
however, make no attempt to distinguish between the prospective and the actual. 

The Commercial and Financial Chronicle compiled a list of what it called the 
"Industrial Consolidations of 1899." 70 Chron. 561. From this list were eliminated 
public utility and mining enterprises and all purely local businesses. Only those 
incorporations with total capital in excess of $1,000,000 were included. After 
making the various eliminations and adjustments to the list, it appeared that there 
were 259 incorporations in 1899, which might possibly be considered as_ industrial 
consolidations with a capitalization in excess 01 $1,000,000. The following results 
of a tabulation of these 259 incorporations may throw some light on "trust" 
capitalization when "trust" promotion was at its very height. 

NuMBEK OF Consolidations 

Total number of incorporations 259 

Number having common stock only 117 

Percentage of total having common stock only 45% 

Number having common and preferred stock 105 

Percentage of total having two or more classes of stock 40% 

Number having bonds 37 

Percentage having bonds 15% 

Capitalization of Consolidations 

Total capitalization of the 259 corporations $2,893,880,000 

Total common stock 1,865,930,000 

Percentage of total capitalization represented by common stock 6490 

Total preferred stock $838,350,000 

Percentage of total capitalization represented by preferred stock 30% 

Total bonds $ 1 89,600,000 

Percentage of total capitalization represented by bonds 6% 

The distribution of the different capitalizations is as follows: 

Number of Total 

Capitalization Corporations Capitalization 

$1,000,000 43 $43,000,000 

From $1,000,000 up to 5,000,000 70 176,380,000 

" 5,000,000 " 10,000,000 64 257,500,000 

" 10,000,000 " 15,000,000 23 247,500,000 

" 1 5,000,000 " 20,000,000 lo 1 59,500,000 

" 20,000,000 " 25,000,000 14 290,000,000 

" 25,000,000 " 30,000,000 7 179,500,000 

" 30,000,000 " 40,000,000 6 183,000,000 

** 40,000,000 " 50,000,000 6 247,000,000 

" 50,000,000 " 60,000,000 3 164,000,000 

** 60,000,000 " 70,000,000 8 501,500,000 

" 70,000,000 " 80,000,000 a 150,000,000 

" 80,000,000 ** 90,000,000 I 80,000,000 

" 90,000,000 " 100,000,000 I 90,000,000 

Over 100,000,000 I 125,000,000 

Totals 359 $2,893,880,000 


of "trusts" had already been fully exploited by the bankers 
and promoters. Accordingly the ground was combed over 
again. The trusts themselves were consolidated. A pyramid 
was built of pyramids. The United States Steel Corporation, 
capitalized at over thirteen hundred millions of dollars, was 
built up out of half a dozen smaller "trusts," themselves, in 
several cases, the combinations of smaller combinations. By 
1902 signs were apparent that many of the trusts had not 
justified the predictions of their promoters. The public in- 
vestors became suspicious. Stock market quotations of specu- 
lative industrial common stocks became at first unsteady and 
then began to fall.^ New promotions became infrequent and 
several embryonic consolidations were stifled before their birth. 
By 1903 a veritable panic occurred in the stocks of industrial 
consolidations and new promotions ceased altogether. An in- 
dustrial depression ensued. 

During 1905 and 1906 few consolidations were formed, 
and these few were of insignificant importance. After the 
depression following the panic of 1907 there were occasional 
consolidations of industrial businesses, more especially in the 
retail merchandising and automobile industries. Yet, after 
all is said, the evidence is clear that during the period from 
1902 down to the opening of the Great War the number of 
industrial consolidations was insignificant compared with the 
period of fifteen years preceding the depression of 1903.* 

Several highly significant reasons explain why the move- 
ment toward consolidations ended as quickly as it did. Para- 

* S«e Noyes, A. D., "Inflated Capitalization and the Mania of Speculation," 
»9 Q- J. E- 188 (Feb. 1905). 

* It 18 impossible to state specifically the number of industrial combinations that 
exist at any one time because it is impossible to define precisely industrial com- 
bination and to apply the term practically to existent businesses. Numerous attempts 
have been made, out the value of such statistical generalities rests quite entirely 
upon the arbitrary definition of fundamental terms. A report of the Ways and 
Means Committee of the House of Representatives (April, 1913) enumerated 224 
industrial consolidations. A slight change in the meaning of the terms would haye 
had the effect of varying the enumeration one way or the other to a very consider- 
able extent. 


mount is the simple fact that, as a whole, the trusts had turned 
out ill. They failed to meet the expectations of their 
promoters. Competition was not suppressed and the widely 
heralded economies of large-scale production were not realized. 
Most of the securities of the consolidations were acquired 
by public investors with a speculative trend of mind who fully 
expected to make their fortunes out of them. Anticipated 
earnings did not develop. The bankers who underwrote new 
promotions during the closing years of the period found them- 
selves with large amounts of such securities remaining unsold. 
The public investors witnessed the slow but nevertheless un- 
interrupted decline of the "trust stocks." Few paid any 
dividends on the common shares and many ceased to pay 
regular dividends on the preferred shares, even after dividends 
had been begun. Highly speculative common stocks were 
carried on margin by speculators and accumulating interest 
charges steadily increased the loss. Furthermore, many of the 
industrials actually failed. And at the time of each failure, 
financial scandals, unconscionable bankers' and promoters' 
profits, even downright dishonesty and fraud, were fully and 
widely featured by the daily press. As a direct consequence 
the business world, the public investors, even the economists, 
lost faith in the economic expediency and financial wisdom of 
industrial consolidation. 

A second reason for the almost total cessation of industrial 
promotions was the changed attitude of the law.' Although 
the Sherman Act was passed in 1890, it was not until early 
in 1895 that an important case under this act was reviewed 

* It was stated by a distinguished English student of the law of combinations, 
regarding the evolution of the law on this subject, that, "As to the stages through 
which the English law relative to combinations has passed, one observation, on the 
whole, holds good. In developing the law as to combinations, the courts have 
been mainly, though not avowedly, guided by the economic _ theories prevalent from 
time to time — perhaps, to be more accurate, by the political economy of a past 
age, for it will be found that the courts are rarely abreast of the latest economic 
teaching." Sir John Macdonell, Ministry of Reconstruction, Report of the Com- 
mittee on Trusts. This observation, made with_ reference to the whole history of 
the English law of restraint of trade and combination, is directly pertinent to the 
relatively short and limited period during which our courts have been interpreting 
the Sherman Act of 1890. 


by the United States Supreme Court." The decision of the 
highest court indicated clearly that industrial consolidations 
were to be considered legal. The court let them pass, by a 
verbal subterfuge, notwithstanding the spirit of the act. But 
in 1899 the Supreme Court reversed itself .^^ Consolidations 
were not to be legalized by a mere verbal subterfuge. The 
act of 1890 did apply to the combinations of manufacturing 
plants and could, moreover, be invoked to dismember those 
which had been illegally formed. But this idea did not vividly 
and thoroughly permeate the intelligence of the banking world 
until the great Northern Securities decision in 1903,^^ when 
the teeth of the act of 1890 were felt. This decision was 
widely advertised and the country as a whole realized that the 
act of 1890 was not dead legal verbiage, but meant exactly 
what it said — namely, that consolidations of competing enter- 
prises were illegal. 

A third reason that explains the decline of industrial pro- 
motions after 1903 was the shift of investment sentiment. 
This reason was perhaps less important than the others, but 
it was, nevertheless, very vital in the point of view of the 
banker without whom no industrial consolidation could be 
promoted. Public utilities began to assume importance to 
promoters and to bankers. Prior to 1900 most of the local 
utilities had been built and extended by local capital alone. 
The savings of the commimity produced the local utility. But 
slowly the promoter-engineer began to succeed in enlisting 
the help of bankers in combining local utilities into large 
operating and holding companies. Much new capital was 
required. And both bankers and investors turned from manu- 
facturing enterprises, where competition could not be inhibited 
by combination, to public service enterprises where competi- 
tion was legally prohibited by means of the exclusive franchise. 

*»U. S, V. E. C. Knight Co., 156 U. S. 1. Decided January 21, 1895. 
"Addyston Pipe & Steel Co. v. U. S., 17s U. S. 211. Decided December 4, 1899. 
** Northern Securities Co. v. U. S., 193 U. S. 197. Decided March 14, 1904. 


These were the main causes which brought about the shift 
of promoting, banking, and investing sentiment away from in- 
dustrial consolidations in the decade preceding the Great War. 
But beginning in the autumn of 191 5, as a direct consequence 
of the enormously increased demand for manufactured 
products, the rapidly rising prices, the loosening of restrictions 
on monopoly — all economic concomitants of a great war — a 
new movement toward industrial combinations began. These 
recent consolidations differed in many important respects from 
the consolidations of twenty or more years before. In the 
first place, no attempt was made to secure all the plants in a 
given industry — good, bad, and indifferent — in the confident 
hope that thereby competition could be suppressed. On the 
contrary the purpose was to select a relatively few plants and 
these were chosen on the basis of efficiency of operation. Very 
often the chief purpose was to secure more capital for an 
old-established industry, either from bankers or the public. 
The consolidation of separate and independent plants was a 
mere incident to expansion. New capital, rather than the 
suppression of competition, was held to be essential to success. 

These bare historical outlines do not give an accurate 
picture of the so-called consolidation movement of the last 
thirty years. It is easy to sketch the movement in its broad 
perspective. Yet it is difficult to picture now or even to 
understand the childish and uncritical atmosphere of optimistic 
sophistry which surrounded the promotion of all the con- 
solidations of the closing decade of the last century. In terms 
of figures, the difference between foresight and hindsight is 
remarkable. It is the difference between the promise of pro- 
moters, bankers, and economists — for the trust contagion in- 
fected all — and the results of this promise in the actual earn- 
ings of the consolidations in the first years of their existence. 

In order to test, empirically, the actual results of consolida- 


tion, as compared with previous earnings under competitive 
conditions and with the anticipated earnings after consolida- 
tion, a statistical study of the earnings of twenty-nine indus- 
trial consolidations was prepared. This is a promiscuous collec- 
tion, including those reputed successful, unsuccessful, and 
"indifferent." As a whole, therefore, it represents a fairly 
accurate index of the actual financial results of consolidation 
as reflected in the hopes of the promoters. Viewed in terms 
of rough averages it shows that the earnings during the period 
immediately preceding consolidation, when the component 
plants were operating under competitive conditions, were 
approximately a quarter more than during the first year of 
the consolidation, and exceeded both the average earnings of 
the first ten years and the earnings of the tenth year when 
the consolidation might be supposed to have worked out its 
salvation after the addition of improvements and extensions. 
Furthermore, promoters, bankers, engineers, and accountants 
were prone to estimate what the earnings after consolidation 
were likely to reach, making liberal allowance for the 
economies of large-scale production, and co-operation in con- 
tradistinction to competition. These estimates exceeded by 
nearly a half the actual earnings during the first year, and 
were conspicuously greater than the average earnings for the 
first ten-year period. Putting the matter another way, only 
twelve of the twenty-nine consolidations had earnings during 
their first year of existence equal to the earnings of the separate 
plants before consolidation ; and four only had earnings equal 
to the estimated earnings. The majority of them were formed 
during the earlier stages of a boom, so that general economic 
conditions were in their favor rather than against them. The 
average earnings for ten years were in seventeen cases out 
of the twenty-nine less than the earnings of the independent 
plants, and in twenty-four cases less than the anticipated earn- 
ings. In fact, looking at these statistics in terms of broad 


averages it would appear that the industrial consolidation never 
attained, even approximately, the expectations of its pro- 

Although these statistics are not extensive, they do include 
consolidations which have been considered both successful and 
unsuccessful. They show actual conditions, without the bias 
of some preconceived theory of the economies of industrial 
consolidation. They indicate that the roseate hopes of pro- 
moters were not realized, but that, once the era of promotion 
past and the new company is well established in its trade 
position, its earnings are not very different from the earnings 
of the companies out of which it was formed. At all events, 
enormous profits did not follow upon mere consolidation and 
mere large-scale production. 

To understand industrial consolidations we must not only 
weigh the aspirations of the promoters of the early trusts 
in the light of actual financial results, but also consider the 
economic postulates upon which the movement rested. The 
premises upon which the "trust movement" was based were 
simple — suppression of competition and economies of large- 
scale production." Owing to the fact that the Sherman Act 
of 1890 was directed against all consolidations the intent of 
which was to suppress competition,^" the former motive was 

*• See Appendix. 

** As stated in another connection: 

"Two purposes lay at the bottom of every consolidation with which we are 
here concerned. The promoters believed that they would be able both to allay 
the disastrous eflFects of competition, and to bring into existence improved and 
economical methods of manufacture through production on a large scale. These 
two reasons were fully understood by all classes of people concerned. They were 
the mystic oracles which led the business competitors of years to join in a common 
undertaking; they were the baits which prompted the bankers to give financial 
backing to the extravagant enthusiasm of the promoters; they were the motives of 
personal advantage dangled before the eyes of an investing public; and they were 
the 'signs of the time' about which the public discussion of the 'trust movement' 
centered. Nor did these two reasons develop only as the consolidations became 
more frequent. Congressional debates leading up to the passage of the Sherman 
Act of 1890 are full of expressions of both of these ideas. The whole spirit of 
that act was a desire to preserve to the nation the benefits of industrial competition 
in the belief that the economies of production on a large scale would be accomplished 
through the self-interest of the manufacturer. This was in 1889, fully a decade 
before the consolidation movement reached its height." Dewing, A. S., Corporate 
Promotions and Reorganizations, 523, 524 (1914). 

** Jones, in a recent study, contends that severe competition was not a primary 
motive in bringing about industrial consolidation. To prove his position would 


not publicly acknowledged. It was implicitly recognized, how- 
ever, and explicitly stated in terms of the number of important 
competitors that were included in the consolidation, and the 
relatively large output to be controlled by the new company.*' 
The reasons usually emphasized to support the prophecy 
that the consolidated company would earn more than the 
previous competing companies were based on the presumptions 
of the economics of large-scale production. Much argument 
was advanced to support the general contention that the "big 
company" could buy its raw materials and manufacture and 
distribute its products more cheaply than a small company.*^ 

require more evidence, covering a wider range of cases, than that offered in his 
study. And even were his main thesis established, the fact would still remain true 
that the very large profits which were anticipated to follow consolidation were 
conceived to flow at least partly from the cessation of competition. Jones, E., "Is 
Competition in Industry Ruinous?" 34 Q. J. E. 473 (May, 1920). 

'• "As the majority of the consolidations came into existence after the passage 
of the Act of 1890, the motive of suppressing competition was stated with less 
explicit emphasis than that of attaining the economies of large-scale production. The 
former was usually expressed by drawing attention to the percentage of the industry 
the consolidation would control, and the reader of the prospectus was allowed to 
infer what would happen to competition in an industry where 70 to 90 per cent 
of the production was under one management. The promoters had been familiar, 
through the experience of the immediate past, with the effect of pools and trade 
agreements upon prices. They believed that with centralized control, possible only 
through centralized ownership, all the advantages of pooling agreements could be 
secured, and the disadvantages of personal disloyalty among the members of the 
organization avoided. This was the reason that lay in the back of the minds 
of those who were instrumental in bringing about the consolidations, but the degree 
of emphasis which it was given in appeals made to the public depended, to a 
considerable extent, upon the width of market sought for the securities of the 
new corporation. For example, when the United States Leather Company was 
organized, practically all the stock was taken by the tanners. We therefore find 
very little said about the effect of the combination on competition, and nothing 
whatever upon the ability of the new corporation to control prices. When, on the 
other hand, the United States Shipbuilding Company was promoted, the people 
interested were actively concerned in distributing its securities to an investing 
public. The promoters, therefore, advertised widely the alleged fact that the new 
corporation would control the most efficient and economical yards on the Atlantic 
and Pacific coasts. The promoters, in the majority of cases, found themselves 
between the Scylla of the demands on the part of bankers and investors for a 
trade stability possible only through some degree of monopoly, and the Charybdis 
of public opposition to all forms of monopoly. For example, the banking interests 
of Drexel, Morgan and Company refused to take hold of the old National Cordage 
Company until that corporation had secured the control of the Plymouth Cordage 
Company, so essential did they consider a high degree of monopoly to the permanent 
investment value of the companies' securities. Dewing, A. S., Corporate Promotions 
and Reorganizations, 524, 525 (1914). 

""At the time the movement toward industrial consolidation was_ discussed, 
contemporary students laid emphasis upon and expended no little a priori reasoning 
in describing the economies in production to be made possible through the methods 
of business contemplated by a centralized ownership ot many manufacturing plants. 
Clever students of economics went so far as to arrange tables showing the external 
and the internal economies to be effected by the new organization of business. 
Among the external economies were the savings in advertising, in purchasing,^ in 
traveling salesmen, in executive officers, in freight rates and in foreign agencies; 
among the internal economies were the greater command of capital, the larger 
■urplus for experimental work, the better facilities for placing the right man in 


The entire line of reasoning — whether it is assumed that one 
low-priced traveling order clerk could be substituted for several 
high-priced salesmen, or that a thousand tons of pig iron 
could be bought more cheaply than ten tons — was based on 
the belief that methods of uniformity could be substituted for 
methods of diversity. Whether looked upon as the transition 
from the independent and unco-ordinated to the centralized 
and co-ordinated way of doing business, or as the transition 
from the inefficient small manufacturer to the dominating and 
efficient captain of industry with his militaristic lieutenants 
and sergeants, the whole movement presupposed that business 
could be successfully organized and standardized. It assumed 
that the planning and responsibility could be centralized at the 
head, and that all the other parts of the business organization 
needed only to function in set lines of routine practice; a 
pattern of a business could be constructed, and the business 
would succeed, if only the pattern were followed. By sub- 
stituting the automatic machine for hand-labor, routine intelli- 

the right place, the wider opportunity for development work and the more intelligent 
organization of the purchasing and selling departments." Ibid. 529. 

Nor are such mental amusements confined entirely to the period when the large 
industrial consolidations were being formed. In 1919 the British Report of the 
Committee on Trusts was submitted to the Ministry of Reconstruction, containing 
an elaborate "Study" by John Hilton of the Garton Foundation in which the 
advantages of consolidation are again arrayed in tabular form, as follows: 
"Buying (materials, plant, stores, etc.): 

Assured and steady supply of material. 

Unification of buying departments and staffs. 

Bulk instead of detail purchases. 

Greater opportunity for comparison and selection. 

Cheaper credit and better discounts. 

Standardization of materials. 

Standardization of product. 

Specialization in product. 

Improvements in plant. 

Use of by-products. 

Equalized distribution of work. 


Transport economies. 

Unification of selling departments and staffs. 

Extension of export trade. 

Collective advertising. 

Lower costs of distribution; fewer middlemen. 

Interchange of data and experience. 

Standardization and interchange of costings. 

Collection and dissemination of trade statistics. 

Promotion of scientific and technical research." 



gence had been dispensed with in the shop and the rate of 
production enormously increased; by substituting the auto- 
matic system for reasoning, executive intelHgence could be 
dispensed with and the rate of production enormously in- 
creased. It was reasoning by analogy. 

The unfortunate part of this reasoning, however, was that 
the analogy did not hold — ^uniformity of automatic methods, 
whatever their mechanical excellence, could not be substituted 
for the individuality of human judgment. Business ability 
of a sufficiently high order to manage a large group of plants 
could not be obtained easily and quickly. Nor could the human 
cogs of the machine be easily and quickly adjusted to their 
respective positions so that they functioned in exactly the 
right way, showing just enough intelligence to meet the rou- 
tine requirements of their respective positions without en- 
dangering the co-ordination of parts by showing too much 

" Specifically, the difficulties of the large and centralized organization in reducing 
men to the positions of machinery have been classified, in another connection, under 
six separate heads. 

". . . . I. Foremost, perhaps, was the diffusion of responsibility. A man with 
ample business skill to manage a small factory was given the management of a 
group of plants widely separated and each operating under local conditions. He 
was then compelled to delegate the actual management to paid superintendents, 
over none of whom he had more than indirect authority. If he tried to manage 
the scattered plants as he had his single plant, he found that the enormous detail 
involved too great a burden for his mind; important matters passed unnoticed, and 
the local superintendents degenerated into automatic i>arts of a machine, without 
initiative or power of assuming responsibility. (As a large manufacturer once 
expressed it — ^there comes a point where the man in the twentieth story of an 
office building cannot make up, no matter how brilliant he may be, for the waste 
and shiftlessness of a variety of superintendents in many mills hundreds of miles 
away in all directions.) If, on the other hand, he delegated a large share of the 
authority to his local superintendents, he found that he required men of marked 
business ability to manage the separate plants efficiently; he required, in fact, a 
degree of ability which commanded so high a salary as to absorb the presumptive 
economies due to consolidated management. 

"2. Lack of knowledge of individual employees. A successful competitor of a 
large consolidation declared that his success was due to the fact that he knew 
the parents and grandparents of the employees in his mill. He watched his men grow 
up from childhood. He knew the skill and deficiencies of each, and therefore, the 
kind of work and the condition which would bring out the greatest earning power 
of each. Such possibilities of individualized superintendence of labor were impossible 
where the organization had grown so large that all personal contact between employer 
and employee was lost. 

"3. Lack of loyalty of officers and directors. In order to maintain the continuity 
of the separate businesses it was the custom to have the more prominent men. 
who had disposed of their plants to the consolidation serve as members of the 
board of directors, or as managing officers of the corporation. But the center of 
their loyalty was changed. They were no longer operating their own plants. Personal 
motives easily supplanted any feelings of responsibility they might have toward 
the great body of stockholders. As directors they were tempted to burden the 


These specifically human defects were not the only weak- 
nesses. Mere size, in itself, often proved a serious handicap 

consolidation with useless plants at personal profit, or to make advantagfeous contracts 
with other companies in which they were interested, or give employment to relatives 
at high salaries. They were tempted to speculate in materials in such wise that the 
burden of loss fell on the corporation, or to purchases and sales of the corporation's 
securities, based on knowledge exclusively their own. If the body of stockholders 
found fault with such codes of business ethics, the directors could resign their 
positions and sell their securities. They could even enter into competition with 
the consolidation and grow strong through a knowledge of the trade enhanced 
by their previous connections. 

"4. Lack of attention to the laborious parts of the business by the higher officials. 
The directors considered their positions too important and their time too valuable 
to spend on matters of detail. Previously, as owners of competitive plants, they 
were at their business offices each day from early in the morning to late in the 
afternoon; as 'Vice-Presidents' they were more often at the office of the corporation 
from ten until three o'clock, and not at all on Saturdays. They no longer felt 
obliged to sacrifice social pleasures for business motives. They were no longer 
concerned with petty economies of manufacture, insignificant alone, but large in 
aggregate. Even in the utilization of by-products, where one of the economies of 
large-scale production was supposed to lie, the executive officers would frequently 
take the position that the possible advantage was too insignificant to be worth their 
attention and trouble. (There are two temptations which confront every director 
in a large corporation. "The success with which a man, suddenly risen to influence, 
resists the feeling that he is too important to devote himself to the current detail 
of management and the feeling that he is in a position to profit through stock 
market manipulation measures his future success in the position of responsibility. 
No human mind is great enough to manage a large business with consummate skill 
and follow in detail the market quotations of its securities. It is a modern instance 
of serving two masters.) 

"S. Prejudice of customers against improved methods. There was, and still is, 
a grroup of men who are so blinded by an external appearance of efficiency that 
they have come to think that the more automatic and impersonal a business becomes 
the greater will be its productive power. Fortunately this theory is no longer 
widely held. But at the time the industrial consolidations were created it 
was popular. As a consequence the central management undertook to substitute a 
more scientific and carefully articulated method of producing and selling goods 
for the slipshod methods of the small establishments. In cases of a standardized 
product the application of more scientific methods to production were undoubtedly 
wise but in all branches of the selling organization they were an absolute failure. 
Few things count more in salesmanship than the personal magnetism of an able 
salesman basing his appeal on long-established trade connections. The directors 
of the consolidation sought in the interest of organization and economy to replace 
high-salaried salesmen by low-paid order clerks. Many of these salesmen had been 
the proprietors of the old businecses, men who held their customers by family 
association — the customers of their grrndfather and greatgrandfather perhaps. 'Among 
the oldest houses doing business with us' was a bond which the force of circum- 
stances broke with difficulty. Instead of profiting through this bond the new order 
of scientific salesmanship interposed the deadening influence of organization between 
buyer and seller. Customers found that they were no longer dealing with the 
son of their old friend but with some cog in the machine designated as ABC. 
Before, they had arranged the terms of their contracts in a dingy office, replete 
with the memories of half a century; now their contracts were forwarded to them 
from the central office or delivered to them by the manager's secretary. As a result 
they often turned elsewhere. 

"An excellent illustration of this principle is afforded by an incident at the 
time of the promotion of the American Hide and Leather Company. This was the 
consolidation whose prospective annual profits were estimated by the promoters in 
excess of $5,000,000, of which $4,000,000 was to come from consolidation. At the 
time the promotion of the company was discussed the Boot and Shoe Recorder, 
a prominent trade journal, sent out a letter to two hundred and fifty shoe manu- 
facturers, reading as follows: 

" 'In case this combine (the American Hide and Leather Company) goes through, 
and you were purchasing stock, whom would you favor, manufacturers outside the 
trust, or the trust itself?' 

"A large number of answers were received. More than half expressed bitter 
antagonism against the prospective consolidation. A few replies only were indifferent. 
The following was an example which, although superficial in its reasoning, shows 
the innate trade prejudice from which the majority of consolidations suffered. 



in competition with smaller and more mobile competitors. In- 
stead of reducing the cost of raw materials, the large company 
found it not only more hazardous to contract for the large 
quantities required for sustained production, but the very pub- 
licity of the company's demands tended to raise the prices it 
was forced to pay." Further, the very size of the large 
company made it less able to withstand depressions in the 
trade. There was more "overhead" to be carried during the 
inevitable periods of lessened demand in order that the entire 
organization be prepared for the periods of heavy demand. 
And in order to maintain the operation of the plants at some- 
where near a point of efficient production the large company 
would be forced to accept unprofitable business. The small 
competitor could withdraw entirely from the market at his 
discretion, or take the most profitable business at only enough 

Lynn, Mass., May 23, 1899. 
" 'Boot and Shoe Recorder: 

'We would prefer to buy from the outside firms every time, for the simple reason 
that we believe they could serve our interests much better than the trust; the 
manner in which the trusts' stocks have been watered and the enormous expense 
they have been under are reasons why shoe manufacturers are not going to be 
benefited by this combination. 

W. J. Creighton & Co.' 

"6. Prejudice of customers against 'trusts.' There is a large body of intangible 
evidence pointing unmistakably to the fact that in the years immediately following 
the establishment of the large consolidations, many small manufacturers and merchants 
were influenced by the popular dislike of 'trusts.' This feeling undoubtedly influenced 
customers in those cases in which the product of the consolidation was sold directly 
to the ultimate consumer, as with starch or bicycles. This feeling was especially 
conspicuous if the goods were sold directly to members of the laboring class who 
were led to believe that the rise of general prices, which set in about 1899, was 
due primarily to business concentration. The newspapers of a sensational tone 
exploited this feeling in their editorials and their cartoons; the competitors displayed 
the words 'not made by a trust' on their goods." Ibid. 558-562. 

''This was conspicuously true if the consolidated company used a raw staple 
product, such as cotton, wool, corn, or pig iron. The large orders had to be 
placed openly, often with one of two or three large producers who alone were 
able to guarantee deliveries. If the raw materials, like cotton or corn, were quoted 
openly on one of the exchanges, the consolidated company's buyers were forced 
to supply the needs at the open contract prices. A small competitor with a relatively 
small total demand, could "shop around the market, purchasing secretly odd lots 
at a marked concession from the published prices. In many instances, therefore, 
"quantity purchases" proved a disadvantage rather than an advantage. During the 
early years of the starch and glucose consolidation a small competitor made himself 
conspicuously troublesome by closing down his factory during periods of small 
demand — when heavy "overhead" charges made operation unprofitable — and starting 
it up when the demand returned, using odd lots of ungraded corn. In this 
manner he was able to_ produce glucose much cheaper than it could be made by 
the consolidation. By bidding under the prices asked by the consolidation be could 
sell just enough glucose to use up the amount of cheap odd-lot corn procurable 
at any one time. But, small as was his possible production in comparison with 
that of the consolidated company, he made it impossible for the large company 
to maintain its prices uniformly in all markets. 


secret concession from the large company's published prices 
as would be required to give him the order. The small com- 
petitor would thus force the large company to take up the 
slack of the business. Again, the large consolidations, es- 
pecially in the first years of their existence, were very reluctant 
to substitute improved machinery and equipment for that 
acquired with the original plants. Instead of encouraging 
improvements and stimulating experimental work, the con- 
solidations were reluctant to scrap their great masses of worn 
and obsolete machinery. Under these circumstances the newer 
competitor, with a thoroughly improved plant, obtained lower 
costs of production. 

The different ways in which the consolidated company was 
defeated in securing marked economies of large-scale produc- 
tion and handicapped in its competitive battle with smaller 
businesses might be further extended.^" But it would add 

" If the combination operated in an industry in which competitive units could 
easily come into existence, it was severely handicapped in subsequent competition 
if it had been formed during a period of high prices. This is excellently illustrated 
by conditions surrounding and following the organization of the International 
Mercantile Marine. This was a combination involving the purchase of the stocks 
of six large transatlantic steamship lines. It was organized in 1902, at the top 
of the industrial boom that preceaed the depression of 1903. At that time there 
was abnormal activity in the shipping industry, in consequence of which ocean 
freight rates ruled high and the value of seagoing steamers was correspondingly 
high. Thus an English statistician computes that the unit cost of a "new ready 
7,500-ton cargo" steamer was approximately £60,000 in the period immediately before 
the organization of the International Mercantile Marine. It fell rapidly and in 
1 90s was only £36,000. It remained at about this level until 191 1. See 74 
Fairplay (London) 102 (Jan., 1920). The excessive prices paid by the Inter- 
national Mercantile Marine are discussed, from collateral evidence in Meade, 
E. S., 19 Pol. Sci. Quar. 50 (1904), and reprinted Ripley, W. Z., Trusts, Pools, 
and Corporations, Chap. X (1916). As a result of the boom prices paid, the 
combination did not prove a success. This is shown by the earning statement: 

Earnings of International Mercantile Marine 

A combination acquiring its _ properties at boom prices, and subject to international 

competition (figures in even thousands). 

Operating Expense Net Earnings 

(Not Including (Without 

Gross Earnings Depreciation) Depreciation) Fixed Charges 

1902 Organized 

1903 $3i|037fOOo $27,036,000 $4,001,000 $3,645,000 

1904 28,846,000 27,040,000 1,806,000 3,845,000 

1905 33.362,000 27,456,000 5,906,000 3,889,000 

1906 37fi59>ooo 29,155,000 8,004,000 3.795,000 

1907 39,266,000 32,242,000 7,024,000 3,488,000 

1908 30,529,000 29,653,000 875,000 3,695,000 

1909 33.9S3.000 29.257.000 4,695,000 3,692,000 

1910 — 38,073,000 29,775,000 8,298,000 3,896,000 

1911 39,153,000 31,070,000 8,082,000 3,620,000 

1912 43,726,000 36,128,000 7,597,000 3,809,000 

1913 49,041,000 39,474,000 9,567,000 3,850,000 

1514 45,620,000 38,700,000 6,920,000 3,613,000 

191S Receivership 


little of general significance. The important conclusion to be 
obtained from a survey of the great consolidation movement 
at the close of the nineteenth century is that competition can- 
not be inhibited by combination. There is nothing in large- 
scale production, taken alone, that is necessarily economical. 
Nor are these conclusions essentially different if we con- 
sider the results of imbridled expansion where that expansion 
represents merely internal growth without such absorption of 
outside elements as would permit one to use the term con- 
solidation. Examples of businesses having attained a national 
scope through mere growth are not as common as businesses 
that have become great by consolidation. But having become 
great they are subject to the same economic laws. During 
their period of growth they represent usually the work of a 
single man. In his youth and prime this man is a veritable 
business genius. He overcomes difficulties; he stifles com- 
petition. His company gradually but steadily forges to the 
head. It may even become the largest single factor in the 
industry. But once the man has passed his prime the same 
failure to observe the ineffectiveness of mere size creeps in 
as in the case of a direct consolidation. The business becomes 
too big for a single man, now passing beyond middle life, 
or the group of subordinates to whom he has to entrust execu- 
tive administration. In order to strengthen itself in one or 
another direction the business has probably branched out into 
allied or even different lines of enterprise. Some of these 
prove profitable, others do not. Large amounts of liquid capital 
are absorbed in an endeavor to maintain and increase the 

From the apparent earnings approximately $27,300,000 was deducted for depredation. 
The depreciation charges were very irregular and made only in "good years"; they 
were totally inadequate, as is shown by the fact that in 1916 the company charged 
a lump sum of over $23,000,000 to depreciation to make up for its past delinquencies. 
As a whole, then, we may say that for the period of twelve years from its formation 
to the Great War, the International Mercantile Marine Company failed to earn 
its fixed charges after due allowances for depression. (The figures of "net earnings" 
given here are different from those employed in the table given in the Appendix where 
depreciation was prorated and charged against net earnings.) 


volume of sales. And when the whole situation is analyzed 
it will be found that the business has actually fallen back when 
measured in return on invested capital, during the time when 
it has, apparently, gone forward, if measured in terms of 
volume of sales. If wastes and mistakes of management are 
too pronounced, especially if they develop rapidly at a time 
of financial panic, the business fails.^^ Ordinarily, however, 
the results are not so dramatic. The big business merely 
continues to exist, yielding a lower return to its proprietors, 
proportionately to the capital invested and the volume of 
business, than is the case with its smaller competitors in the 
same industry. 

These conclusions have a direct application to contem- 
porary business. That is why so much stress has been laid 
upon them. But they have also a direct application to our 
social philosophy. One of the commonest lines of reasoning 
indulged in by the state socialists is that the whole trend 
of modern industrialism is toward large-scale production and 

*i The two largest mercantile failures during the last twenty years meet these 
conditions exactly. The Westinghouse Electric and Manufacturing Company was 
built up from an insignificant beginning to one of the largest factors in the electric 
industry in the world, through the business genius of George Westinghouse. But 
the business expanded too rapidly and became unwieldy; it exhausted its working 
capital and failed in the panic of 1907. (Referred to again, Chapter VII, note 10.) 
The causes leading to the Westinghouse failure were summarized in Dewing, A. S., 
Corporate Promotions and Reorganizations, Chap. VII (19 14). Horace B. Claflin 
started a wholesale dry goods business in 1843 in New York. By the end of the 
Civil War the sales of H. B. Claflin and Company had reached $64,000,000. Printers 
Ink, June 26, 1914. The business steadily increased until the death of H. B. Claflin 
in 1885. The house was at the time the largest wholesale jobbing house in the 
country — possibly in the world. The net annual earnings amounted to approximately 
$700,000. 50 Chron. 572. Meanwhile smaller dry goods jobbing houses sprang 
up in the West, and this movement developed rapidly after the depression of 1884. 
The specialty jobber also came into prominence. These tendencies were recognized 
by H. B. Claflin, who at the time of his death was entering the importing and 
manufacturing fields. Printers Ink, June 26, 19 14. The son, John Claflin, sought 
to follow his father's aggressive policies, but lacked the judgment. Seeing the 
jobbing business slipping away to smaller competitors, he sought to preserve his 
position and stabilize his market by establishing a chain of department stores all 
over the country — upwards of forty in all. Over these extensions John Claflin 
exercised the most indirect methods of control. The sales policies of the retail stores 
were inefficient and antiquated. Their accounting systems permitted the local managers 
to deceive the central office regarding their true value. Tnere was no standardization 
of purchases and no attempt to pool purchases so as to obtain quantity discounts. 
Many of these stores were purchased from the proceeds of the discount of ordinary 
commercial notes bearing the Claflin name, so that what purported to be commercial 
notes secured by quick assets were really only financial notes backed by the rapidly 
declining good-will of scattered and poorly managed department stores. Finally 
in June, 1914, the banks withdrew further extensions of credit and the structure 
collapsed. See note 31 of this chapter. 


monopoly. This necessitates the premise that large-scale 
producers can invariably drive the small-scale producers out 
of business, since the former can produce and distribute com- 
modities more cheaply. This being so, the issue for the public 
at large becomes merely one of choice of masters, whether 
to be ruled by privately owned monopolies or by a state 
monopoly. The former are founded on a crass and selfish 
materialism, whereas state-owned and operated monopolies are 
actuated by no private greed because the monopolists and the 
exploited are one and the same, namely the public.^' 

Now it is obvious that this whole train of reasoning rests 
on the presumptions of the essential economy and the inevi- 
tableness of large-scale production. The considerations pre- 
sented in this and the preceding chapter, however, tend to 
show that large-scale production is not of itself necessarily 
economical, and if large-scale production is not necessarily 
economical, to show that it is inevitable is difficult. But if 
monopoly is not inevitable, the foundation of this particular 
argument of the state socialist vanishes. 

These conclusions and the underlying principles which are 
responsible for them can be applied to present-day consolida- 

** The whole socialistic doctrine flowing from the presumption of the economy 
of large-scale production has been clearly and vigorously expressed by Taussig 
in his broad treatment of the entire field of economics: "To view the progress of 
industry as has here been done is, the socialists say, to see the trees but not the 
forest. The large outstanding fact is the collapse of competitive industry. Com- 
bination and monopoly are the inevitable result of the machine processes and of 
large-scale production. Legislation cannot prevent monopoly, nor can it prevent 
its concomitant of ever-growing inequality. The bourgeois economist only palters 
with the situation when he weighs the pros and cons of competition and combination. 
The bourgeois legislator, whether he tries to repress or to regulate combination, 
is trifling with a force that is irresistible. The evolution of industry necessarily 
brings full-fledged monopoly. The ultimate outcome is already plain — the state 
will expropriate the monopolists and will manage all large-scale industry for itself. 
Socialism is the one goal and the one gospel; it is the desirable and the inevitable 
end. To this problem we turn in the chapters that follow." Taussig, F. W., 
Principles of Economics, 442 (1915). 

Such reasoning as this also runs through considerable amounts of contemporary 
writing on industrial consolidations. Some of this may be even of a semiofficial 
nature. Thus the British Report of the Committee on Trusts (Edward Shortt, 
chairman, report dated April 24, 1919), especially the minority report signed by 
Sidney Webb and J. A. Hobson, is so utterly devoid of a critical understanding 
of the problems of industrial consolidatioi as to represent biased propaganda mas- 
querading as a public document. 


tions. So far as the failure of the earlier consolidations is 
to be attributed to the human and personal reasons, the law 
of balanced return outlined in the preceding chapter is directly 
pertinent. And these human and personal reasons can usually 
give a thorough and sufficient account of why one consolida- 
tion is, from its birth, doomed to failure, and why another is 
destined to achieve success. But besides pointing out a means 
for distinguishing between those industries which, by reason 
of the large use of machinery, can succeed on a considerable 
scale of production and those which, by a predominance of 
hand-labor, are foredestined to remain small-scale industries, 
the law of balanced return suggests certain general types of 
industrial combinations most likely to succeed. 

Before describing these types, however, we cannot over- 
look one pertinent observation. It is the simple fact that 
extraordinary business ability can sometimes bring success out 
of conditions otherwise doomed to failure. The difficulty en- 
countered in classifying all social phenomena, whether business 
failures or divorces, is that human nature is in itself so varied 
that two different men may act in opposite ways when con- 
fronted with apparently the same set of external conditions. 
A business genius might easily assume control of an industrial 
consolidation, which by reason of the law of balanced return 
and every other law ever invented by an economist or anyone 
else, ought not to succeed, and make it succeed. True, had the 
same innate entrepreneur ability been exercised under more 
favoring conditions, the consolidation must have proved an 
even more conspicuous success. And conversely, unusual lack 
of ability will destroy an enlarged business, otherwise destined 
to succeed, if by accident or family connection it is given 
control. The fact remains, and it transcends any further 
reduction to economic principles, that remarkably able or stupid 
business ability entirely upsets any attempt to predetermine 


the conditions of success or failure. We can at most, in 
deducing conclusions from any set of business statistics, deal 
only with an array of instances in which average conditions 
predominate. Acknowledgment that exceptions will inevitably 
crop out merely shows that the apparent rigor of physical law 
does not pertain to laws governing human actions in what- 
soever sphere they occur. It does not imply that these laws 
are non-existent. 

Four types of industrial consolidations seem, at the present 
time, to be achieving at least a modicum of success. The 
most important and the simplest type is to be found in those 
industries which have been conspicuous in rapidly unfolding 
improvements in the mechanical processes. Particularly is 
this true if the industry is such that automatic tools can be 
successfully substituted for hand-labor. In this manner, in 
strict accordance with the reasoning given in the previous 
chapter, the point of maximum return can be pushed forward 
so that constantly growing units prove more and more profit- 
able. The increased efficiency, resulting from the mere size 
of the establishment or series of establishments, more than 
compensates for the wastes and limitations that accumulate 
as the size grows. Increased mechanical efficiency more than 
takes up the slack of decreased human efficiency. 

Consolidations in the iron, steel, and other heavy metal 
industries have proved, on the whole, successful. The mould- 
ing machine — an example of the automatic machine — was in- 
troduced not many years before the consolidation movement 
began. Electric cranes and the countless other devices of the 
modem steelmills have enormously multiplied the efficacy of 
human labor and correspondingly reduced the need of skill. 

A second type of enterprise, in which consolidation has 
been of obvious benefit, is in those industries in which it is 


possible to reach back to the primal raw material and forward 
to the ultimate consumer. This is known as "integration." 
A business concern, originally controlling only an intermediate 
process of manufacture, acquires by consolidation another 
concern which produces its chief raw material and still an- 
other which distributes to retailers or even to consumers its 
finished products. A furniture factory, for illustration, ac- 
quires a lumber company on the one hand and a furniture 
jobbing business or even a chain of retail stores on the other 
hand. In this way it controls the entire course of the furniture 
production and distribution, from the forest to the home. A 
shoe factory reaches back and acquires a series of tanneries, 
and forward, to acquire a chain of retail shoe stores. An 
automobile tire company acquires a fabric-mill and cotton 
acreage; a rubber concern acquires plantations in Ceylon. 
These combinations are certainly not always successful, be- 
cause the close integration removes the spur of competitive 
buying and selling at the different stages of manufacture and 
distribution, but many of them have turned out well, especially 
if no great administrative ability is required in conducting 
the subordinate or "tacked-on" businesses. Besides effecting 
such economies as the closer union makes possible, the producer 
of the material at any one stage can regulate its production 
in accordance with the known demands of the next higher 
stage. The whole process of production and distribution is 
therefore less susceptible to fluctuation than when each unit 
is producing for a competitive and uncontrollable market. The 
expenses and the wastes, the lost motion and the friction 
of selling the intermediate products is entirely done away with. 
There is but one real sale, that to the ultimate consumer at 
the end of the whole chain. 

Integration has been one of the chief reasons for the 
success of the United States Steel Corporation. It acquired, , 
with the old Illinois Steel Company, extensive iron mines west 

Sp expansion 

of Lake Superior; it acquired, with the Carnegie Steel Com- 
pany, a railroad from Lake Erie to Pittsburgh. Certain of 
its constitutents, like the American Steel and Wire Company, 
the National Tube Company, and the American Bridge Com- 
pany, manufactured and sold fabricated steel products to the 
ultimate consumer. The Steel Corporation acquired coking 
coal and limestone deposits, coke ovens, and pig iron furnaces. 
It organized numerous intermediate links to the chain so that, 
soon after its organization, the corporation could claim, in 
truth, that it carried on every branch of the steel business, 
from mining the ore to the sale of the fabricated products to 
their ultimate consumers. Other successful industrial consoli- 
dations have followed the same policy, so far as individual con- 
ditions permitted. The American Agricultural Chemical Com- 
pany owns very large areas of phosphate rock in the South, 
and had, until the events of the Great War changed entirely 
the complexion of American investments abroad, a large in- 
terest in German potash deposits. In addition, it has pushed 
the retail sale of its private brands of fertilizers among the 
small farmers. One conspicuous reason for the success of the 
present Corn Products Refining Company under the Bedford 
management has been the fact that it has directed its chief 
efforts to producing end products sold directly to the ultimate 
consumers, rather than intermediate products sold to other 
manufacturers. It even acquired control of companies which 
produced the end products when this course seemed preferable 
to developing a market of its own. The number of instances 
in which this kind of vertical consolidation has taken place 
within recent years is very large. But the central idea in 
every case is the same — to control all the steps of production 
and distribution from the raw material to the delivery of the 
finished product into the hands of the ultimate consumer.^' 

*• This subject of integration and its weaknesses is touched upon again in con- 
nection with the community of interests between producers at different steps in 
the production of the final product. An interesting review of certain attempts of 


A third type of consolidation and large-scale enterprise of 
somewhat recent origin is the chain of retail stores." The 
retail chain store has, on the whole, proved successful. It is 
based on two fundamental assumptions, the economy of large- 
scale buying and the economy of standardized merchandising 
involving a minimum of special services rendered to the cus- 
tomer. ' The chain store aims to get its goods onto its shelves 
at the lowest net cost, and then to sell them rapidly, at a very 
low "overhead" expense and at a very small net profit.^^ 

large business to integrate appeared in the New York Times Annalist of which the 
following quotation is an illuminating extract: 

"It is said to be the dream of the genius behind the General Motors Corporation 
to make that company self-sustaining in every particular. W. C. Durant, his friends 
say, plans for the day when the General Motors pyramid will reach out into the 
ore fields and mine its own ore; when, over its own lines, which may be lines 
of motor trucks, it will bring the ore to its iron works,_ move it along to its 
steel-mills, distribute the steel to its own plants which will turn out the parts, 
take the parts to its assembly plants, and then send out the cars, trucks, and tractors 
to the sales agents, also part of the General Motors consolidation, for ultimate 
distribution to the users. And already there is the General Motors Acceptance 
Corporation which can finance the purchasers. A ranch or two for the leather 
upholstering and maybe an electric light plant might be added and, if the Durant 
idea comes to realization, as those close to him expect it to, probably will be." 
i6 Annalist 132 (Aug. 2, 1920). 

See Chapter VI, page 155. See also reference to the same subject in note 28 
of this present chapter. 

*• It is not altogether easy to determine the exact time at which the chain 
store, as we now know it, first came into existence. Most of the prominent chains 
of retail stores started originally from a nucleus of a single store, and the idea 
of an extended chain came onljr after the proprietor had discovered that he could 
manage a_ number of stores quite as well as he could manage the two or three 
stores which easily developed out of the original nucleus. The Great Atlantic and 
Pacific Tea Company dates back to 1858, but it remained a relatively small enterprise 
down to the depression of the middle nineties, and it was not until 19 12 that it 
started on its nation-wide extension of economy stores where the customer pays 
cash and carries away his purchases. Frank W. Woolworth started his first store 
in 1879, but this was based on the idea of "small price" merchandise, rather than 
a chain of stores. The chain idea came only when Woolworth had discovered that 
he must have a large agency of distribution in order to purchase merchandise on 
the best terms. 

*' The dual purpose of the chain store was briefly and forcefully expressed 
by Frank W. Woolworth: "The success of our organization may be attributed to 
great buying power and ability to take advantage of all cash discounts, combined 
with economy in distribution." Letter of February 14, 1912, in connection with 
the reincorporation of the Woolworth Company. 

These two primary purposes are excellently illustrated by the motives prompting 
the organization of the original United Drug Company of New Jersey in 1902. 
This company was organized originally as a kind of "co-operative wholesale to 
enable drug stores to pool their purchasing, manufacturing, and advertising under a 
single organization and a single name. Forty drug stores in different towns each 
contributed $4,000, for which each received $4,000 in the preferred and $4,000 in 
the common stock of the United Drug Company. Of the total $300,000 of common 
stock, $140,000 went to Louis K. Liggett, thp promoter and moving genius of the 
whole organization. His plan, in brief, was as follows: 

1. To manufacture staple drug preparations for the stockholding druggists. These 
preparations were to be sold only to the stockholders at prices that should not 
yield a net profit to the United Drug Company of more than 25 per cent— except 
on widely advertised products. 

2. There should be only one stockholding druggist in each town. 

3. All the products should be sold under a single trade-name, and this name 
should be extensively advertised. 



Generally speaking, the successful chains of retail stores have 
grown up from small beginnings.^* Some, however, represent 
consolidations in the sense we are using the term here.'' As 

4. The original subscription of $4,000 from each stockholding druggist was to 
be expended in advertising for the benefit of the druggist in his own town. 

5. Prices should be uniform and each stockholding druggist should have the 
exclusive agency of the company's products. Should he wish to dispose of his 
interest, the stock must first be offered to the company. 

It is obvious from this analysis that the company was not organized to finance 
a chain of retail stores, nor as a means of reducing the expenses of retail selling. 
It was organized as a kind of co-operative enterprise among established retailers 
to supply themselves with standardized and trade-marked prescriptions upon which 
there was a substantial retailer's profit. The chain of stores owned and operated 
by the United Drug Company was a later d«velopment. 

*• Most of the prominent chain stores started with a single store. The chain 
grew solely through the investments of the profits of the established stores in new 
stores. This was true of the chains mentioned in the following table and in no 
case was outside capital added until the chain had attained considerable size. 



First Store 





Rate at 
Out of 

Sales at 








Scottdale, Pa 




JS. 700, 000 


J. C. Penney. 
S. H. Kress . . 


Kemmerer, Wyo. 







Memphis, Tenn . 






C. S. Kresge . 


Detroit, Mich. . . 






^ For example, in 1916 there was a consolidation of two chains of drug stores. 
The stores operated by the United Drug Company (see notes 25 and 28) sold cigars 
at "cut prices." In 191 3, men interested in the tobacco business, particularly the 
United Cigar Stores, becoming incensed at this price-cutting by the United Drug 
Company, acquired control of a chain of 110 retail drug stores known as the 
Riker-Hegeman stores. The purpose was, apparently, to retaliate by cutting prices 
on drug preparations. This was done. In 1916, the United Drug Company of 
Massachusetts was organized which absorbed the old United Drug Company, with 
its chain of retail stores, and the Riker-Hegeman chain of stores. 

"There are other cases in which the consolidation is quite complex; of these the 
American Stores Company and the United Retail Stores Corporation are illustrations. 

The American Stores Company was formed in 19 17 as a consolidation of four 
independent chains. One of these, the Bell Company, was itself a consolidation 
(1905) of the orig^inal Bell Company, established ni 1890, controlling at the time 
28 stores, and the Eagleson Company, established in 1898, controlling at the time 
II stores, which consolidation acquired the Butler Company with 71 stores in 19 15. 
This Bell consolidation had grown to 214 stores in 1917. With the Bell Company 
was consolidated to form the American Stores Company: (i) Robinson and Crawford, 
established in 1891 and controlling 187 stores; (2) Childs Grocery Company, estab- 
lished in 1883 and controlling 268 stores; (3) George M. Dunlop Company, established 
in 1888 and controlling 122 stores; (4) Acme Tea Company, established in 1885 and 
controlling 433 stores. 

The United Retail Stores Corporation was organized in 1919. Its chief component 
was the United Cigar Stores Company. This was originally organized in 1901 to con- 
duct a chain of retail cigar stores but subsequently acquired the stores of the Independent 
Cigar Stores Company, C. A. Whelan and Company, Inc., The Royal Company, 
Moeks Cigar Stores Company, Wm. Baeder and Company, Whelan Brothers, and 
the cigar and drug stores of the United Chemical Company. (See also the first 
paragraph of this note.) With the United Cigar Stores Company was united, in 
1 9 19, to form the United Retail Stores Corporation: (i) the candy factory of 
Feurst and Kramer Company and the Chocolate Products Company, about which 
as a nucleus was built the United Retail Stores Candy Stores, Inc.; (2) Gilmer 


consolidations they have turned out well. Like other types of 
large businesses likely to prove successful, a chain of retail 
distributing stores requires for its management a special and 
unusually able form of executive ability. But once this 
peculiar executive ability is assured the length of the chain 
may be considerably increased without lowering the general 
efficiency of the entire management. No new problems arise 
in the management of a consolidation of twenty stores, of the 
same general character, than existed in the management 'of 
five or ten. No essentially new executive qualities are required. 
Consolidation can therefore be effected provided that the two 
chains of stores are doing the same kind of business, and 
provided also that the ability and experience of management 
required in the new enterprise differ in scope, but not in kind 
from what has been required previously.^^ 

Brothers, operating 9 department and general merchandise stores; and (3) the great 
mail-order business of Montgomery Ward and Company of Chicago. On the whole 
this is the most "hybrid" combination ever attempted in chain store finance; it is 
an indication that the period of steady intensive growth has passed and the period 
of financial exploitation has come — and the future is problematical. 

'* An entirely new problem, not so easily disposed of, arises when an attempt 
is made to consolidate chain stores engaged in dissimilar businesses, or when an 
executive, having made a conspicuous success of one type of chain stores, loses 
his perspective and launches into other lines of business and consolidates these 
with the original chain. To stick to his own business requires great self-control 
on the part of the chain store operator who has overcome every obstacle in building 
up a successful business. 

The consolidation of chains engaged in fundamentally different businesses 
is seen in the United Retail Stores Corporation, described in the preceding note. 
Recently Louis K. Liggett, the guiding genius of the United Drug Company, took 
control at the solicitation and with the co-operation of bankers, of the Winchester 
Repeating Arms Company. This company had become weak through the feeble 
administration of the descendants of the founder and had outstanding a large volume 
of short-term notes. Liggett proposed to start a chain of hardware stores with the 
Winchester Company as a nucleus, and develop them along the same lines as his 
chain of drug stores. The result is distinctly problematical because, no matter 
how much business ability an entrepreneur may possess, there comes a point in 
the extension of enterprise when it is spread too thin. 

The temptation of the chain store to embark in connected but dissimilar busi- 
nesses is a constant and grievous one. The extension back into the fields of 
production is the form it ordinarily takes. Integration back to ultimate production 
and forward to ultimate consumption has been discussed elsewhere (pages 54 and 155 
of present volume) and its weaknesses pointed out. See particularly the memorandum 
covering a contemplated policy of the General Motors Company, note 23. Nowhere, 
however, are these weaknesses so obvious as when integration is attempted by the 
chain store, for the simple reason that retail merchandising is a highly specialized 
business requiring unusual attention to its own detail and very different from 
production in any form. Nevertheless the great distributing power of the chain 
store has led very able chain store managers to assume that they could reduce 
their costs through their own agencies of production. Such a dream is admirably 
illustrated by a quotation from the letter of a prominent official of the Great Atlantic 
and Pacific Tea Company. 

"There is a plan that we have in mind that is economically correct and that 
seems to be the right and proper way of conducting our business, and that is to go 


Besides the usual form of the chain engaged primarily in 
retailing through small stores covering a wide geographical 
area, there are two slight modifications. There is the small 
intensive chain that is restricted to one locality, but covers 
this locality thoroughly. These local chains are very common 
in the grocery trade.^® There is also the chain of retail stores 
operated primarily as the assured means for the distribution 
of the products of a manufacturing business.'" And recently 
tKere have been chains established by jobbing houses in an 
effort to meet the competition of other chain stores which go 
over the heads of jobbers to the original producers.'* 

even farther in the direction of the producer than anyone has gone so far. As 
an illustration of what we mean is the day may come when we will own our 
own farms on which we will raise our own cattle, the milk from which will 
be used in the making of our own cheese, butter, condensed milk, and evaporated 
milk. We probably also will plant our own wheat to be used in the production 
of flour, have our own sugar plantations in Cuba with the refineries on the spot 
for the production of our sugar. 

"Our own rice fields in South Carolina and Louisiana, our olive trees in Spain 
and Italy, our apricot and peach orchards in California, our own canning plants 
on the Pacific Coast to take care of our canned fruit business, our pineapple 
plantations in Hawaii, our chicken farms in Ohio and Michigan, may all become 
part of the general scheme. 

"There is no reason why, with a sufficient output we should not be able to 
grow our own teas in India and Ceylon, catch our own fish in the Columbia River 
for the canning of salmon, and develop our business along the lines of the large 
packers such as Swift, Armour, Wilson, Cudahy, and Morris." 

The observer, in addition to recognizing the economic fallacy of this kind of 
dream, may perhaps recall what the great analyst of human character has said 
about vaulting ambition o'erleaping itself and falling on the other side. 

" Although the locality of metropolitan Boston is quite thoroughly covered by 
the grocery stores of the Great Atlantic and Pacific Tea Company, there are three 
other large grocery chains which have developed the region intensively. The John 
T. Connor Company has i6o stores in metropolitan Boston, and some 65 in towns 
within a radius of a few miles. The Ginter Company has approximately the same 
number of stores in the same locality and "is opening approximately two new stores 
a week." 

* The retail stores of the United Drug Company were established, originally, 
to provide enlarged distribution for the manufactured products of the United Drug 
Company. A chain of candy stores known as Loft, Inc., has been established in 
metropolitan New York, to distribute the candy manufactured by a concern of the 
same name, established just before the Civil War. Most of the chains of retail 
shoe stores were established primarily to furnish a dependable outlet for special 
shoe factories. As a whole these retail shoe store chains have not proved successful 
because a shoe store must be prepared to offer a greater variety of shoes — men's, 
women's, and children's, McKays, welts and turns — than can be economically manu- 
factured by a single shoe factory or combination of factories. 

" The chain of department stores established by the H. B. Claflin Company 
had exactly that origin. When the dry goods jobbing business centered in New 
York, during the twenty years following the Civil War, the Claflin organization was 
one of the most prominent, if not the most prominent in the city. But jobbing 
houses sprang up in the West. Larger retail department stores went over the 
heads of the jobbers to the mills and importers. To maintain their business the 
Claflin Company slowly established a chain of retail department stores. It was 
the weight of these that, primarily, caused the Claflin failure. (See note 21 of 
this chapter.) 

The grocery jobbers have had their business seriously affected by the chain 
stores. Lichtenstein and Hirsch, jobbers, opened up a chain of twenty-five "economy 
stores" in the vicinity of Savannah, Georgia. 98 Printers Ink 66 (March i, 1917). 


The two considerable sources of economy in the operation 
of chain stores are wholesale buying and "short-cut" devices 
in the administration of retail store organization. The former 
is a matter of considerable importance. The small retail 
merchant has always found intelligent and economical buying 
one of his most difficult problems. He ordinarily has neither 
the time nor the knowledge to seek out his sources of supply, 
but must needs take what traveling salesmen are able to sell 
him. If his store is in a town of less than ten thousand 
inhabitants — in such towns chain stores have been exception- 
ally successful — the small merchant has the disadvantage of 
very little competition among the jobbers and his weak credit 
often requires that he confine his purchases to a single jobbing 
house. This results, necessarily, in giving him a narrow selec- 
tion of merchandise purchased at relatively high prices. The 
buyers for a chain of stores are able to buy as closely and 
intelligently as jobbers themselves.^^ They can cover the 
market thoroughly. They can purchase job lots of varying 
size, without direct reference either to the intermediate market 
or the limited credit of a single store. Furthermore, by offer- 
ing manufacturers large orders at slack times when their fac- 
tories would otherwise run at less than normal and efficient 
capacity, they have often obtained merchandise at less than 
the actual gross cost of production. By means of these ex- 
pedients the chain store is able to place goods on its shelves 
at a lower cost than the local proprietary store. 

Probably the most conspicuous gain in the operation of 
a consolidated group of retail stores is in the detailed manage- 
ment of the stores themselves. The proprietor of the small 
store usually conducts his business in what might be called 
an unscientific manner. His system of accounting is poor, 

** The purchases of a single commodity by the Atlantic and Pacific chain of 
grocery stores are so extensive that, in this particular instance, they have been 
able to get the goods from the manufacturers at approximately lo cents a case 
less than the prevailing wholesale prices to jobbers. On the other hand, heavy purchas- 
ing contracts may entail losses, as the sugar contracts of this same chain in 1920. 


SO that he is ignorant of his "overhead" expenses and the true 
cost of his goods. He does not know where to economize 
and where to be Uberal in his expenditures. Tradition and 
methods sanctified by years of use cannot be dislodged. His 
business lacks buoyancy and resilience. In contrast, the man- 
ager of the chain store has no traditions, no preconceived 
notions of business expediency; he has no friends or relatives 
to be maintained for reasons of sentiment or pride. His 
methods of accounting are thoroughly modern, so that the 
detailed results of every one of the chain of stores can be 
compared and the efforts of each local manager scientifically 
valued. Retail salesmanship is reduced to a science, so far as 
American resourcefulness makes it possible.^^ The very suc- 
cess of the chain store consists in suppressing personal in- 
dividuality and making uniform a tried, workable system of 
store management which has nothing particularly striking about 
it except its very colorlessness. In certain cases this colorless- 
ness is carried to the extreme of doing away, utterly, with any 
attempt to serve the customer, as in the "Piggly-Wiggly" and 
"U-save" stores where the customer collects his merchandise 
from the shelves himself, pays for it and carries it away under 
his arm.^* The personal factor is entirely eliminated and with 
it "service" as an element in retail merchandising. 

** Much has been written regarding the actual economy of the chain store at 
compared with the local proprietary store. The most accurate and instructive 
comparison can probably be made between the proprietary grocery and chain grocery 
stores. The comparison is actually between a retail grocer, purchasing through 
a jobber and offering customers deliveries and credit, and the chain store purchasing 
direct from the manufacturer and offering neither deliveries nor credit. As a basis 
of comparison, suppose both the jobber and the chain store buyer paid $i net 
to the manufacturer for merchandise. To this the jobber will add approximately 
121/2 per cent (Price, T. H., Outlook, November, 1916), transmitting the merchandise 
to the retailer at $i.i2}4. The retailer must then add an average of 21 per cent 
to his cost (Bureau of Business Research, Harvard University, Bull. No. 13) in 
order to cover his services to the consumer and save a net profit to himself of 
from 2.5 to 5.5 per cent. The merchandise is sold to the consumer at $1.36^. The 
chain store of the ordinary type must add 17 per cent to its costs to cover buying 
and selling expenses and leave a margin of approximately 3.5 per cent net profit. 
See table given in note 37 of present chapter. The merchandise goes to the consumer 
at $1.17, or a saving of over 50 per cent in the total cost of distribution. 

** In chains of this type merchandise is placed on the shelves and in bins and 
conspicuously priced. The customer enters tne store and passes about collecting his 
purchases in a basket. When he has served himself to his satisfaction he presents 
the basket of goods to a cashier who assesses the total cost. The customer then 
pays the amount, and carries away his purchases under his arm. The system has 


The type of retail chain store that has proved most suc- 
cessful in the past and that will probably be found most suc- 
cessful in the future is confined to those fields of merchandising 
where individual personal services of the storekeeper are least 
important. In general this includes the distribution of those 
kinds of commodities which are frequently bought in small 
quantities by the ultimate and immediate consumer — the cheap, 
common articles of daily consumption. And it is in exactly 
such lines — cafeteria restaurants, grocery stores, drug stores, 
cheap dry goods, and notions stores — that the retail chain has 
been most successful. In a purchase from a store of this 
kind the salesman is merely a cashier. As the price paid is 
small, the transaction is completed in a moment's time; no 
credit is extended and the customer carries away his purchase. 

Statistics have been gathered covering the financial results 
of nine retail chain stores during a single year.^^ The list 
includes, with one exception,^® all of the most successful chains 
having anything like a national scope of operation. In every 
case the commodities distributed are low in price, but of con- 
stant and universal demand, so that the total national con- 

been most cleverly developed by Clarence Saunders who has patented the fixtures, 
accounting forms, and general methods under the name "Piggly-Wiggly." Territoriea 
are licensed. The licensee must buy his fixtures from the Piggly-Wiggly Company 
and pay over to it J4 of i per cent of the gross sales. Saunders' first store was 
in Memphis, Tennessee. Here he did a gross business of $114,000 at a net expense 
of $3,400 (about 3 per cent) during the first six months. From this beginning the 
idea spread through the South and Middle West where over 250 stores had been 
established by January, 1920. In March, 1920, an allied company had been organized 
to manufacture merchandise for the Piggly-Wiggly stores. The whole movement 
is very interesting and instructive, especially as the total cost of operation has 
been, in well-managed stores, reduced to less than 3 per cent of _ the total gross 
sales. It represents the most economical form of retail merchandising yet devised. 
For details see a rather self-laudatory pamphlet entitled "Concerning Piggly-Wiggly," 
by Saunders, C. Also Saunders, C, "Facts about Piggly-Wiggly," loi Printers 
Ink 17 (Dec. 20, 19:7). Also Brief articles Jour, of Commerce, Nov. 20, 1917; 
Boston Transcript, Sept. 3, 1919; United States Investor, Dec. 13, 1919. 

•'The year chosen was the calendar year of 19 19. But the fiscal year of the 
various chains studied does not always coincide with the calendar year. The fiscal 
year chosen for comparison was the one including six months or more of the calendar 
year 1919. 

••The United Drug chain was not included for two reasons. The accounts are 
not presented in such a form that the capital invested in the retail drug stores 
owned entirely by the United Drug Company can be segregated from the rest of the 
capital. And this _ is true also of the gross sales, gross and net profit. The total 
revenue of the United Drug Company is derived from three sources — the manufacture 
and sale of proprietary products, the income of subsidiary enterprises, like the 
production of rubber hot-water bottles, and the ownership of an extended chain 
of retail drug stores. 



sumption is enormous. The stores do not create a demand, 
they merely satisfy an already existent demand. A comparison 
of the figures is instructive. Perhaps, from the standpoint 
of retail merchandising, the results of greatest interest are 
the rapid rate at which the capital is turned over and the 
small margin of net profit in comparison with the gross sales. 
These two outstanding facts explain the merchandising success 
of the chain store, in comparison with the personally owned 
local store. The statistics, therefore, merely illustrate the 
theoretical analysis of the whole chain store movement.^' 

A fourth group of industrial combinations, having to do 
with foreign trade, has proved successful and is likely to 
prove more so as international competition after the Great 
War becomes increasingly intense. So far as the United States 
is concerned these combinations are of comparatively recent 

•'Chain Store Statistics for the Year 









American Stores Co. . . 
Great Atlantic and Pa- 
cific Tea Co 






































3. 531. 594 







g and lo Cent Stores: 
C. S. Kresge Co 

S. H. Kress and Co... 

McCrqry Stores 

P. W. WoolworthCo.. 


Childs Co 







Waldorf System 

J. R. Thompson 

Dry Goods: 
J. C. Penney 


United Cigar 

• This figure is approximate only as the company refused to give the exact figure. 
It has been checked by independent, indirect sources and is believed to be sufficiently 
accurate for these purposes. 



origin. They are of two distinct classes. The one class repre- 
sents a combination of shipping companies, each one of which 
had done a more or less localized foreign trading business. 
The other class represents a combination of American produc- 
ing companies, organized for the specific purpose of exporting, 
in close co-operation with each other, their surplus production 
to foreign parts. It is quite possible, as our enlarged foreign 
trade becomes stabilized, that the two kinds of export busi- 
ness will coalesce, but this has not occurred as yet. 

The first class is spoken of as export companies, or export- 
ing corporations. They produce no merchandise themselves, 
but act merely as foreign merchants on a large scale. Before 
the Great War much of our foreign commerce was handled 
by agencies or small exporting merchants who did a restricted 
business, confined to relatively few localities, perhaps to a 
single one.'* The merchants and manufacturers of this coun- 





















American Stores Co. . . 
Great Atlantic and Pa- 
cific Tea Co 














4. 22 


S and 10 Cent Stores: 

C. S. Kresge Co 

S. H. Kress and Co... 

McCrory Stores 

F. W. Wool worth Co. . 


5. 34% 
4 04 












IS. 226 









4- 13 



Childs Co 

















S3 88 

Waldorf System 

J. R. Thomijson 

23 39 


Dry Goods: 
J C. Penney 


7. IS 










6. 14 

United Cigar 


* For example, one of the most successful American agencies of this character, 
W. R. Grace and Company, was conspicuously strong on the west coast of South 


try were, before the Great War, so intensely concerned with 
exploiting our own natural resources and developing our own 
markets that they entirely neglected export trade, except for 
an occasional spasmodic onslaught, when there happened to 
be a glut in our own domestic markets. But with the closing 
of neutral markets to the European belligerents, during the 
Great War, an unprecedented and extraordinary opportunity 
to enter foreign trade was offered to American exporting 
houses. In response to the pressure suddenly placed upon 
them, these exporting houses either expanded their businesses 
with the aid of new capital or else combined among themselves 
into large, widely extended organizations. These combina- 
tions have, thus far, been uniformly successful. They com- 
mand large capital and credit and widely extended banking 
connections. As manufacturers' agents, they are able to reach 
many more markets than is possible for a single exporter. 
Several of these combinations have embraced smaller organiza- 
tions with widely separated agencies — as a combination be- 
tween one exporting concern doing business in Central America 
and ports of the Caribbean Sea and another doing business 
on the east coast of South America.^^ As merchants, doing 
exporting for their own account, they are able to develop a 
much more accurate and comprehensive understanding of 
foreign demands than is possible for small exporters with 
very limited markets. In this manner they are able to exercise 
far more intelligence in purchases for their foreign accounts 
than could the small exporter. And in addition to the wider 
facilities for merchandising American products these combina- 
tions are able to control steamship companies, wharves, storage 
warehouses, besides having command of considerable banking 
and credit facilities. 

America. It did comparatively little, however, on the east coast and practically 
nothing in Venezuela. Other export companies were much more confined, even, in 
their respective "spheres of influence." 

*■ A certain combination embraced one concern with agencies in South America, 
one with agencies in Scandinavia, and a third with agencies in Mediterranean ports. 


The other class of industrial export companies is almost 
too recent in origin to be included in this survey, except by- 
way of prophecy. It includes the consolidations of manufac- 
turers legalized by the so-called Webb bill. Ever since 
prosecutions under the Sherman Act of 1890 began to inhibit 
the formation of new consolidations and cause terror to those 
already' formed, business men who believe in large-scale pro- 
duction have argued for the need of consolidations on the 
ground of foreign trade. The contention that large-scale units 
of production in this country are required in order to meet 
successfully the large-scale units of other countries looms 
large in their apology for the trusts. And it has a sound 
basis in fact and theory. The small business has not at its 
command the capital, the organization, the flexibility of pro- 
duction, even the intellectual grasp of commercial affairs, to 
enable it to enter successfully the field of foreign trade. It 
is urged, therefore, that public policy, which requires that 
foreign commerce shall thrive under the best auspices, should 
countenance the large industrial consolidations. Some even 
advocated that the Sherman Act should be repealed or at best 
modified so as to legalize industrial consolidations engaged in 
foreign trade. By no other means, they believed, could Ameri- 
can export trade be developed. The Webb bill was the com- 
promise between those who would encourage consolidations 
in order to promote foreign trade and those who would pro- 
hibit them in order to prevent monopoly in domestic trade. 

The Webb Act provides that American export business be 
liberated from the restrictions of the Sherman Act of 1890. 
It enables manufacturers to combine for the purpose of carry- 
ing on foreign trade, even though such combinations are 
specifically prohibited by the Sherman Act. Under the Webb 
bill domestic competitors may collectively form an export cor- 
poration which markets a certain proportion of the output 
of all the competitors, each one of which assigns to the export 


company a stated percentage of its production. The act pre- 
sumes that manufacturers can be associated in their foreign 
business and yet remain competitors in their domestic business. 
It requires a kind of trade duplicity. Part of this dupHcity 
is a pure fiction and part is based on sound economic principles. 
In so far as the Webb bill presumes that foreign business can 
be carried on without affecting domestic business, it is an 
anomaly; but so far as it presumes that foreign business 
requires the continued support of a large producing organiza- 
tion, it is absolutely sound. In this it is merely copying what 
European nations have already done in building up their 
foreign commerce. And without this support our rapidly 
expanding foreign trade would be stifled by the very anxiety 
of the small producers to preserve their existence at least under 
the necessarily competitive conditions of the domestic market. 
In other words, some kind of organized and united effort must 
take place in order to enable American manufacturers to export 
their merchandise in competition with the organized and united 
efforts of European exporting organizations. But whether 
the problem is to be solved by combinations among export 
houses themselves, which carry many lines into a few highly 
developed markets, or by combinations of manufacturers carry- 
ing a single product into many markets, only the future devel- 
opments of commerce can tell. 



Methods of treating subject, 69; Analysis of forms, 71; The 
lease, 74; Traffic leases, 76; Gross earnings leases, 76; Net earnings 
leases, yy. Fixed rental leases, 79; Stock control by purchase, 83; 
Stock control by exchange, 85; Stock control by collateral trust 
bond, 86; Outright purchase, 92; Historical periods of railway con- 
solidation, 94; First period of end-to-end consolidations, 96; Second 
period 100; Third period, 106. 

A study of the expansion and consolidation of American 
railways is now a matter of little more than nistorical im- 
portance. While there are likely to be many changes in the 
corporate and financial organization of the railways, in the 
years succeeding the government operation of the period of 
the Great War, still the changes will inevitably follow lines 
different from those during the long period between the com- 
mencement of railway consolidation in the early forties and 
the assumption of federal control on January i, 19 18. The 
enactment of the Cummins bill, under which the private opera- 
tion of the carriers was resumed, has given the government 
a direct and explicit supervision over changes in operating and 
financial control. The welfare of each road is now completely 
conditioned and circumscribed by theories of general public 
expediency. The period of promotion and personal direction 
during which the railway net was built, ended at the opening 
of the Great War; and with it ended, too, the expansion and 
consolidation of railway properties in the sense that these 
terms could be made to apply to the railroad history of previous 



But although now a matter of historical importance only, 
the expansion and consolidation of our railways afford most 
striking examples of complex corporate organization. From 
the point of view of the use of the holding company, railway 
consolidations have not, perhaps, been quite so prolific in 
anomalies and complexities as the consolidations of lighting 
and power companies. Yet from every other point of view, 
and by the use of every other legal and intercorporate device 
within the inventive power of astute lawyers and even more 
astute financiers, the history of American railway consolida- 
tions affords the most fertile field for the study of intricate 
financial legerdemain. Most, if not all, of the subtleties of 
"high finance" originated in connection with some problem of 
railway consolidation. For these reasons the subject demands 
detailed and exhaustive attention. 

The general topic of railway expansion and consolidation^ 
may be studied from five different points of view. The first 
and most exhaustive would be a detailed study of the genesis 
and development of each large railway system of the United 
States. Such a method would be exhaustive and cumbersome 
beyond the limits of a single volume, and out of question for 
a single chapter.^ Another method, akin to this, but more 

* The general topic of railroad consolidation and expansion has been treated 
many times with varying degrees of fulness and acumen. Many writers fail to 
assume a scientific point of view, unaffected by a personal prejudice for or against 
the social expediency of railroad consolidation. Perhaps the best study of the 
kind, written when railroad consolidation was looming up as a great social and 
political problem was Ripley, W. Z., Transportation, 19 U. S. Indus. Com. Rep. 
259 (1902). Other studies are: Newcomb, Recent Great Railway Combinations; 
Cunniff, Increasing Railroad Consolidation; Intercorporate Relationship of Railways, 
as of June 30, 1906. Special Report I. C. C. (1908); Cleveland and Powell, Railroad 
Finance, 272 (191 2). 

* There have been a large number of historical studies of the development of 
single railway systems. A few such are: Davis, J. P.. The Union Pacific Railway 
(1894); White, H. K., History of the Union Pacific Railway (1895); Hinsdale, E. B., 
History of the Long Island Railroad (1898); Smalley, E. V., History of the 
Northern Pacific (1883); Mott, E. H., Between the Ocean and the Lakes (Erie) 
(1901); Dozier H. D., History of the Atlantic Coast Line (1920); Wilson, W. B., 
History of the Pennsylvania Railroad (1899); Gary, F. E., Lake Shore and Michigan 
Southern Railway (1900); Stennett, W. H., Yesterday and Today (Chicago and 
Northwestern) (1905); Gary, J. W., Organization and History of the Chicago, 
Milwaukee and St. Paul Railway (1893). 

In connection with the physical valuation of railroails very careful empirical 
studies have been made of the corporate history of each of the components and 
antecedents embraced in the railroad being valued. Although these digests are nothing 
more than corporate skeletons they afford extremely accurate epitomes of individual 
railroad history. 


cursory, would be to trace the consolidation of railways accord- 
ing to large geographical divisions of the country.^ Such a 
study, however, would turn rather upon the physiographical 
and operating features with which each railway system must 
contend, than upon the conditions and problems of its financial 
structure. A third method would be to consider railroad 
expansion and consolidation in terms of the motives under- 
lying each case. Sometimes the motives have been purely 
economic, sometimes they have had their roots in ambitions 
and personal jealousies ; sometimes they have been of a political 
nature ; sometimes they have sprung from stock market opera- 
tions and the machinations of speculators. To make such a 
study in a comprehensive manner, however, is practically im- 
possible because of the limited data available; and the true 
motives that have led railroad financiers to adopt the courses 
that they have followed are seldom confessed by the men 
themselves. A fourth method would be to describe railroad 
consolidations according to the historical periods during which 
different waves of consolidation have been most conspicuous. 
This method is followed in the latter part of this chapter. 
A fifth method would describe the various legal and financial 
expedients that have been employed in the past, and that 
account in large measure for the intricacies and anomalies 
of the present corporate structure of the railway system. These 
expedients comprise the means taken to develop railway sys- 
tems out of the original heterogeneous and disjointed separate 
lines. They constitute the structural forms of railway con- 
solidations. This method will be pursued in the present study 
as it affords a sound basis for considering railroad consolida- 
tions from the point of view of financial policy. 

In detail the means employed to effect the consolidation 

* This is the method pursued by Ripley in his comprehensive outline of railway 
consolidations. Ripley, W. Z., Railroads, Finance and Organization. Chap. XIV: 
"Combination: Eastern and Southern Systems"; Chap. XV: "Railroad Combination 
in the West" (1915). 



of railway lines in this country have been as varied and com- 
plex as the irregular and unsystematic growth of our railway 
network would indicate. Every possible device has been tried 
at one time or another. These devices vary greatly in the 
degree of closeness of union they bring about — in the coher- 
ence and rigidity of the resulting consolidation.* Any form 

* It is possible perhaps to describe railroad consolidation in terms of a series 
of devices varying in closeness of connection from mere traffic agreements — not 
consolidations at all — at one end of the series, to absolute ownership at the other 
end. A series of such types would run somewhat as follows: 

1. Traffic agreements, interchange of traffic being optional. 

2. Pools, with central bureau having autocratic direction of routings. 

3. Traffic agreements with provision for exclusive traffic interchange when possible. 

4. Lease. 

5. Control by the ownership of a majority or working minority of the stock. 

6. Lease and partial or entire stock ownership. 

7. Ownership of entire capital, but the subsidiary road operates under separate 

franchise rights and maintains a separate corporate existence — and possibly 
a separate name. 

8. Absolute ownership, either through the outright acquisition of the real estate 

and personal property or else through the complete extinction of the separate 
existence of one or more corporations. 

All these forms of loose and close combination among railroads must be dis- 
tin^ished from any of the forms of "community of interest" among railroads. 
This latter is not consolidation at all. It is discussed in another chapter — 
Chapter VI. 

Other attempts have been made to_ separate from each other and to classify 
the various types of railroad consolidation and railroad control. One of the most 
carefully worked out is that given by the Interstate Commerce Commission in its 
Report on Intercorporate Relationships of Railways, 15 (1908). Quoted in condensed 
form in Cleveland and Powell, Railroad Finance, 281 (191 2). 

Control of or over a corporation means "ability to determine the action" of that 
corporation. Control has been classified under eight different headings: 

1. Right to possess all the property of the corporation except its instnunentalitiea 
of organization. 

2. Right to possess all the property of the corporation except its instrumentalities 
of organization, its money, and its choses in action other than corporate securities. 

3. Right to possess such portion of the tangible property of the corporation as 
is capable of being employed in discharging the duties of a common carrier. The 
principal form of control contemplated under this class, as well as under class 
2, is the control effected through lease, class 2 difiFering from class 3 only in the 
extent of the property and interests covered by the contract. It has been ur^ed 
by many of the carriers that a lease of the tangible property of a corporation 
does not constitute control of the corporation; that it merely gives possession of 
certain physical property and in no way interferes in the management 01 the corpora- 
tion itself. This contention has some merit; but in view of the fact that the 
provisions of lease contracts vary so widely in the extent to which they allow 
participation in the affairs of the lessor corporation, and that even the most simple 
forms of lease agreement are likely to bring about, either directly or indirectly, 
a very considerable degree of control, it did not seem wise or practicable to 
eliminate lessor corporations from the railway systems into which their contracts 
brought them and to class them as independent carriers. It has been felt that the 
inclusion within a particular system of all railways leased by any corporation within 
that system would better present the existing intercorporate situation. Any possible 
misunderstanding that might arise from this practice has been guarded against in 
the table by the reservation of a special column in which the character of the 
intercorporate relationship is stated. It has also been the practice in this tabulation, 
where a corporation was owned by one corporation and leased to another, to assign 
it primarily to the system in which it was owned. 

It should be especially noted that this classification distinguishes between leases 
and trackage rights. For the purpose of this compilation a lease is understood 
to give control, either sole or joint, over_ the lessor corporation. A mere right to 
use a portion of a track in company with the owning corporation is a trackage 
agreement and is excluded from consideration. 


of relationship among railroads, sufficiently close to be deemed 
^ a consolidation, must involve an absolutely unified control of 
:i the technical and financial affairs. The roads must be operated 
as one; the control of their financial operations must be thor- 
oughly and completely unified. This excludes from the scope 
of railroad consolidations mere pools and traffic agreements, 
no matter how close ;^ it also excludes the various forms of 
"community of interest" in the railway world by which a 
single man or banking institution, or group of men exercise 
dominion over several railway systems. 

Railway consolidation, in the broad but restricted manner 
in which the term is used here, implies the direct merger of 
financial and operating control. It is brought about by either 
lease or direct ownership, or both. And direct ownership 
may be either through the ownership of stock or the complete 
merger of real and personal property, with the total extinction 
of the separate existence of one or more corporations. These 
are types. A great many cases exist in which consolidations are 
effected by both lease and merger. And the particular forms 
of these fundamental types are as various as the ingenuity 
of man can invent." But for the sake of simplicity of exposi- 

4. Right to exercise the major part of the voting power attached to the shares 
of stock and other securities of the corporation. 

5. Right to name the major part of the board of _ directors of the corporation, 
whether by virtue of voting trust agreement or by virtue of title to securities or 

6. Right to foreclose a first lien upon all the property of the corporation. 

7. Right to foreclose a first lien upon a major part of the property of the 

Forms 6 and 7 constitute control for the purposes of this compilation only in 
case the securities which constitute the lien have matured, or the interest upon 
such securities has been defaulted, and the right to foreclose such lien has not 
yet been exercised. The mere possession of the unmatured first mortgage bonds 
of a solvent corporation would not, from the standpoint of this investigation, 
constitute control. 

8. Right to determine the action of the corporation in a specific respect or 

This last class is intended to cover any peculiar forms of control not included 

in the other classes. Under this class would fall control throup:h advances for 

construction purposes, which is referred to under a separate heading later in this 

' Steps I to 3, in the first part of the preceding note. 

• Financial legerdemain has led the way and the legislatures and courts have 
followed in the distant background. The stakes in the game of railroad consolidation 
and the manipulation of values have been so large that the game has attracted men 
endowed conspicuously with constructive and imaginative ability. The men who 
played at the game of railroad consolidation were more able and resourceful than 


tion we shall consider the lease and the ownership as the two 
primary types of consolidation. Each has modified forms and 
these will become clear from a detailed study. 

' /• 

Consolidation by means of the lease of one railroad prop- 
erty by another secures the benefits of united operation with- 
out the financial cost involved in the outright purchase of a 
railroad property or even of the controlling shares in a rail- 
road property.^ This is the chief advantage of the lease; 
its disadvantages will become apparent presently. 

The feature of importance in all lease agreements is the 
compensation. This is either fixed or contingent. In the fixed 
rental leases one railroad corporation agrees to pay to another 
railroad corporation or to its security holders a stipulated 
annual amount; in the contingent rental leases the annual 
payments depend on some variable element, such as earnings 
or the volume of interchanged traffic. During the earlier years 
of railroad consolidation, perhaps down to the period follow- 
ing the panic of 1873, the two forms of rental payment were 
about equally common. A railroad corporation paid the fixed 
rental when the line to be leased had proved its earning capac- 
ity through a period covering several years of operation, 
whereas the contingent rental was insisted upon in those cases 
in which the earning capacity or the volume of the inter- 
changed traffic was yet undetermined, or where the relative 
value of the leased line was entirely problematical. * This prin- 

the statesmen and justices who were supposed to keep their predatory instincts in 
check. Simon Sterne, writing in 1888 when railroad consolidation was in full 
swing all over the country, stated: "The intelligence of our law administrators is not 
equal to the intelligence of our leading bankers and railway magnates. . . . The 
industrial development of this age has oeen far beyond the judicial development. 
. . . The consequence is that the applied arts and sciences have invited into their 
fields the strongest and best intellects of the community, and they are better equipped 
than the law administrators in ingenuity and intellectual alertness. . . . The law in 
the machinery of formation has not kept pace with the general development of 
the community." Sterne, S., "De Maximis non Curat Lex," reprinted in, Railways 
in the United States, 200 (1912). 

' A copy of a typical corporate lease is given in Gerstenberg, C. W., Materials 
of Corporation Finance, 555 (1915)- 

• This principle is excellently illustrated by a study of the early lease agreements 
of the Pennsylvania Railroad. No less than 48 little railroad corporations all 


ciple would apply even to the extent of dividing a line into 
two parts, the better established part carrying a fixed rental, 
while another part with a lower density of traffic carries a 
contingent rental.® In later years subsequent to the panic of 
1873 and when the large railway systems were emerging from 
the chaos of disconnected lines, the fixed form of rental 
became much more common than the contingent form, so that 
now a fixed and perfectly rigid rental is the usual form of 
compensation under a lease. And this is true whether one 
considers the number of effective leases or the importance 
of the lines involved.^" 

Uncertainty about the future was, in the past, the usual 
reason for adopting the contingent rather than the fixed rental. 
It was — and still is with but few unimportant exceptions'^ 
— based on one of three methods of computation. The rental 
is made contingent: ( i ) on the volume of traffic interchanged ; 

(2) on the gross earnings of the leased line from all sources; 

(3) or else on its net earnings.'^ 

representing roads less than a hundred miles in lengrth and many less than ten 
miles in length were held by the Pennsylvania Railroad in 1893 under lease. Many 
of these lines were first leased on a contingent basis and later on a fixed basis. 
(The year 1893 is used as a basis of a study of railway leases because this year 
is regarded as marking the end of the period of direct railway consolidation — 
the formation of single railway systems in contradistinction to the formation of 
systems of systems, which characterized the later period. See note 30.) 

• This was exactly the case of the original lease of the New Haven and the 
Northampton Railroad in 1849 and 1850. The section from Plainville to Granby 
together with certain branches was leased by the New York and New Haven Railroad 
for an annual fixed rental of $40,000. The portion of the line from New Haven to 
Plainville was leased to the same road "at an annual rental of $45,000, provided the 
gross earnings should amount to $75,000 a year, any deficiency in that amount to 
be deducted from said rent, and any excess thereof to go one-third to the lessor 
and two-thirds to the lessee." 

'• See the results of the statistical study given in note 30. 

" Were one disposed to find cases of irregular and unusual contingent rentals 
in the history of railroad consolidations, the task would not be difficult. Many 
variables, other than some form of the three here mentioned, have been used. For 
example, the Massawippi Valley Railway was leased in 1870 to the Connecticut and 
Passumpsic River Railroad. The latter road agreed to pay as rental the annual 
interest on Massawi|)pi bonds and a dividend on the Massawippi stock of the same 
rate as it paid on its own stock. A simpler plan was used in the lease of the 
Southwestern Railroad to the Central Railroad and Banking Company of Georgia 
(August, 1869) only here the rental had a minimum of 7 per cent on the stock, 
and I per cent above this for every i per cent of the Central Railroad's dividend 
above 9 per cent. 

" This classification does not include those border-line cases in which the associa- 
tion amounts to little more than a rigid traffic agreement, or at most a lease, so 
casual and contingent in its provisions as to nullify any effectiveness as a means 
of consolidation. For illustration, in 1879 the New York, New Haven and Hartford 
Railroad agreed to operate the Boston and New York Air Line Railroad. The 


The traffic interchange rental leases are used in cases where 
a trunk line wishes to control some connection, without assum- 
ing complete control of its operation and without assuming 
any financial responsibility for its independent success." This 
is probably the loosest form of union among railroads that 
can be dignified by the name of consolidation. It is resorted 
to only in cases in which the structural unity of a railroad 
system will not be seriously harmed by the loss of the leased 
line. A lease of this character varies from the ordinary traffic 
agreement only in the length of time it may be presumed to 
last" and the relatively greater legal bond it establishes between 
the roads. But for these reasons it is merely a makeshift. 
If a loose connection is sought for, resting on the mutual 
advantage of traffic interchange and that alone, the ordinary 
traffic agreement is preferable; if a strong connection is 
desired, which shall effect an actual consolidation of lines — 
not a mere agreement for mutual help — then some other form 
of union is much to be preferred. 

Rental payments depending on the gross earnings were 
the commonest form of contingent rentals during the period 

agreement was to run for five years. The New Haven road was to pay 6 per cent 
of the gross earnings during 1879-80 and 6 per cent later. In 1882 this loose 
agreement was canceled and the New Haven road leased the Air Line on a fixed 

1* An interesting type of this is afforded by the contract between the Grand 
Trunk Railway of Canada and the Central Vermont Railway (a Vermont corporation). 
The former owns $2,164,500 par value of the latter's $3,000,000 of stock. But the 
real value, such as it is, of the Vermont Central was represented by approximately 
$11,000,000 P'irst Mortgage ^i per cent Bonds refunded in 1920. These were 
guaranteed as to interest only by the Grand Trunk Railway of Canada, up to 
30 per cent of the gross revenue received from the traffic interchanged between 
the two roads. 

In rare cases a minimum is specifically mentioned: thus the lease (February, 
1869) of the Sandusky, Mansfield and Newark Railroad to the Central Ohio required 
a minimum of $174,350, and in addition 15 per cent on a portion of the gross 
traffic interchanged. 

" The time element is less important than might appear, because short leases may 
be continually renewed and long leases are usually "Adjusted" if too one-sided. In 
19 1 8, of the 205 cases studied (note 30) the following were the original periods. 

Original length "On Notice" Under 20 yrs. 21 to 49 yrs. 50 to 99 yrs. 

Number of cases 10 17 18 69 

Original length 100 to 1,000 yrs. Perpetuity Corporate or Charter Life 

Number of cases 61 19 11 


in which the great systems were built up." Out of a selection 
of sixty important contingent leases in force January, 1893/" 
forty-four were contingent on gross earnings. The rentals 
varied from a minimum of 20 per cent^^ up to a maximum 
of 50 per cent.^* The most frequent specific gross earnings 
rental was 30 per cent.^^ In quite a number of cases the propor- 
tional rental varied according to the magnitude of the gross 
earnings — the rental being greater as the earnings were 
greater,^" or else increased with the passage of time.*' 

The variability of the cost of operation through a long 
period of time has led to the frequent use of net earnings 
as the basis for computing a contingent rental charge. While 
not so frequently used as gross earnings, in the period during 
which railway systems were being built up,^* it was almost 
universal among certain systems. Practically all of the Penn- 
sylvania's leases were of this kind, for example.^^ These net 
earnings rentals were of two kinds — either the whole of the 

**This statement is subject to broad exceptions. For example, none of the 
Pennsylvania Railroad's early leases — although most of them were of the contingent 
form — rested on gross earnings solely. One or two of the Pennsylvania Company's 
leases, like that of the Massillon and Cleveland Railroad, were of this type. See 
note 30. 

'* See note 30; leases of the Pennsylvania system not included. 

"The old Massachusetts Central Railroad was sold at foreclosure in 1883 and 
reorganized as the Central Massachusetts Railroad. This was leased to the Boston 
and Lowell Railroad for 20 per cent of the gross earnings up to $1,000,000, 25 per 
cent on amounts above. 

1* The Holyoke and Westfield was leased to the New Haven and Northampton 
Railroad at 50 per cent of gross earnings. 

'•The result of this tabulation has, perhaps, some interest, as showing the various 
kinds of gross rental leases prior to the beginning of the amalgamation of railway 
systems, in 1893. 

Gross Rental 20% 225^% 25% 30% 33 i/3% 35% 3754% 40% 50% 

No. of Cases i i 9 15 4 7 3 3 i 

*> For example the St. Louis, Vandalia and Terre Haute Railroad was leased 
to the Terre Haute and Indianapolis Railroad at 30 per cent of gross earnings 
which increased gradually to 35 per cent as the operating ratio was reduced below 
70 per cent. 

The old New London Northern Railroad was leased to the trustees of the 
Central Vermont Railroad in 1871. The trustees agreed to pay a minimum of 
$150,000 a year, and $15,000 a year for every $100,000 of gross earnings in excess 
of $510,000. 

" The Kansas City and Pacific Railway was leased August 1, 1890, to the 
Missouri, Kansas and Texas Railway for ^q per cent of gross earnings for the 
first five years and 33 1/3 per cent thereafter. 

^ See statistical study, note 30, covering leases existing in 1893. 

*• See note 30. 


earnings, above operating expenses, were considered the rental, 
or else only a certain proportion. Almost invariably, in those 
cases in which the entire net earnings were regarded as the 
rental, the operating company owned all the securities of the 
leased line subsidiary. This is today the condition of most 
of the Pennsylvania Railroad's "net earnings subsidiaries," 
although originally many of these subsidiaries had outstanding 
securities in the hands of the public — mostly bonds — the in- 
terest or dividends on which the Pennsylvania was forced to 
include among the operating expenses of the leased sub- 
sidiary." When the rental is a percentage of the net earnings 
it is usually a large proportion. 

It is distinctly an open question as to what form of con- 
tingent rental is fairest to all concerned. A rental, which 
is ultimately a contract between the security holders of the 
two corporations, must obviously involve advantages to both. 
Usually the most important advantage is in the exchange of 
traffic. This is registered in the volume of gross business, 
so that a proportion of gross earnings would seem at first 
thought to be the fairest basis for determining the rental. 
And this would be true were the earnings of the subsidiary 
not affected by the joint traffic agreement between the two 
roads. But when the main line is able, through the control 
of a majority of the stock of the subsidiary, to impose on the 
latter an agreement on interchanged traffic which returns to 
the subsidiary an unconscionably small percentage of the joint 
revenue, the earnings remaining to the subsidiary's own 
security holders will be meager and unfairly small. If all 
the securities of a leased line are owned by a parent company, 
or at the other extreme if the larger company has little owner- 
ship in the subsidiary or cannot exercise any control over the 
traffic interchange contract, then there can be complete free- 
dom of contract between the two boards of directors and no 

** Sec note 30. 


unfairness of rental can be alleged. But in cases like those 
enumerated above, when there is a conflict of interest between 
a controlling majority and a helpless minority of security 
holders, a question not only of the expediency but also the 
fairness of leased line rentals is inevitably raised. And this 
difficulty is increased when the rental is based on net, rather 
than gross earnings. For in such cases the controlling parent 
company may not only determine the division of the revenue 
from the interchange of traffic, but it may also control the 
expenditures for operating expenses of the subsidiary, so as 
to fix arbitrarily its net earnings and its rental.^' 

These difficulties proved to be serious obstacles in the build- 
ing of railway systems. The contingent rental must be fair, 
arid not open to the accusation of secret manipulations. Yet 
at the same time the leasing road should be given the benefits 
of its abler and more highly organized operation. The latter 
would not assume the responsibility of the lease without the 
benefits which would be likely to increase through the years. 
For these reasons fixed rentals have been preferred over any 
form of contingent rental and their use, as compared with 
contingent rentals in any form, has increased during each 
succeeding period of railroad consolidation.^" They were, at 
the beginning of 1918, the only important leases.^^ 

This uncertainty about the future was the only reason 
which led to the early use of the contingent form of rental. 

" It is to be observed also that the net earnings basis may prove unfair to the 
main company when the subsidiary is controlled by an independent board of directors. 
Such an independent board of directors, having the interests of the subsidiary 
solely in mind, may manipulate the operating expenses — especially the maintenance 
accounts — so that the net rental which the main company is forced to pay shall 
be unfairly large. Such cases are, obviously, rare; but they illustrate the possibility 
of manipulation of accounts when there is a conflict of interests between the 
lessor and the lessee. 

*• See note 30. Excluding the Pennsylvania system for reasons explained in 
note 30, at least 23 per cent of the important railroad leases were contingent in 
1893 and only 11 per cent in 19 18. 

" See note 30. In cases in which old contingent rental leases still existed — 
like the numerous net rentals on the Pennsylvania system — the parent or leasing 
road had acquired absolute ownership of all the stock of the leased subsidiary 
so that the allocation of the contingent rental was merely a matter of intercompany 


But since 1876 the persistent optimism of railroad operators 
has led them to adopt, almost universally, the fixed rental on 
the assumption that the future is brighter than the past. This 
optimism has been based on a confidence in their own effec- 
tiveness of management and on the economies incident to mere 
consolidated operation. They have believed that their own 
skill of operation could secure a margin of unrealized profit 
not available to the older management of the leased line. They 
have believed also that when separate and perhaps competing 
lines are operated as a single unified system, with all the 
apparent wastes of independent operation eliminated, increased 
profits necessarily result as a mere by-product of consolidation. 
The differences in form of fixed rental payments are not 
as important as would appear at first sight.^* In most cases 
there were outstanding, at the time the lease was originally 
written many years ago, considerable amounts of stocks and 
bonds in the hands of the public. In the majority — ^but by 
no means all — of the leases of this character, the parent road 
has gradually acquired the stocks and often the bonds of the 
leased road, so that the payment of the fixed rental is merely 
a bookkeeping adjustment involving the transfer of credits 
from one account to another. When considering the lease, 
indeed, merely as a device for consolidating railway lines, the 
fixed rentals are significant only in the smaller number of 
cases in which the leased line securities are still in the hands 
of the public. It is important, however, to note that the 
number of such cases, especially among New England lines, 
is still sufficiently numerous to present an important and often 
embarrassing problem. 

** There are five or six different types depending on the manner in which the 
fixed rental is paid. The commonest is the guaranteed dividend payment on the 
outstanding stock of the leased line after the full payment of the fixed charges, 
if such exist. This is the ordinary form for the Boston and Maine and the 
New York, New Haven and Hartford leases, where the fixed rental is still of 
greatest importance. In most cases of long-standing leases the dividends are paid 
directly by the main company — they become, in effect, assumed dividends. In fact 
the rental payments under long-standing leases are ohen regarded as the same as 
fixed charges on bonds, except in name. 


The device of fixed rentals with large amounts of the leased 
line's stock remaining in the hands of the public has great 
advantages to the parent road during the time that the pros- 
perity of the railroads is ascending. It then shuts out the 
old leased line's security holders from the increased profits 
due to greater prosperity and gives to the controlling manage- 
ment the full fruits of increased economy and efficiency of 
operation. But just the reverse is true when the lease is 
consummated before or during a period of declining pros- 
perity. In that case the security holders of the leased road 
may demand their rental whether or not it has been earned. 
The charge has become fixed and inflexible and its default 
would precipitate failure of the whole consolidated structure.*' 
And it is unquestionably true that with the further develop- 
ment of railway consolidation, under the encouragement of 
the Cummins Act of 1920 rather than the discouraging pro- 
hibitions of the Sherman Act of 1890, the lease will dwindle 
to insignificance as a means of consolidation. In forced 
reorganizations, like that of the Boston and Maine, it has, so 
far as possible, been superseded by direct consolidation. And 
this change is destined to occur in the future in all cases where 
the fiction of a lease is not required as a legal subterfuge. 
Nevertheless it has a great historical significance in the develop- 
ment of American railway consolidation.^** 

" The truth of this is manifest from the rather pathetic history of the Boston 
and Maine (figures in even thousands, year ending, June 30). 

1915* 1914 1913 1912 

Net Income before Fixed Charges.... $9,984,000 $9,152,000 $9,931,000 $9,833,000 

Miscellaneous Charges 1,702,000 2,391,000 2,022,000 1,265,000 

Interest 3,027,000 3,318,000 2,547,000 2,084,000 

Balance 5.255.000 3,443,000 5,363,000 6,484,000 

Rentals to Leased Lines 5. 589,000 5,488,000 5,313.000 5,194,000 

Balance for Stockholders — 334>ooo — 2,045,000 -fSo,ooo +1,290,000 

"Year prior to the receivership. 

See also Volume III, Chapter V, note i, and Chapter VI, note 7. The method 
of presenting the figures in these two previous notes was somewhat different. 

*" Statistical studies were made of most, if not all, of the important railway 
leases in force in 1893, the year of the close of the second period of railway 
consolidation in America, and in 1918, just prior to the assumption of government 
control. The results have been referred to several times in the immediately preceding 
pages. Because of the laws of Pennsylvania on the one hand, and the early traditions 
of the Pennsylvania Railroad officials on the other, the leases of the Pennsylvania 


A lease, whatsoever the form of compensation, is a rela- 
tively weak and uncertain means for effecting consolidation. 
Its very economy, even, is not always an advantage, for what 
is cheaply got is often easily lost. If the union is very im- 
portant to the consolidated system, a railroad management will 
not, ordinarily, allow it to rest on a mere lease. The stock- 
holders of the leased line might find some excuse for canceling 
the lease directly ; or they could allow their road to be thrown 
into the hands of a court receiver who would then cancel the 
lease as an imdesirable contract inherited from the past man- 
agement.'^ The leasing road would be helpless in either event 
to prevent the action or even to collect damages from the 
receiver or the reorganized road. In order to prevent any 
such misfortune, leasing railroads have always sought to rein- 
force the lease by the purchase of at least a portion of the 
stock of the leased road. This introduces at once the second 
great type of consolidation expedients, namely that of stock 

system belong to a class by themselves. In these studies small lines less than 
twenty miles in length have for the most part been omitted. 

Summary of Contingent and Fixed Rentals — 1893 

Gross Rentals Net Rentals Fixed Rentals 
Excluding Pennsylvania and Allied Roads 

(256 cases) 44 16 196 

Percentages 17% 6% 77% 

Pennsylvania Railroad : 

Owning No, or a Minority Stock Interest. . . 6 6 

Owning a Majority Interest or All Stock. .. 33 .. 
Pennsylvania Company: 

Owning a Majority Interest or All Stock 295 

Totals (Including Pennsylvania) 46 64 207 

(Owing to the peculiar and individual circumstances surrounding the development 
of the Pennsylvania system, the total in the first line is more significant of the 
railroads of the country at the close of the second period of consolidation than 
the totals including the Pennsylvania lines.) 

SuMMASY OF Contingent and Fixed Rentals — 19 18 

^ , „ " Gross Rentals Net Rentals Fixed Rentals 

Excluding Pennsylvania and Allied Roads 

(20s cases) II 13 181 

Percentages 5% 6% 89% 

Pennsylvania System 9* 13 

•The Pennsylvania Railroad owns all or practically all the stock of its net rental 
leased lines, so that the lease is merely a legal fiction. 
« See Volume V, Chapter III. 


Ever since the consolidation of railroads commenced, it 
has been the policy of railroad managers to purchase at least 
a minority stock interest in the railroads the operation of 
which was important for the main system.^^ This was true, 
even when the subordinate road was controlled by lease. And 
if the subordinate road is of essential importance, it is probable 
that those in control of the consolidated system will insist on 
obtaining sufficient stock to secure a majority stock control 
in addition to the lease.^' 

The advantage of consolidation through ownership of a 
portion of the stock of a railroad, rather than complete owner- 
ship, lies in the greater economy. Complete control is secured, 
moreover, if a majority of the shares are acquired, so that the 
danger of the repudiation of the lease is not present as when 
the road is held by a contract of lease alone; yet the invest- 
ment is small compared with that required for the outright 
purchase of the road. Especially is this true if the subsidiary 
road has a considerable bond issue which would have to be 
paid off before absolute title could be acquired. It is this 
security of control, combined with the small money outlay 
that has made this method of consolidation the usual one in 
the history of American railways. 

All manner of combinations of the lease and the stock 
control are to be found in the annals of American railway 
consolidation.^* And very frequently the lease is employed 
as a reinforcement to stock control, just as stock control is 

" This was well stated by Edgar Thomson, the President of the Pennsylvania 
Railroad during the period of its growth: "It was early foreseen that a trunk line, 
intended to accommodate the traffic between the East and the West, would fail 
in its object if wholly dependent upon the uncertain navigation of the Ohio River 
as a feeder. ... To overcome this disadvantage, it became essential that other 
lines connecting your road with the trade centers of the West should be commenced, 
and to effect this, direct and efficient aid by this company toward their construction 
was necessary." 20 Penn. R.R. Rep. 10 (1867). 

•* This was illustrated exactly by the early history of the corporate relations 
between the Pennsylvania Railroad and its Chicago extension, the Pittsburgh, Fort 
Wayne and Chicago Railroad. See note 70 of present chapter. 

** Such combinations are illustrated at every turn in the present chapter. For 
a variety of concrete cases, see the exchanges of stock following leases represented 
in the New Haven system, note 39. 


used to reinforce a lease. But in theory the two methods are 
distinct. The stock control involves the outright ownership 
of sufficient of the voting stock to give the main road absolute 
executive management of the subsidiary. It selects the board 
of directors. It initiates matters of policy with the same 
autocracy as for its own lines. The control is permanent 
and absolute, so that the directors of the consolidated system 
may look upon the subsidiary road in their plans about the 
future as if it were, to all intents, their own absolute property. 
For this reason, control through stock ownership permits 
greater scope and comprehensiveness in determining policies 
than control merely through a lease. 

In acquiring stock control three important methods have 
been followed. The simplest is of course the outright purchase 
of a railroad's shares, either at private sale or on one of the 
exchanges. Ordinarily a large road, wishing to acquire stock 
control of a smaller road, ascertains by inquiry the names of 
the road's largest stockholders. Its representatives then make 
overtures looking toward the outright purchase of a sufficient 
number of shares to give it control. Having arranged for 
the purchase of a large or majority interest from a few of 
the most important stockholders, the road then announces pub- 
licly that it will purchase all the stock offered to it at a specific 
price, reserving to itself the right to withdraw the offer at 
any time. The road is thus enabled to retire from the market 
as soon as it has acquired the requisite control, or it may 
continue to purchase all the shares offered in the hope of 
obtaining not only a majority of the shares but also the entire 
capital stock. In the latter case it becomes relieved, forever, 
from the fear of any legal interference or obstructions arising 
from a small but recalcitrant minority.^' 

* When the stock of a small line is widely held, or when two railroads are 
seeking to acquire its control, it may be necessary to go to extreme lengths in 
picking up the stock. Instances have been known of the agents for the purchasing 
railroad going from bouse to house among the stockholders in order quickly to 
secure a majority of the shares. 


Another method of obtaining stock control, at the time 
of railway consolidation, is through an exchange of stock. 
This method was very common in the period during which 
the large railway systems were being built up — down to the 
panic of 1893.^* In fact some very important railway systems 
came into existence, originally, through an extensive exchange 
of the stocks of numerous small lines for the stock of a new 
company formed for the very purpose. This was the origin 
of the New York Central.^^ This method of consolidating 
by an exchange of stocks has the advantage over outright 
purchase in requiring no direct money expenditure, so that no 
financial expedients have to be adopted in order to obtain 
money. On the other hand, it was usually necessary for the 
road that acquired the stock of another through exchange of 
its own shares to make a particularly favorable offer to the 
shareholders of the other road in order to tempt them to 
surrender control of their property. This is expensive, when 
viewed as a dilution in the value of the purchasing road's own 
stock. In a number of instances the advantage of securing 
a stock of greater marketability is quite as effective in leading 
the shareholders of a small local road to exchange their stock 
for that of a large road at an apparent profit; in some cases 
the prosperity of the small road is so closely connected with 
that of the large road that the shareholders feel that their 
investment is better protected when made an integral part of 
the consolidated system.^^ 

*• See illustrative example of the New Haven system, note 39 hereafter. 

" See note 54 of this chapter. 

* An illustration of this principle is shown in the acquisition of the old New 
York, Providence and Boston Railroad by the New York, New Haven and Hartford 
Railroad in March, 1892. The former road was, in effect, an integral part of the 
New Haven Railroad's "Shore Line," forming the link between Providence and 
New London. All the traffic of the road reached New York over the New York, 
New Haven and Hartford from New London, except that carried on boat by the 
New London and Stonington lines. It had little value if separated from the New 
Haven Railroad, yet in connection with the latter it was very prosperous, having 
paid 10 per cent dividends on its stock since 1886. The $5,000,000 of stock had 
a narrow market. The $23,375,000 of the New Haven Railroad's stock was quoted 
on the New York Stock Exchange and therefore had a wide market. It had paid 
dividends of 10 per cent for many years. From every point of view it was 
desirable for the shareholders of the New York, Providence and Boston Railroad 


The fact is that several railroad systems have been built 
up by supplementing the control through a lease by the acquisi- 
tion of the leased-line stock through exchange. The Penn- 
sylvania system, especially in the years from 1865 to 1880, 
strengthened its control over its leased lines by this means. 
This was the means employed almost universally in building 
up the New Haven system, and explains, more than any other 
single circumstance, why the New Haven Railroad emerged 
from the period of its consolidation with such a small amount 
of bonded debt in comparison to its share capital.*^ 

A third important way in which one railroad secures the 
control of the stock of another road is through the use of 
the collateral trust bond."*" This is as characteristic of the 
period succeeding the panic of 1893, as the lease was of the 
period before. And, more than any other device, it has been 

to consolidate their road with the New Haven road. Accordingly they accepted 
an offer of exchange of their stock for that of the New York, New Haven and 
Hartford Railroad, the latter increasing its capitalization to provide the requisite 
stock. See also next note. 

*• The unification of the New York, New Haven and Hartford Railroad system, 
as an operating railroad (not including its outside ventures) was practically com- 
pleted in February, 1893, with the lease of the Old Colony. The railroad system 
as such had its origin in the consolidation effected in August, 1872, between the 
New York and New Haven Railroad extending from New York City to New Haven 
(and by a leased line to New London) and the New Haven and Hartford Railroad 
from New Haven to Springfield. Subsequently, down to 1893, other railroads were 
leased, but in almost every case provision was made for the exchange of the shares 
of the leased line for those of the New York, New Haven and Hartford Railroad. 
This is illustrated by the table on page 87 which includes the original consolidation in 
which the corporate existence of the New York, New Haven and Hartford Railroad 
began. These exchanges were successful, and by 1893 all the stock of the sub- 
sidiary had been acquired by exchange; except that in certain cases, notably that 
of the Old Colonv Railroad, the exchange was not carried out as contemplated. 
In fact, by 191 8, by purchase as well as exchange, the New Haven road held only 
98,132 shares of the Old Colony out of a total of 222,940 shares. 

*• See previous discussion of the same subject from the point of view of the 
collateral trust bond itself. See Volume I, Chapter III, page 54. and following. 

The collateral trust bond was occasionally used before the panic of 1873. For 
example, the Pennsylvania Company acquired direct ownership of the Pennsylvania 
Railroad's western connections in 1869. See note 71. The later borrowings of the 
Pennsylvania Company were based on the securities of these lines as collateral. 
In 1879 the old Union Pacific Railway issued collateral trust bonds because the 

fovernment had forbidden it to increase its direct bonded debt in order to pay 
or extensions. But as few railroads were allowed to hold the securities oi other 
roads without special legislative consent, the practice of purchasing securities and 
pledging these as collateral was seldom indulged in. After 1880 collateral trust 
Dondfs were used with increasing frequency to secure funds to reimburse the main 
line treasury for expenditures in building miscellaneous small branch line extensions. 
See Volume I, Chapter III, note 39. After 1893 they were used extensively for 
the purpose of consolidating railway systems. See page 108 and following. 



te of 
. H. 


- -+ 

I » 1 

3 _ 



tH M 




fO •* 


>o n 






Ov -o 


"O , 



-0 00 




5! r~ 

(M »0 


vO t- 



I. a 

■* ■* 

Oi 0) 

00 00 

V Pi 


-C ,^ 

•a w 


>- .at 




^ z 

c t: 


> > 


a m 

X a 


0) a> 

z 2: 




^ ^ 

■Z X 


3 4)00 

a « 

^ 5 



10 Tf-- 




S S 

ll 1.1 

N w 

N K) 


« . ^ 1 











^ r^ 

d « t^ 


i 8 


ol 0" 

6* <M N 

l/l M 






•* t^ 


»-l t^ 

8 8 





"O J3 


S 8 

a <i> 



m « 

n " 


« „ 














CO -"t 




ro « « 

10 fO 



4! s 


S". 0> 


£ S 


• 2 » 

o* S 



B >J 

: ^ 




t^ t~ 



N fO 

00 00 

00 t^ 


Oi o\ 


00 00 

00 00 


so 00 

Ov vO >-< 

10 Ov 



ifl Tt 



W M 

M so 


b c 

^>^ ^ 
-1? ^ 

n M 


t^ tn 

Si S-o 

t^ ifl 


ro n 


t-t M 


00 00 

M »H 


c a 

New Lon- 

idence and 


fi -^ 



rovidence to 


oston to Prov 


e above 

ew Haven 
to Conwa 
ratford Jc 
ew Haven 
tic, Conn 
ew Haven 
artford to 

1 «> Z M 

•z z 


CL. m 1 


X 1 







, Providence 



a 1 


ew York, 
and Hart 
ew Haven 

1.. u 




t Valle 


d Host 



m CO 

^ S 1 §2 1 


z ■z ^ 


z 1 


used in building up the great "systems of systems" that char- 
acterized railroad consolidation between 1897 and 1907. Per- 
haps the most notable general use of the collateral bond in 
this particular is in the expansion of the Union Pacific follow- 
ing its reorganization in 1897,*^ and the most notable particular 
instance is the acquisition of the control of the Chicago, Bur- 
lington and Quincy Railroad by the Great Northern and 
Northern Pacific railroads.*^ The substitution of credit for 
money is the essential purpose that underlies the acquisition 
of the stock of one railroad by another through the issue of 
its own bonds secured by the acquired stock as collateral. 
A railroad wishes to purchase outright the stock control of 
another road, but it cannot command the necessary capital. 
It can, however, use its own credit. It can arrange with the 
owners of the stock to relinquish the stock in return for the 
bonds of the purchasing road, secured by the deposit of the 
stock surrendered. In this manner the collateral trust bonds 
given in exchange for the stock are secured both by the stock 
collateral and the general credit of the purchasing railroad. 
While the stockholders that sell their stock get no cash, they 
are certainly as well off as they were before, since they still 
have a lien on the stock and, in addition, whatever value 
attaches itself to the bond as a direct obligation of the pur- 
chasing railroad. In some cases this additional value is very 

There have been many instances during the thirty years 

*> For extended discussion of the use in connection with the expansion of the 
Union Pacific Railroad, see Mitchell, T. W., "The Collateral Trust Mortgage in 
Railway Finance," 20 Q. J. E., 443 (1906); Ibid., "The Growth of the Union Pacific 
and its Financial Operations," 21 Q. J. E. 569 (1907); 12 I. C. C. Rep. 319; 
Daggett, S., "The Decision on the Union Pacific Merger," 27 Q. J. E. 295 (1913); 
Daggett, S., "Later Developments in the Union Pacific Merger Case," 28 Q. J. E. 773 
(1914). Also brief account in Ripley, W. Z., Railroads, Finance and Organization, 
499 (1915)- 

"This particular episode in American railway history has been described many 
times. See long list of titles 'eferring to this, and the aftermath, the Northern 
Securities Company, in the "List of Books Relating to Railroads in their Relation 
to the Government and the Public." published b^ the Library of Congress. Also 
Meyer, B. H., A History of the Northern Securities Case, Bull. Univ. of Wisconsin 


from 1880 to 19 10 in which the collateral trust bond has been 
used by one railroad system to acquire stock control or even 
entire stock ownership of another railroad. Three notable 
examples require more than mere passing comment because 
of the extent and importance of the railway mileage involved. 
In 1898, the New York Central and Hudson River Railroad 
found it necessary — as the Pennsylvania Railroad had found 
it necessary thirty years before — ^to acquire absolute control 
and ownership of its Chicago extension. Accordingly, the 
directors of the New York Central and Hudson River Rail- 
road offered to give to the stockholders of the Lake Shore 
and Michigan Southern Railroad a collateral trust bond, $1,000 
in demonination and bearing 33^ per cent interest, in exchange 
for five shares of stock. The stock was deposited as collateral 
for the bonds. The Lake Shore stock had been paying 6 per 
cent dividends since 1888 and large sums had been invested 
in the property out of earnings. The shareholders had an 
apparent increase of income. At the same time they obtained, 
in addition, a direct obligation of the New York Central 
system that ranked ahead of the large investment of the 
Central's stockholders, and were well protected against the 
further issue of mortgage bonds."*^ 

In 1902, when the movement in the direction of the con- 
solidation of great railway systems reached its greatest scope, 
two large issues of collateral trust bonds were used to acquire 
control of the stock of two great railroad systems — the Louis- 
ville and Nashville, and the Chicago, Burlington and Quincy. 
In the former case the Atlantic Coast Line acquired the ma- 
jority of the stock of the Louisville and Nashville Railroad 

** Among the protecting clauses was the restriction that the old New York 
Central and Hudson River Railroad should issue thereafter no bonds having a 
priority over these collateral trust bonds. In the final corporate merger in 191^ of 
the New York Central and Hudson River Railroad with the Lake Shore and Michigan 
Southern, it was found necessary to increase the rate of interest from 334 to 
4 per cent, giving to the holders a refunding junior mortgage lien bond. Only 
in this way could the New York Central Railroad have complete freedom to provide 
for its future financial requirements. 


as the outcome of a speculative raid. There was, apparently, 
no preconceived plan on the part of the Atlantic Coast Line 
to secure control of the Louisville and Nashville. Yet, as a 
result of the efforts of a certain Wall Street gambler, a ma- 
jority of its shares had been brought together and were offered 
for sale. To place them under the control of the Atlantic 
Coast Line seemed on the whole the best solution of the 
difficulty, and the collateral trust bonds of the Atlantic Coast 
Line were issued to secure the necessary funds.** 

The acquisition of the stock of the Chicago, Burlington 
and Ouincy Railroad by the roads controlled by the late 
James J. Hill was, on the other hand, the result of a pre- 
conceived plan. Neither the Great Northern nor Northern 
Pacific railroad had an eastern terminal in Chicago. This 
was a very serious handicap in the competition for transcon- 
tinental traffic. Especially was this true as the Union Pacific 
had a closely affiliated Chicago connection in the Chicago and 
Northwestern Railroad and the Atchison reached Chicago 
over its own tracks. Accordingly the directors of the two 
northern railroads offered to give to the stockholders of the 
Chicago, Burlington and Quincy Railroad — many of them 
New England investors — ^$1,000 par value in the 4 per cent 
joint bonds of the Great Northern and Northern Pacific rail- 

♦• For brief description of the Gates raid on the shares of the Louisville and 
Nashville Railroad, see Ripley, W. Z., Railroads, Finance and Organization (1915). 
An extended description of the incident is given in Dozier, H. D., History of 
Atlantic Coast Line, 147 (1920). To indicate how casual and often incidental are 
the occasions for this "pyramiding" of railroads, the following brief account from 
the New York Evening Post is at least amusing and, perhaps, illuminating: 

"While discussing the stock market with his 'buccaneer* associates, early in 
1902, at an uptown hotel. Gates casually met one of the southern directors of the 
Louisville with the usual: 'What do you know?' To impress the plunger with his 
importance, the Louisville director replied: 'We are going to issue $5,000,000 new 
stock for working capital.' Gates attached no importance to the chance information 
until a few days afterwards when Louisville began to decline sharply on _ what 
appeared to be inside selling. Remembering his brief conversation with nis Louisville 
acquaintance. Gates quickly conceived the idea of setting a trap for the Louisville 
directors, who appeared to_ be selling short for a turn, on the theory that the new 
stock issue would temporarily depress prices. Gates bought all of the shares offered, 
advancing the price from around 105 in April, to 146 in May. Then he made the 
discovery that he had an actual majority of the $55,000,000 outstanding stock. 
T. P. Morgan then bought Gates' stock and sold it to the Atlantic Coast Line." 
New York Evening Post, November 8, 1013. Contemporarv references to thia 
important incident, see 34 Rd. Gaz. 759; New York Times, April 10, 11, and 16, 
1902; 74 Chron. 775, 833; 75 Chron. 830. 


roads in exchange for each five shares of the BurHngton Com- 
pany's stock. These bonds were to be secured, in addition to the 
joint and separate guarantee of the two railroads, by the 
deposit with the trustees of the Burhngton stock. Practically 
all the stockholders of the Burlington road accepted the offer, 
and, without the use of any of their own capital the two 
Hill roads secured the absolute control of one of the finest 
railway systems in the world.^^ 

The evil of pyramiding of credit by the issue of collateral 
trust bonds occurs when the earnings of the road whose stock 
is acquired fail to permit a dividend sufficient to carry the 
interest on the collateral trust bonds. As in the case of the 
fixed rental, the plan works very well so long as the earnings 
of the newly acquired road equal or exceed the cost of carrying 
it. But railway earnings fluctuate. And the experience of 
several roads which have followed this plan of consolidation 
has been very unfortunate. In fact the receivership of the 
Toledo, St. Louis and Western Railroad in 19 14 was due 
to this cause and this cause alone.'*® In other receiverships 
it has been an important contributing cause.*^ Nevertheless 
the collateral trust bond has been and is still used as the 
simplest and distinctly the cheapest means of pyramiding rail- 
road properties.*^ 

*• See note 42. 

■•* In August, 1907, the Toledo, St. Louis and Western Railroad acquired 
64,800 shares out of 195,579 shares of the 4 per cent non-cumulative preferred 
stock of the Chicago and Alton Railroad and 144,200 shares out of 195,428 common 
shares of the same railroad. The Toledo, St. Louis and Western Railroad issued 
$11,527,000 collateral trust bonds — with the Chicago and Alton stock as collateral 
security. Approximately $6,500,000 of these bonds bore immediately 4 per cent 
fixed interest and approximately $5,000,000 bore 2 per cent until 1912 and 4 per cent 
thereafter. These collateral trust bonds involved a fixed charge in 1908 of $365,000, 
and the dividends on the Chicago and Alton stock amounted to $836,000, the maximum 
amount received in any one year. In 19 13 the charges on the bonds amounted 
to $460,000 and the Alton paid no dividends. In fact the Alton showed a deficit 
after charges of $1,900,000. (The _ dividends on the Alton's preferred stock had 
ceased in 191 1 and on the common in 1910.) This burden was temporarily absorbed 
by the Toledo, St. Louis and Western's own earnings. But in the autumn of 1914, 
the latter's earnings showing a marked falling off, a receivership became necessary. 
Except for a short period in 1914 the earnings of the Toledo, St. Louis and Western 
have been more than sufficient to meet its own interest charges. 

*' St. Louis and San Francisco, more especially. 

* The following table expresses, in summary form, some of the best known cases 
of direct consolidation by the acquisition of the stock of one railroad by another 



The third general method of consolidating railroads is by 
complete, outright purchase. It is the most expensive method, 
requiring a large outlay, but it results in the most complete 
and permanent union possible among railroads. Sufficient 
money must be advanced by the purchasing road to pay for 
the outstanding stocks of the road to be acquired and in addi- 
tion sufficient to meet all its outstanding liabilities. Because 
of this heavy outlay of capital, the outright purchase of one 
road by another is resorted to ordinarily only either if the 
road is small so that the actual money outlay is relatively 
insignificant, or else if it is possible to arrange a direct transfer 
of liabilities. These two types of direct purchase, do not 
require more than a passing comment.** 

The simplest and in a sense the most direct case of out- 
right purchase is when a large, opulent main-line railroad 
purchases a small road in essentially the same manner that 
it might purchase a locomotive or a postage stamp. The small 
road, we may presume, was probably built by a group of local 
business men. Their purpose in building the road was quite 
as much, probably, to improve the industrial facilities of their 
city as to obtain a profit. Often the local banks supplied con- 

railroad by the issue of the collateral trust bonds of the latter road, 
were exchanged directly for the stock. 

The bonds 

Purchasing Road 

Stock AcQxiired 


Par Value 
Bonds for 
Each lioo 
of Stock 





New York Central 

Lake Shore 





100 (pfd.) 
3S (com.) 



New York Central 

Michigan Central 

Mobile and Ohio 

Central of New Jersey 



Great Northern and 


St. Louis and San Francisco. 
Toledo. St. Louis and Western 

Chicago and Alton 


* There is also another reason which has, in a few cases, led to outright purchase. 
It is when two railroads are each competing for the purchase of a third. In such 
cases it may be necessary for the successful road to pay for its purchase quickly 
and with ready money. In 1881 the Baltimore and Ohio Railroad and the Penn- 
sylvania Railroad each sought control of the old Philadelphia, Wilmington and 
Baltimore (subsequently the Philadelphia, Baltimore and Washington). The Penn- 
sylvania Railroad was successful in securing the property, mainly because it was 
able to pay the actual money demanded by those in control of the sale. 


siderable amounts of money and these advances were carried 
by notes, regularly renewed at stated intervals. The stock, 
let us say, is held by a few men — not more than half a dozen 
at most. The little road is the source of a considerable amount 
of through traffic and is therefore of value to the main-line 
connecting railway system. Under these circumstances it may 
happen,that the main-line railroad, not wishing to be burdened 
by the complex financial network which the local capitalists 
have woven about their little road, will offer a certain sum 
of money for the railroad itself as a going concern. This 
offer, if accepted, will involve the transfer of the actual rail- 
road property — the franchises, right-of-way, stations, yards, 
and moving equipment — free from all encumbrances. It will 
require that the director-owners pay off all the bank loans, 
merchandise accounts, and other debts before the property 
can be transferred. When this has been done, they can then 
divide what remains from the purchase price, if anything, 
among the stockholders. But neither the complexities of cor- 
porate organization of the little road nor the particular dis- 
position of the purchase money is of any concern to the main- 
line railroad. Its only concern is to acquire the actual physical 
property of the little road, divested of all liens and liabilities. 
From its own point of view the value of the road is not 
sufficiently large to make it worth while for the main line to 
engraft the financial intricacies of the little road upon its own 
financial structure. 

The other case of direct purchase applies to a larger rail- 
road and involves a transfer of liabilities. One railroad desires 
to acquire absolute title to another railroad, believing that 
mere stock control is insufficient for its purpose. Yet the 
railroad to be purchased has outstanding a large issue of bonds, 
bearing a low rate of interest and quoted on the exchange 
for less than the face value. To buy or redeem this entire 
issue of bonds — a necessary procedure in order to acquire com- 


plete title to the railroad — would require too much capital. 
Yet the purchasing railroad is able to command enough money 
to buy the entire outstanding stock and to pay off all the debts 
of the road except this issue of bonds. In a case like this 
the one railroad may acquire title to and complete ownership 
of the other, subject to the bond issue. These bonds then 
become a direct liability of the purchasing railroad, in addition 
to whatever specific security they originally had. In technical 
language they are assumed bonds.^" This assumption of 
underlying bonds is often a consideration of great value. In 
fact the mere explicit assumption of the bonds of a small 
line has been, not infrequently in the history of railroad 
extension and consolidation, the only price a large and estab- 
lished railroad has had to pay for the acquisition of a small 

The application of these forms and devices by which rail- 
road consolidation and expansion has occurred will become 
clear from a summary statement of railroad consolidation in 
the United States. This is a subject of great significance to 
American corporation finance, because many of the expedients 
employed in the consolidation of other industrial units arose 
in response to a social demand which required operating — 
and incidentally financial — unity among railroads. 

The history of railroad consolidation in the United States 
may be roughly divided into three periods of tmequal length, 
according to the extent and the character of the prominent 
railway consolidations of the period. Down to the early fifties 
railroads were built as small, separate, distinctly local enter- 

so See Volume I, Chapter IV. 

"The Washington County Railway of Maine was completed in 1899 through the 
efforts of Grant B. Schley, a prominent New York banker born in that section 
of the state. It failed to meet operating expenses. In 1903 the proprietors consented 
to refund their issue of over $2,000,000 of s per cent fifty-year bonds due in 
1948 and representing the construction costs of the road into 3J4 per cent bonds 
due in 1954, and surrender to the Maine Central Railroad their entire stock interest. 
In return the Maine Central Railroad guaranteed, principal and interest, the payment 
of the new bonds. 


prises." Railroad consolidation, in the broad sense in which 
the term is used in the present chapter, did not occur until 
about 1855.^^ From then until the depression following the 
panic of 1873, small local railroads all over the East and Mid- 
dle West were jointed together longitudinally, to form through 
lines between large cities. A second period of railway con- 
solidation began in the later seventies when these through 
lines were connected with each other, and with lateral branches, 
to form railway systems. Just before and following the many 
railway reorganizations of the middle nineties, a third period 
of consolidation set in during which the widely articulated 
systems created during the previous period were still further 

"A writer in an encyclopedia article remarked in 1852, at the close of the 
building of the small local roads and before a movement had been made toward 
consolidation: "The railroad system of the United States is now being gradually 
developed towards completion by the annual filling up of gaps in connections which, 
perfected, present a mighty network of rails that put every section of the Union 
in familiar communication." 

In the introduction to the initial volume in Poor's Manual of Railroads, Henry 
v. Poor, commenting on the general course of early railroad building, stated the 
matter clearly: "The construction of railroads in the United States has proceeded 
without reference to any general system and without anything like supervision or 
oversight by the different states. . . . Railroads and canals were at first undertaken 
almost universally as local works and for local and sectional objects." Poor's Manual 
of Railroads of the United States (1868), 32. 

A study of the promotions and early directors of the New England railroads 
indicates that three groups of men were instrumental in the early promotions. There 
were, first, the large Boston merchants, ship-owners, and bankers, who constituted 
the "backbone" of New England's commercial supremacy in the period between 
1820 and 1850. These men had accumulated large fortunes in shipping and sought 
new avenues for capital investment and speculation. They were men of broad 
vision, great courage, and accustomed to take risks. The second group were the 
local manufacturers located usually inland at fall towns, who regarded the railroad 
as a means of extending their markets. The third class comprised the local store 
keepers, and "chief citizens" along the line. They were led to back the new 
railroads chiefly from pride in helping their towns and from the self-gratification 
and local prestige in being connected with a business enterprise engaging the 
attention of the Boston merchants and the "chief citizens" of neighboring towns. 
Of the first directorate of the Fitchburg Railroad, two members were prominent 
Boston merchant-bankers, the president was a paper manufacturer of Fitchburg, two 
directors were cotton manufacturers of Acton and Shirley, another was a chair 
manufacturer of Fitchburg, and another a lead pipe manufacturer _ of Concord. 
Most of the others were local storekeepers or district lawyers and politicians. See 
Willis, H. A., Early History of Railroads in Fitchburg (1892), and Willard, S., 
History of Middlesex County. A similar personnel is to be found among the 
builders of the other early New England roads. 

'* Such a statement, like so many historical generalizations, is subject to numerous 
exceptions. Cleveland and Powell mention a case of end-to-end consolidation — 
characteristic of the period after 1850 — as early as 1838. This was the formation 
of a through line between Philadelphia and Baltimore by the union of the Philadelphia, 
Wilmington and Baltimore, the Wilmington and Susquehanna, and the Baltimore 
and Port Deposit railroads. Cleveland and Powell, Railroad Finance, 274 (19 12). 

The period of mere building, without consolidation, ended and true railroad 
consolidation began in 1853 when the New York Central was formed. Prior to that 
time a railway journey was made up of various small journeys over connecting 
lines. For example in 1852, before the longitudinal consolidation of railroads had 
begun a passenger traveling along the great north-south artery of travel would use 


unified into great, loosely organized railroad combinations. 
They became, as it were, systems of systems. 

During the first period of consolidation, roughly from 1855 
down to 1873, small, local, end-to-end roads were brought 
under a single operating and financial organization. The pur- 
pose invariably was to establish better connection between two 
large cities, rather than to develop railway systems. The first, 
and for a time the most important, of these end-to-end con- 
solidations was that of the five connecting roads constituting 
a through line from Albany to Buffalo. These five roads, 
with various lateral and parallel branches, were united in the 
summer of 1853 to form the New York Central Railroad." 

eighteen different roads between Augusta, Maine, on the north, and Montgomery, 
Georgia, on the south. 

Distance Railroad 

Points of Connection Traversed Railroad Completed 

Augusta to Portland 63 Kennebec and Portland 1853 

Portland to Portsmouth 51 Portland, Saco and Portsmouth 1843 

Portsmouth to Boston 56 Eastern Railroad 1841 

Boston to Worcester 45 Boston and Worcester 1835 

Worcester to Springfield 54 Western 1830 

Springfield to New Haven 62 Hartford and New Haven 1848 

New Haven to Williamsbridge 63 New York and New Haven 1848 

Williamsbridge to New York 13 New York and Harlem 1841 

New York to South Amboy 18 Steamboat ferry 

South Amboy to Camden 63 Camden and Amboy 1834 

Philadelphia to Baltimore 98 Philadelphia, Wilmington and Balti- 
more 1838 

Baltimore to Washington 31 Baltimore and Ohio (Washington 

branch) 183s 

Washington to Acquia Creek 35 Steamboat 

Acquia Creek to Richmond 75 Richmond, Fredericksburg and Po- 
tomac 1841 

Richmond to Petersburg 22 Richmond and Petersburg 1838 

Petersburg to Weldon 61 Petersburg Railroad '. 183a 

Weldon to Wilmington 162 Wilmington and Weldon 1840 

Wilmington to Kingsville 171 Wilmington and Manchester 1852 

KingsviTle to Branchville 37 South Carolina Railroad 1833 

Branchville to Augusta 76 South Carolina Railroad 1838 

Augusta to Atlanta 171 Georgia Railroad and Banking Com- 
pany 1839 

Atlanta to West Point 87 Atlanta and West Point 184a 

West Point to Montgomery 89 Montgomery and West Point 1844 

It is interesting to note that when the South Carolina Railroad was opened 
in September, 1833, from Charleston to Hamburg, opposite Augusta, Georgia, a 
distance of 132 miles, it was the longest continuous railroad in the world. 

•^ The formation of the New York Central Railroad was the first of the important 
end-to-end consolidations, and, for historical reasons, if for no other, it has consider- 
able interest. The New York Central Railroad, as originally formed, represented 
the consolidation of five end-to-end roads constituting a connected line from Albany 
to Buffalo, together with eight smaller roads representing lateral branch and projected 
lines. The promoters of the new company agreed to pay stock of the new company, 
the New York Central Railroad, to the extent of the par value of the stock of 



Three years later this end-to-end consoHdation showed itself 
in the West in the formation of the Chicago, Burlington and 
Quincy by the union of the Chicago and Aurora and the Cen- 
tral Military Track Railroad. In New England, end-to-end 
consolidation by lease appeared when, in 1861, the old Concord 
Railroad and the Manchester and Lawrence agreed to the 
joint operation of their roads together with the lease by the 
former of the Portsmouth and Concord Railroad and the 
Manchester and North Weare Railroad. By 1873 there were 
no less than 69 of such end-to-end consolidations of more 
than 200 miles in length. The average length of all these 
69 consolidations was only 389 miles and the longest, the Erie, 
was only 959 miles." In some cases they represented mere end- 

the old roads. In addition, the owners of the old roads were to receive varying 
rates of premium — approximately the market value above the par value — for their 
stock in the 6 per cent bonds of the Central. Certain bonds and advances to 
other roads were to be refunded in these same bonds, as also were the floating 
debts of the separate roads. The financial mechanism of the consolidation may be 
shown best by means of a table (see page 98). 

The roads had all been prosperous in the years before the merger. Accordingly, 
while the par value of the securities issued by the New York Central far exceeded 
the cost of the properties, it was not excessive on the basis of their earning capacity. 
This is shown indirectly by a table compiled by the New York State Engineer based 
on the business of 1848, five years before the consolidation. 









of Cost 

Albany and Schenectady 

Utica and Schenectady 

Syracuse and Utica 

Auburn and Syracuse 

Auburn and Rochester 


Attica and Bufifalo 

Total cost (1848) main line Albany to Bufifalo 

Rochester and Syracuse direct, built between 1850 

and 1852, cost* 

Total cost 

Total securities of the New York Central issued for 

these main line roads f 












13 I 

12. 1 

* Second Annual Report, Rochester and Syracuse Railroad (1852). 

t See table, page 98, first part — "Main line Albany to Buffalo." 

*» These figures do not include the Union and Central Pacific railroads, 
approximately a thousand miles in length, as they cannot, in any way, be considered 
as end-to-end consolidations. Otherwise the figures include all roads, the main 
and branch lines — including lines leased and operated as part of the road — which 
exceeded 200 miles on January i, 1873. The large components of what were then 
being welded into the "Pennsylvania system" were considered as separate railroads. 
Summary deduced from the lists given in Poor's Manual of Railroads for the year 
1873. It is not strictly exact since it was often difiiicult to decide whether a road 
was independent or belonged to a loose consolidation. 






^ 2 




•-4 » 









r »" V 
>^^w si,»< (U.2 2 



b VI 

,r-a o5 «•- o 

cj'O ii v* >3 o 
M ° 

O V 


►3 -^ 


o s» . 



C C! 
cil at 

2 c c g 

C.S B) CD . 
O O M o 

m o 



q M o 

Ttua >n 
00 coo 
w 5 M 

•00000000 0000 000000 

.Soo : 
3 .S * . 


• CO »-« 

>*5 ^ 

I 03. 2 ^ o2« 


o •« 

O a> 

lis :d.2« 

fn i-i «i O is « 

t".E rt-- cfe 

n CO 







V V 5 
00 1 




to-end consolidations, without the construction of new mileage, 
except incidentally.^" But in the majority of cases the con- 
solidation represented the bringing into a single line completed 
small railroads and others partially completed, but embarrassed 
for want of money to continue construction.^^ The new com- 
pany, in such cases, secured its charter for the express purpose 
of completing the unfinished sections of road and building 
other sections beyond.®* The methods and purposes were 
about as varied as the consolidations. It was a question in 

" Like the New York Central, described above. 

" One of the earliest cases, of which the author can find specific reference, 
of this system of guaranteeing the securities of a connecting line was in 1849. 
It was the "linking-up," or end-to-end consolidation, of what was known as the 
"northern route" — a trunk line through northern Vermont and New York State 
to aflFord a direct connection between Boston and the Great Lakes. The Vermont 
Central was at the end of its resources. Its western connection, the Vermont and 
Canada Railroad, by which alone traffic could reach the Central from the Ogdensburg 
line and the Great Lakes, was unfinished. Accordingly the Vermont and Canada issued 
stock, the dividends on which were guaranteed by the Vermont Central, and the 
stock was marketed very largely (over half) as a high-grade "guaranteed" stock 
among Boston's conservative investors. The roads failed. Among these Boston 
investors v/ere the Boston Children's Friends Society, the Trustees of Derby Academy, 
the Alliance Insurance Society, the Treasurer of the Society for Aged and Indigent 
Ministers; so that institutional trustees were quite as intelligent about investments 
in 1850 as in 1920. Ralph Waldo Emerson subscribed to 68 shares and Francis 
Parkman to 51 shares. 

'' Such mixed motives are represented by the promotion of the old New York, 
Boston and Montreal Railway, a road which was to give_ a direct line between 
New York City and Montreal. The road was organized in January, 1873, as a 
combination of a series of small unconnected sections of line running northward 
from New York, and lying between the New York and Hudson River Railway and 
the New York and Harlem Railroad. The through route was to be created by 
filling in the intermediate links between the already completed sections, to build 
which several different charters were obtained. 

Beginning at High Bridge (Harlem River) a charter was obtained in 1869 to 
build a line to Carmel and Brewster, known as the New York and Boston Railroad. 
The Putnam and Dutchess Railroad was then incorporated to build a line from 
Carmel to Hopewell. 

Hopewell was a point on the Dutchess and Columbia Counties Railroad. This 
road had been incorporated in 1866 and 63 miles of it completed by local interests. 
It was acquired by the New York, Boston and Montreal as the third link in 
the chain. The fourth link was represented by a construction project, the Pine 
Plains and Albany Railroad, and a company was formed to build a line from Pine 
Plains on the border of Dutchess and Columbia Counties to Chatham. The fifth link was 
the old Lebanon Springs Railroad extending from Chatham to Bennington, Vermont. 
The sixth link was the Bennington and Rutland extending between these two cities. 
The Bennington and Rutland had been built in the late forties, largely from 
the proceeds of bonds subscribed to by Vermont towns. It had failed in 1854, 
had been operated for a time by the trustee of the bondholders, then leased by 
another road, and finally in 1867 the lease was abandoned. In 1870 the road was 
consolidated with the Lebanon Valley as the Harlem Extension Railroad. The 
Vermont towns were allowed to foreclose on the lines covered by their mortgage 
bonds and the New York, Boston and Montreal Railway acquired the line at foreclosure 
sale. The seventh link was represented by the reorganized Vermont Central Railroad, 
carrying the line from Rutland to Montreal. The men behind the New York, Boston 
and Montreal _ acquired an option on a majority of the Vermont Central's stock. 
But before this option could be exercised or the intermediate links completed the 
panic of 1873 burst and the project failed after $11,700,000 had been expended. 
Subsequently the separate parts were disposed of at foreclosure sales. 


every case of local expediency. Yet, behind this variety, it 
is important to observe that the chief characteristic of con- 
solidations, throughout this period down to the panic of 1873, 
was the obvious purpose of establishing longitudinal through 
lines. Branch lines were absorbed and even built, but these 
were incidental to the main purpose of establishing through 
lines of communicatiorL Railroad strategy and competition 
for territory were unimportant factors in shaping the course 
of consolidation.^" Questions of the gauge of the connecting 
lines played a part in shaping some consolidations; in others 
matters of local pride were mainly significant. But the para- 
mount question throughout the period was the simple one of 
getting through, continuous service between the large cities of 
the Union. 

The second period, following the panic of 1873, centered 
about the formation of railway systems. It is perhaps impos- 
sible to draw a distinct line between the two ; and the distinc- 
tion between a through line and a railway system is arbitrary 
indeed. Nor did the change of emphasis occur simultaneously 
in all parts of the country, so that the historical divisions we 
are insisting on here are admittedly crude and arbitrary. 
But it is an historical fact that prior to the panic of 1873 
little effort was expended in developing unified, self-dependent, 
well-rounded railway systems,*" whereas in the years following 
the awakening of business in the late seventies this was the 
center of interest among railway operators. Their vision had 
become enlarged. 

** Exceptions of course abound. And, as in so many other phases of railroad 
history, early precedents can be culled from the histor^r of the Pennsylvania Railroad. 

The Pittsburgh, Fort Wayne and Chicago Railway in 1863 emerged from receiver- 
ship. At the first stockholders' meeting of February 25, 1863, a lively, even heated 
discussion took place as to whether or not the Fort Wayne road should "buy off" 
the impending competition from the yet unfinished Cleveland and Pittsburgh Railroad. 
One Mr. Ogden naively put the argument, "Competition would certainly reduce the 
receipts of the Pittsburgh, Fort Wayne and Chicago 20 per cent, to prevent which 
it would be advisable to enter into almost any contract. United, the policy of the 
two roads would be identical and the consequence would be a large increase of 
trade." i Pitts. Ft. W. and Chi. Ry. Rep. 9 (1863). 

*o As usual the exception is to be found in the Pennsylvania. It had begun to 
develop a system within the first decade of its history — before 1855. See note 70. 


Aside from the natural desire of railroad owners and 
officials to expand their properties, several facts connected 
with the physical operation of railroads tended to promote 
the amalgamation of railways into systems. Perhaps the most 
prominent of these was the acceptance of a uniform gauge 
for all the railroads of the country. In 1865 there was no 
uniformity of gauge and great inconvenience and expense was 
involved in the trans-shipment of freight at connecting points 
between railroads having different gauges. These varied from 
4 feet to 6 feet, although even before the Civil War the 
present standard gauge of 4 feet and S}^ inches predom- 
inated.®^ By 1875 rnost of the roads of the Northeast and 
West had adopted the standard gauge,*^ and the important 
roads having a wider gauge had laid a third or fourth rail 
to accommodate the interchange of rolling stock. ®^ By 1886 
the roads of the entire country had adopted the standard 
gauge®* and a loaded freight car could move freely over the 
whole national system of railroads. 

In addition to the establishment of a uniform gauge 
throughout the country there had gradually developed a great 
number of technical improvements in the rolling stock,*^ the 

•1 The reason for the adoption of the particular gauge that has become standard 
is a matter of historical accident. The early English railroads had a gauge of five 
feet. This was narrowed by i^ inches on either side when the flange wheel was 

* At the time of the Civil War practically all the roads south of the Potomac 
had adopted 5 feet as the standard gauge. This followed the precedent established 
by the South Carolina Railroad, the first important railroad of the South. 

The original Camden and Amboy was laid with a gauge of 4 feet 10 inches 
and later the Ohio legislature decreed that all the railroads of the state should be 
laid with the 4 feet 10-inch gauge. On the other hand, many eastern and New 
England roads had been laid with the standard English gauge of 4 feet S'/i inches. 
At the same time certain important roads — the Erie and the Lackawanna, for example 
— in order to increase the carrying capacity of cars had increased the gauge to 
6 feet. 

**The Delaware, Lackawanna and Western Railroad for example. 

•♦ The southern roads clung tenaciously to their five-foot gauge. Most of them 
ohanged during the months of May and June, 1886. 

*In t8s5, Felton and Crocker built at Taunton, Massachusetts, the first successful 
coal-burning locomotive. About the same time locomotives adapted for coal were 
built by the Baldwin works for the Pennsylvania Railroad, but this type of coal- 
burning locomotives was difficult to fire and but little used. It was not until 
after the Civil War that they came extensively into use. Heavy locomotives of the 
"consolidation" and "mogrul" types were introduced about 1868 and "Krupp's patent 
steel tires" for locomotives came into general use a few years later. 

Conspicuous improvements in the size, convenience, and comfort of passenger 


road-bed®' and the signaling systems."'^ Radical improvements 
along these lines were most conspicuous in the decade follow- 
ing the Civil War.®* The result, in every case, was to improve 
the quickness, certainty, ease, and cheapness of movement of 
trains. And in response to the greater rapidity and safety of 
transportation the public came to demand an improved service. 
One of the chief requisites of this improved service was fast 
through trains, both passenger and freight. This demanded 
extensive organization which easily tended to promote the 
development of the railroad system. 

Coincident with the growth of improved methods of opera- 
tion was the growth of competition. As small railroads were 
joined longitudinally so as to form through routes between 
large cities, competition over these routes began to develop. 

coaches developed in the decade succeeding the Civil War. Through sleeping-car 
service was inaugurated in 1863 and became widespread by 1869. In 1863 the 
Central Transportation Company ran sleeping-cars on the Pennsylvania and Central 
of New Jersey railroads. In September, 1863, it published the following announce- 
ment: "This company (the Central Transportation Company) . . . having, by purchase, 
recently become the sole owner of Woodruff's, Knight's, Myers', and other patents 
for seats and couches in sleeping-cars, would respectfully give notice to all railroad 
companies of the United States that may desire sleeping-cars on their roads that 
this company is now prepared to negotiate for placing, wholly at its own expense, 
on such roads as may require them, their sleeping-cars, and operate them upon 
terms at once liberal and satisfactory to railroad companies." Quoted, Ringwalt, 
J. L., Development of Transportation Systems in the United States, 208 (1888). 

•• For example, the gradual substitution of steel for iron rails. Steel rails 
appear to have been first laid in the United States in 1863, on the Pennsylvania 
Railroad. 17 Penn. R.R. Rep. 13 (1864). President Thomson had observed their 
use in England in 1862 and imported 150 tons. (First used in England, London 
and Northwestern, May 2, 1862.) The following year they were tried experimentally 
on five other eastern roads. In 1867 they cost about $170 a ton (currency). 
Although they were acknowledged from the very first to be vastly superior to 
iron rails, from an operating standpoint, their great cost prevented wide-spread use. 
Thus Thomson, the early genius of the Pennsylvania Railroad, stated in 1867: 
"The cost of steel rails is at present about twice that of the best iron rails, while 
their durability is fully eight times greater. . . . The general introduction of steel 
rails is now wholly a commercial question, in which the cost of the increased capital 
required for their purchase becomes the chief impediment to their general adoption." 
20 Penn. R.R. Rep. 26 (1867). Perhaps steel rails were first produced in this 
country in i86s by W. F. Durfee in Chicago. By 1877 the cost had fallen to 
less than $50 a ton. In 1881 over half of the railroads of the country, including 
all the principal roads of northeastern and middle western states, were laying steel 
rails on at least parts of their lines. For further details on this interesting topic. 
Bee Welch, A., "A Memoir on Rails," 3 Trans. A. S. C. E. (187.S); Raidabaugh, 
G. P., The Railway Rail (1915); Elfreth, J., "American Rail and Track," 22 Trans. 
A. S. C. E. 

Up to the end of the Civil War practically all railway bridges were of wood. 
Beg^inning about 1865 iron bridges were used. 

" The first use of signaling by telegraph occurred, according to Ringwalt, quoting 
the Hevf York Times, in 1850, when Charles Minot, superintendent of the New 
York and Erie, thought of telegraphing ahead from one station to another to 
ascertain the movements of a delayed train. Ringwalt, J. L., Ibid. 164. 

Special sig^nal stations came into general use on main lines about 1868. 

■ Observe the dates in the three preceding footnotes. 


Soon after a through route from the Great Lakes to New 
York had been established by way of the New York Central 
to Albany and the Hudson River road to the Harlem, the 
Erie and its connections also began to offer a corresponding 
service.®^ No sooner had one series of roads established a 
connection between two important points than some other 
routes-began to compete with it for the meager traffic available. 
Competition loomed large as a factor in railroad operation 
and railroad management. Inevitably, whatever the field of 
industry, consolidation is sought as a remedy for competition. 
And this, unquestionably, was one of the underlying causes 
that led to the development of railway systems in the period 
succeeding the panic of 1873. 

But more important by far than any advances in the tech- 
nical or administrative operation of the railroads and the 
rivalry engendered by competition, was the growing strength 
among prominent business executives of the impulse to expand. 
The crude beginnings of railway systems were to be found 
before 1873. But, like the early development of the Pennsyl- 
vania system, they were the result of the force of pressure 
from without rather than from within.^'* 

•• For an illuminating account of the popular attitude toward this particular 
combination, see the article entitled "Sketch of the Rise and Progress of the Internal 
Improvements and of the Internal Commerce of the United States"; with a review 
of the charges of monopoly made against railroad corporations by Poor, Henry V., 
Poor's Manual of Railroads (1881), xxiv, et seq. 

'" The underlying motives and surrounding circumstances that led to the develop- 
ment of the Pennsylvania Railroad system, especially the trunk lines west of 
Pittsburgh, are thoroughly typical of the consolidation of roads into systems char- 
acteristic of the period after the middle seventies and are also significant in themselves. 

Beginning as early as 1850 the management of the Pennsylvania Railroad began 
to concern itself with western connections. As stated by President Thomson 
some years later, it had been the purpose of the Pennsylvania to develop three 
independent western connections, one leading to Chicago and the others to points in 
Ohio — Columbus, and Cincinnati. 20 Penn. R.R. Rep. 11 (1867). A detailed study 
of these developments illustrates early railroad consolidation. 

In 1848 a project was launched to connect Pittsburgh with Chicago. Accordingly 
the Ohio and Pennsylvania Railroad was incorporated in Ohio and Pennsylvania, 
to build a road from Pittsburgh to Crestline, Ohio. Two years later the Ohio 
and Indiana Railroad was incorporated to build a line from Crestline to Fort Wayne, 
Indiana; and in 1852 the Fort Wayne and Chicago was incorporated to extend 
the line to Chicago. Meanwhile the Ohio and Pennsylvania experienced difficulty 
in securing the requisite capital; and on the assumption that the completed road 
would favor the Pennsylvania Railroad in the interchange of traffic, the latter was 
empowered by the legislature in 1852 to subscribe to the capital of the Ohio 
and Pennsylvania. Portions only of the through line were completed by 1856, 
and in order to unify the building and operation of the roads a consolidation 


After the depression following the panic of 1873 the 
whole motive changed. A new force, psychological rather 
than technical or economic in character, had injected its virus 
into the railroad world. Just as, some fifteen or twenty years 
later, the development of internal commerce made it appear 
possible to combine the operation of geographically separated 
factories under a single management, so the creative imagina- 
tion of the railroad operators grasped at the possibility of 

was agreed upon. It was a typical end-to-end consolidation of the early period. 
As a result the Pittsburgh, Fort Wayne and Chicago Railroad was organized, 
in which the Pennsylvania Railroad, by the exchange of its Ohio and Pennsylvania 
stock at $120 a share, became a large stockholder. Three years later the road 
failed. In 1862 it was reorganized, as the Pittsburgh, Fort Wayne and Chicago 
Railway (an early reorganization, see Volume V, Chapter IV, note 13), in which 
the Pennsylvania retained an interest, justified by the "written pledges" of the 
Fort Wayne officials for an interchange of traffic. 23 Penn. R.R. Rep. 15 (1870). 
In the following years the road became successful — the stock rising from $35 a share 
at the time of reorganization, to $152^4. in 1864. At the same time the officers, 
elected by the majority of the stockholders began to divert traffic away from the 
Pennsylvania Railroad, contrary to the original understanding; they even had an 
extension east of Pittsburgh surveyed in order to release the Fort Wayne road 
from dependence on the Pennsylvania. (Ibid. 16.) Also, after the Fort Wayne 
road haci given evidence of its independent earning power and strategic importance, 
the board of directors of the Erie Railway sought to obtain control of its stock 
through the purchase of stockholders' proxies in the open market. The 
management of the Pennsylvania Railroad was incensed, but helpless. The Pennsylvania 
had even sold a large part of its stock in the Fort Wayne road, lured by the 
high market price (20 Penn. R.R. Rep. 13 [1867]), notwithstanding the fact that 
the Fort Wayne road, as the Chicago extension, was necessary to it. In this 
predicament, in order to insure control, the Pennsylvania leased the road in 1869 
on very liberal terms, and subsequently purchased a majority of its stock. 

The histories of the Ohio extensions are analogous. In 1848 a company was 
incorporated to build a line from Steubensville, on the Ohio River about thirty 
miles southwest of Pittsburgh, through Columbus to the Indiana state line. In 
the following year another company was incorporated to build the line from 
Pittsburgh to Steubensville. Part of the money for both enterprises was supplied 
by the Pennsylvania Railroad or its officers and the rest was promised by local 
merchants and the cities and towns traversed — the city of Pittsburgh and the county 
of Allegheny being large contributors to the Pittsburgh and Steubensville line. Both 
roads came into financial difficulties before their lines were completed. The 
Pennsylvania Railroad organized -and subscribed to a majority of the stock of the 
Western Transportation Company for the purpose of completing the Pittsburgh and 
Steubensville (20 Penn. R.R. Rep. 12 [1867]), but difficulty was encountered in 

fetting the right to cross the seven-mile stretch of West Virginia between the 
'ennsylvania state line and the Ohio River. Finally in 1868 the lines were com- 
pleted, reorganized, and consolidated into the Pituburgh, Cincinnati and St. Louis 
Railway, of which the Pennsylvania Railroad assumed the operating control through 
ownership of a majority of its stocks and bonds. 22 Penn. R.R. Rep. 13 (1869). 
In the same year, 1868, an end-to-end consolidation was effected of a group of 
roads reaching from Columbus to Chicago and Indianapolis, all of which had 
experienced difficulties, under the name of the Columbus, Clhicago and Indiana 
Central Railway. This lyas in the following year leased by the Pittsburgh, Cincinnati 
and St. Louis Railway, the contract being guaranteed by the Pennsylvania Railroad. 
(Ibid. 16.) Soon after the same road leased the Little Miami Railroad, which gave 
the Pennsylvania lines direct access to Cincinnati and the railway traffic converging 
there from the Southwest. 

The Pennsylvania Railroad having thus acquired a considerable investment and 
leasehold interest in these western connections, secured from the Commonwealth 
of Pennsylvania a charter for the Pennsylvania Company, one of the few holding 
company charters ever granted by the state. 24 Penn. R.R. Rep. 19 (1871). See 
also Chapter V, note 4. The railroad then transferred to the Pennsylvania Company 
all these interests uking in return $8,000,000 of its $12,000,000 of stock. 


combining through routes and branch lines into closely knit 
railway systems. The natural instinct of the business execu- 
tive is to play for bigger things. This is his mode of exercising 
the primal Anglo-Saxon craving for conquest. This simple 
statement is all that is necessary to explain why, during the 
ten or fifteen years of business expansion between the panics 
of 1873 ^^^ 1893, a large number of the great railway systems 
of the country were created out of disjointed parts. 

The methods employed in building up a railroad system 
varied in individual cases. They have been discussed already 
so far as they consist of legal devices and financial expedients. 
But a general plan of physical development has been sufficiently 
common among important railway systems to be considered 
typical. In brief, it has consisted of the extension, longitudi- 
nally and laterally, of a single relatively short trunk line. This 
extension was usually effected both by consolidation with 
previously existent lines and by the construction of new lines 
and new connecting links. A single line, oftentimes only a 
few miles in length and of relative insignificance, became 
dominated by men who were moved by the impulse for expan- 
sion. The line was then extended longitudinally and laterally. 
It seemed to move forward, like a primitive amoeba, by the 
extension of lateral processes in all directions. It acquired a 
significance in the railway world quite disproportionate to its 
size. It became, in effect, the nucleus of a railway system. 

This history is so characteristic of the origin and expansion 
of our American railway systems that an illustrative case can 
be chosen, quite at random, from almost any railway system. 
North, South, East, or West.^^ The development of the 
Atchison, Topeka and Santa Fe rail system is an illustration 
of these principles although no more typical than is the develop- 
ment of other large railway systems. Finished as a completed 

" The nucleus of the Atlantic Coast Line was the Petersburg Railroad, 21 miles 
in length. For a careful study of the development of the Atlantic Coast Line 
system, see Dozier, H. D., A History of the Atlantic Coast Line Railroad (1920). 


road of 471 miles in 1873, it grew rapidly until in 1892 — 
less than twenty years — it became a railway system of over 
9,000 miles in length." And the growth of railway systems, 
similar to the growth of the Atchison, but not quite so extreme, 
was taking place all over the United States. In 1873 there 
were no railroads in the country more than 1,200 miles in 
length, including the branch lines, and only three in excess 
of 900 miles. In 1893 there were 35 systems possessing a 
mileage in excess of 1,000 miles and 5 separate systems that 
exceeded 5,000 miles.''^ 

But the development of railway systems was not enough. 
In the late eighties, about the time the formation of industrial 
trusts began to attract seriously the attention of business men 
and political and social observers, railway operators began to 
enlarge their spheres of influence from railway systems to 
systems of systems. Thus began the third and last period 
of railway consolidation. 

Again the line between the two periods is arbitrary, and 
again the parallelism between the development in the East and 
the West is not exact. Nevertheless there is discernible the 
effort to extend the scope of the railway operating system to 
a loose combination of systems, distinct from each other in 
operation but unified by intercorporate connections and finan- 
cial control. This is the combination movement in the railway 
industry, parallel to the trust movement among manufacturing 
corporations. The underlying causes which brought it about 
were much the same as those which led in the earlier period 
to the formation of railway systems, only the emphasis was 

" The development of the Atchison, Topeka and Santa Fe system between the 
panics of 1873 and 1893 is perhaps an extreme illustration of the typical development 
of railway systems during the period, as the Atchison system after 1888 was a 
loose union of several systems. In its development from 1888 to 1892 the history 
of the Atchison was more typical of the period of railroad consolidation following 
the panic of 1893. See Daggett, S., Railroad Reorganization, Chap. VI (1908}. 

" In this computation the loose union of the Atchison and St. Louis and San 
Francisco was not recognized. Also the Richmond and Danville, the Ka«t Tennessee, 
and the Central of Georgia were considered separate systems. 


not on formal combination, but on the efficacy of mere con- 
solidation of management, mere large-scale operation, to bring 
about increased revenues. It is what Ripley calls "the higher 
strategy in railroad consolidation." ^* 

In the earlier periods, combination was usually dominated 
by traffic expediency. It was the hope of holding and increas- 
ing traffic that led to the end-to-end unions of the early period 
and to the welding of disconnected lines into systems in the 
second period. But in this third period of consolidation the 
ruling motive was not so much the increasing of traffic, for 
that could be obtained by intensive development of the already 
existent systems, but the increasing of administrative and 
financial control over whole sections of territory. Instead of 
consistency and internal coherence a myopic, headstrong, and 
unreflective competition for power dominated railroad 
strategy. As a result, railroad systems were jointed together, 
often by mere accident,''^ provided the power of the railroad 
operators was increased and the scope of their activities 

This is no place for an extended discussion of the numerous 
combinations of railroad systems that were consummated in 
the ten years from 1896 down to 1907. Such "higher strategy 
of railroad consolidation" has been often and excellently 
treated elsewhere in great detail.^® The process continued, 

" The passage from which this clause is drawn summarizes the conditions sur- 
rounding the railway consolidations of the period from a slightly different angle. 
"The working out of the higher strategy in railroad consolidation was the most 
significant feature of American transportation history in the decade to 1910. . . . 
Nor was the growth of large units confined to railroading alone. In fact the 
rapid rise of great banking units undoubtedly had much to do with the activity 
in this direction in the railroad field. All the various events of the period naturally 
dovetail together — rising freight and passenger rates; growing interest in govern- 
mental control; hostility." Ripley, W. Z., Railroads, Finance and Organization, 459 

'* Like the acquisition of the control over the Louisville and Nashville Railroad 
by the Atlantic Coast Line Railroad. See note 44. 

^* Probably the best statistical account of this "higher strategy of railroad con- 
solidation" is an exhaustive study prepared by Adams, H. C, for the Interstate 
Commerce Commission — Spc. Rep. No. i, I. C. C. (1908) — covering the intercorporate 
relations of all the railroads of the United States. This study presents an extended 
array of financial statistics showing the extent and character of control exercised 
by one railroad over another in 1906. 

An extended account of the later railroad consolidations is to be found in Ripley, 


uninterruptedly, until the Northern Securities decision of the 
Supreme Court forced a reversion, or perhaps slowing down 
of the consolidation mania. Then, following the panic of 
1907 and the railroad legislation of 1910, the railroad 
operators began to question the expediency of burdening the 
already extended railroad systems by still further extensions. 
Railroad consolidations ceased altogether. And in the 
reorganizations occurring between 19 13 and 19 18 there was 
a reversion of the process and large parts of the bankrupt 
railroads were lopped off. The problems of efficient railroad 
management were serious enough with a small system; they 
became well-nigh insurmountable with a great disjointed and 
inarticulate system. Railroad consolidation was discredited 
by actual experience quite as much as by the Supreme Court. 

W. Z.j Railroads, Finance and Organization, Chaps. XIII to XVIII (1915). See 
also Cleveland and Powell, Railroad Finance, Chaps. XV and XVI (1912). 

For tracing, in detail, the development and co-ordination of a ^reat railroad 
system, there is no better account than Dozier's history of the Atlantic Coast Line 
system. Dozier, H. D., A History of the Atlantic Coast Line Railroad (1920). 
This has the advantage over most histories of individual railway properties of being 
written by a trained economist. 

There are several uncritical accounts. One written by Spearman, F. H., The 
Strategy of Great Railroads (1903), gives an illuminating account of the "higher 
strategy of railroad consolidation" as it was actually taking place. 



Means of control over many small companies, 109; Early history, 
no; Four advantages, 113; Superior technical efficiency, 114; 
Economy in purchase of equipment, 118; Advantage in business deal- 
ings with public, 118; Advantages in financing, 122; Financial struc- 
ture of the public utility holding company, 128; Special types of hold- 
ing company, 134. 

One of the most remarkable illustrations of corporate con- 
solidation with some degree of individualization of parts is 
represented by the public utility holding company. This finan- 
cial device represents a means which gives concentrated finan- 
cial and operating control over small independent public utili- 
ties, widely separated geographically. 

In its simplest form, the public utility holding company 
consists of a corporation organized under the laws of some 
state which permits its corporations to hold the securities of 
other corporations in its treasury. It acquires at least a 
majority of the stock of local gas, electric, and traction com- 
panies. Against these treasury securities it issues its own 
stocks and bonds. In brief,_ the holding company acquires a 
control of the equities of local utilities, and through the owner- 
ship of these equities exerts a direct administrative control 
"over the operation of the local utilities themselves. It assumes 
^at a single central organization can exert a more efficient 
and economical management, although it may be miles away, 
than is possible by the local owners. It assumes that the 
public utility business is susceptible of a high degree of special- 
ization, and that a few trained specialists can operate many 



widely separated plants — it is a kind of industrial combination 
applied to the field of local public service companies. 

The early history of the public utility holding company, 
although it does not extend back further than the eighties, 
is very difficult to trace. The first corporation of the kind 
at all analogous to the modern holding company was the pred- 
ecessor of the present organization known as the United Gas 
Improvement Company. The old United Gas Improvement 
Company was incorporated in 1882 as a Pennsylvania corpora- 
tion, for the purpose of introducing improvements in the gas 
industry. The company immediately acquired the exclusive 
license from T. S. C. Lowe for the exploitation of his patented 
process for the manufacture of water gas.^ The older method 
of manufacture of illuminating gas from the destructive dis- 
tillation of coal was so firmly entrenched that the United Gas 
Improvement Company found great difficulty in introducing 
the manufacture of water gas. Accordingly the company at 
first leased gas works in various parts of the United States 
and subsequently acquired their stocks. This policy of acquir- 
ing control of disconnected local gas works began about 1884. 

1 Lowe's process had been in successful operation in several places, notably 
Baltimore, Maryland, and the United Gas Improvement assumed his licenses for 
about twenty-three states not already pre-empted. Lowe himself became a stockholder 
to the extent of about lo per cent of the original outstanding capital stock of 

The Lowe method of water gas manufacture consisted in passing hot steam over 
hot hard coal or coke. Chemically it is a very simple process, in that the hot 
coal combines with the oxygen of the steam, forming carbon monoxide, which passes 
out mixed with the free hydrogen evolved from the breaking down of the water 
molecule. Water gas is, therefore, primarily, a mixture of carbon monoxide and 
hydrogen. This mixture, however, burns with a colorless flame, so that water 
gas to be used for illuminating purposes must be enriched by the vapor of some 
hydrocarbon rich in carbon. This enrichment is usually accomplished by adding 
"gas oil," an unrefined petroleum remaining after the distillation of the lighter oils. 
The manufacture of water gas is carried on in a series of upright cylinders, the 
whole known as a "gas set." When petroleum is of low cost — the "gas oil" is 
the largest single expense in water gas manufacture — water gas is cheaper to 
produce than the g^s made from the destructive distillation of coal. Also in small 
gas works, small water gas sets are cheaper to operate than gas benches of the 
same relative capacity. Some large gas works maintain the two independent systems. 
They produce a prepondering proportion of water gas when oil is cheap and gas 
coal expensive, and gas from the distillation of coal when opposite conditions prevail. 
Under normal conditions the coke produced from the destructive distillation of 
coal provide^ the coke for the production of water gas. There is, therefore, a kind 
of balance between the two processes. For the development and exploitation of 
water gas manufacture, the United Gas Improvement Company is largely responsible. 


It was, perhaps," the first concerted attempt to bring under 
one management numerous independent, geographically 
separated public utilities. 

At first the stocks of gas companies acquired by the old 
United Gas Improvement Company were placed in the hands 
of a trustee, as the general corporation laws of Pennsylvania 
did not permit one corporation to hold the securities of another 
corporation. This procedure, however, was indirect and cum- 
bersome. Accordingly the men responsible for the Gas Im- 
provement Company acquired the charter of the Union 
Company, an old charter granted by a special act of the 
Commonwealth of Pennsylvania in 1870.^ This charter was 
one of the most liberal ever granted by special legislative sanc- 
tion,* and permitted, among other things, the corporation to 

• So far as the author has been able to ascertain. 
•P. L. 1870, page 1247. 

* The early charters granted by the Commonwealth of Pennsylvania were matters 
of legislative favor. They were as liberal as the political influence of their sponsors 
could make them. In 1868 a charter was granted to the Continental Improvement 
Company (P. L. 1868, page 822) which, after reciting all the ordinary powers and 
contractual relations a corporate body could possibly have need of, provided that 
the corporation "shall have full power and authority to hold and own securities 
of any form, either as collateral or otherwise, and dispose of the same at pleasure." 
In 1870 the legislature granted a similar "omnibus" charter to the Pennsylvania 
Company (P. L. 1870, page 1025) to enable it to own the securities of and operate 
the lines of the Pennsylvania Railroad west of Pittsburgh. (Chapter IV^ note 70.) 
The legislature of Pennsylvania was then under the influence of officials of the 
Pennsylvania Railroad; and Thomas A. Scott, an important officer of the road 
obtained, in December, 1870, a charter for the Union Contract Company which 
specially provided that this company should "have full power and authority to hold 
and own securities of any form, either as collateral or otherwise" (Sec. 2). And 
the charter also provided that the company should have all "the privileges conferred 
on the Continental Improvement Company" (Sec. 8). And furthermore a supple- 
mentary act was passed conferring on the company "all the rights, powers, and 
privileges" conferred on the Pennsylvania Company a few months before. 

The power to charter "omnibus" corporations of this character was taken away 
from the Pennsylvania Legislature in 1873, but before that time some five or six 
had been created. Besides the three just mentioned, there were others, as follows: 

The Excelsior Enterprise Company, later the "National Company," chartered in 
187 1. Its charter was acquired in 1896 by the reorganization managers of the 
Philadelphia and Reading Railroad to bring into one corporate ownership the 
railway and coal properties. 64 Chron. 84 (1897); Daggett, S., Railroad Reorganiza- 
tion, 141 (1908). 

The Erie and Western Transportation Company. This was organized by men 
associated with the Pennsylvania Railroad, to own and operate steamships on the 
Great Lakes. 

The Philadelphia Company. This was a large holding company operating the 
public utilities in and around Pittsburgh. It is now a subholding company within 
the United Railways and Investment Company. See note 35 and page 134 of this 
chapter and the accompanying text. 

The National Transit Company. This operated a series of pipe lines in the 
interest of the old Standard Oil Trust. 

The Union Contract Company, referred to in the earlier part of this note, 
was used as a construction company for numerous railroads in the South, and 



purchase atld own the securities of other corporations. The 
name of the Union Company was changed in 1888 to the 
United Gas Improvement Company. The new United Gas 
Improvement Company then acquired the assets of the old 
United Gas Improvement Company, by exchange of stock 
and also the shares of gas companies held in the interest of 
the latter by trustees." 

The United Gas Improvement Company has been success- 
ful in its general plans. It has acquired the control and owner- 
ship of gas, and later electric light plants in all parts of the 
United States. These are operated by thirty-four subsidiaries, 
having a combined capitalization of $200,000,000, in addition 
to the $60,000,000 of common share capital of the United Gas 
Improvement Company itself." Its income has steadily in- 
creased and since 1889 the company has paid regular dividends 
of 8 per cent. In 19 18 its accumulated surplus amounted to 
over $35,000,000. 

for several others in Colorado, including the Denver and Rio Grande Railroad. 
It was freed from possible claims by a tax sale in 1885 and the name clianged 
to the "Union Company." In 1888 the charter was acquired by men associated 
with the old United Gas Improvement Company. 

* The corporate existence of the old United Gas Improvement Company was 
maintained down to 1918, as this company held the leases to the Waterburv Gaslight 
Company and the Vicksburg Gaslight Company. It was not considerea wise to 
transfer these to the new company. 

* Summary for Securities of the United Gas Improvement Company, 1918 




Securities of subsidiaries: 
Intercorporately owned: 

Owned directly by United Gas Improvement. . , 

Owned by subholding companies 

Funds in sinking fund and treasury 


Publicly owned 

Total securities of subsidiaries 

United Gas Improvement securities (holding company's 
own securities outstanding) : 

Publicly owned 

Securities of United Gas Improvement and subsi 


Grand Totel of all securities j2S7, 




IS. 003, 000 



Total securities intercorporately owned. 
Total securities publicly owned 

Percentage of total securities owned by the public 
represented by different classes 











SI. 7% 


The success of the United Gas Improvement Company as 
a holding company for the stocks of local utilities attracted 
imitators. The first of these, in 1890, was the North American 
Company, a reorganization of the old Oregon and Transcon- 
tinental Company/ The plan of the directors of this company 
was to develop, intensively, the electric business in a single 
locality and secure profits for the holding company through 
the unified control and economical operation of all the electric 
utilities of a single, relatively confined, but thickly populated 
area. This plan was first applied to the electric utilities of 
Milwaukee ; later the North American Company acquired con- 
trol of the street railways of St. Louis and a minority interest 
in the Detroit Edison Company, one of the most successful 
central station enterprises in the country. Later the American 
Light and Traction Company was organized for the purpose 
of acquiring and operating local utilities, and from 1900 down 
to the period of the Great War, holding companies of great 
variety were organized by banking and engineering firms.* In 
many cases the covert purpose seems to have been to secure 
a promotion profit rather than a profit through economies and 
efficiencies in the operation of the local utilities. In conse- 
quence these later companies have not prospered markedly. 

Four advantages have been alleged to justify the holding 
company form of organization as applied to public utilities. 
It is presumed that the central organization gains a high degree 
of technical skill at a relatively low cost for the individual 
plants. It is presumed that the central organization is able 
to purchase material, equipment, and supplies more intelligently 
and at better terms than the local organization. It is presumed 
that the central organization can deal more intelligently and 

^ See so Chron. 875; S4 Chron. 1007. For important statistics of the North Ameri- 
can Company see note 36 and the accompanying text. 

» One of the first in the electrical field was the United Electric Securities Com- 
pany, organized in 1890 hy the old Thomson-Houston JElectric Company. See Chapter 
Vl, note 27. Note also the Edison Electric Lighting Company, Chapter VI, note 26, 


far-sightedly with the pubHc authorities and the customers 
than can the local organization. It is presumed that the central 
organization can secui j the capital required for extensions 
more easily and at cheaper rates of interest than the local 
organization. Upon the truth of these presumptions — 
particularly the first and the last — rests the economic and 
social justification of the public utility holding company, and 
so important has this form of organization become that each 
of these grounds of economic efficiency should be carefully 

The superior technical efficiency of a centralized manage- 
ment as compared with a local management is most often 
alleged as the conspicuous advantage of the public service 
holding company. This allegation deserves considerable atten- 
tion. It has been pointed out already in connection with the 
promotion of public utility corporations" that most utilities 
were promoted and operated during their early existence by 
local men who knew next to nothing about the technique of 
the business. The minimtmi of technical knowledge was ob- 
tained by hiring a manager or superintendent who had "picked 

» The advantages of the public utility holding company over the independently 
owned and operated local utility have been often reviewed. Nowhere have these 
advantages been more clearly expressed than in a certain brief filed May ii, 1914, 
with the Interstate Commerce Committee of the United States Senate with reference 
to Senate Bill No. 4160. See also Gerstenber^, C. W., Materials of Corporation 
Finance, 570 (1915). "The holding company unites under one control and manage- 
ment the public utilities of several communities. The increased volume of business 
so obtained enables the holding company to make the expenditure necessary to secure 
a thoroughly competent executive, engineering, and operating staff, whose services 
are available to all of its subsidiaries. Thus, along with the resulting increase 
in efficiency, the expenses of each subsidiary are materially reduced. Expenses are 
further reduced by the standardization of materials and supplies, and by the purchasing 
of such supplies by skilled purchasing agents in large quantities in a far wider 
market and upon much better terms of credit than could possibly be secured by 
the separate local companies acting independently. The centralized expert manage- 
ment effects further economies in the cost of production by the standardization 
of operating and accounting methods. Plants are combined and construction work 
is standardized, so that equipment outgrown by one community can be utilized 
by transfer to another smaller community, instead of being discarded as useless; 
in this way the enterprise is run with a minimum amount of capital, and depreciation 
charges are materially lessened. The distribution of the business over an enlarged 
territory 'averages the risk' and secures the holding company against irreparsmle 
damage from purely local causes. All of these improved conditions operate to 
increase the attractiveness of the enterprise to the investor, and, consequently, to 
bring about the very great economy of decreased cost of capital and the resultant 
fixed carrying charges." 

"Volume II, Chapter V. 


Up" a modicum of practical experience working in another 
plant. Such a manager had learned the business much as a 
grocer or hardware dealer had learned his. This scrappy- 
technical knowledge was sufficient for all practical purposes. 
The manager could understand the actual operation of the 
gas works, the electric light plant, the water works, or the 
little gtreet railway. He could make small repairs and attend 
to the ordinary replacements and extensions. But he was 
utterly unfamiliar with the real technique of the industry. 
Above all, he could not tell when machinery and equipment 
became obsolete, as compared with newer or essentially dif- 
ferent models. In consequence, the local utility settled down 
into a kind of humdnuu existence, quite outside the current 
of industrial progress. 

This humdrum kind of existence the centralized manage- 
ment of the holding company sought to improve. By reason 
of its ownership of a number of utilities, it was able to employ 
a general manager of far greater technical knowledge and 
business acumen than the meager resources of the single local 
utility could command. And the fraction of the time that 
the man of superior skill was able to devote to the single 
company afforded the necessary stimulus and guidance that 
brought it out of its routine of inefficiency. The pro rata 
cost of the general manager's service that should be charged 
against the earnings of the single company was small, compared 
with the operating economy that resulted from following his 
instructions. On the other hand, the high cost of the expert 
manager's services, valuable as they were, would have been 
prohibitive had the single utility been forced to bear them 
alone. The local utility, that is to say, could very wisely bear 
its proportionate share of the salary of an able and progressive 
manager who planned the technical policy it should follow, 
but it could not bear the entire salary." This co-operative and 

*^ The problem whereby the holding company may secure compensation for all 


centralized planning is what the holding company furnishes." 
This advantage of having marked technical skill to direct 
the general policies of a small company, even though the actual 
operation has to be left with an immature or only partly trained 
local superintendent, has unquestionably worked out well in 
practice. The administrative operation of any public utility 
consists of two fields of activity. The operator must determine 
the technical policies of the company, and he must attend to 
the day-to-day routine business of the company. The former 
requires a broad knowledge of electrical or gas engineering, 
the product of highly specialized technical training, keen busi- 
ness insight, and a wide experience. Yet decisions of policy 
are made infrequently. The question of whether to substitute 
a steam turbine for a steam engine of older type, and if so 
what should be the size in view of the probable future load, 
is a question that comes up for consideration only once in 
every few years. A new generator must be installed, because 
of an excessive, but short-time peak load. Great care and a 
wide knowledge of many things are required to tell whether 
it is best to install two smaller units or one large unit. Such 
questions do not present themselves often, but if a mistake 

the services rendered to its subsidiaries often presents difficulties. If all the 
securities of the subsidiary are owned by the holding company, then the method 
and the amount of compensation the parent may demand of its subsidiary is entirely 
a question of bookkeeping. But if there is a considerable minority ownership in 
the securities of the subsidiary, then it becomes a matter of importance whether 
the earnings of the subsidiary are brought into the holding company's treasury 
partly through an arbitrary service charge in which the minority security holders 
have no share, or entirely through stock dividends in which the minority interests 
have a proportionate participation. In an important case a holding company charged 
a subsidiary $2,000 a year for its services. The Commission ruled that this was 
all the rate payers were called upon to bear, even though it could be shown that 
the local utility could not obtain services of equal value by other means except 
at a much greater cost. 68 Electrical World, 1182 (1916). The American Telephone 
and Telegraph Company levies on each of its subsidiaries a charge of 4^ per cent 
of the gross receipts for the services of its central organization. This includes 
not only the customary legal, technical, financial and administrative assistance 
rendered by the holding company, but also a rental for the subscribers' telephone 
instruments, all of which are owned by the holding company. 1914 Am. Tel. & 
Tel. Rep. 3. 

" The services rendered by the regular and consulting engineers for the sub- 
sidiaries of the American Gas and Electric Company is a conspicuous case in 
point. Not only have these subsidiaries the advantage of the technical talent directly 
employed by the holding company, but also, because of the close connection between 
the American Gas and Electric Company and the General Electric Company (see 
Chapter VI, page 167), these small operating companies have at their command — 
provided their technical and operating problems require it — as able electrical engineers 
as there are in the country. 


is made when it comes time to decide them, considerable losses 
result. On the other hand, the ordinary detailed problems of 
day-to-day operation require constant attention, but they do 
not involve decisions of much importance. If the local man- 
ager buys a car of poor coal, it may make trouble temporarily, 
but the loss to the company is slight ; if he puts in a transformer 
at a certain point, rather than continue the secondary circuit 
a few hundred yards further, he may fail to exercise shrewd 
judgment, but the loss to the company is slight. 

These two phases of actual operation require, then, abili- 
ties of an entirely different order. The actual day-to-day 
operation of the utility may be entrusted to a man of quite 
mediocre ability, provided he has a mind for detail and is 
careful in small matters. Men having a capacity of this kind 
are numerous, easily trained, and are contented with a small 
sphere of usefulness. Their salaries are small, ordinarily. They 
may make mistakes, but the sum total of the losses arising 
to the company because of the mistakes of such a man amount 
to considerably less than the difference between his salary and 
the salary of a thoroughly competent resident engineer. But 
this is all predicated on the presumption that the local operator 
does not have to make judgments concerning policy. In the 
relations subsisting, ordinarily, between the holding company 
management and the subsidiary operating companies, these 
judgments of policy are made by the highly trained technical 
engineers, so that in actual practice the two phases of the 
operator's duties are actually divided. The technical j>olicies 
are determined by a corps of high-salaried, trained engineers 
under the employ of the holding company, who have general 
supervision over all the subsidiaries. The routine, day-to-day 
operating problems are settled by the low-salaried resident 
superintendent. In this way the local company secures both 
types of operating administration at least cost to itself. 

Another advantage alleged to pertain to the holding com- 


pany is the economy In the purchase of equipment. This 
arises both from greater inteUigence and from the economies 
resulting from large contracts with manufacturers. The cen- 
tral purchasing department of the holding company, upon 
which requisitions are made by the local managers, is able 
to use greater discrimination in selecting machinery and equip- 
ment than the manager of the local company when acting 
alone. In the matter of intelligence, the single purchasing 
department can devote considerable time to a study of the 
relative costs of different types of transformers, gas retorts, 
or cars, as the case may be, and purchase standardized equip- 
ment for all the subsidiaries. Economies, too, are often pos- 
sible in the purchase of standard equipment, even where no 
discriminating judgment is required.^^ For it stands to reason 
that the manufacturers of even such staple commodities as 
cast iron pipe and copper wire will offer special discounts to 
the purchasing agents of groups of companies able to negotiate 
exclusive contracts carrying a large volume of purchases. 

Still another advantage alleged to belong to the holding 
company form of organization is the advantage in business 
dealings with the public. This is the same as saying that the 
ordinary methods of business administration are better if 
under the supervision of men with special training or long 
experience. This may show itself in several ways, but in 
none is the advantage of wide experience more important than 
in the placing of contracts and in determining the wisdom 

" A good illustration of this is shown in the purchase of incandescent electric 
lamps. The important producers are subsidiaries of the Westinghouse and General 
Electric companies (Chapter VI, page 165). These companies have made an agreement 
with each other covering a uniform scale of discounts, based on the gross purchases 
under a yearly contract, as follows: $150 a year, 17% discount on standard 
packages"; $300 a year, 21%; $600, 24%; $1,200, 2^%•, $2,500, 29%; $5,000, 31%;, 33%; $20,000, 34%; $30,000, 35%; $50,000, 36%; $100,000, 37%; 
$150,000, 38%; $225,000, 39%; $300,000 and over a year, 40%. Such lamp purchase 
contracts permit a single _ management controlling several companies to pool the 
purchases. The contract is sig:ned by the purchasing department of the holding 
company, and attached to the contract is a rider giving a list of all the subsidiary 
companies whose total purchases are to be lumped together in figuring the composite 


of making extensions for new customers. Both of these mat- 
ters illustrate the advantage of a large centralized organization, 
and deserve, therefore, more than passing notice. 

Companies supplying water, gas, and electrical energy to 
private customers make individual contracts with the con- 
sumers. The traction company offers a kind of general service 
which, is paid for as it is delivered, and requires, therefore, 
no special contracts. Water, gas, and electricity are furnished 
to contract customers according to published rate schedules, so 
that the "selling" problems of the company are confined to 
determining the proper rate schedules and to determining 
the amount of capital outlay the company can afford to make 
in order to "take in" a new customer or group of customers. 
The former is the problem of rates; the latter is the problem 
of extensions. 

Attention has already been drawn to the fact that a water, 
gas, or electric company sells its services on the basis of a 
monopoly price.^^ It is not called upon, ordinarily, to meet 
competition of the same commodity, although it may compete 
with substitutes in the sense that gaslight is still somewhat 
of a competitor of electric light, and electric heating is becom- 
ing to some extent a competitor of gas heating. But the prob- 
lem of rate-making is still a problem of monopoly price — 
the maximiun total net return, rather than the profit on the 
individual sale. This being the case, the prediction of both 
the gross and net revenue likely to accrue to a gas or electric 
central station company from a given schedule of rates is a 
matter of guesswork at best, and unless the guessing is done 
by men of wide experience it is apt to be harmful if not 
actually disastrous to the company. This is conspicuously true 
in determining a schedule of power rates, especially for central 
station electric companies. Electric energy must be sold as 
it is generated, but the generating machinery must be prepared 

"Volume II. Chapter V. 


to deliver current on the instantaneous demand of the cus- 
tomer. As a result, power customers who require a regular, 
constant supply of energy throughout the twenty-four hours 
are most desirable; those whose requirements fluctuate from 
nothing to the maximum demand of their entire machinery, 
are least desirable. The rate that the central station company 
can afford to make for the latter customer must be computed 
on an entirely different basis from the rate for the customer 
with a regular demand. Yet the two rates must be scientifically 
computed. They must be matters of public record, so that 
any other customer operating under essentially the same con- 
ditions could enjoy the same rates.^*^ 

All this is stated to show the intricacy of determining 
a rate schedule that justly apportions the costs of public service, 
so that each customer bears a fair share of the burden, and 
yet one that yields the company sufficient revenue. It is, 
indeed, so intricate that a wide experience with the wants 
of different kinds of customers as well as a thorough knowl- 
edge of the production problems of the utility are required 
on the part of the rate-maker. Such an experience and such 

"The power rate is now regarded as a function of three variables — the maximum 
demand, tne maximum quantity of energy consumed, and the total quantity of 
energy consumed. The first two are frequently, especially for small customers, 
grouped together as the "demand charge." 

The subject may be well illustrated from a concrete case. A certain mill might 
have required for a period of twenty minutes i68 horse- power of electrical energy. 
The first element of the power bill will be i68 multiplied by the demand rate, 
say $1.50 — ^making the demand charge $252. We will assume, too, that it consumed 
27,860 kw.-hrs. of energy. Now the energy schedules provide for a varying rate, 
somewhat as follows (all power consumption above 1,000 kw.-hrs. metered on the 
primary side of the transformer at 2,200 v.) : 

• Kw.-hrs. Cents 

1,000 to 2,000 3.00 

2,000 to 5,000 2.75 

5,000 to 1 0,000 2.50 

10,000 to 20,000 2.25 

20,000 to 50,000 2.00 

all over 50,000 1.75 

From this schedule it is apparent that the energy charge will be $649.70. This 
added to the demand charge gives a total power bill of $901.70. 

Another variable still, the "load factor," or relative variation of demand, has 
been introduced by some rate engineers of late. As a whole, rate scheduling for 

?ower loads grows increasingly intricate as the complexity of the subject is more 
ully realized. The whole purpose is to charge to each customer the fair share 
of the cost of maintaining and operating the central station plant that can be 
properly allocated to him. 


knowledge are certainly not at the command of the man who 
operates a small local public utility for a group of local owners. 
Such a man, when confronted with the necessity of drawing 
up a rate schedule will probably copy the one used by a neigh- 
boring company or else try to construct a new one without 
an adequate understanding of the subject. At all events the 
rate schedule of the local manager is bound to be less intelligent 
than a schedule worked out by a trained engineer who has 
made a study of scientifically constructed rate schedules. It 
is this advantage which the central organization of the holding 
company offers to its subsidiaries. And it is an important 
advantage. In extreme cases, an unfair power contract, under- 
taken through the stupidity of a local manager, has caused 
the failure of the utility.** 

The other assistance that the holding company renders 
to its subsidiaries in the selling of service is in connection 
with new business. The "new business" solicitor is a necessary 
adjunct to every progressive public utility, because the form 
and character of new business ought to be intelligently guided, 
and this guidance is dependent on considerable experience. 
Many gas and electric light companies have extended their 
lines in a quite haphazard fashion. If a customer in an out- 
lying section of the town was particularly urgent in his 
demands for service, a main or a line would be extended to 
him in the hope that new customers along the way would 
ultimately take services and thus render the extension a profit- 
able investment. But often the accumulation of interest 

>* A certain Massachusetts corporation engaged in the distribution of electric 
energy purchased its current of a large hydro-electric company. The contract had 
the usual demand charge and a sliding scale energy charge, the latter complicated by 
a "coal clause." The manager of the local distributing company, wishing to reduce 
the cost of his energy as much as possible, signed a contract with a large paper-mill 
on the basis of an energy charge approximately equivalent to the lowest bracket 
of the hydro-electric company's charge to him. But he neglected to protect himself 
by a proper demand charge. In actual experience it was found that the load of 
the paper-mill had, at times, an abnormally high "peak." This high peak so increased 
the "demand" of the entire distributing system that the sales of electricity to the 
paper-mill resulted in a very substantial loss. In fact the losses on the paper-mill 
contract entirely obliterated the profits on all the rest of the business. A receivership 
was threatened, and the company was taken over by a committee of creditors. 


charges on the sparsely used extension acted as a permanent 
burden to the whole company. It has become universally 
recognized that an intelligent placing of the new business is 
even more important than the new business itself. For this 
reason new business campaigns are carefully planned by the 
new business engineers of the holding company, put under 
the charge of a man or woman" who follows definite pre- 
scribed plans. The primary lines and transformers or the 
mains are plotted, the points and areas of undersaturation are 
noted, and the new business solicitor concentrates his energy 
upon these points or areas. The trained solicitors are moved 
about from one district to another and from one subsidiary 
to another, according to the immediate needs. Ordinarily 
they carry on their work independent of the local management 
and their compensation usually consists, in part if not alto- 
gether, of commissions on the new services they secure.^* 

But after all has been said, there is little doubt but that 
the most conspicuous help that the holding company renders 
to its subsidiary is in financial matters. This shows itself in 
two ways. The holding company advances money to the 
subsidiaries, taking in return the ordinary demand notes. It 
also acquires for permanent investment or for subsequent sale 
the stocks, bonds, or debenture notes of the subsidiary. In 

" In new business campaigns of gas companies, the object of which is to extend 
the use of gas for cooking, women are frequently better new business solicitors 
than men. They have more patience in arguing with a prejudiced or penurious 
housewife the advantage of the gas-range over other forms of cook-stoves. 

"In one instance that comes to mind, the new business solicitor is allowed $10 
for each new service he secures, out of which he must meet all his expenses. 
In this way the company is able to capitalize the cost of securing each new customer 
at a definite, predictable figure. Such a plan will work well when it is desired 
to increase tne concentration of domestic consumers; it will not answer for power- 

Another system of compensation for solicitors was adopted by a holding company 
for gas-works. Each solicitor received a small weekly salary, a commission of $5 
on each new service, and in addition a small bonus on the margin of increase 
of consumption of gas in the district in which the solicitor had been working. 

The American Gas and Electric Company publishes a monthly magazine for 
distribution among the employees of its subsidiary operating companies. In _ this 
magazine is published the records" and relative standing of all the new business 
men in the entire organization. To direct compensation it adds, therefore, the 
stimulus of rivalry. 


brief, it assumes to render both temporary and permanent 
financial aid to its subsidiary operating companies. 

The outstanding problem of all public utilities since the 
beginning of the century has been the financial problem of 
obtaining the money necessary for improvements and exten- 
sions/^ Since the wide-spread adoption of the Lowe system 
of gas manufacture and the universal substitution of alter- 
nating for direct current machinery for electric companies, 
the technical advances in the utilization of gas and electrical 
energy have outstripped the capital available with which to take 
advantage of these advances. Because of their public nature, 
the return allowed by commissions, the courts, and public 
opinion on the capital invested in utilities has never been as 
liberal as that available to the capital invested in a well-man- 
aged bank or manufacturing company.^" They have bid for 
capital more by stressing the permanence and stability of the 
industry than by offering high interest rates. As a result, 
that portion of the savings fund of the community available 
for the extensions and improvements of public utilities has 
been inadequate to public demands. Severe competition en- 
sued among the utilities themselves for what was available, a 
competition stimulated by the incessant clamor of the public 
for improved service. 

In the presence of this competition for capital, that utility 
has fared best which has had some direct financial support.^^ 
This support has been given by the holding company. By 
the ownership of the controlling shares — the equity, as it were 
— of a number of utilities, the individual capital demands of 

*'This is literally true except among the utilities of Massachusetts and some 
other New England states, where the steady accumulation of capital, the limiting 
tax laws, and the inertia of local managements, resulting in failure to keep their 
properties technically abreast of the times, have created a situation which enabled 
these utilities, down to the period of the Great War, to obtain easily and at a low 
rate all the new capital they required. 

*" See memoranda of prices at which securities could be sold before the Great 
War, as given in Chapter VIII, note 3. 

" Again excepting the Massachusetts utilities and some others of the New England 
states. In such cases the utilities have been able to sell common stock at such a 
premium that the net return to the investor has been close to 4 per cent. 


each are averaged. The capital available from the treasury 
of the parent company is passed over to the subsidiary to be 
used under such conditions as confer the greatest benefit. 
Weak subsidiaries are tided over critical periods — often by 
the use of the credit of the stronger subsidiaries — and the 
credit of the whole organization is made available to those 
companies which are so small or so deficient in earning 
capacity that they have no independent credit. 

The first aid extended to the subsidiary is in the form 
of direct advances on open accounts or on demand notes. 
These advances are used by the subsidiaries to meet the ac- 
counts of merchandise dealers and contractors, and the pay- 
ments for wages incurred in building the extensions. In this 
way the subsidiary's own credit is not, except in rare cases, 
used for its current expenditures. These open accounts or 
demand notes are carried by the holding company as free 
treasury assets or else rediscounted with its indorsement. ^'^ 

It is a fundamental principle of finance^' that fixed invest- 
ments, such as constitute the improvements and extensions 
of public utilities, should not be paid for from the proceeds 
of the sale of short-time notes. On the contrary, property 
of this character which is not self -liquidating must be paid 
for by the sale of long-term bonds and stock. This elementary 
principle of finance has been acknowledged, from necessity 
as well as business sagacity, by the officers of most holding 
companies. And they have sought to fund the accumulation 
of short-term notes and accounts by one of several means. 

The simplest means, and the one invariably adopted when 
the credit of the subsidiary is strong, or at least as strong 

** The amount of these notes and open accounts, which a holding company may 
carry representing temporary financial operations, sometimes reaches very large 
proportions. This was particularly true during the latter part of the Great War- 
say the calendar years of 1918 and 1919 — when the bonds of established public 
utilities declined steadily and most of the new capital available was being absorbed 
by government loans._ Under these circumstances, the permanent financing of 
extensions was well-nigh impossible. Extensions and improvements were reduced 
to a minimum, and this minimum had to be carried by means of temporary borrowings. 

a See Chapter VI. 


as the credit of the holding company,^* is to have the subsidiary 
issue its own bonds and preferred stocks which are then sold 
for its account by the financial department of the holding 
company. And the indirect help which the holding company 
renders, even though it does not indorse the securities, is very 
great. The mere fact that a small local company is owned 
and controlled by a well-known holding company will in- 
variably aid in the marketing of its securities — in fact the 
bonds and preferred stocks of many such operating companies 
would be utterly unmarketable were it not for the fact that 
the equity common stocks are owned by well-known holding 
companies, which must protect the underlying securities in 
order to protect their own common stocks. Even though the 
subsidiary is not paying its way and the equity common stock 
is worthless, a prosperous holding company will continue to 
advance bond interest on open accounts for a considerable 
period of time, rather than allow the subsidiary to default on 
its charges and pass into the hands of receivers. The failure 
of a subsidiary, notwithstanding any excuses, invariably 
affects the credit of the holding company. 

Also, in marketing the underlying securities of the sub- 
sidiaries, a large and successful holding company usually has 
close connections with bankers. And the bankers are made 
to feel that it is incumbent on them to take the less desirable 
bonds and preferred stocks of smaller subsidiaries along with 
the more desirable and more easily sold issues of the parent 
company and its wealthier subsidiaries. 

If the holding company believes it expedient to reinforce 
the credit of the subsidiary by its own credit, it may either 
indorse with its guarantees the subsidiary securities; or it 

**It must not be inferred that the credit of the holding company is invariably 
stronger than that of its subsidiaries. The North American Company holds a large 
minority interest in the Detroit Edison Company. The general credit of the latter 
is probably equal or superior to that of any other local utility in the country, 
barring a few Massachusetts companies which have no bonded debt. There is no 
question but that it is superior to that of the North American Company. 


may issue securities of its own, based on the subsidiary stocks, 
notes, and bonds acquired for its treasury. There are no fixed 
rules observed ; a holding company may follow one method at 
one time and another method at another time. 

The sale of underlying subsidiary securities, with the guar- 
antee of the holding company, is, on the whole, a less common 
practice among public utilities than among railroad holding 
companies. The reason for this is probably that investors 
are inclined to give less weight to the credit of the former 
than the latter.^' The policy has, however, been followed in 
a few sporadic instances in which a holding company tried to 
market a considerable issue of subsidiary securities under 
peculiar circumstances,^" or sought to market some bonds of 
a subsidiary before the earning capacity of the subsidiary 
would warrant.^^ This policy of the holding company in 
withholding its indorsement of subsidiary securities is, on 
the whole, wise. The volume of such securities in the hands 
of the public is very large, as compared with the free assets 
in the holding company's treasury.^* The indorsement, if 
extensively indulged in, would stand merely as a form and 
therefore lead to deceit and misrepresentation. 

The usual method by which the holding company will 
seek to finance its subsidiaries is by means of the issue of 
its own securities. These are likely to be either collateral 

** A railroad holding company, such, for_ example, as the Southern Pacific Company 
of Kentucky, in spite of the fact that it is a mere "paper corporation" carries far 
more weight with the rank and_ file of investors than any public utility holding 
company unless perhaps the United Gas Improvement Company or the American 
Light and Traction Company. But neither of these follows the practice of indorsing 
the securities of their subsidiaries. 

'•This is illustrated by the case of the Consolidated Cities Light, Power and 
Traction Company's First Lien Collateral Trust 5's, due 1962. These bonds were 
first offered in London in 1912. The Cities Service Company, the parent company, 
was unknown, so also was the subholding company, the Consolidated Cities, and 
80 also were the small operating companies whose bonds and stocks constituted the 
collateral security. To give the English investor every possible security the bonds 
were guaranteed, principal and interest, by the Cities Service Company. 

"The American Public Utilities Company's Twenty-year Secured Notes, due 1936, 
are secured, largely, by the stock of the Wisconsin-Minnesota Light and Power 
Company. This was an extensive power development which had not demonstrated 
its earning capacity when the notes were issued. 

*» See note 35 of this chapter. 


trust bonds, if the holding company has not a strong inde- 
pendent credit, or debenture bonds and preferred stock, if 
it has. 

If the holding company is forced to issue collateral trust 
bonds, serious difficulty arises in regard to the nature and 
extent of collateral that shall be deposited with the trustee 
as security. If the bonds are to be issued merely to furnish 
the subsidiary companies with money for extensions, then 
the holding company will wish to use, as the collateral for 
its own bonds, only the particular securities issued in connec- 
tion with the extensions. But such securities would be prob- 
ably only parts of issues. And if, subsequently, the holders 
of the collateral trust bonds were forced to foreclose their 
lien and take possession of the collateral they would find them- 
selves unable to reach forward to the actual property as the 
pledged collateral constituted only a minority interest in the 
total securities of the subsidiary. Consequently most banking 
houses that undertake to offer the collateral trust bonds of 
a holding company insist that the pledged collateral shall 
constitute at least sufficient proportions of the outstanding 
securities as will enable the holders of the bonds to secure 
possession of the physical property of one^^ or more^° of the 
subsidiaries, without having their liens destroyed by the actions 
of an antagonistic majority interest. And it is essential that 

'"Thus when the collateral deposited consists only of the common shares of 
the subsidiary, it is provided that additional common shares, if issued by the 
subsidiary, shall be deposited under the collateral trust. 

This was discussed in connection with collateral trust bonds as a whole. 
Volume I, page 54. It is specifically illustrated by a provision of the indenture 
securing the collateral trust bonds of a small holding company in western Penn- 
sylvania, the Pittsburgh District Electric Company. This corporation owns all the 
stocks, bonds, and outstanding notes of the Mercer County Light, Heat and Power 
Company, the operating company, all of which securities are pledged to secure its 
collateral trust bonds. The indenture provides that the operating company shall 
not issue any securities, not even ordinary notes, unless they are immediately 
acquired by the_ holding company and pass under the lien of its collateral trust 
bonds. A provision, such as this, which makes it impossible for the operating 
company to issue to the public even an ordinary note is unusual. It is, however, 
a very real way to prevent the emasculation of the assets of the holding company. 

*• In rare cases the collateral trust bonds of the holding company are secured 
by the deposit of first mortgage bonds of several of the subsidiaries. (American 
Public Utilities Collateral Trust s's of 1942 mentioned Volume I, Chapter III, 
note 40.) The trustee could probably secure the actual title to the property of 
at least some of these subsidiaries in case of default. 


this be so. For if the credit of the holding company is such 
as to demand the additional security of collateral, it is likewise 
necessary to protect this collateral from emasculation through 
the issue of other securities having an equal or superior lien 
on the actual property of the subsidiary operating company. 
If the credit of a holding company is good, it will in- 
variably issue its own simple securities. These will be its 
preferred stock, its debenture bonds, or — more generally — 
one or another according to the temper of the investment 
market. And it is interesting to note the gradual substitution 
of preferred stock and debenture bonds for collateral trust 
bonds as the credit of the holding company grows stronger.'* 

Turning from theoretical consideration and purely deduc- 
tive reasoning to the public utility holding company as it 
actually exists, one is confronted with a great variety of cases. 
There are insignificant concerns — holding companies in form 
only — which are created as a mere subterfuge to enable pro- 
moters to recapitalize a single operating company more liber- 
ally. There are great holding companies, each of them owning 
the equities of a hundred or more local utilities scattered "from 
Maine to California." Some of these, like the Standard Gas 
and Electric Company of Delaware, are largely holding com- 
panies for other holding companies, which operate within a 
relatively restricted geographical range. In a given instance 
it is sometimes difficult to distinguish between the small holding 
company and the large operating company, especially when 
all the municipalities served are in the same locality^^ but the 

** When the American Gas and Electric Company (for its community of interest 
with the General Electric, see Chapter VI, page 167; also note 35) was organized, 
it issued its hundred-year collateral trust bonds, pledging: its most valuable securities. 
The company was successful. All its later issues of bonds have been ordinary 

« Thus companies like the Southern Utilities Company and the West Penn. 
Power Company are almost on the border line. All the separately operated companies 
of the former are in Florida and southern Georgia, all of those of the latter are 
in a relatively confined area of western Pennsylvania. From an operating point of 
view, all the local properties can be managed as a unit — in fact it is conceivable 
that all might be physically connected by means of transmission systems. Yet in 


operating plants are physically distinct from each other. And 
any attempt to draw an arbitrary distinction between the two 
must end in confusion, for in actual experience there are 
countless combinations. Yet the cases to which special refer- 
ence is made in this chapter are those which are the holding 
companies of many individual operating companies distinct 
from each other in organization and financial structure. 

A study of the financial structure of the typical public 
service holding company presents difficult problems. There 
is, usually, hopeless confusion in reaching both the net capital- 
ization and the net earnings. This confusion is due to the fact 
that both subsidiaries and holding company have securities 
outstanding, some of which are held among the companies, 
some held by the parent company as collateral on the basis of 
which other securities are issued and some, finally, are in 
the hands of the public. These last only are of significance 
in estimating either capitalization or earnings because inter- 
company securities are, at the last analysis, only bookkeeping 

To reduce the capitalization of the holding company to 
some kind of intelligible form, an exhaustive study was made 
of the gross and net capitalization of twelve typical holding 
companies.^' These twelve holding companies and their sub- 
sidiaries had outstanding approximately two and a half billion 
dollars of securities.** Of this amount about two-fifths were 

their corporate organization and financial administration they are thoroughly typical 
of the holding company. 

** Graduation thesis of Harley, R. J., Harvard School of Business Administration, 
April, 1920, unpublished. The statistical matter of the present paragraph is taken 
from this source. Although the grroup selected does not include all the holding 
companies, and a more or less arbitrary method was adopted in the selection, it 
does include some of the largest in the country, many of medium size, and one 
or two of smaller size and of relatively local significance only. None of the holding 
companies included has more than an incidental interest in street railways or 
interurban tractions. In most cases the subsidiaries represent a wide geographical 
distribution. Both the financially successful and unsuccessful are included. The 
group may be considered, therefore, as representative of the public utility holding 

** There has never been a systematic attempt to classify all the public utility 
holding companies and to compute the aggregate capitalization of the subsidiaries and 
of the holding companies themselves. Numerous intelligent guesses have been made. 
For example, in a brief filed May 11, 1914, with the Interstate Commerce Committee 


represented by bonds, two-fifths by common stocks, and a 
fifth by preferred stocks. But of these two and a half billion 
dollars of securities only three-fifths were actually owned by 
investors, the remainder being merely intercompany holdings 
— the bonds or stocks of subsidiaries held in the treasury 
of the holding company against which its own securities were 
outstanding. Of this billion and a half of publicly owned 
securities, including the publicly owned stocks and bonds of 
subsidiaries as well as those of the holding companies, ap- 
proximately a billion dollars, or two-thirds of the entire 
amount, was represented by bonds bearing fixed charges, and 
the remaining third was about evenly divided between pre- 
ferred and common stocks. In other words, of the total out- 
standing securities of holding companies, about 40 per cent is 
mere bookkeeping debit and credit between companies, about 
40 per cent represents publicly owned bonds, and about 10 
per cent publicly owned preferred stocks ; while the remaining 
10 per cent represents the equity common stocks in which is 
vested the complete control.^^ 

of the United States Senate with reference to Senate Bill No. 41 6o^ it was alleged 
— the supporting statistical computation was omitted — as follows: "The total capital 
employed in electric, gas, street, and interurban railway companies, commonly 
called 'public utility corporations, in this country today is estimated to exceed 
eight billion dollars. Of this capital, nearly five and a half billion dollars are 
controlled by holding companies and their subsidiary companies. Of the approximately 
eighty-nine millions of people served by electric light and power and gas companies 
over sixty-two millions (approximately 70 per cent) are served by holding company 

"The electric light and power companies represent approximately two billion 
dollars of capital of which approximately 76 per cent is controlled by the holding 
company form of organization. These utilities serve over fifty_ millions of people 
approximately thirty-eight millions of which are served by holding companies. Of 
577 cities of ten thousand or more population served, 428 are served by holding 
company systems. Of the 114 cities in the United States of a population in excess 
of fifty thousand, 103 are served by holding con\panies. Of the 54 cities in this 
country having in excess of one hundred thousand population, 49 are served by the 
holding company. 

"Artificial gas companies represent a capital of approximately one and one-third 
billion dollars. Of that capital, approximately two-thirds is controlled by_ holding 
companies. The gas utilities of the country serve approximately thirty-eight and 
one-half million people. Of this number nearly twenty-five million are served by 
holding companies or their subsidiaries. 

"Street and interurban railway companies represent a total capital of approximately 
fire billion dollars. Of this sum it is estimated that not less than two-thirds is 
controlled by holding companies. In the 28 cities of the United States having a 
population in excess of two hundred thousand, the mileage of track controlled 
Dy holding companies is in excess of 61 per cent." 

" The approximate figures given above were derived from a study of the 
published capitalization, as of 1918. for the twelve holding companies, the capitalization 
of which is summarized in the loUowing table. (Figures are in even thousands.) 



Tlie securities of the subsidiaries, the subholding companies, and the main holding 
company are all lumped together. 


Preferred Stock 

Name of Company 
("Company" omitted) 
































United Railways Investment 


Middle West Utilities 














American Power and Light 








Common Stock 

Name of Company 
("Company" omitted) 






























Middle West Utilities 









The same results may be expressed by summarizing the totals of the various 
subsidiary, intercompany, and holding company securities. 




Securities of subsidiaries: 

Intercorporately owned 

Publicly owned _. _. 

Holding company securities: 

Intercorporately owned 

Publicly owned 

Total outstanding securities of holding com- 
pany and subsidiaries 

Grand Total of all securities.. . . $2,557,056,000 

Total securities intercorporately owned 

Total securities publicly owned 

Percentages of total securities that are pub- 
licly owned represented by different classes 









317. 875.000 









A discussion of the comparative gross and net income of 
the public service holding company presents serious difficulties, 

The percentage ratios of the different types of securities throw a good deal of 
light on the intercompany relationships of the public utility holding company. In 
spite of marked differences, these percentages indicate certain conspicuous char- 
acteristics of holding company capitalization. 





"3 o 

« >» 

C " 

Cities Service 74% 79% 

United Railways Investment. . . 83 84 

United Gas Improvement. ... 76 70 

Middle West Utilities 95 97 

United Gas and Electric 95 95 

Federal Light and Traction. ... 61 8S 

Massachusetts Lighting 100 loo 

North American 92 92 

Standard Gas and Electric 94 9S 

American Gas and Electric. ... 62 75 

American Public Utilities 100 100 

American Power and Light. ... 95 96 

Average* 86.5% 

O 0^^ 

V .a 
<» « 

« S 5 

v o ^ 









o o 

^ . 


o a, 

U O fe 





(4 .a 










87.5% 49% 72.5% 



•a A "S >» .i <J .i ""O .JL " o 

.S B .2.0 Ca . C-.3 « C3 o 

a P fitl H 3^ o 3 S O 3 5 

SI S| "^1 ^^a ^^i 

1^ il 14 I.-". I.-". 

«-.S^ ^S ri'O'O ["•o'O [r-o-a 

oi^S "S-iS "SgS "og^ "oSiJ 

ail a§ . a|i a|i s^s 

5«° ^Sia 5*^S "o« . rtOg . 

^w^ ^c^a ^^ ^2-3 ^^g,-^ 

s^§ 8^1 n.iB p.^^° 9.i^^ 

(ki &i di cu P4 

Cities Service 47% 53% 55% 3i% I4% 

United Railways Investment 55 45 69 15 16 

United Gas Improvement 36 64 44 4 52 

Middle West Utilities 19 81 54 a8 18 

United Gas and Electric 33 67 68 24 8 

Federal Light and Traction 37 63 55 21 24 

Massachusetts Lighting 15 85 15 41 44 

North American 22 78 63 10 27 

Standard Gas and Electric 27 73 65 24 11 

American Gas and Electric 39 61 76 19 5 

American Public Utilities 23 77 62 30 8 

American Power and Light 37 63 62 25 13 

Average* 38.4% 61.6% 61.6% 20.2% 18.2% 

* Not average of percentages, but the percentage of the sum of like figures for all the 
companies to the sum of other like figures. 


owing to varying accounting methods. Some holding com- 
panies permit the subsidiaries to account for their entire earn- 
ings as their own corporate property, merely a part of which 
reaches the holding company in the form of dividends.^* Other 
holding companies obliterate entirely, apparently, the corporate 
distinction between the parent and the subsidiary, and claim 
as theix earnings the total aggregate earnings of all subsid- 
iaries, whether or not they have been legally distributed as 
dividends. Furthermore, there is no uniform method of com- 
puting depreciation for the plants and equipment of the in- 
dividual operating companies; a holding company may even 
prescribe different policies for its separate subsidiaries.^^ 

Several holding companies refuse, absolutely, to make pub- 
lic the earnings of their separate subsidiaries. In some cases 
the earnings from local utilities are commingled with earnings 
from oil properties, for several of the larger public utility 
holding companies have acquired extended investments in oil 
wells and even in oil refining and distributing companies.^* 

" The United Gas Improvement Company, for example, takes no credit on 
its own books for the net earnings of subsidiaries — even though it owns all the 
securities — except such proportion as is paid over in the form of interest and 
dividends. The practice varies with different holding companies under different 

•^ The author once made an examination for bankers of certain subsidiaries of 
one of the subholding companies of the Middle West Utilities. The depreciation 
accounts presented an insoluble mystery until it was realized that the laws of one 
state required that specific reserves for depreciation should be set aside by all 
utilities, whereas no such requirement was made by the laws of an adjoining state. 
The accounts of the subsidiaries operating in the former state showed arbitrary 
charges to depreciation very clearly marked, whereas there were no depreciation 
charges for the subsidiaries operating in the latter state. Until this diflFerence 
in the state laws was realized, it was difficult to understand why the wear and 
decay of one generator need not be charged to earnings, whereas the earnings of 
another company, under the same management, a few miles distant must be burdened 
by analogous charges. 

** The Cities Service Company, the public utility holding company which has 
gone most extensively and successfully into the oil business, has three important 
subsidiaries with an aggregate capital of over $50,000,000, engaged exclusively in 
the production and refining of oil and the marketing of its products. Many of 
the company's other subsidiaries do an extensive business in petroleum products 
in connection with the distribution of natural gas. The Empire Gas and Fuel 
Company owns and operates oil leases and pipe lines in California, Oklahoma, 
Kansas, Missouri; Texas. The Empire Refining Company owns and operates pipe 
lines and refineries in Kansas, Oklahoma, and Texas. The Crew Levick Company 
owns oil wells in Pennsylvania, Ohio, and Oklahoma, pipe lines and several refineries 
near Philadelphia, distributing stations, and ocean steamers designed for the exporta- 
tion of petroleum products. Largely as a result of these incursions into the oil 
business, the gross earnings of the Cities Service Company have risen from $1,191,000 
in 1912 to $19,250,000 in 1917, and the net earnings from $290,000 to $15,000,000. 


For these various reasons a comparative study of the earnings 
of the pubHc utility holding company is not of significance. 

The public service holding company heretofore described 
exercises absolute control over its subsidiaries. Subject to the 
securities of these subsidiaries in the hands of the public, it 
may be said to exercise absolute ownership. But there are 
other forms of public utility holding companies where control 
and ownership are neither as certain nor as direct as in these 
cases. Such instances are represented by three different types 
of public service holding companies, each organized for a 
single main purpose. There is, first, the holding company 
organized primarily for distributing investments over a large 
range of utilities operating under diverse managements and in 
diverse localities. This type is analogous to the investment 
company, pure and simple, especially in the sense in which 
the phrase is used in England. There is, again, the holding 
company organized for the specific purpose of enabling many 
small, undeveloped operating companies to market their bonds 
during the period of their early growth. Often holding com- 
panies of this type are under the direct tutelage of equipment 
companies or banking houses. There is, still again, the holding 
company organized by engineers to hold small interests in 
numerous operating companies over which they exercise the 
managing control. These types may be designated, for con- 
venience, as the investment holding company, the banking 
holding company, and the management holding company. 

The public utility investment holding company exists in 
many forms. There are cases in which a considerable sum of 
money originally subscribed for another purpose is invested 
in public utility securities because these are deemed by the 
trustees sound and liberal in their income.'® There are other 

*■ Such was the case of the early history of the North American Company. See 
notes 7 and 35. 


cases in which investments are made in public utilities, because 
the trustees hope in this manner to profit through the growth 
of the communities served, a growth indirectly reflected in 
the enhancement in value of the local gas, electric light, and 
traction stocks and bonds,^** In all such instances, however, 
the securities are bought and held entirely for their income. 
There are no hidden motives of control underlying the pur- 
chase of these securities; nor is there any expectation on the 
part of the directors of the holding company to influence or 
even interfere with the management of the companies whose 
securities they buy. 

The public utility banking holding company gained con- 
siderable prominence in the decade immediately before the 
Great War. The electric power industries increased in amaz- 
ing proportions*^ and made ever increasing demands on the 
equipment makers for new and enlarged machinery and on 
the investment bankers for capital. The banking type of 
holding company was created to meet these demands. Private 
banking houses, in order to obtain securities to sell, organized 
public utility holding companies either with or without the 
explicit co-operation of an electrical equipment organization. 
These public utility holding companies then acquired blocks 
of bonds or stocks of young operating companies, and pledged 
them as collateral to secure issues of their own collateral trust 
bonds. The collateral trust bonds were purchased by the 
public because of the credit of the holding company issuing 
them, rather than because of the strength of the securities 
of the unknown operating companies used as collateral. With 
the proceeds of the sale of its securities to the holding company 

■••A company was formed in the spring of _ipi4 for the specific purpose of 
investing and speculating in the stocks of public utilities, on the expressed assumption 
that the increase in wealth and population would inevitably create a steady increase 
in the gross and net earnings of public utilities. The Great War was thrust upon 
the world within a few months; and public utility earnings the country over declined, 
except for temporary periods, steadily until 1920. 

** The total output of central stations increased from two and a half billion 
kw.-hrs. in 1902, to eleven and a half billion kw.-hrs. in 1912. It was over twenty-five 
billion kw.-hrs. in 191 7. Special Census of Electrical Industries for 1917 (1920), page 23. 


an operating company was able to meet the cost of its im- 
provements, and from the proceeds of the sale of the collateral 
trust bonds to the public the bankers were able to obtain 
substantial commissions.*'^ 

The public utility management holding company is usually 
organized by a firm of engineers who control the operation of 
numerous local utilities — absolutely independent of one an- 
other, except that a certain community of interests subsists 
by reason of the common management. The engineers, wish- 
ing to assist in financing the extensions of these utilities, 
organize a holding company which acquires some of their 
bonds or stocks. The securities of the holding company are 
then sold by the managing engineers to the public. The 
previous success and good reputation of the engineers is thus 
made to contribute materially in securing capital for small 
independent companies which lack an easy access to invest- 
ment funds.*' 

** This device is described in connection with the Electrical Securities Corporation 
of the General Electric Company. See Volume I, Chapter III, page 63, note 53. 
Also Chapter VI of this volume. 

** Two holding companies organized by Messrs. Stone and Webster, managing 
engineers, are of exactly this type. 

The Railway and Light Securities Company was organized in 190s "with fully 
paid capital of $1,600,000, for the purpose of holding and trading in securities of 
transportation, lighting, and other public service corporations." Of the capital, 
$1,000,000 6 per cent preferred and $600,000 common stocks, bankers offered shortly 
after the organization five shares of preferred and two shares of common for $725. 
The proceeds of this sale were invested primarily in stocks and bonds of companies 
managed by Stone and Webster. In December, 1905, bankers sold $500,000 par 
value of the company's 5 per cent collateral trust bonds, secured by $625,000, 
par value, of the bonds of companies under the Stone and Webster management. 
The company obtained further capital from time to time by the issue of additional 
stocks and bonds, so that by January i, 1920, it owned the stocks and bonds of 
forty-eight companies, twenty-one of which were managed by Stone and Webster. See 
reports of the company; also 80 Chron. 721. 

The Public Service Investment Company was organized in 1909, with the avowed 
purpose of obtaining a fund with which to buy and hold for income and appreciation 
m value the common and preferred shares of companies operated and controlled 
by Stone and Webster. The capital was fixed at $1,500,000 6 per cent preferred 
and $1,500,000 of common stock. The stock was offered by Stone and Webster 
in "blocks" consisting of ten shares of preferred and ten of common for $()5o 
per block. The immediately apparent dividends from the stocks acquired would yield 
an income of 6 i>er cent in the preferred and 2 per cent in the common stocks 
of the Public Service Investment Company. On January 1, 1920, the company owned 
a little over $5,000,000 of common stocks of local utilities and a little less than 
$1,000,000 of the preferred stocks. The investments were invariably in stocks of 
companies controlled and operated by Stone and Webster. The earnings of many 
of these local utilities were unfavorably affected by war conditions, so that the 
dividends on their common stocks ceased. In consequence, the Public Service 
Investment Company was forced to cease paying dividends on its own common 
stock, although the regular rate on the preferred stock was continued. 



Problem of business organization a balance between unity and 
diversity, 137; A balance involving advantages of each, 139; Trade 
associations, 145; District associations, 146; Manufacturers' associa- 
tions, 151; Community of interests, 154; Community of interests in 
production and distribution, 155; Community of interests in stock 
ownership, 157. 

All the forms of combination heretofore described repre- 
sent actual, virtually complete, consolidations of business units. 
The ownership and the management of the small units are 
thoroughly and completely merged. The component parts of 
a great industrial "trust," a great railway system, or a great 
power company are merely parts of a completely organized 
whole. They have no independent ownership, no independent 
financial structure, and above all their directors have no 
separate power of initiative. The name of a branch line of 
railway may be retained and there may be outstanding in 
the hands of the public separate issues of bonds, but the branch 
line has no separate management independent of the manage- 
ment of the whole railway system. Its earnings are merged. 
Its schedules of trains are made to fit into the schedules of 
the whole system. If it preserves, in order to retain some 
old non-transferable franchise, a separate corporate structure, 
the directors and officers are the same as those of the whole 
system, or else are men nominated by them. In brief, the 
branch line is merged in all except its name with the railroad 
system of which it forms merely one of many parts. 

But, admitting the advantages of complete consolidation 
in the various lines of business, it has been found, invariably 



in practice, that the very closeness of the consolidation has 
been attended by many disadvantages. It suppresses individual 
initiative. The big business has gained in weight, momentum, 
and width of power, but it has lost in spontaneity, capacity 
for detail, and depth of penetration. It gained the brute force 
of great size ; it lost the agility of small size.* 

Throughout every field of human thought there is the 
antithesis between the large, all-embracing imity and the small, 
distinct individuality. In its broadest aspect, it is a contrast 
between personalities — Heraclitus and Parmenides, Abelard 
and Anselm, Leibnitz and Spinoza, Locke and Hegel. In 
political theory and practice, it is the contrast between the 
relative advantages and disadvantages to its inhabitants be- 
tween the small state and the large empire. In social theory, 
it is the contrast between the residuimi of human happiness 
vouchsafed us mortals by industrial individualism and by 
socialism. And finally, in the limited field of modern business, 
it is the contrast between two types of business organization. 
On the one hand, there is the small, mobile, and compact busi- 
ness imit — the owner-manager business in which quickness of 
appreciation and personal initiative do much to counterbalance 
ignorance and lack of organization.^ On the other hand there 

1 One very important phase of this subject has been discussed already in 
Chapter III. 

* This idea was well expressed by an English writer who is, admittedly, unsym- 
pathetic with small business enterprise and fails to recos:nize the efficacy of 
competition; yet he says, "Where there is struggle for survival or supremacy among 
hosts of small concerns in the same line of business, each man knows what it 
is to carry the responsibility of a business and to stand or fall by its success 
or failure. The incentives to effort are strong. Each has a direct personal interest 
in improving methods, _ eliminating waste, reducing costs, and striking out in new 
directions. There is wide diversity and ample opportunity for experiment. Initiative 
and resource are developed in large numbers of individuals. There is, without 
doubt, something of an evolutionary struggle, in which those well endowed with 
the qualities that make for commercial success survive and the less competent, or 
worse equipped, or more sensitive go down and out. Again, the small man's 
independent business is a thing to himself, and, in a very real sense, a part of 
himself. The small business concern has personality. The employees of a small 
firm work for a person, and the relations between proprietor and workpeople, if 
not always cordial, are at least human relations. Business dealings with a _ small 
firm are_ dealings with a person, and there is little doubt that the personality of 
British industry in the past has been a powerful factor in its development. The 
type of character produced by these influences may not be wholly aamirable, but 
it is at any rate strong, forceful, and self-reliant." Hilton, J., "A Study of 
Trade Organizations and Combinations in the United Kingdom." Printed in the 
Report on Trusts prepared for the Ministry of Reconstruction, and dated April, 1919. 


is the "big business," often the largest single factor in an 
industry, in which great size and a kind of perfection of 
mechanical organization do much to counterbalance the lack 
of individual initiative and the lack of personal contact with 
employees and customers. Certain types of mind emphasize 
the particular. In their thought, and when they are called 
upon, to play a part in our modern commercial world, they 
prefer their own, personally dominated business, every detail 
of which remains incessantly imder their supervision. The 
opposite type thinks and acts in terms of economic generali- 
ties. It is endowed with great imagination. It suppresses 
differences and exaggerates likenesses. To such a type of 
mind details are abhorrent; business is to be unfolded like 
the plot of a great drama, in which individual character and 
incident are significant only as they further the end. Mere 
size is its own justification. And under the spell of men 
of this type business strategy becomes a mad rush toward 
consolidations, holding corporations, and other devices which 
enable a few to control large amounts of labor and capital. 

It is a very pertinent question: Can there be a form of 
business organization which retains the initiative and respon- 
siveness of small size and at the same time the scope and 
integration of the big organization? In other words, can 
there be a form of business organization which embodies the 
strengths both of the individual unit and of the combination 
of units? Or, putting the matter in another way, does the 
evolution of modem business forms bring into existence a 
new form in which business individuality and business unity 
may both exist? This is the problem of the present chapter. 

The intermediate stages of organization between the small 
unit and the consolidation of many units may be described 
briefly from an historical point of view. A multitude of small 
producing and distributing businesses that flourished at the 


time of the panic of 1873 were combined, for reasons hereto- 
fore described, into great industrial combinations that flour- 
ished just before and just after the panic of 1893. The ten 
years from 1879- 1889 were in many respects a transition 
period from the small to the large, and in this transition period 
various forms of indirect and loose combinations were tried 
in the effort to solve the problem of a balance between the 
free and unbridled competition of abject business individuals 
and the growing demand for a real co-operation in business 
that leads directly to consolidation and large industrial units. 
It is not the purpose of this discussion either to recount 
the evolution of industrial forms of organization during the 
transition period, or to present an exhaustive summary of all 
such intermediate forms as may exist.^ But as an introduc- 
tion to the few types of contemporary importance that it is in- 
tended to describe, a brief historical summary of the stages 
through which this evolution passed may serve as a pertinent 

* A note should be added, perhaps, to point out what is not intended in this 
connection. The text above refers only to types. It makes no pretense of exhaust- 
iveness. Above all, no attempt has been made to present an array of the different 
kinds — by order, genus, and species — of the trade associations. 

There have been, even since the later eighties, innumerable studies by economists, 
jurists, and students of social tendencies of the various types of pools, trade 
agreements, and clandestine price-maintenance agreements which have from time 
to time appeared in the business world. Each writer has his own classihcation 
of these forms of inarticulate combination, and the methods of classification are 
as varied as the interests, presumptions of social theory, and the economic postulates 
of the classifiers. Pools, trade associations, price associations, "Gary dinners" 
are all examples of the wide and ever widening range of loose business organizations 
which might, acceptably, be included in a classification of trade associations. In 
all cases, however, it is acknowledged that the fundamental characteristic of everv 
trade agreement and pool is an attempt to obtain some advantage that arises through 
combined rather than independent action. Ripley in his introduction to "Trusts, 
Pools and Corporations" gives a brief classification with special reference to the 
different types of pools. Ripley, W. Z., Trusts, Pools and Corporations, Chap. XII 
(1916). An exhaustive and easily accessible array of these trade associations is 
represented by five chapters in Haney, L. H., Business Organization and Combination, 
Chaps. X to XIV (1914). 

As a result of the economic conditions attending the Great War, hundreds 
of trade associations were organized in Great Britain. An attempt to classify these 
has been made in a Report on Trusts made to the Ministry of Reconstruction, 
dated April, 1919. See Chapter III, note 9. 

*The use of the idea of evolution is not a mere figure of speech. There is 
a close analogy between organic evolution — moving from the simple to the complex, 
from the elemental to the derived, from the homogenetic to the heterogenetic — 
and the transitional stages of business organization described here. Even the 
definitive principle of ontogeny made famous by Haeckel, that the embryonic and 
adolescent life of the individual is a shortened recapitulation of the evolutionary 
stages of the race, is not without its counterpart in modern business organizations. At 


At the close of the Civil War and down to the depression 
following the panic of 1873, American manufacturing business 
consisted, for the most part, of small independent units. These 
simple businesses were owned and managed by a single in- 
dividual, by the heirs or the members of the family of the 
founder, or by a group of local merchants who subscribed 
to the stock of the local mill. However existing, whether 
proprietary or a locally owned corporation, the business was 
narrowly limited in size and in scope of activities. Competi- 
tion was severe. Co-operation of any kind was unknown, 
and motives of industrial independence and isolation governed 
the business policy of American manufacturers. 

In the years before the panic of 1873, railroad construction 
and consolidation had so widened the area within which com- 
peting manufacturers could sell their product that in the boom 
period following the depression of the middle seventies, com- 
petition was extended over a wider field than ever before. 
Under the stimulus of an increasing volume of business and 
rising prices, manufacturers invaded each other's territory. 
Competition reached an unprecedented degree of severity, and 
in this competition the larger units were able, by rebates and 
midnight tariffs, to secure more advantages from the carriers 
than the smaller units through rampant individualization and 
cutthroat competition. The pendulum began to swing toward 
larger units and co-operative trade practices. 

The first stage in this evolution, both historical and logical, 
was the gentlemen's agreement governing the area of com- 
petition. Often, as a result of a casual meeting, manufacturers 
agreed not to send salesmen into each other's territory. The 
second step was the gentlemen's price agreement, likewise often 
the result of a mere casual conversation. The manufacturers 

the present day hardly a large business corporation is organized which has not, in the 
years immediately preceding its final development, passed through some of the 
transitional stages through which business organization as a whole passed in the 
transitional period between the panics of 1873 and 1893. 


agreed upon a minimum base price, below which they would 
not sell their goods. In both of these instances, there were 
no written contracts, for even before the passage of the 
Sherman Act in 1890, it was vaguely felt that all such agree- 
ments were contrary to the common law of restraint of trade. 
Business men merely agreed that they would be bound by their 
verbal agreement "on their honor as gentlemen." 

The gentlemen's agreements with regard to the territorial 
distribution of sales and with regard to cutting prices were 
both invariably broken. The manufacturers could not be held 
in law or equity to observe their agreements, and there was 
no other way of enforcing them. Competition which had 
extended over years, possibly over generations, could not be 
annulled by a verbal understanding, the very nature of which 
was at variance with our Anglo-Saxon law. Accordingly, 
some kind of loose but centralized and direct control had to 
be voluntarily endured by the manufacturers in order to render 
their verbal agreements effective. Such a contralized control 
was first accomplished by the pool. All pools had as their 
immediate object the direct control over the production or 
the distribution, or both, of all the co-operating manufacturers. 
This control was invariably vested in a central bureau which 
attempted to exert a mild dictatorship. On the relative strength 
of this dictatorship and the means at hand to enforce it de- 
pended the relative strength of the pool and its position in the 
evolution from the rudimentary gentlemen's agreement to the 
true business consolidation. 

The managers of the simplest pool merely sought to dis- 
tribute the output of the members. The central bureau, usually 
represented by a paid secretary, apportioned (he business avail- 
able in accordance with a prearranged schedule. This schedule 
sought to allocate to each manufacturer an amount of the 
available business that was proportional to his total producing 
or distributing capacity. But such pools were ineffective^ 


because the central bureau had no real authority to hold each 
manufacturer to his proportional allotment. A second type 
of pool required that the manufacturers belonging should bid 
among themselves for contracts, the proceeds of the bids being 
distributed among the members of the pool.^ A third, and 
by far the most important type was known as the "paying-in 
and drawing-out" pool. The cases of this type were very 
numerous." They were based, as were the two simpler types, 
on the distribution of the available business according to the 
total net capacity of the manufacturers belonging to the pool. 
Those maufacturers whose sales exceeded their proportioned 
allotment were to pay to the central treasury the total net 
profit realized in excess of their allotment. And, on the 
other hand, those manufacturers whose sales fell below their 
proportioned allotment drew from the pool's treasury the 
net profit on the sales representing the difference. No manu- 
facturer belonging to the pool could, therefore, obtain an 
increased profit through an increase of sales. Thus there was 
no incentive for a manufacturer to cut under the selling price 
agreed upon by the pool in order to Increase his sales. But 
even these closely organized pools failed of their object, either 
because of the growth of outside competition, or because of 
the deceit and perfidy of the members.^ Consequently the 

•The "cause cel^bre" of this type was the pool of manufacturers <5f cast iron 
pipe, known colloquially as the Addystone Pipe Pool. The case acquired considerable 
notoriety because the decision of the United States Supreme Court condemning the 
organization of this particular pool constitutes an important, perhaps nodal point 
in the evolution of tne judicial interpretation of the Sherman Act of i8go. For 
extensive description see 78 Fed. 712; 175 U. S. 211. Sections reproduced in 
Ripley, W. Z., Trusts, Pools and Corporations (1916). See also Haney, L. H., 
Business Organization and Combination, 172 (19 14). 

• A large number of such pools have been described in economic literature. See 
Haney, L. H., Chap. XI (1914). An excellent example is found in the Southern 
Railway and Steamship Association of which a description is given in Ripley, W. Z., 
Railway Problems (1913). 

'' In the instance of one pool, the history of which came under the writer's 
observation, an important member kept two sets of books. One set showed his 
true sales and was kept for his own information. The other was a fictitious record 
of sales prepared especially for the inspection of the pool's auditor in such a 
manner as to show much smaller sales. In this manner the manufacturer could 
make a surreptitious profit through an excess of sales beyond his allotment without 
being forced to pay back the profit to the pool's treasury. This ingenious plan 
was soon discovered by another member and it immediately caused the disruption 
of the pooL 


pools of all descriptions tended to break up. After repeated 
efforts manufacturers adopted the trust form of organization 
and later the true corporation. These later and advanced 
stages in the evolution of business organization have been 
treated already in the sections dealing v\^ith industrial con- 

Notwithstanding the development of the more highly or- 
ganized forms of business organization and the universal 
acknowledgment of the efficacy of the large corporation as 
a means of carrying on certain types of business, the defects 
of mere size are apparent. These were discussed at some 
length in a preceding chapter,® and need not be repeated here. 
But the thing of importance is that these defects are being 
more and more fully recognized, and with this recognition 
a reaction has set in toward the adoption of the smaller busi- 
ness unit. Mere consolidation — mere bulk— is not of itself 
and of necessity a source of strength. With this acknowledg- 
ment the permanent, if not the paramount problem of our 
contemporary industrial democracy, becomes the working out 
of the relations between the large and small business, and 
the bearing of each upon the problems of the economical use 
of labor and capital. The solution is not in working back 
over the road along which industrial evolution passed from 
the small business to the great corporation. The historical 
forms through which this evolution passed were negative. 
Gentlemen's agreements, pools, and the like, had as their object 
the stifling of competition. The intermediate forms now 
sought are positive. Industry is in a flux. Ease of transporta- 
tion, the general dissemination of technical knowledge, the 
scarcity of labor, the great accumulation of funds waiting for 
investment — all facilitate the formation of large units. In 
consequence, the intermediate forms which are now coming 

•Chapter IIL 


into prominence seek to temporize the inherent defects of big 
business with some degree of the freedom and spontaneous 
initiative of highly individuaHzed and independent parts. An 
exhaustive summary of such forms is not within the present 
purpose, but two general movements deserve rather detailed 
attention both because of their own significance, and because 
of the balance between the large and the small that they 
illustrate. They are the association — a loose, but co-ordinated 
form of union — and the community of interest — a closer form 
of union with a limited concentration of financial responsibility. 

Trade associations in one form or another have been in 
and out of fashion for many years. In the closing decade 
of the last century they furnished the fertile soil from which 
sprang the earlier industrial "trusts." Men found that the 
agreements made in the association meetings had no binding 
strength at law, and they sought a more direct and explicit 
means of suppressing competition. Out of the association 
agreement grew up the trust, and out of this the great indus- 
trial consolidation. But at the present time the movement is 
in the opposite direction. The problems are not so much 
those of suppressing competition as those of mutual protection 
against the demands of labor unions, the assessment of inor- 
dinate taxes, and the enactment of unfavorable tariff legisla- 
tion, on the negative side; and the development of trade ad- 
vantages in the presence of competitive substitutes and the 
exploitation of foreign markets, on the positive side. All 
competitors in any industry are interested in these ends; at 
the present time they are much more interested in them than 
in secret price agreements and pooling contracts. 

The types of trade association now prominent, that squarely 
face the issue of the relative advantages and disadvantages 
of individual and united action and seek to bring about an 
open, direct, and relatively permanent solution of the problem 


are in two general classes. ( i ) There are district associations, 
which include all manufacturers or all retailers in a certain 
geographical district. (2) There are also trade associations, 
which include all manufacturers or all wholesalers or all 
jobbers in any single line of business. Each is quite distinct 
and each seeks to achieve separate ends. 

The district association, of which there are numerous ex- 
amples in the smaller industrial centers of the East, embrace 
all the manufacturing establishments within a specific geo- 
graphical locality. These district associations, often the direct 
offshoots of the local chambers of commerce, are usually 
formed for the ostensive purpose of stimulating the industrial 
activity of the locality. This, as stated, is their ostensible 
purpose. Quite generally, however, their real purpose is to 
create a solid front of opposition to the inordinate demands 
of organized labor, or even to fight for or against differentials 
in freight rates before railroad commissions. 

The organization is much stronger than the ordinary cham- 
ber of commerce. Its secretary — the title usually bestowed 
upon the man who serves as the general manager of the 
organization — exerts almost an autocratic power among the 
members. He may practically order one manufacturer to 
increase his wage schedule if it appears that the industrial 
peace of the community requires it, or he may, for the same 
reason, order another manufacturer to decrease his. If there 
is a strike in the plant of a member of the association, it 
becomes a matter of concern of the entire association. If it 
is obvious to the acute intelligence of the association's secretary 
that the men on strike have a justifiable ground of complaint, 
or that a quick settlement of the dispute is wise from the 
point of view of economic expediency, then the secretary will 
adjust the differences, quite generally in favor of the men, 
and order the manufacturer to accept the decision. If the 


manufacturer refuses, he is dropped from the association. 
If, on the contrary, it is apparent to the association's secretary 
that labor troubles would be fomented in other industries 
should the striking laborers obtain their demands, or that 
their success would establish a dangerous precedent, then the 
association as a whole, on the recommendation of the secretary 
or an, investigating committee, assumes the responsibility for 
the strike. The manufacturer suffering from the labor trouble 
obtains the support of the manufacturers of the entire district. 
The association bears the expense out of the proceeds of 
assessments levied on all the members. 

In an industrial community the influence of an association 
of manufacturers of this character is apparent at once. The 
intelligent cohesion of all the members of the association gives 
to each manufacturer, no matter how small, the strength 
belonging to the large consolidation in respect to the purchase 
and control of the most important element in the total cost of 
his product. Yet, by reason of the fact that the activities 
of the association are geographically limited and carefully 
circumscribed by its by-laws and the vote of its members, 
each manufacturer has complete freedom in all other details 
of the administration of his business. In this way the associa- 
tion combines the strength of group action with the freedom 
and initiative inherent in the small business. ^° 

*• The city of Taunton, Massachusetts, has some peculiarities as an industrial 
center that give it more than common interest. Like many small cities, it enjoys 
a marked diversification of industries. While it is the center of the stove foundry 
business of New England, it includes, besides, a multitude of other manufacturing 
businesses. There are foundries of various types, machine-shops, cloth and yarn 
mills, copper and brass works, silversmith establishments, etc. Many of these 
establishments require skilled labor, and the union spirit attains great strength, 
although the local labor unions are not as strong as m cities devoted entirely to 
a single industry. In other words, the labor union spirit is strong, but there is 
not an unusual degree of local strength in the unions themselves. Likewise, because 
of the diversity of business, there cannot be a local association including the 
manufacturers of _ a single product. As a result of these conditions, a closely 
organized association of manufacturers was formed which included practically all 
the large employers of labor in the district no matter what the character of their 
business. The membership in the association depended, therefore,^ merely on the 
geographical location of the plants. It was organized, and still is a district association 
m a very true sense. 

The Manufacturers' and Employers' Association of Taunton was formed in 1917. 
It now (1920) comprises forty different employing corporations representing upwards of 
seven thousand employees. Its by-laws and constitution are somewhat elusive, and 


The district associations are not confined to industrial 
localities where the management of labor is perhaps the most 
insistent problem. They are very common and very influential 
in agricultural districts devoted to the production of a single 
commodity. Here, however, the problems that absorb the 
attention of the association are not those of production but 
of distribution. In consequence, the products of all the mem- 
bers of the association are marketed by the association under 
a single generic name, such as "Sunkist Oranges" or "Sun- 
maid Raisins." Expenses of advertising, of carload ship- 
ments, of wholesale merchandising, which no one producer 
could afford to bear alone, are shared by all the members of 
the association in proportion to the production of each. True, 
the association's secretary may prescribe conditions of excel- 
lence with which the fruit of each member must comply before 
its sale is undertaken by the association, but these conditions 
have regard only to the character or quality of the product, 
not to the methods followed or the economy in raising the 
product or the wages and working conditions of the labor 
employed by the planter. These are left to the personal initia- 
tive of each member of the association.^^ 

propose as the objects of the association the furthering of the industrial and cotL- 
mercial welfare of the Taunton district, and fostering amon^ the members of the 
association "a spirit of friendliness and progress." In detail, it proposes to equalize 
and specialize wages, to reduce labor in "turnover," and to protect the Taunton 
district against unfair freight rates. Its officers consist of a president, whose position 
is purely honorary, and a salaried secretary, upon whom devolve the affairs of 
the association. Almost from the first, its problems centered about labor, and 
to meet these labor problems in detail, the association, at an early date, adopted 
certain general policies. The association advocates that the wages paid in any one 
plant be not lower than the wages in another plant doing the same kind of work. 
The association advocates that the hours of labor and general working conditions 
be uniform through the district, unless circumstances determine that they be other- 
wise. The association seeks to have knowledge of all labor conditions throughout 
the area. It carries on an employment bureau for the_ benefit of the members 
and labor in general. If a strike threatens, the association, through its secretary 
and its executive board, conducts an investigation on its own behalf. If this 
investigation shows that the employees are demanding no more than economic 
conditions warrant, or other manufacturers engaged in the same business are paying, 
then the association decides for the men, and exerts its pressure to force the 
employing firm to accede to the demands. If, on the contrary, the investigation 
shows that the employees are making unreasonable demands, the pressure of the 
association is exerted to break the strike. 

'* An excellent illustration of such a district association for the marketing of 
agricultural products is the California Fruit Growers' Exchange. This is a co-operative, 
non-profit organization built up by the orange-growers of central and southern 
California to supervise the packing and manage the marketing of citrous fruits. 


There are many associations which meet to a greater or 
less extent the general description of these district associations. 

Oranges were first shipped from California (the Woolfskill Orchard in Los 
Angeles) to an eastern market in 1877, from which time the size of the industry 
increased steadily. The California producer was at a disadvantage in the central 
and eastern markets, as compared with the Florida grower, because of the greater 
time and expense required to get his fruit to the centers of consumption in the 
northeastern states. So that when large gfroves, planted at first because of the 
apparent profits of the early shippers, began to come into bearing there was large 
overproduction of the California fruit. The growers found their business mere 
speculation, whether they sold their crops to contractors or shipped to commission 
merchants. Accordingly they organized the Orange Growers' Protective Union. 
This failed to improve the conditions. About 1888, one T. H. B. Chamblin organized 
the Pachappa Orange Growers' Association at Claremont, in order to permit a 
group of small growers to own and operate their packing plant. This local association 
was on the whole successful and obtained better returns for its members than 
those obtained by independent growers. In Los Angeles, accordingly, in 1893, 
a meeting of the owners of orange groves was held, who, influenced by Chamblin s 
enthusiasm for the "co-operative plan," planned the formation of numerous district 
co-operative associations like that already organized at Claremont. There was to 
be a central association consisting of a representative from each local association. 
The whole organization was to be carried on without profit to itself, in order "to 
provide for the marketing of all the citrous fruit at the lowest possible cost under 
uniform methods, and in a manner to secure to each grower a certain marketing 
of his fruit and the full average price to be obtained in the market for the entire 
season." Such an organization was formed, which, in 1895 took the name of the 
Southern California Fruit Exchange. It prospered, although it was some years before 
half the orange crop of the state was marketed through its agency. The citrous 
fruit acreage of California rapidly expanded so that in 1905 the name was changed 
to the California Fruit Growers' Exchange. This organization prospered and grew 
strong, and is today the largest single factor in the world in the citrous fruit 

The California Fruit Growers' Exchange, as now constituted, consists of three 
units — the local association, the district exchange, and the central exchange. The 
local association is formed by a group of growers owning contiguous groves who 
contribute the necessary capital. A certificate of membership cannot be assigned, 
nor have the members any rights except through the by-laws of the association. 
They appoint the association their "sole agent to pack and sell all citrous fruits 
which may be grown in our respective orchards during the entire period of 
membership." The contributions to the capital necessary to build the packing 
bouses are contributed in proportion to the bearing acreage, while the profits 
are divided in proportion to the quantity and quality of the fruit delivered by each 
member. This encourages intensive development and promotes efficiency. The fruit 
oi .each_ grower is picked, graded, and sold by the association, the manager of 
which, in the majority oif cases, has absolute and dictatorial powers over these 
matters. And a member who fails to comply with the by-laws of his association 
or obey the orders of the manager is penalized or else excluded. These local 
associations vary considerably in size. Their membership may include from fifty 
to two hundred growers, and a single association may ship as much as a thousand 
cars of fruit. 

The local associations are grouped together in the form of district exchanges. 
These district exchanges are the intermediary selling agencies which attend to the 
details of marketing; they are the middle terms between the local associations, 
which have nothing to do with marketing, and the California Fruit Growers' Exchange, 
which organizes, in national scope, the marketing of the entire crop produced by 
all the co-operating growers. This latter is the crux of the whole system. 

The California Fruit Growers' Exchange is controlled by a board of directors 
chosen by the seventeen odd district exchanges, just as the directors of the latter 
are chosen by the local associations. Its duty is to direct the marketing — at 
profitable prices and at a minimum of expense — of the entire crop of the members 
of the local associations. Accordingly it has established a trade-mark brand, "Sunkist," 
and is spending approximately $250,000 a year in national advertising. It maintains 
representatives in the chief eastern fruit-distributing centers, and from them obtains 
information of the conditions of the fruit markets all over the country. These 
representatives telegraph to the home office the sale of every car of fruit, and 
the central exchange issues a daily bulletin to each of the district associations, 
telling them of the conditions of the markets in the fruit-consuming areas. It 
does not sell any fruit directly — that is the function of the district exchange — 
but it supplies the nation-wide facilities for these exchanges to work with. "The 


The great difficulty, as with all associations, pools, and volun- 
tary trade agreements, is to secure such unanimity of mem- 
bership that the decisions of the association command respect, 
and such strength that comes from the voluntary action 
of a united body. Membership is entirely a matter of self- 
interest. A weak association defeats its own ends; and this 
weakness may be due either to lack of support from the 
members of the district, or else to a vacillating, stupid or head- 
strong secretary and executive committee. Experience has 
shown it to be unquestionably true that district associations 
of this character achieve worth-while ends only if they receive 
practically the unanimous support of all the manufacturers 
within the district, and are led by liberal-minded, tolerant, and 
courageous men. 

agent in the market acts directly under the order of the shipper, who determines 
the prices at which each car shall be sold outside of the auction markets, and 
all other matters connected with its distribution, the California Fruit Growers' 
Exchange acting as the medium through which orders pass from the agent to the 
shipper, but never selling a car or determining the price at which the fruit shall 
be sold." 

In addition to these marketing facilities, the California Fruit Growers' Exchange 
attends to the collection of accounts and the adjustment or litigation of claims, 
and carries on researches intended to extend the sale and consumption of citrous 
fruits. To further these ends it has created the Fruit Growers' Supply Company 
which furnishes orchard and packing house supplies — a business amounting in 191 9 
to over $6,000,000 — and has even acquired a tract of over 40,000 acres of timber 
with facilities for manufacturing 125,000,000 feet of timber annually into orange 
box shooks. It has created companies to manufacture citric acid and marmalade. It 
has retained counsel to lobby for a reduction in freight rates on citrous fruits 
and an increase of duty on foreign importations. The magnitude of the exchange 
may be gathered from the fact that in 1919 it handled $55,000,000 worth of 
fruit (f.o.b. California basis) out of approximately $75,000,000 received for the 
entire citrous crops of California, approximately 70 per cent. 

It should not be inferred from the apparent success of this co-operative effort, 
that co-operative associations of the producers of agriculture or of^ producers of 
commodities in general are likely to be equally successful. Peculiar and individual 
economic conditions surround the marketing of California oranges. The producer 
is upward of three thousand miles from his market. His product is perishable; 
it is a luxury for which a demand must be created and sustained and the costs 
of marketing (transportation and refrigeration) nearly equal the net value of the 
crop in the orchard. All these considerations point to the greater success of large- 
scale as compared with small-scale distribution. Yet raising citrous fruits is 
essentially a small-scale business. It requires great detail; it is "fussy." Expensive 
machinery cannot be utilized and the labor that is employed must have a high 
degree of skill. Consequently the greatest productivity can be obtained with small 
individualized production; but the greatest economy of distribution can be obtained 
through large-scale marketing. It is the opinion of the writer that a large corporation, 
conducted for profit, could probably distribute the California citrous fruits more 
economically than does the co-operative association. Further details in Cumberland, 
W. W., Co-operative Marketing (1917); U. S. Dept. of Agriculture Special Report 
No, 98 (Jan. 2, 1913); Univ. of Calif. Agric. Exper. Station Circular 123 (Oct., 
1014) — contains a bibliography on co-operation in agriculture; Western Fruit Jobber 
(March, 1316); the various annual and special reports of the California Fruit 
Growers' Exchange; California Citrograph, the periodical of the industry; Los Angeles 
Times, March 10, 1920. 


Another type of association is that of the manufacturers 
or producers in a given line of business." Membership is 
based on the nature of the product, rather than on geographical 
location. These associations aim to include every manufac- 
turer in the country engaged in the industry. Their prototypes 
of twenty or thirty years ago virere the trade associations 
which fostered the pooling agreements, gentlemen's agree- 
ments, "Gary dinners," and other forms of secret and illicit 
combinations of manufacturers organized to restrict competi- 
tion. The difference between the older and the newer types 
is one of intent, rather than form. The purpose now is posi- 
tive — to familiarize the public with the products of the indus- 
try, to secure tariff legislation favorable to the industry, to 
prevent repressive or harmful legislation, to retain competent 
counsel to represent the industry at judicial hearings. 

The two most important objects usually sought for by 
nation-wide manufacturers' associations are the extension of 
the demand for the products of the industry and the protection 
of the industry against attack.^^ In the results of both of 
these lines of effort all the members of the association share 
the benefit 

The activities in the direction of increasing the demand 
may take the form of a nation-wide advertising campaign to 
increase, directly, the retail sales of the products by exciting 
a demand in the minds of consumers. This is profitable, or 
rather expedient, only when practically all the manufacturers 
in a specific industry co-operate in the publicity expenses. 
Most manufacturers prefer to pay for advertising their own 
specially branded products, rather than for advertising the 
products of the industry in general. But when manufactured 

" An excellent example of this type, a description of which is easily available, 
is the National Founders' Association. See 30 Q. J. E. 352 (Feb. 19 16). 

1* Again it should be observed that no reference is here extended to trade 
associations organized primarily, perhaps entirely, to restrict or allot output and 
maintain or raise prices. The English report referred to in note 7, stated as its 
opinion that all the trade associations organized during the Great War had these 
purposes primarily in view. 


products cannot advantageously be sold under trade-marks, 
and when the demand to which appeal is made is the demand 
for the commodity in general, as opposed to similar competing 
products, like "cypress, the wood eternal," ^* or walnut, "the 
noblest of all cabinet-woods," ^^ then the advertising can better 
be done by an association rather than by the individuals. 

These activities for increasing the demand may also take 
the form of exploiting foreign markets. Prior to the Great 
War the efforts of our manufacturers to sell goods in foreign, 
competitive markets were of a most desultory character. Our 
manufacturers, protected by a tariff wall, were too busy ex- 
ploiting domestic markets to concern themselves with foreign 
consumers. But the Great War changed utterly the point of 
view. And in the period following the war they find them- 
selves forced to consider foreign markets — either to protect 
themselves against foreign competition or else to dispose of 
their own surplus production. Many manufacturers' associa- 
tions, notably in the copper, steel, and textile industries, 
already — before the Great War — ^had bent their efforts toward 
foreign selling. And when the liberal privileges of the Webb 
Act are more fully understood, the activities of these associa- 
tions in this direction will undoubtedly be increased. 

The other important activities of these associations are 
in the direction of the protection of the industry against legis- 
lative or political attack. The manufacturers' associations in 
the textile industry, for example, have already sought to in- 
fluence tariff legislation for the benefit of their own interests ; 
associations of manufacturers of boots and shoes have be- 
stirred themselves when the tariff on hides came under dis- 
cussion. Many industries are subject to indirect attack through 
special legislation. The Investment Bankers' Association has 
fought, in the lobbies of the state legislatures, and in the 

" Customary advertisement of the Southern Cypress Manufacturers' Association. 
^ Customary advertisement of the American Walnut Manufacturers' Association. 


courts, the enactment of blue-sky statutes. Associations of 
food manufacturers have fought "labeling" and "branding" 
laws; associations of fire underwriters have fought state fire 
insurance; and liabiHty underwriters, the various forms of 
compulsory state liability insurance. In all these and in similar 
cases, the associations exist — indeed they were often organized 
— for defensive purposes, but their influence usually develops 
along constructive lines." 

" One of the best examples of a coherent and highly organized manufacturers' 
association exerting itself both in the direction of increasing the demand for the 
products of the industry and in the direction of defending the industry against 
legislative attack, is afforded by the American Manufacturers' Association of Products 
from Corn. As this association is, by reason of the small number of concerns 
engaged in the wet milling of corn, rather a compact and highly developed manu- 
facturers' association, it is worth while to examine its tenets and its activities at 
some length. 

For many years the American manufacturers of glucose and starch made from 
corn had fought against a popular prejudice against the use of glucose as a food. 
In the minds of some people, this prejudice was due to the similarity between 
the words "glucose" and "glue"; in the minds of others it was due to the original 
use by Kirchof and by the early commercial manufacturers of sulphuric acid as 
a catalytic agent. But the missionary work carried on by each manufacturer was 
desultory; it was an unimportant part of his general policy in advertising. In 
19 1 2, it occurred to certain men in the industry that this work of educating the 
public to the uses of the products of corn and of defending the industry against 
popular prejudice could be carried on best by an association in which all the 
manufacturers concerned contributed to the expenses in proportion to the benefits 
derived from the work. Accordingly such an association was formed March 12, 1913. 

The objects of the association are specifically defined by its constitution as: 

"First. To maintain the standard of purity and qualify of products from corn 
in all possible ways. 

"Second. To take united action in correcting all opinions adversely and unjustly 
affecting the consumption and uses of products from corn. 

"Third. To educate the dealers in and consumers of products from corn in 
regard to the purity, wholesomeness and uses of said products. 

"Fourth. To take united action in respect to all questions before State or National 
Legislatures wherein untrue impressions in regard to the nature and uses of products 
from corn are involved, and whereby unjust rules, regulations, standards or laws 
restricting or adversely affecting the sale of products from corn may ensue." 

Other articles of the constitution provide for officers and a board of directors. 
The latter shall receive no salaries, but are entitled to be reimbursed for legitimate 
expenses. Besides the annual dues ($100 for each member), "assessments may be 
made by the President, with the unanimous consent of th*" Board of Directors. 

"When assessments are made, each member shall be notified of the specific 
purpose for which the assessment is to be used. 

"In making assessments, the President shall designate the amount each member 
shall be assessed, the said amounts being based upon the interests of the respective 
members in the purposes for which the special funds are to be used, and upon the 
volume of business of said members so interested." 

The association was a success from the beginning. There are not more than 
nine important manufacturers in the United States, and all of these presently 
became members, so that the association had the strength that goes with unanimity 
of action. 

It entered immediately on vigorous campaigns to extend the use of corn products- 
It published corn-books for housewives, pamphlets on mixed flours for bakers, and 
on glucose for candy-makers. One publication intended to reach the farmers contains 
the following: 

"Mr. Farmer: 

"You are interested in the increased flow of corn from the cornfield to the home 
and so are we. 

"For the third year the doors of our office at Chicago stand open with a welcome 


The other type of business structure, representing the effort 
to obtain the mobihty and spontaneous initiative of the small 
independent unit and also the scope of the large organization, 
is a community of interests. This is not new. Nor can it 
be defined with precision. The dominating idea is an effort 
to establish a balance between complete independence and com- 
plete co-ordination. The community of interests implies a 
number of business units having considerable independence 
of action with respect to one another, and yet such unity of 
purpose that the fortunes or misfortunes of each affect the 
others or some common interest to which all are related. In 
most cases, also, the financial affairs of the units are linked 
together by some quite direct means, so that there is uniformity 
of business policy. 

There are many instances of community of interests in 
modern business, and they represent various types of relation- 
ship and various degrees of unified organization; and for these 

to the corn belt. We represent 'corn publicity' — ^larger acre yields, faultless 'product 
of corn' manufacture, and the swiftly increasing home consumption of pure corn 

"Corn is our greatest natural source of wealth, and the manufacture of it into 
such varied .products, adaptable as they are to so many uses as foods and in the 
arts, makes it a national institution which creates the liveliest interest and should 
have the enthusiastic support of all the community, especially the farmer. 

"i. The hand of the farmer touches our hand. 

"2. The corn grower cannot overestimate the importance of the 'products of corn' 

"3. Our booklets give the best available information on corn products. 

"4. Any discrimination against corn foods is a blow at the corn grower. 

"We have a corn products exhibit for schools. Have your teacher send for it." 
Our publications are as follows: 

" 'Corn and Its Uses.' 

" 'References as to the Wholesomeness of Corn Syrup.' 

" 'All Made from King Corn.' 

" 'Candies Good for Children.' 

" 'For Better Baking.' 

" 'Process of the Manufacture of Corn Products.' 

" 'Dr. Bryant's Address on Corn Syrup.' 

" 'Food at Fifty Cents a Day.' 

" 'Wash Day.' 

"These are free." 

In addition to these efforts to increase the consumption of corn products, the 
association has fought legislation which might tend to decrease their use or further 
prejudice the people against them. For example, it prepared the case for the glucose 
manufacturers in the "Hearing before Illinois State Food Standards Commission in 
the Matter of Investigation of Corn Syrup (Glucose) and Its Use in Foods, Jan. 22, 
i9i6."_ And the association has been active whenever and wherever efforts have been 
made in state legislatures to enact statutes prohibiting, restricting, or limiting the 
sale or consumption of corn products, particularly glucose. 

It sought by distribution of pamphlets to secure the passage of the Rainey Bill, 
which repealed the taxes on 'mixed flours" — made from corn starch and wheat 
flour — enacted at the time of the Spanish-American War. 


reasons it is impossible to arrange the different types in any- 
thing approaching an accurate classification. Two types, how- 
ever, stand out conspicuously. These are the community of 
interests among business units bound together by an exclusive 
contract of purchase and sale; and, secondly, that among 
concerns bound together by a minority stock ownership. In 
both types there is strict independence in the actual administra- 
tion of the separate units embraced in the community of 
interests, while there may or may not be financial independence. 
At all events, many of those vitally interested in the success 
of the one are as much interested in the success of the other. 

A community of interests represented by direct dependence 
of the units on each other for the purchase and sale of some 
commodity is relatively common in modern business.^'^ It 
works out in the following manner. A manufacturer of a 
relatively expensive or relatively complex product requires 
some semifabricated material or some specialized part. He 
requires this material or this part in large quantities, in regular 
and dependable deliveries. Yet his own business requires all 
his time and capital, and is of an absolutely different character. 
He may make automobiles for which starting and lighting 
generators are required. Yet the automobile business is ab- 
solutely different from the electric business. He may build 
bridges for which large quantities of steel are required. Yet 
a successful bridge-builder and a successful steel-maker cannot 
be combined in the same person. Under these circumstances 
an agreement is entered into between the two manufacturers 
under which one agrees to manufacture the product required 
by the other in such quantities and according to such specifica- 
tions as may be mutually decided upon, and correlatively the 
other manufacturer agrees to purchase the product under pre- 

"Thc case in which all the steps from raw material to finished product are 
consolidated into a single corporate organization — integration, as it is called — was 
discussed in Chapter III. 


arranged conditions of delivery and payment. The buying 
expenses of one and the selling expenses of the other are 
saved, and both are relieved of uncertainty regarding future 
supply and demand. Once the agreement is undertaken, each 
becomes mutually important to the other; and if the product 
manufactured by the one and purchased by the other is a 
relatively highly specialized part, like a generator for an auto- 
mobile or a governor for a turbine, the two manufacturers 
might even be said to be necessary to each other. At all events 
there is a very close community of interests. 

In the period of industrial combinations, it was common 
for businesses dependent upon each other to tinite under a 
common ownership and control. The process was integration. 
In extreme cases it involved the consolidation into a single 
corporation of all businesses engaged in all the steps from 
the production of the raw material to the distribution of the 
final product among the ultimate consumers. But integration 
did not prove successful. The manager of the iron mine was 
not likely to prove an able furnace man ; the brewer could not 
readily become a maltster; the cotton-mill operator could not 
continue to run his plant and in addition grow cotton and 
then look after a bleachery and a converting business. Essen- 
tially different businesses could not be combined successfully 
under a single management. Yet there were obvious economies 
in integration. Since each of the successive or collateral steps 
in the production of the final product could be made to play 
into each other, the community of interests idea resulted from 
an attempt to secure these advantages without involving com- 
munity of ownership. 

During the last decade it is probable that the automobile 
industry showed the most conspicuous use of this kind of 
community of interests among business units. The industry 
developed very rapidly. It absorbed in its rapid growth very 
large amounts of capital. Yet investors regarded it as at best 


uncertain, even precarious, so that automobile manufacturers 
were forced to secure most of their capital from local banks 
and from the reinvestment of surplus in the business. As a 
result, they were forced to limit their scope of operation, and 
one of the ways in which this was done was to contract with 
other manufacturers for the purchase of special parts and 
accessories. The manufacture of automobile parts, such as 
closed bodies, starting and lighting units, batteries, carburetors, 
gasoline feed systems — even axles and bearings — has devel- 
oped into a great industry. It rested on a strict mutuality of 
interests between the automobile manufacturer on the one 
hand, and a specialty manufacturer on the other, in which one 
produces what the other consumes. 

Distinctly the commonest form of community of Interests, 
in which individuality and unity of purpose have been success- 
fully combined, is in businesses loosely bound together through 
the common ownership of minority stock interests. In some 
instances minority stock ownership in several corporations, all 
operating in harmony with each other, is held by one or more 
persons, in some instances by a stock-owning company, and 
in some instances by mutual stock holdings. In spirit all these 
forms are the same, namely devices to secure harmony of 
operation based on a mutuality of financial interests without 
in any sense involving actual centralized control or even inter- 

Obviously the simplest of these forms Is the ownership 
of a substantial minority interest in several corporations by 
a single individual. Usually it takes the form of interlocking 
directorates, because if the minority interest is sufficiently 
large to constitute an actual community of interest, co-opera- 
tion can be secured only through a voice in the management.^® 

"Much has been made in propaganda studies of the great, almost illicit, power 
exerted by banking houses through the system of interlocking directorships. That 
kind of community of interests, if such exists, is not implied by the analysis given 



This kind of community of interests is found in an industry 
where there is no other sign of co-ordination, and it is 
especially common in a manufacturing business made up of 
many separately owned plants confined to one geographical 
locality/** In a one-industry town, for example, a dozen or 
more competing plants are engaged in the production of one 
and only one product, like the jewelry of Attleboro, the chairs 
of Gardner, or the shell goods of Leominster. In such a case 
a few prominent manufacturers, men recognized to be the 
leaders of the industry, will be found to be directors in a 
number of competing factories. They have small stock hold- 
ings in these competing organizations so that their horizon 
extends to the welfare of the industry as a whole and is not 
confined to one factory. Through the influence of these men 
some kind of harmony among all the producers in the town 
or locality is obtained. ^° In no sense can it be said that there 

in the text above. The banking "community of interests" and interlocking director- 
ships are intended to secure financial control if any intention at all is implied. 
Ordinarily there is none. Usually banker representation is sought as a check to 
extravagance and unsound business policy. Bankers underwrite, or sell to their 
own customers, the securities of a corporation engaged in a kind of business which 
reaches out and touches many other kinds of business. Such would be the breadth 
of scope of any transportation business, a public utility, or a bank. In order to 
safeguard their own interests and those of their customers a member of the banking 
house is elected to the board of directors. Later, and for similar reasons, a member 
of the same banking house is elected to the board of directors of one of the 
corporations with which the first has intimate dealings. Obviously the banker- 
director will do nothing to hurt seriously the welfare of either corporation for which, 
because of the sale of their securities, he has a responsible interest. But to assume 
that he consciously purposes, or even is able should he wish, to mould the business 
policy of each so as to create a harmony of interests, is too much of a presumption. 

" Observe the interlocking directorates in the mill cities of Fall River and New 
Bedford described in the succeeding footnote. 

5* The interlocking directorships and minority stock ownerships in the New 
England cotton manufacturing industry illustrate these principles. In almost every 
case at least a majority of the stock of a New England cotton-mill is owned by 
the directors, their families, and the trustee interests they represent. The interlocking 
directorships indicate, therefore, interlocking ownership and indirect, but never- 
theless highly organized community of interests. For the purpose of gathering 
statistics the New England cotton industry may be divided into three sections. The 
first would include the scattered mills of Maine, New Hampshire, and Massachusetts, 
outside of Bristol County. Most of these mills are operated by local agents, but 
managed by treasurers and selling agents living in Boston. The particular geographical 
location of these mills is therefore more an accident of good water power or favorable 
labor conditions than of the personnel of the ownership. These mills are referred to 
as the Boston group. The second section is the closely unified district of Fall 
River, where the mills are owned and operated directly by men living in Fall River. 
The third section is the equally unified district of New Bedford containing somewhat 
larger and more costly mills than Fall River with the ownership somewhat more 
scattered. Statistics refer to 19 19. 

I. Boston group, 60 mills, all mills of considerable size. For these 60 mills 
there are 279 directorships filled by 168 different individuals. Of these 168 different 


is real consolidation of operating plants, but there is a real 
co-operative unity based on mutual financial interest in each 
other's welfare and on a mutual understanding of each other's 
business problems. Yet the management of each part is free 
and unhampered. 

A community of interests is effected through the owner- 
ship by a corporation of a substantial minority of the shares 
in several corporations the businesses of which are somewhat 
allied. In no sense could it be said that the parent corporation 
controls the others, nor could one assume a financial inter- 
dependence, yet the minority ownership is sufficient to create 
at least a harmony, if not an explicit community of interests 
throughout the entire group. Instances are not unusual, 
throughout our American finance, of corporations formed for 
the explicit purpose of owning, ostensibly for investment al- 

individuals, 72, or 43 per cent, hold directorships in two or more mills. A group 
of 15 men, mostly partners in commission houses or representatives of old New 
England textile families, hold 88 directorships. The positions for these 168 director- 
ships are as follows: 

96 individuals are directors in one corporation 


" two corporations 


" three 

12 " 

" four " 


" five " 


" six " 

2 " 

" seven " 

2 " 

" eight " 

For an example of community of interests among these Boston-owned mills through 
a corporate holding company, observe the Greelock Company, note 22. 

2. Fall River group, 31 mills. For these 31 mills there are 144 directorships 
filled by 75 different individuals. Of these 75 individuals 35, or 47 per cent, hold 
directorships in two or more mills. A group of 8 men hold 41 directorships. The 
positions of these 75 directorships are as follows: 

39 individuals 

are directors in one 


20 " 

3 " 
I individual 
I " 

" " " two 
" " " three 
" " " four 
" " " five 
is director in six 
" " " eight 


3. New Bedford group, 27 mills. For these 27 mills there are 202 directorships 
filled by 107 different individuals. Of these 107 different individuals, 46, or 43 
per cent, hold directorships in two or more mills. A group of 13 men hold 58 
directorships. The positions of these 107 directorships are as follows: 

61 individuals are directors in one corporation 


« .< 

" two corporations 


" " 

" three 


" " 

" four 

4 " 

" " 

" five 

I individual 

is director 

in six •* 


though actually for the speculative enhancement in market 
value, large minority interests in corporations engaged in one 
kind of business. Several such holding companies exist in 
the public utility field ;^^ and they are not unknown among 
industrials, although the natural competitive instincts of manu- 
facturers in the same line of business, selling in competitive 
markets, does not tend to encourage mutuality of interests if 
based only on minority stock holdings. Exactly such a case, 
however, is to be found among the textile mills.^^ 

One of the most recent of these corporate community of 
interests, and one perhaps destined to achieve considerable 
importance, is found in the field of our rapidly developing 
foreign trade corporations. As pointed out in another con- 
nection these enterprises arose in response to the opening up 
of new avenues of foreign trade, in consequence of the changes 
brought about by the Great War.^* A foreign exporting and 
importing business, to be. successful, must have close affiliations 
with manufacturing, transporting, and banking companies. 

** See Chapter V, pages 134 to 136. 

**As already pointed out in note 20, the New England textile industry, although 
never successfully consolidated into large units, has oeen always subject to a kind 
of human community of interests through interlocking minority stock ownerships 
and interlocking directorships. This indirect community of interests, through minority 
holdings in diverse textile mills, has reached an extreme development in the 
formation in jo 15 of The Greelock Corporation. The name was made out of that 
of Lockwood, Greene and Company, the firm of mill engineers and operators which 
was responsible for the formation of the company. This corporation was organized 
with only $200,000 stock for the purpose of acquiring small interests in a number 
of textile mills. The capitalization has been rapidly increased by the issue of stock 
and collateral trust notes until, in 1920, the company owns mill stocks to the par 
value of $10,000,000 having a market value of approximately $15,000,000. Its stock 
is owned by a dozen men prominent in New England textile circles, it is managed 
by a firm of well-known mill operators having close relations in a large number 
of mills and its directors are all very prominent in the industry. Two of the 
directors represent the firm of mill operators just mentioned, two are partners in 
textile commission houses and directors in several allied mills, including some 
of those in which the Greelock Corporation is interested, one is an operating official 
of one of the most important textile machinery corporations in the country, another 
is a director in eight separate mills, and the other two are influential in the 
management of the Pacific Mills, the most important of the Greelock Corporation's 
holdings. The Greelock Corporation now has minority stock ownership in the 
following textile companies, manufacturing a large variety of cotton fabrics: 

Pacific Mills: worsteds and figured cottons, medium counts. 

Lancaster Mills: ginghams and print goods. 

Lawton Mills: coarse goods. 

International Cotton Mills: ducks, drills, low countt. 

Winnsboro Mills: automobile cord fabrics. 

Roxbury Carpet Company: carpets. 

"Chapter III, page 64. 


In fact its business is primarily that of supplying a service 
intended to bring about the efficient co-operation of these 
agencies in foreign commerce. Accordingly, the foreign trade 
companies, in order to strengthen their position in this country 
and to fortify their agency business abroad, have sought to 
secure a community of interests among businesses upon which 
they are directly dependent. This takes the form of direct 
stock control in some instances, but such control involves a 
large investment of capital, whereas the trading company 
would ordinarily prefer to keep its available capital in its own 
business. Unless the trading company, therefore, has large 
resources, or can acquire control of the affiliated business with 
only a small expenditure, it must content itself with resting 
its community of interest on the ownership of less than a 
majority of stock. Great as are the financial resources of the 
American International Corporation, and strong as is the com- 
munity of interest among its affiliated companies, its influence 
in three of the largest and most important of them is assured 
only through the ownership of distinctly less than a controlling 
stock interest.** 

**The American International Corporation was organized daring the latter part 
of 1915. It owed its origin, in the first instance, to Frank A. Vanderlip, President 
of the National City Bank of New York City, who sought to create a powerful 
organization to further the development and extension of foreign trade. Important 
financial interests were represented on its board of directors, and a capital stock 
of $50,000,000 was easily secured through subscription. As announced later the 
business of the company was to follow along five separate and relatively independent 
lines: (1) It proposed to establish foreign offices and secure representation in 
foreign corporations. (2) It proposed to carry on research and investigations in 
connection with prospective foreign trade and foreign commerce. (3) It proposed 
to carry on engineering undertakings for government account and for private parties, 
at home and abroad. (4) It proposed to acquire the control of already existent 
companies and agencies, and to create others, for carrying on foreign trade. These 
subsidiaries were to be relatively independent of each other and of the central 
organization of the_ American International Corporation. (5) It proposed to make 
"participations" or investments in the securities of "foreign or domestic corporations 
doing foreign business" or "corporations whose activities are in accord with the 
purposes for which the_ American International Corporation was formed." 

Omitting from consideration the first, three purposes, it is evident that, under 
the fourth caption, the American International Corporation proposed to secure absolute 
control over certain agencies engaged in foreign commerce and, under the fifth 
caption, a community of interests in others through the acquisition of substantial 
minority stock interests. Both of these purposes were carried out. The American 
International Corporation acquired the control of a number of concerns. It bought 
and reorganized the old-established Pacific Mail Steamship Company, the Allied 
Machinery Company which with its subsidiaries is engaged in the export of American- 
made machinery, the Rosin and Turpehtine Export Company for the export of 
naval ^stores, the Grace American International Company, an affiliation with W. R. 


Probably the most comprehensive and highly organized 
community of interests is when one large and important cor- 
poration owns a share in a great number of small corporations, 
all carrying on allied businesses, and the whole constituting a 
kind of family group. This kind of organization is not com- 
mon because it is too intricate to develop easily. Nevertheless 
when a comprehensive plan is evolved by a business genius 
possessing a true breadth of imder standing, it represents what 
is probably, in a real sense, the highest type, and the most 
highly developed form of modem corporate organization. 

In its ideal form this type of community of interests 
requires a strong central corporate organization, possessing 
almost unlimited credit and unbounded public confidence. It 
must be managed by men who have the rare faculty of inspiring 
a confidence and independence of action in higher executives, 
and the ability to promote true co-operation without making 
the affiliated concerns and their officers mere cogs in a great 
machine. In other words it must solve, practically, the 
theoretical problem of the proper balance between concentra- 
tion of control and administration, and spontaneity of in- 
dividual effort. 

Probably no business organization would profess that it 
has solved this problem, in a sense the central problem of 

Grace and Company for conducting an export business with Russia, Carter Macy 
and Company, a tea importing house, the International Steel Corporation, to export 
American steel products, F. W. Home and Company, an export business trading 
in the Orient, G. Amsinck and Company, an export business trading with South 
America. All these companies represented a relatively small investment and the 
outright ownership was obtained in every case. 

But besides the actual ownership of these smaller enterprises, the American 
International Corporation secured a substantial minority stock ownership, "participa- 
tion," as it was called, in three large and well-known companies. Within a few 
months of the organization of the company the American International Corporation 
purchased in the open market a large number of the preferred and common shares 
of the International Mercantile Marine Company, then undergoing reorganization. 
This company was, and is, the dominant factor in transatlantic shipping. Although 
the American International probably does not own more than a third of the stock, 
the community of interests of the two organizations is secure. Later the American 
International purchased in the open market a substantial, but not controlling, interest 
in the United Fruit Company, a fruit and sugar development and importing business 
in Central America and the Caribbean Islands. Later still it purchased a substantial, 
although by no means a controlling interest in the United States Rubber Company. 
Through the extensive rubber plantations of this company it is an important factor 
in the rubber importing trade. 


business administration. But some have come far nearer to 
a solution than others. Among those which have consciously 
sought to obtain a true community of interests and preserve 
a spirit of real independence among the subsidiaries is the 
group of affiliated enterprises known as the "General Electric 
family." The success with which the community of interests 
idea has been worked out by the managers of the General 
Electric Company is worthy of something more than passing 

The General Electric Company, the center and parent of 
the whole organization, was formed in 1892 as a consolidation 
of the electrical manufacturing interests of the Edison General 
Electric Company^^ and the Thomson-Houston Electric Com- 
pany." Early in their development, both of the constituent 
interests had acquired the stocks of lighting companies, in 
some instances in exchange for licenses to operate under 
patents, in some instances in exchange for apparatus, and in 

^ It is interesting to note that the man above all others whose insight and 
acumen was responsible for the balance between organization and initiative — cen- 
tralization and decentralization — was in no sense an electrical engineer. He had 
been a shoe manufacturer until thirty-nine years of age. Skill of organization, 
more than technical skill, accounts for the conspicuous success of the "General 
Electric family." 

^ The Edison manufacturing interests began in 1879, when Thomas A. Edison, 
then thirty-two years of age produced his first successful incandescent lamp in the 
Menlo Park Laboratory. Immediately thereafter Edison's efforts turned to the 
production of appropriate generators. This side of the business so increased that 
It was removed to a factory on Arch Street, New York City. In 1884 the lamp 
business was removed to Harrison, New Jersey, and separately organized as the 
Edison Lamp Company. The generator manufacturing business was separately 
organized as the Edison General Electric Company and removed to Schenectady, 
New York, in 1886. Other special Edison companies were combined into the United 
Edison Manufacturing Company which in 1885 acquired the Sprague Electric Railway 
and Motor Company. Meanwhile the Edison Electric Lighting Company was incor- 
porated to act as a holding company for the stocks of lighting companies which 
had exchanged their stocks for licenses to operate under the Edison patents. In 
1890 all the Edison companies, including the Sprague and Bergmann companies, were 
consolidated into the Edison General Electric Company, mentioned in the text above. 

"About 1878 Elihu Thomson, then twenty-five years of age, manufactured a few 
arc lamps and generators in a small machine-shop on Buttonwood Street, Philadelphia. 
In 1880 the business was moved to New Britain, Connecticut, and incorporated as 
the American Electric Company. Two years later Houston and his patents were 
brought into the enterprise, the factory moved to Lynn, Massachusetts, and the 
name changed to the Thomson-Houston Electric Company. In the years immediately 
following a number of competing electric companies, with their special and often 
basic patents, were acquired. In 1890 the Thomson-Houston Electric Company 
took over the stock of the United Electric Securities Company. This company had 
acquired the bonds of electric light power and railway companies, and issued against 
them its own collateral trust bonds. It was the first instance of an electric securities 
holding company in the United States, and the nucleus of the present General 
. Electric Company's affiliated finance companies. 


some instances for money in order to stimulate electrical con- 
struction. These investments, wise and necessary though they 
were in order to further the construction of central stations 
and electric railways, proved burdensome, as it was almost 
impossible to turn them into liquid capital. The Thomson- 
Houston Company had attempted to segregate securities of 
this type under the ownership of a separate company and sell 
collateral trust bonds secured by them to the public.^® But 
the experiment was only partially successful. In the depres- 
sion following the panic of 1893 the General Electric Company 
was in acute financial difficulties, and an important cause of 
its troubles lay in the considerable proportion of its capital 
tied up in the valuable, but unmarketable, securities of these 
local electrical utilities. By selling, at a great sacrifice, a part 
of these securities, and by the help of money advances from 
men who had faith in the future of the electrical industry, 
the General Electric Company was able to extricate itself from 
its financial difficulties. But as a result of this experience 
the management realized the danger of tying up its own 
capital in local utility securities, although fully aware of the 
importance of co-operation between the manufacturer and 
the user of electrical equipment. The plan of creating finan- 
cial and operating subsidiaries and affiliations to care for these 
separate, but important auxiliaries was gradually evolved and 
the "General Electric family" developed as a result of the 
community of interests of the whole group. 

The General Electric Company's community of interests, 
as now constituted, consists of subsidiaries and affiliations of 
five different types, differing in the closeness of control exer- 
cised by the parent organization. There are certain subsidiaries, 
owned entirely by the parent, over which the parent company 
exercises entire control and management. These are merely 
incorporated departments. And the relations subsisting be- 

^ See preceding note. 


tween the General Electric Company and these subsidiaries is 
no different and no more instructive than that subsisting 
between any other large industrial combination and its multi- 
farious subsidiaries. They may therefore be passed over 
without further comment.^* 

The other four types of affiliated corporations vary in the 
degrecof closeness of union with the parent concern. In none 
of these types of corporations, notwithstanding the General 
Electric Company may hold the entire stock, does it presume 
to exercise an administrative control. In brief these types 
are: (i) those companies in which the General Electric Com- 
pany owns a majority or the entire stock, but which are man- 
aged by a separate organization quite independent of the 
parent; (2) those of which the General Electric Company 
may own a majority stock, indirectly through affiliated in- 
terests, but which are operated as separate and entirely inde- 
pendent businesses; (3) those in which the General Electric 
Company owns only a minority stock interest, but which 
operate in harmony with the whole organization; (4) those 
with which the General Electric Company has operating and 
pooling agreements. Even a superficial understanding of the 
General Electric Company's community of interests requires 
some conception of the intricate, yet nicely adjusted inter- 
relations of these types of affiliations. 

The companies of the first type, those owned directly by 
the General Electric Company, but operated independently, 
constitute a large and varied group. There are companies 
manufacturing appliances,^" others which manufacture special 

*• For example, the various lamp works of the General Electric Company itself 
and of the old National Lamp Company. These incorporated departments are often 
of minor importance, as the companies operating mica mines in New Hampshire 
and ^ebec. 

■• The General Electric Company owns a majority of the stock of the Edison 
Appliance Company. This is a consolidation of the Hughes Electric Company of 
Chicago (electric ranges), the Hotpoint Electric Company (heating and small cooking 
devices), and the department of the General Electric Company previously devoted 
to small heating devices. This company has an office in Chicago and is managed 

The General Electric Company owns the stock of the Premier Vacuum Cleaner 
Company of Cleveland, which manages its business quite independently. 


devices;'* there are merchandising and jobbing houses/' and 
even a wireless telegraph company,'* But the subsidiaries of 
greatest interest are three corporations organized to help 
finance local electric utilities. These are the United Electric 
Securities Company, organized in 1890 (see note 27), the 
Electric Bond and Share Company, and the Electrical Securi- 
ties Corporation. These three companies purchased for their 
own account, either to resell or to hold, the stocks and bonds 
of local utilities. In the case of the first and the third, capital 
is secured from the public in order to finance these purchases 
of securities, by the issue of collateral trust bonds secured 
by the deposit of the local issues.'* The second makes a 
practice of reselling the local securities to investment bankers, 
who in turn resell them to the public. The financial assistance 
rendered by these companies provides the local utilities with 
funds with which to extend their operations, and incidentally 
to buy equipment from the General Electric Company. 

The second type of affiliations includes those in which the 
General Electric Company has a large, if not controlling stock 
interest, but this is held in some indirect manner. As in the 
previous cases, the parent corporation exercises no adminis- 
trative control. The best illustrations are the two large hold- 
ing companies organized to operate local electrical utilities. 

** A good example is the D. and W. Fuse Company of Providence. This company, 
under independent management, was in difficulties; but it made an excellent product. 
The General Electric Company bought the company, furnished it with ample capital, 
continued the business under the same name and under the old management. To 
all intents and purposes, except in the greater strength of improved credit, it was 
the same company after the acquisition by the General Electric Company as before. 

" The General Electric Company either owns outright or controls some ten 
jobbing houses for the distribution of small equipment — even storage batteries for 
automobiles. Each management is quite independent and maintains its independent 
buying, selling, and finance departments. It deals in merchandise manufactured by 
concerns which are competitive with the General Electric Company: the Capital 
Electric Supply Company, Florida Electric Supply Company, Mohawk Electrical 
Supply Company, Northwestern Electrical Equipment Company, Pacific States Electric 
Company, Pettengell-Andrews Company, Sibley-Pitman Electrical Corporation, Southern 
Electric Company, Union Electric Company, Wesco Supply Company. 

** The Marconi Wireless Telegraph Company was closely connected with the 
British Marconi Company. This foreign amiiation hampered its action, especially 
in dealings with the United States Government. The company was also in want 
of money to carry on its program of extension. Accordingly the General Electric 
Company acquired a controlling interest, through the formation of the Radio Corpora- 
tion of America and the exchange of the Marconi shares. 

** See Volume I, Chapter III, note 39. 


The American Gas and Electric Company, a majority of 
whose common stock is owned by the Electric Bond and Share 
Company, operates electric, steam, and hot water heating plants 
in a number of cities in Pennsylvania, Ohio, and Indiana, and 
to some extent in West Virginia, New Jersey, and Illinois.®^ 
It is an operating company, independent and entirely self- 
sustaining. The American Power and Light Company is a 
holding company for a series of local holding companies, each 
one of which controls and operates a group of local utilities.^* 
These public utility holding companies are managed quite 
independently of the General Electric Company, although the 
affiliation is a great help to them in selling their securities. 

The third type of associated company, in which the Gen- 
eral Electric Company has only a minority stock interest and 
no administrative control, is relatively rare.^^ The fourth 
type, in which the General Electric Company has no pecuniary 
interest but a close working agreement is met with in its trade 
relations with certain other manufacturers of electrical equip- 
ment.^^ Such working agreements are vague and uncertain 
and furnish an unsubstantial basis for a real community of 

*• For certain statistics, see Chapter V, note 35. 

** Ibid. The complex organization of this company is somewhat baffling. The 
American Power and Light Company has outstanding its notes, debentures, and 
preferred stock, all held by the public, and its common stock partly held by the 
public and partly by the Electric Bond and Share Company and other affiliations 
of the General Electric Company. It owns the common stock, but not the bonds 
nor preferred shares, of the Kansas Gas and Electric Company, the Nebraska Power 
Company, the Pacific Power and Light Company, the Portland Gas and Coke Company, 
and the Southwestern Utilities Corporation. Each of these, except the last, operates 
a group of local utilities. The Southwestern Utilities Corporation owns the common 
stock, but not the bonds, of the Southwestern Power and Light Company. This 
in turn owns the common stock — but not the preferred stock nor bonds — of two 
operating companies, the Texas Power and Light Company and the Fort Worth 
Power and Light Company. Each local company operates independently, with local 
men as directors and officers. 

** This is illustrated by the Allegheny Steel Company. The General Electric 
Company owns only a minority interest, and the majority control is closely held by 
other parties. 

»* The arrangement with the Western Electric Company, the manufacturing sub- 
sidiary of the American Telephone and Telegraph Company, is of this type. Prior 
to 1910 the Western Electric Company manufactured general apparatus beside the 
special equipment required for the telephone industry. In that year an agreement 
was executed whereby the Western Electric Company agreed to confine itself to 
the manufacture of telephone apparatus. The General Electric Company agreed to 
furnish it with generators, motors, and transformers and the Westinghouse Electric 
and Manufacturing Company supplied certain other equipment. 



Problem of new capital, i68; The investment of earnings, i68; 
Growth of short-term corporate borrowings, 172; Evils of short-term 
notes, 174; Distinction between self-liquidating and fixed property, 176. 

The previous chapters of this volume dealt with the forms 
of business organization to be followed by an expanding busi- 
ness. Except incidentally little reference was made to the 
means available; yet this is a question of great importance. 
During times of large surplus of investment funds, when the 
rates on bank loans are low and long-term securities are in 
great demand, the corporation has merely to justify its policy 
of expansion by the most superficial analysis in order to get 
the requisite new capital. But when surplus investment funds 
are scarce, and banks are restricting rather than expanding 
loans, the availability of money becomes the crux of any 
policy of expansion. It is this question of the sources of new 
capital that must be fairly faced under any circumstance, what- 
ever the condition of the general market for capital and the 
resources of the corporation. To this question this and the 
succeeding two chapters are devoted. 

The simplest and most evident method of obtaining capital 

to meet the expenditures of an expanding business is through 

/the reinvestment of surplus earnings. It was pointed out in 

connection with the disposal of the surplus that the proportion 

of net earnings retained in the business, rather than paid out 



in dividends, is entirely a matter of expediency.^ So that, 
barring fraud and misrepresentation, the directors may keep 
for the use of their corporation as much of their earnings 
as they wish. And their action is, in the end, a reconcihation 
of two motives — a desire to gratify the stockholders, thereby 
maintaining the investment credit of the corporation, and a 
desire, to secure additional capital without increasing the 
liability to the public, thereby strengthening the credit of the 
corporation with the banks. The particular balance between 
these two motives will rest, very largely, upon the policy of 
expansion then being followed by the directors. A static 
business, having no plans for enlargement, can dispense all its 
earnings as dividends without seriously affecting its credit. 
An expanding business cannot. All this was discussed in 
detail in the previous volume, but the matter is of great im- 
portance from the point of view of the sources of the capital 
required for expansion. 

It is illuminating to look at the life history of a corporate 
enterprise as consisting of three great periods, analogous to 
the periods under which the physiographer describes the life 
cycle of land forms. There is a period of youth in the history 
of every corporation; there is a period of maturity; and there 
is a period of old age and decay. In a thoroughly typical 
case the period of youth is the period of growth. But it is 
growth from within since it is well-nigh impossible to enlist 
the aid of outside capital in a young, expanding enterprise. 
Much if not all of the capital required for this growth must 
therefore be extracted from the business itself, namely from 
the reinvestment of earnings. And this is conspicuously true 
if not only the corporation itself, but the industry in which 
it operates, is young and growing. Neither banks nor in- 
vestors, neither old women nor speculators, care to assume 
the double risk of both an undeveloped industry and an un- 

i Volume III, Chapter VI. 


tried corporate management. All the funds for expansion 
must therefore come out of earnings.* Gradually as the in- 
dustry develops and exhibits its inherent earning capacity or 
as the corporation shows successive years of liberal net earn- 
ings, in other words, as it approaches the maturity period of 
its life cycle, capital may be obtained from banks and investors. 
But even then the investment credit of a corporation is very 
much improved if investors feel that the managers of the 
industry are willing to reinvest at least a part of their annual 
earnings in the business for which they seek capital from out- 
side sources. 

This same principle applies during the period of rehabilita- 
tion, analogous to the period of youth, which follows the 
bankruptcy and reorganization of a corporate property. If 
an unsuccessful corporation is finally to attain success after 
its reorganization, it must be allowed a considerable period 
of rest during which all its surplus earnings are turned back 
into the property. Only in this way can it re-establish its 
credit. It was in this way that the great railroads which 
failed in the middle nineties developed into some of the 
strongest railroad properties of the country in the decade 
from 1899 to 1909.' In some instances, like those of the 
Union Pacific and Southern Pacific roads, the reinvestment 
of earnings in property was hidden from the great majority 
of the stockholders by heavy betterment expenditures charged 
to maintenance. On the other hand, roads like the Norfolk 
and Western in the period of its rehabilitation while under 
the control of the Pennsylvania Railroad, clearly distinguished 
between betterments charged to capital and betterments 

* The rate of expansion of a growing business is a rapidly developing industry, 
solely out of earnings, is remarkable. The original money investment of the Ford 
Motor Car Company was $28,000. Out of this was constructed an organization 
which in the year ending August 1, 1920, manufactured over a million cars, more 
than half the total number of automobiles manufactured in the United States. 

• This policy is excellently summarized by a resolution of the Board of Directors 
of the Union Pacific Railroad, passed while the road was being rehabilitated and 
strengthened by the investment of earnings during the years succeeding its reorganiza- 
tion. Resolution quoted Voltune III, Chapter VII, page 124. 



charged to earnings.* At all events, whatever the accounting 
practice followed the money to pay for the rehabilitation came 
from the reinvestment of the earnings of the corporation 
rather than from outside sources. And it was this which 
enabled the roads reorganized in the middle nineties to recover 
their credit among investors so quickly and so thoroughly. 
Expansion by means of the reinvestment of earnings, 
rather than by the issue of additional securities, is easier for 
industrial, insurance, and banking companies than for rail- "^ 
roads and other public utilities. The rate of turnover of the 
capital is so much greater, and the proportion of fixed invest- 
ment to the total gross business so much smaller that the 
industrial can "finance itself" under ordinary circumstances. J 
This explains why great industrial enterprises like the United 
States Steel Corporation are able to grow with such rapidity 
without increasing their bonds and stock appreciably, and why 
great railroads like the Pennsylvania are forever putting out 
new issues of securities. It is not so much a difference in 
fundamental financial policy, as in the nature of the business.® 

When capital is obtained from outside sources to meet 
the cost of extensions, it may be had through the sale of 

* This differentiation between capital and income is seen from the allocation 
of the Norfolk and Western Railway's betterment expenditure during the period 
from 1902 to 1910 (figures are in even thousands). 


for Additions 



Charged to 



Charged to 



Charged to 



3. S 13.000 

















• This difference was already alluded to in connection with the factors controlling 
the dividend policy of different types of corporations. See Volume III, Chapter VI, 
pages 77 and 78. 


temporary obligations in the form of notes or permanent 
obligations In the form of long-term bonds or stock. The 
former is a kind of intermediate step between financing exten- 
sions from earnings and from the sale of permanent obliga- 
tions. But it is fraught with certain inherent limitations and 
restrictions, the importance of which cannot be overestimated. 

Temporary financing may be based upon two different 
financial presumptions. In one case the directors of the cor- 
poration may issue the short-term notes in order to pay for 
extensions and improvements in structures and other 
permanent or fixed property on the assumption that the 
market for bonds will be better when the notes mature Ijhan 
at the time of issue. In other words, short-term notes are-> 
issued at a time when improvements must be made, and the 
bonds needed to meet them cannot be sold on advantageous \ 
terms. In the other case, the directors may issue short-term ^ 
notes on the assumption that when the notes mature the prop- 
erty which was bought from the proceeds of their sale can 1 
be sold to pay them off. In the former case the issue of notes 
is admittedly only a temporary substitute for the issue of 
bonds; in the latter case the issue of notes is a means for 
temporarily expanding the available capital. -^ 

The policy of issuing notes in anticipation of the issue 
of permanent long-term bonds is of comparatively recent 
origin. Prior to 1900 it was the custom of all large corpora- 
tions, particularly railroads, to anticipate their capital needs 
and sell bonds or stocks before the money was actually needed. 
True, all the railroads that failed about the time of the panic 
of 1893 had large "floating debts," represented by notes car- 
ried by the banks; yet the presence of these notes was the 
result of lowered credit rather than of conscious forethought. 

The good results of some of the early issues of short-term 
notes" proved an evil precedent. During the year ending June 

* During the depression of 1903, for instance. 


30, 1907, the railroads and large manufacturing companies 
had had their capacities taxed to the utmost to meet the 
enormous volume of business that always marks the culmina- 
tion of an industrial boom. Very heavy expenses for improve- 
ments and plant enlargements followed as a consequence. 
Some of these expenses were paid for by the sale of bonds 
during 1906 or the early part of 1907. By the middle of 
the year, however, signs foretelling a financial crisis were clear 
and interest rates rose steadily. Under such circumstances 
long-term bonds fell in market value and new bonds could 
not be sold at anything like the price prevailing during 1906 
and the years immediately before. Consequently, many large 
corporations, particularly street and steam railroads, sold 
three-year notes at the high rates then prevailing, in the ex- 
pectation that by 19 10 interest rates on long-term obligations 
would have returned to the levels prevailing before the panic 
of 1907. It was hoped that in this way a permanent saving 
in interest could be effected. 

Had the railroads stuck firmly to the original intention of 
refunding their short-term notes in 19 10, this expectation of 
a permanent saving in interest would have proved correct. 
But the price of bonds had not fallen in 19 10 to the levels 
of the period before 1906 and many railroad officials were 
deluded into thinking that they had but to wait a little longer 
and presently bonds could be sold at the previous high prices. 
Furthermore the short-term note "habit" had been indulged 
in. Railroad managers found that a new market had been 
secured for railroad securities among the national and state 
banks and among those private investors who preferred ob- 
ligations that matured quickly to long-term bonds. Again, 
railroads — and even large industrials — which were burdened 
by issues of prior lien mortgage bonds found that they could 
sell short-term notes, even though unsecured or inadequately 
secured. Bankers and investors consented to buy a note with 


meager security if it matured in one, two, or three years on 
the assumption that the corporation would remain solvent for 
a few years at least. These three factors, then, the hope of 
falling interest rates, the demand for a wider market for 
corporation securities, and the comparative ease of marketing 
a poor security, explain the growth of the use of short-term 
notes in the six or seven years immediately before the Great 

In all respects this movement has proved to be imf ortunate. 
Interest rates on long-tertn bonds steadily rose from 19 lO 
to 1920. Consequently the prices at which they could be sold 
by corporations declined. Banks have acquired corporation 
notes to some extent, and so also have many investors who 
felt confident that interest rates would continue to rise and 
wished therefore to place their available funds in quickly 
maturing obligations. And because of this artificial demand, 
it cannot be denied for a moment that corporations have been 
able to dispose of poor securities which could not have been 
sold under other conditions. But this success has not proved 
of lasting benefit to the issuing corporation because it formed 
too easy an excuse for the overextension of unfunded debt.^ 
Nor did it prove wholesome for the financial situation as a 
whole, because it led to the accumulation of a large unas- 
similated mass of notes of anomalous character. 

Furthermore, and quite aside from the unfortunate ex- 
periences of the last few years, the issue of short-term notes 

* An interesting instance of an attempt to prevent such an accumulation, typified 
by the unfortunate case of the Missouri, Kansas and Texas Railway described in 
note 9 (next page 175), is suggested by the conditions surrounding the issue, in 1914, of 
$33,000,000 five-year s per cent notes by the Chesapeake and Ohio Railroad. These 
notes were issued to refund maturing notes originally sold to pay for improvements 
and extensions which ou^ht to have been paid for by the sale of bonds or stocks. 
The bankers in underwriting the issue required that the directors agree to spend 
$2,000,000 during the first year for capital improvements directly out of net earnings 
—that is, before dividends. During the next two years $^,000,000 a year must be 
similarly spent, and $4,000,000 eacn year for the remaining three years that the 
notes remained outstanding. In other words, the directors obligated themselves 
to turn back $20,000,000 of net earnings into the railroad property before any 
dividends should be paid. 


by corporations to pay for permanent improvements has proved 
expensive. Even had it proved economical because indulged 
in during a period of falling interest rates, it would have no 
justification in theory or sound practice. The excuse ordinarily 
offered is that short-term notes can be issued more profitably 
when interest rates are high, and long-term bonds when in- 
terest rates are low. One financial writer expressed the point 
of view of the issuing corporation when he said: "They (the 
railroads) buy long-time credit far in excess of immediate 
need when money is plenty and short-time credit at higher 
rates when money is scarce. The New Haven road is especially 
alert to take advantage of changing interest rates." * Such 
a generalization has little basis in fact, and the selection of 
the financial administration of the New Haven road as "es- 
pecially alert" is humorous, if nothing else. But the successful 
practical application of this rule presumes that corporation 
officials have a prophetic understanding of the general trend 
of the money market. The simple fact that interest rates 
have steadily risen from 1910 to 191 7, when the entrance 
of the United States into the Great War made difficult any 
financing, and that during this period short-term notes were 
put out in increasing abundance, shows clearly that corporation 
officials have not this understanding.® 

* Chamberlain, L., The Work of the Bond House, 35. 

• All this is excellently illustrated by the history of the short-term note issue 
that proved the proverbial "last straw" on the already overburdened back of the 
Missouri, Kansas and Texas Railway. In 1910 the railway company required $3,600,000 
to purchase the Texas Central, $2,000,000 for terminal improvements in St. Louis, and 
about $4,000,000 for new equipment and improvements to the main and branch lines. 
All these expenditures were for capital and all represented permanent improvements 
to the railway system. But instead of issuing stock or bonds, or else waiting to 
make the improvements and extensions until stock or bonds could be sold, the 
road issued $10,000,000 one-year notes maturing August i, 1911. In 191 1 these 
notes were refunded by an issue of two-year notes, the amount being increased to 
$12,850,000 and the proceeds of the sale of the additional notes used to pay for 
certain betterments. In 1912, $3,150,000 additional of these notes were issued to 
acquire branches and the like; also $1,500,000 one-year notes were issued to pay 
for the Wichita Falls road. In 1913 the Missouri, Kansas and Texas issued 
$19,000,000 two-year notes, $17,500,000 to refund the notes falling due and $1,500,000 
to pay for betterments. These fell due May 1, 19 15. An extension of one year 
was asked by the road. A few noteholders refused and threatened to file suits. The 
receivership followed in September. 

A writer in a financial periodical made the following comment in June, 191 5, 
when the status of the notes was very low. Hindsight is usually keener in financial 
space-writers than foresight. "Missouri, Kansas and Texas, and Missouri Pacific 


But aside from the fact that the use of short-term notes 
has been expensive, their issue is fundamentally wrong. A 
quickly maturing note should be given for the purchase ^f 
property only when the property is "self-liquidating," This 
implies that the ultimate sale of the property affords in itself 
the means of meeting the notes when due.^° The bridge of 
a railroad, the new warehouse of a factory, the new turbine 
of an electric company, will not do this. Given a period of 
years, the presence of the bridge, the warehouse, the turbine 
will so increase the earning capacity of the corporation that 
uses it, that the latter will be able to set aside annually a fund 
to pay for the structure years hence. This is the justification, 
and the only justification, for the purchase of fixed equipment 
through the sale of long-term bonds. But it affords absolutely 
no justification for the purchase of equipment by the sale of 
short-term notes." 

have been in a ticklish position, and moreover it will add emphasis to the precarious 
turn short-time financing takes during periods of hard times and tight money. It 
is far better to pay a little more interest and have a debt spread over a term 
of years so that it will not pinch so badly at the wrong time, than to resort to 
short-term, patchwork finance. 24 The Financial World (June 5, 1915). 

" There have been cases where this implication has been used as a means of 
deceit. During the long period of its history H. B. Claflin and Company had 
built up an excellent credit with the banks. (See Chapter III, note 21.) In order 
to reach forward to the ultimate consumer the company purchased department stores 
in all parts of the country. But instead of paying for these stores by means of 
stock or at least long-term bonds, the Claflin Company used notes issued under 
questionable circumstances. One of its employees in New York was appointed 
treasurer of these stores. This treasurer would issue notes drawn for odd sums 
so that they would have the appearance of actual commercial paper arising through 
the purchase of salable merchandise. These fictitious notes were then indorsed 
by H. B. Claflin and Company and sold to banks. The proceeds were used by the 
Claflin Company to pay tor their stores. At each maturity of the notes, others 
of a similar character were drawn and sold. 

^* This whole idea was excellently expressed in an editorial in the New York 
Times Annalist, commenting on the announcement that "The Southern Railway 
Company, believing in the continued prosperity and growth of the territory it 
serves, and recognizing the necessity of enlarging its facilities to keep pace with 
that growth, has, pending the improvement of the market for long-term securities, 
sold $10,000,000 5 per cent three-year notes, secured by pledge of development and 
general mortgage 4 per cent bonds of the company, which for some time past have 
been held in the treasury of the company available for sale. This new capital is 
to be applied by the Southern Railway Company in carrying through to completion 
plans for improvements and betterments." 

The editorial writer then went on to say: "Many had hoped that the experiences 
of the New York, New Haven and Hartford and the Boston and Maine with 
short-term notes, which have an ugly way of coming due at the wrong time, afforded 
sufficient evidence against the fallacy and danger of that kind of finance. Here 
is a railroad that cannot sell its treasurer bonds, save at a greater immediate sacrifice 
than it is willing to accept; therefore, it pledges those bonds at 60 under an issue 
of short-term notes. To use the proceeds of short-term notes in permanent con- 
struction is to convert what ought to be liquid capital into what is technically 
known as fixed capital, and when it comes to funding the notes into long-term 


A very important principle of business policy is evidenced 
by this distinction between self -liquidating and fixed property. 
It applies to the method of financing all purchases of material 
required by an expanding business. In general, a business 
buys two kinds of property as it expands — more raw materials 
and merchandise to be manufactured or redistributed, and 
more Structures and equipment with which to carry on its 
enlarged business. The raw materials and merchandise are 
sold within a comparatively short time, and if the business 
is sound a profit will be realized through handling them. Ob- 
viously the amount and the cost of these merchandise pur- 
chases will fluctuate according to the customers' demands for 
the finished product. Even in a business requiring a very 
long time for the "conversion" of its material, there will be, 
necessarily, a fairly accurate correspondence between the 
amount of the inventories carried and the relative demand for 
the finished product. During periods of marked demand — 
business booms — the purchases of raw materials and mer- 
chandise will be large. And, conversely, during periods of 
restricted demand — business depressions — the purchases of 
raw materials and merchandise will be small. Obviously the 
shorter the period required for "conversion" or "turning the 
stock," the quicker will be the response and the more exactly 
will the amount of the purchases correspond with the amount 
of the sales. But even in businesses requiring long periods 
for "conversion" there is a definite and approximately accurate 

The other kinds of purchases made by an expanding busi- 
ness are structures and equipment. These are not resold. 
They are incorporated, as soon as acquired, into the fixed and 
permanent capital of the business. They cannot be contracted 
during periods of depression. They are definitely and finally 

obligationo, there are more commissions to pay, if nothing worse. Often the notes 
come due while it is either still or again impossible to sell long-term bonds, and 
then the notes themselves are restimed." 


permanent. Once having been acquired, the structures and 
equipment of a business bear no relation whatever to the 
volume of business, nor do variations in the volume of business 
react back on the amount and cost of the structures and 

This distinction is of the utmost importance. That it has 
been ignored by corporation officials is the explanation of some 
of the most serious blunders in the financial policy of many 
large modern corporations. It involves an absolute and in- 
effaceable distinction between the financing of merchandise for 
resale and the financing of permanent improvements. 

The sale of raw materials in a finished state and the resale 
of merchandise brings back into the corporation's treasury at 
least as much and probably more than the raw materials or 
merchandise cost. This cost may therefore be fully met by 
the sale of notes on the reasonable assumption that the money 
with which to pay the notes can be realized from the sale 
of the finished products. Notes serve, therefore, merely as 
a means for enabling a corporation to carry a larger stock of 
raw material, goods in the process of manufacture, or mer- 
chandise in the process of being distributed. As the demand 
for the finished products expands, the raw materials or 
merchandise that must be purchased expand, proportionately; 
and with the increased stock of goods more money must be 
tied up in the inventories. This can best be obtained by 
temporary borrowings. The notes should be arranged to ma- 
ture at about the time the corporation would reasonably expect 
to receive payment for the finished goods. This will represent 
the time required to manufacture and distribute the goods, the 
average period that finished goods remain in stock before their 
sale, together with the time ordinarily required to collect the 
account from the customer. Clearly, each of these three 
factors will vary with the technique and the customs of the 
industry, but gross averages, within a single industry, can be 


determined beforehand with ^ fair degree of accuracy. The 
important and vital fact is that the volume of outstanding 
notes can be made to fluctuate directly with the volume of the 
inventories. One is the obverse of the other. With the sale 
of notes, inventories are acquired; with the sale of the inven- 
tories the notes are p^cid. 

The purchase of equipment and the construction of build- 
ings and permanent improvements necessarily go on — as surely 
as increased inventories — during a period of business expan- 
sion. But they must be paid for differently. For it will be 
noted that nothing which was said in the preceding paragraph 
concerning the intimate connection between inventories and 
notes applies to the connection between permanent structures 
and the obligations a corporation might issue to pay for them. 
Permanent improvements are not resold to liquidate the obliga- 
tions which paid for them. These obligations can be liquidated 
only through the increased earnings of the corporation; the 
increased earnings should be sufficient at least to meet the 
interest on these obligations and to amortize, by means of a 
sinking fund, the improvements before they are worn out or 
become obsolete. If improvements are made wisely the busi- 
ness will show exactly these results, and ultimately this grad- 
ually accumulating fund may be used to pay off the obligations 
incurred in acquiring the improvements. Obviously these 
obligations must run for many years ; they must be represented 
either by stock or by a funded debt that matures after an in- 
terval long enough to allow of sufficient accumulations in the 
fund to meet the debt. Under no circumstances should an 
established and expanding business finance its permanent im- 
provements through bank borrowings or short-term notes. 
Permanent improvements should be paid for from the pro- 
ceeds of the sale of stock or long-term bonds. The procedure 
to be followed will be discussed in the immediately succeeding 




Problems to be considered, i8o; Advantages of issues of bonds 

rather than stock, i8i ; Advantages of stock issues, 184; Advantages 

of sales through bankers, 188; Assurance of sales, 188; Widening of 

market for securities, 190; Relative economy, 193; Exchange, 195; 

Growing use of stocks rather than bonds, 196; Pretended safeguards 

from point of view of investor, 198 

Permanent improvements must be paid for through the 
sale of bonds or stocks. It is obvious that notes, of whatever 
description, should not be used to pay for either such fixed 
improvements which cannot be turned into money easily, or for 
those the usefulness of which extends well beyond the maturity 
of the notes. But the question of whether bonds or stock 
should be sold to pay for permanent improvements is not so 
easily answered. If it seems expedient for the corporation 
to sell bonds, the further questions arise as to whether they 
should be of short or long maturity and what character of bonds 
are best suited to the particular circumstances. If on the other 
hand, it seems expedient to issue stock, it must be decided 
whether the shares shall be common or preferred. In any 
case the directors of a corporation seeking capital for expan- 
sion must decide whether the new securities shall be sold to 
independent bankers or to stockholders. To consider these 
questions aright, it is necessary to appraise first certain general 
advantages pertaining to each class of security, and apply the 
principles of such an inquiry to different types of corporations. 

' Volume II, Chapters II, VII, and VIII, treat of the sale of securities to bankers 
and the work of the banker in connection with promotion. The observations of this 
chapter are confined to the sale of securities of established and prosperous companies. 




These principles, too, will affect the question whether the new 
money shall be obtained through bankers or stockholders. 

There are certain specific advantages which the issue of 
bonds affords, not ordinarily possessed by a new issue of stock. 
The most apparent is the lower rate at which the new capital 
for expansions may be secured through bond issues rather 
than stock issues. Ordinarily^ the rate that must be paid for 
new capital is from i to 3 per cent less on funded debt than 
on stock, especially when the stock is not of the nature of a 
prior lien on unmortgaged tangible property.' 

*The numerous instances in which this is not true will be discussed in the 
next chapter. 

• It is somewhat difficult to estimate correctly the selling prices of hypothetical 
issues, for it seldom happens that both new bonds and new stock are sold at the 
same time under analogous conditions. Since 1914 the prices of securities have 
been so affected by the financial conditions arising out of the Great War that a 
recent comparison is not of general significance. 

The subject can be discussed best in the light of a few specific cases. But even 
with these in view it is very precarious to generalize. The following comparisons 
are based on average conditions between 1910 and 1914. 

I. The first case to be cited is that of a successful public service electric light 
company in Texas under the wise and careful supervision of the General Electric 
Company. (Chapter Vi, note 36). 



Price Paid 

Normal Rate 
to Company 




91 K 
95 M 


Preferred Stock 

This company had been, since its inception, unusually successful and the prices 
cited were realized after this fact had become recognized. At the time the securities 
were sold, each represented perhaps the best of its class among investment securities. 
The bankers who handled both issues were of assured strength. The case is therefore 
indicative of the difference to high-grade successful public service companies of cost 
of new capital by sale of bonds and stock. Needless to remark, had there been 
no bonds, the stock would have sold at a lower net interest rate, but then a direct 
comparison could not have been made! And, moreover, in the public service field, 
the case of a stock with no bonds ahead of it is exceedingly rare outside of 
Massachusetts, and cases drawn from this state are not representative owing to the 
tax laws. 

2. The second case is that of a successful manufacturing company doing an 
international business. 



Price Paid 

Normal Rate 
to Company, 
not including 

Debenture Bond (No Lien Superior to it) 


1 30 

5. 80 



Several reasons explain the greater economy of financing 
expansions through bonds. Obviously the most important 
is the presumptive fact that a bond security is stronger than 
a stock, so that the ultimate compensation for the risk which 
the investor will demand is correspondingly less. But in addi- 
tion to this is the fact that the market for considerable amounts 
of bonds of established enterprises is wider than for a large 
new issue of stock. Consequently the cost of merchandising 
is less. Furthermore, as there are more wholesale and retail 
dealers in bonds than in stocks, the corporation would expect 
to receive a wider range of bids, and therefore a higher price, 
for bonds than stock. These considerations will be discussed 
in detail later. 

This case is not as good an illustration, as the stock had great "speculative 
possibilities" and commanded a market among speculators as well as investors. 
Furthermore the stock was sold to stockholders and the price asked by the company 
was slightly less than the prevailing open-market quotations. The bonds were sold 
to bankers. The conditions of sale therefore were not exactly parallel. 

One might suggest that the following hypothetical table would probably hold good 
as an expression of average conditions. The rates are those which the corporation 
itself is compelled to pay, and are therefore computed from prices paid by bankers. 
As stated before, the estimates are made from averages, computed from security 
issues made during the period from 1910 to 19 14. The comparison is between sale 
of overlying general bonds and preferred or common stocks, each having an established 
investment position. 



High-grade railroad systems in which the common stocks are 

sought for investment purposes 

Medium-grade railroad systems in which the preferred stocks 

are held for investment or the common stocks show a fair 

margin of earnings 

(Low-grade railroads nave had, unfortimately, no choice, but the 

s^e of bonds.) 


Only high-grade, well-established industrials would be able to 
sell bonds. In such cases the preferred stocks alone 
would be of value for comparative purposes, as the value of 
common stocks would be entirely a matter of speculative 

Public Service Corporations: 

High grade. Both bonds and preferred stocks could be sold to 
bankers. The geographical position of the company has a 
great deal of influence in determining the price bankers are 
willing to pay for its securities. These figures are at best 
a rough approximation 

Medium grade 

Low grade 

6. 30 




Aside from economy of issue, bonds would permit a con- 
tinuation of a concentration of control. Stock would 
ordinarily be granted voting power, and as the corporation 
grew in size the new stockholders might very easily outnumber 
the old. At all events, the continual extension of the voting 
privilege, as the requirements for new capital grew, would 
mean -at least a weakening of the influence of the old manage- 
ment in the control of the corporation, even though the actual 
control itself were not jeopardized. Akin to this objection 
to a large increase of stock is the reluctance of a successful 
management to open up the business to the inquiry of a con- 
stantly growing group of new stockholders. This is par- 
ticularly true if the old stockholders are few in number and 
close to the management. They resist the natural inclination 
of the new stockholders to scrutinize the methods and policies 
of an old-established business. The proprietors might well 
take the position that it were better to continue their old 
business within small compass than to extend it through the 
capital furnished by a group of outsiders possessing a right 
to interfere with the established order. 

Still another advantage to be gained by selling bonds, 
rather than stock, is the comparatively large blocks of an 
issue that can be sold to a single customer, thus reducing 
considerably, for either the corporation or the bankers, the 
actual expense of distribution. It is exceedingly difficult to 
place large amounts of stock except among the directors or 
their associates, because no man would desire to become a 
heavy stockholder in a corporation, with its attendant risks, 
without securing some voice in the management. But life 
and other insurance companies, banks, trustees of private 
funds, the treasurers of religious and eleemosynary corpora- 
tions, stand ready to absorb large amounts of bonds without 
requiring, at the same time, a voice in the management. Some- 
times these sales may be forced upon corporations by directors 


who are in important administrative positions, as was done 
by the officers of the various large Hfe insurance companies. 
Some of these large insurance companies* have been con- 
spicuously stupid in the administration of their bond invest- 
ments. Moreover, these large blocks of bonds being once 
placed will probably be held until their maturity instead of 
being sold should there be either a pronounced rise or pro- 
nounced decline in their market value, provided the decline 
did not indicate a loss of fundamental security. This latter 
point is very important, for, at some later time it may be 
necessary for the corporation to market more bonds of the 
same issue and the new supply would ordinarily affect the 
market price of those previously sold. The only way to avoid 
this depression would be for the corporation or the directors 
to form a syndicate to absorb from the open market those 
bonds offered for sale. The chance that large blocks of the 
old issue would be forced into the market might prevent the 
directors or bankers from entering the syndicate; but if it 
were known that a large proportion of the old issue was 
securely locked up in large trust funds, then the syndicate 
could be formed to maintain the general market for the bonds 
at a much lower expense to the issuing corporation. 

The advantages just noted pertaining to the sale of bonds 

* All things considered, the administration of the investments of some of the 
larger life companies has been carried on with what must appear to an outside 
observer a strange lack of skill. The investment of a large trust fund is a very 
complicated and difficult problem of business economics. It is far more than a 
mere day-to-day problem of market quotations. And it is this unusual skill in 
the administration of its "reserve" which should justify the life companies in 
collecting and holding for their policyholders a reserve in excess of the net premium 
and a reasonable loading charge. The management of one leading life insurance 
company, to take a single example of investment incompetence, has bought long-term 
bonds at the very time when interest rates were rising. It has bought the bonds 
of railroads when the "writing on the wall" pointed to the fact that the particular 
railroad bonds had lost their premier position, although not their high price. And 
even the bonds chosen — like the surprising investment in $3,000,000 Chicago and 
Alton Railroad s'A's, practically one-seventh the entire issue — were too often the 
bonds of railroads on the down grade. Of all the investments standing on the 
company's list as of January i, 1920, which had been held for any length of time, 
over 90 per cent showed a loss over the original cost. This is the result of the 
administration of the trust fund of a corporation which advertises itself as able 
to conserve the savings of those portions of the public unfitted to invest their 
savings themselves. 


rather than stock apply only to types of corporations possess- 
ing a real alternative. There are many types of corpora- 
tions which cannot wisely issue bonds and are confined in 
all their financial operations to stock issues. Such corporations 
include banks, insurance companies, and manufacturing com- 
panies situated in states which discriminate in their tax laws 
against investments in bonds. Other corporate enterprises, 
such as mines, patented inventions, retail stores, and the like, 
would wisely do all their financing by means of stocks, al- 
though there are no laws that prohibit the issue of bonds, 
were it possible to sell them. For other types of business 
corporations, including manufacturing enterprises, railroads, 
and public service companies generally, there is no funda- 
mental legal or economic reason that determines whether a 
corporation shall issue stock or bonds in order to meet the 
capital costs of an expanding business. In such cases it is 
essential to gauge carefully the relative advantages of an issue 
of new stock, as compared with an issue of new bonds, for 
in the end the whole question resolves itself into one of prac- 
tical financial expediency. 

The payment of the costs of the expansion of a corpora- 
tion by means of the sale of new stock issues has certain 
very positive advantages over expansion by means of bonds. 
The greatest of these is that stock carries no irrevocable 
promise of dividend payment. And new stockholders are 
quite as much partners in the enterprise as the old stock- 
holders, and assume quite as much risk. Payment of interest 
on a bond is fixed, and if not paid when due, failure is pre- 
cipitated. Most corporation directors, no matter how successful 
the enterprise may be, hesitate to burden it with fixed charges, 
even if the future gives promise of earnings that exceed the 
charges many times over. And even in those instances when 
there seems no reasonable doubt but that the new money 
obtained from the sale of bonds will be invested so as to 


earn immediately, through new or improved equipment, more 
than sufficient to pay the charges, there is no assurance that 
this increased earning capacity will continue throughout the 
life of the bonds. The question, in the end, narrows itself 
down to a simple fact of business expediency. A decrease 
of the net earnings of a corporation might occur at any time, 
owing to conditions beyond the control of the corporation's 
management, and this decrease in net earnings might 
jeopardize the solvency of the corporation through the en- 
forced payment of interest. To avoid this possibility, however 
remote, the corporation's directors prefer to assume the extra 
cost which the sale of stock, rather than bonds, involves 

In addition to this matter of general policy, there is a 
special reason why an expanding industrial business should 
not pay for its capital extensions by the issue of bonds — the 
\ effect on the general credit. At no time in the company's 
history do the credit man and the banker watch a company's 
general credit more carefully than when a small business is 
expanding into a large one. The old-established lines of 
credit must be increased; the limit of bank loans must be 
raised. Otherwise the business cannot carry its enlarged in- 
ventories and accounts receivable. Just at this critical time 
the issue of bonds to meet the increases in the plant account 
would hurt, distinctly, the public credit. The bankers and 
merchandise creditors would naturally assume that the policy 
was prompted by one of several reasons: either the directors 
had not enough financial backing among the stockholders to 
secure new money from the sale of stock, or themselves lacked 
confidence in the enterprise, preferring to risk other people's 
money rather than their own, or else that they proposed to 
follow a different and more audacious plan of financing, the 
success, even the expediency, of which could not be foretold 
from the past. Any one of these inferences would destroy 
the general credit of the expanding corporation, irrespective 


of the margin of current assets over current liabilities. On 
the other hand, if the directors sell to the public an issue of 
stock the proceeds of which are used to extend the plant, 
to pay off maturing loans, and to increase the excess of 
current assets over current liabilities, the power of the cor- 
poration to sell its notes and acceptances will be enormously 
increased. From the bankers' point of view their equity has 
been increased by the full extent of the new capital brought 
into the business. 

These principles do not apply with equal force to all types 
of corporate enterprises. They have the greatest strength for 
industrials and the least for local utilities.^ An industrial 
must borrow heavily at banks in order to carry its inventories 
and receivables. Its earnings are not easily predicted, nor 
can it fortify itself against sudden changes in the demand 
for its product, against labor disturbances and against unusual 
stupidity in management. These unpredictable elements are 
less in evidence in a local utility, although even here too much 
confidence cannot be placed in the assurance of increased earn- 
ing power in which both the public service company operators 
and the bond buyers place their trust. During the entire period 
of the Great War, the class of enterprises that suffered most 
was the various groups of public utilities. Many reduced 
their dividends; some defaulted on their bonds and passed 
into the hands of receivers. Had many of these enterprises 
financed their extensions by means of the sale of stock, rather 
than bonds, in the decade from 1904 to 19 14, they could have 
passed through the critical period of the Great War with their 
credit untarnished. 

The fact that a stock issue carries no direct obligation 

• The principles governing the use of bonds and stocks have been discussed 
already in connection with the financial plans of embryo corporations (Volume II, 
Chapters III to VI). All things considered then, those same principles are pertinent 
to the financial plan of an expanding corporation. Sound judgment in balancing 
many conflicting motives, a conservative, yet far-sighted and aggressive policy is 
quite as necessary at the expansion as at the inception of a corporation. 


to meet fixed and unalterable charges is its greatest advantage 
over bonds for every type of enterprise. But there are other 
lesser advantages which are frequently of considerable mo- 
ment in leading directors to decide to issue stock in order to 
pay for plant extensions. The better borrowing facilities at 
banks has been mentioned already. There is a greater flexi- 
bility in the purchase and sale of real estate if there is no 
blanket mortgage on the property. There is a better invest- 
ment market for stocks among those investors residing in 
certain states which tax bonds but not stocks ; and the federal 
income taxes for small investors are paid directly by the 
corporation, thus giving the holder less trouble of collection 
than in the case of bonds. It is interesting to note also that 
small investors are, as a rule, unfamiliar with bonds, so that 
a corporation can secure a much wider market among small 
investors through the sale of stock than it can through bonds. 

In all probability the decision of the directors of a corpora- 
tion as to whether they shall pay for extensions by the issue 
of bonds or of stock cannot be made without taking into 
consideration the means to be employed in selling the new 
securities. Two distinct means are available. The corpora- 
tion directors may either sell the entire issue directly to bankers 
or they may offer the securities to the stockholders in the 
proportion of stock holdings. The advantages of the sale 
of the new securities to bankers is considered in this chapter. 
The succeeding chapter treats of the conditions surrounding 
a successful sale of new securities directly to a corporation's 
own stockholders. 

Perhaps the foremost advantage of the sale of the entire 
issue of new securities to investment bankers is the assurance 
of a successful sale. Ordinarily the management of a cor- 
poration spends money for improvements before the money 


is actually in hand. A floating debt is incurred which it is 
proposed to fund by means of the money obtained from the 
sale of the new securities. Ordinarily, too, the payment of 
the bank loans representing these floating debts must be met 
in the immediate future; and the improvements themselves 
must be carried through once they are commenced. It is 
therefore imperative that the corporation obtain the money 
its plans call for ; these cannot depend on the temporary fancy 
of stockholders nor be jeopardized by the kaleidoscopic 
changes of the financial markets. Generally, therefore, the 
corporation is very glad to allow the bankers to assume these \ 
risks, even though a slightly less price is realized than if the 
bonds or stock were sold directly to the final investors. It 
is this assurance of the immediate payment of money that 
most often leads to the acceptance of the definite offer from 
the bankers, the more conservative of the directors preferring 
to run no risks of being caught in the meshes of an unfavor- 
able credit market.® 

While the relationship between investment bankers and 
the corporations for which they have once sold securities may 
not require the bankers to underwrite every issue that the 
corporation may thereafter bring out, still the fact that the 
bankers have once investigated the enterprise and decided to 
lend their support in financing it, implies a willingness to 
assume at least a favorable attitude toward future issues of 
securities. In fact, it is one of the unwritten laws of invest- 
ment banking that when a banker has once established intimate 
association with a corporation he shall have at least the first 
opportunity of bringing out subsequent issues. Sometimes 
this closeness of connection works greatly to the advantage 
of the corporations,^ as it protects them during periods of 

• Corporations must use great care that bankers do not set aside contracts already 
implicitly understood, if not legally completed. Too often a banker will postpone 
a legally binding contract until unimportant details are arranged. And if, in the 
meantime, general financial conditions change, the banker will find some excuse 
for refusing to fulfil his part of the agreement. 

' During 1912, a banking syndicate, headed by the joint management of two 


financial stress, when capital is difficult to obtain at any price, 
from being handicapped in financing improvements or in 
refunding old issues of securities. For it is clear that if 
bankers have been responsible for the wide distribution of a 
company's securities in the past, they will acknowledge an 
obligation to protect the company in an emergency so that 
the value of the securities already sold shall not be jeopardized. 
Corporations have, in several important instances, actually 
passed into the hands of receivers, for the reason that their 
managers had, in the past, failed to effect a strong alliance 
with investment bankers. 

Expansion through the sale of securities to bankers widens 
the market for the company's securities in a manner not 
possible through the sale of either bonds or stock to the old 
stockholders, and the wider the market for the company's 
securities, the more secure it is in the control over new capital. 
This is a very important element in the growth of large busi- 
nesses. It is quite frequently neglected by corporation officials 
who, finding themselves able to provide amply for the imme- 
diate future, forget the necessity of providing for the remote 
future. Small additions of capital may be obtained from time 
to time from the old stockholders, but ordinarily large in- 

prominent banking houses, one in Boston and the other in Chicago, underwrote a 
considerable issue of bonds of an electric lightine company in the Middle West. 
The price paid by the syndicate was 92 J4 and the price at which the syndicate 
disposed of its bonds to the public was 97. During the summer of 19 13, owing 
to the conditions in the bond market, the price of these securities fell to 93. In 
the autumn of 1913, when the market price ranged between 93 and 94, the electric 
lighting company desired to sell some more bonds of the same issue, in order 
to pay for extensions. The bankers, owing to the changed conditions of the money 
market, were unwilling to pay 9254 for the second issue. Instead they offered 
the company only 85 per cent, but objected strongly to allowing other bankers 
to bid on the issue. They feared that, should other bankers secure the issue at 
a low price compared with that of the bonds they had already purchased and sold to 
investors, they could not successfully support the market for their old customers. 
That is, in order to prevent loss and to insure stability for those of their customers 
who had already bought bonds of them, they were unwilling to permit other bankers 
to deal in the issue. Under these circumstances the president of the company, 
being a man of considerable wealth, refu.sed the offer with the statement that 
he would take the bonds himself and hold them until the general bond market 
was in a condition to absorb them. In order to protect their clients, the bankers 
were compelled to pay the old price of 92 !4. although they immediately advertised 
the bonds for 94 K- Taking into consideration the expenses involved in the dis- 
tribution, this second purchase resulted in a loss to them. 


creases of capital must be sought in the general investment 

A failure to acknowledge this principle was one of the 
early difficulties with the financing of the American Telephone 
and Telegraph Company. Finding it comparatively easy to 
sell large blocks of stock directly to stockholders, the directors 
resorted to this method of expansion continuously, during all 
the earlier years of the company's growth, while the Bell 
Telephone system was being extended throughout the United 
States. Meanwhile, the individual stock holdings, although 
growing in size, were being concentrated in one geographical 
area, where the early stockholders resided. But the demands 
for expansion grew faster than the savings capacity of the 
stockholders, or rather than that portion of their savings 
which they cared to invest in telephone securities. As a result, 
the management experienced a constantly growing difficulty 
in finding a fair market for the new stock allotments as they 
were successively issued. This destroyed the real market for 
the stock of the American Telephone and Telegraph Company, 
and reduced its market price below its true value, with respect 
to other securities of equal intrinsic value, but possessing a 
wider market. In 1906 a new management, realizing that 
the fundamental financial difficulty of the telephone industry 
was its continual requirements for new capital, sought to 
extend the market for its shares from "Boston to New York 
in the hope of securing a national, and later an international, 
market for its securities. The effort was partially successful, 
although it did not occur early enough to give the company 
the nation-wide investment interest that its enormous expan- 
sion of the succeeding ten years required. What has proved 
true to a large extent with the telephone company has been 
shown to a lesser degree by the Pennsylvania Railroad. The 
railroad has relied for the finding of enormous amounts of 
capital upon its own stockholders, a large proportion of whom 


resided in Pennsylvania. Many of them were not always 
inclined, or financially able, to take up each allotment of new 
stock as it was offered by the railroad. In consequence large 
amounts of stock were thrown on the market at the time of 
each stock offering.* 

When expansions are financed by the sale of bonds to 
bankers, this intensive narrowing of the market for the cor- 
porations' securities does not result. Bankers sell bonds and 
stocks by the sheer strength of their ability as salesmen and 
the confidence of investors in them; their power to market 
securities has nothing to do with the extent of the knowledge 
of stockholders and their loyalty for their corporation. The 
bankers will organize a temporary syndicate^ for the sole 
purpose of distributing the issue. The members of this syndi- 
cate will vary from time to time, so that one issue of securities 
may be marketed by very different persons from those who 
handled the previous issues, even though the banking house 
through which the sale was effected remains the same in all 
cases. Moreover, in any case, the bankers who are brought 
together to help sell the bonds may have been chosen by the 
manager of the syndicate in order that the new securities 
may be taken into sections of the country where investors 
have never before been offered the securities of the particular 
corporation. If, by way of illustration, the majority of the 
stockholders, and even the bondholders, of a certain hydro- 

• The parallelism between the American Telephone and Telegraph Company and 
the Pennsylvania Railroad in these matters is very striking. Both, perhaps, more 
than any other two large American corporations, have relied on their own stock- 
holders for securing new capital. In both cases the general conditions were remark- 
ably well suited to successful sales of stock to stockholders. (See Chapter IX 
for discussion of these conditions.) And furthermore, the entire stockholdings 
during the early years of the expansion of th« two companies were confined to 
a limited and narrow geographical section — Massachusetts for the American Telephone 
and Telegraph Company and Pennsylvania for the Pennsylvania Railroad. True, 
at a later period both companies sought wide geographical markets for their securities 
— even invaded the hallowed precincts of France — yet both companies have_ always 
suffered from what one might call their provincialism. And this provincialism has 
been accentuated by the constantly recurring inclination on the part of both cor- 
porations to secure the funds necessary for extensions from stockholders' sub- 

' For further discussion of the underwriting syndicate, which includes syndicates 
for securities of established, as well as recently promoted companies, see Volume II, 
Chapter VII. 


electric company live in the region of the development — say, 
in western New York State — a new issue of stock or bonds 
cannot be sold in the same region, because the local investors 
already hold enough of the securities. Under these circum- 
stances an investment banker in Philadelphia might very well 
buy the issue. He might sell most of the new bonds to Penn- 
sylvanfa Dutchmen and the remainder through his connection 
in Boston, to Aroostook farmers. By no amount of effort 
could the hydro-electric company itself have reached either 
class, yet the result is easily attained by the distributing 
organization of bankers. Were the issue very large, like the 
Interborough Rapid Transit Company 5 per cent bonds, dis- 
tributed in 19 1 3 by J. P. Morgan and Company and assisted 
by banks and bankers throughout the country, the actual sales 
in all parts of the United States, and to a limited extent in 
foreign countries, would be proportional to the investing capac- 
ity of each geographical region. In brief, the distribution 
of securities through bankers can be made as wide as the 
conditions require. In no respect is it confined to the locality 
in which the company operates, or to that in which the old 
stockholders reside. 

Another advantage, particularly to the issuing corporation 
of an established reputation, is the simple fact that there are 
a great many different investment bankers and competition 
among them enables the corporation to obtain the highest 
price for its new securities which the general investment 
market permits. The business of selling securities is a highly 
competitive one; yet the profits of the business, if managed 
ably, are very large. Bankers long ago recognized that it is 
far better policy to purchase the issues of old, long-established, 
and profitable companies, even though their gross profit on 
each sale is small, than the issues of new corporations where 
the chance of a mistake in judgment is greater, and therefore 


the risk to their reputation is a matter of serious consideration. 
So it is not, with a successful corporation, a difficult problem 
to find a banker; the obstacle usually met with is that of 
inducing the banker to sell the issue on a narrow margin of 
profit. In these negotiations, the corporation is fortified by 
the knowledge that another banker stands ready to consider 
the purchase of the issue, if the first one proves too obdurate. 
As a result, the margin between the price received by an old- 
established corporation for an issue of \vell-secured bonds 
and the price paid by the public investors is sometimes sur- 
prisingly narrow. For example, the New England Telephone 
and Telegraph sold in 19 12 an issue of $10,000,000 5 per cent 
debenture bonds. The bankers received only one-half of i 
per cent commission. This was an exceptionally low margin. 
Little advertising on the part of the bankers was necessary, 
and the bonds were sold within a few hours of the opening of 
the subscription books. It is true that few large bond sales 
can be completed on as cheap a basis as this, but ordinarily 
the cost to an old-established corporation with assured earning 
power did not exceed 2.^2. per cent of the amount actually paid 
by the public purchasers in the period before the Great War. 
Since 191 5, however, the bankers* commissions, or their 
margin of profit, have grown steadily larger. With the in- 
creasing difficulty experienced in placing securities, as a result 
of the world-wide scarcity of capital, bankers possessing an 
assured distributing capacity have been in a strategic position 
as compared with corporations facing the necessity of selling 
bonds. While the highest grade bonds issued by corporations 
with very high credit were sought after by bankers to a limited 
extent, the commissions they demanded were often larger than 
what they obtained for the sale of medium and low-grade 
bonds before the war.^" 

'<* In some too frequent cases the corporation has had its hands tied by the 
influence on the board of directors of some prominent banking house which secures 
the new issue under conditions which prohibit competitive bidding. Without for 


One of the greatest helps at the command of the invest- 
ment banker in the distribution of securities is the custom of 
exchange. The banker will take back securities, in which there 
is then no particular activity, nor any noticeable oversupply, 
in exchange for the new securities which he has just pur- 
chased from the corporation. A company selling its own 
stock— jor even its bonds for that matter — cannot do this. It 
is true the stockholder might himself sell other securities or 
even sell back bonds to the investment banker in order to 
provide himself with funds to subscribe to the new stock, but 
experience has shown that he will not do this. Instead, if 
he has no ready money he will sell his privilege to subscribe 
to the corporation's new stock, provided it has a market value ; 
otherwise he will allow it to lapse. There can be no pressure 
nor even persuasion exerted upon him. There are no silvery- 
tongued bond salesmen to propound elaborate schemes of ex- 
change which show, on paper, a nominal profit to the investor. 
Just such tricks of salesmanship can be enlisted if the bonds 
are taken by the investment banker, who, temporarily at least, 
is compelled to force the new issue into the vaults of investors. 
Quite often the bid price of seasoned bonds rises somewhat 
after their issue, so that even when the banker is forced to 
take back some bonds he has previously sold at approximately 
the same price paid for them by the investor, he can ordinarily 
resell these so that the entire transaction will show him a 
slight net profit. Moreover, it generally happens that some 
of the bonds taken back in exchange for the bonds of the 
new issue are listed securities, upon which the banker can 
realize money immediately. As everyone familiar with the 

the moment underestimating the value to any corporation of the constant assistance 
and advice, not to speak of the financial support, of prominent bankers, it is 
necessary to acknowledge that no man may act as buyer for himself and seller 
for the stockholders, for whom, as director, he is trustee. It may be true that 
the banker is indirectly paid for innumerable services, not specifically accounted for, 
by the low price at which he is able to buy the bonds. But he is truer to the 
principles of his trusteeship if he insists on paying the full competitive price for 
the bonds, and then requires of the corporation specific payment for specific services 


situation knows, the volume of listed stock exchange securities 
which the investment bankers dump on the market as a result 
of forcing their own unlisted bonds into the strong-boxes of 
investors, reaches enormous proportions. 

Prior to the Great War it was the common custom for 
successful, expanding corporations to sell bonds to bankers 
and stock to their own stockholders. But since the beginning 
of the Great War this sequence has ceased to have much of 
its old significance. Bankers are now increasingly employed 
to distribute preferred and common shares for the purpose 
of financing extensions, and they are forgetting much of their 
old-time insistence that the securities they distribute to in- 
vestors shall have the strength and stability of bonds. Several 
causes are accountable for this change — none of them very 
creditable to the intelligence or the ethics and responsibility 
of the bankers. 

The first of the causes of the shift of bankers' purchases 
from bonds to stocks is the demand of what might be called 
the new investors for large income return. This class includes 
men who, because of abnormally high wages or inordinate 
profits during and following the Great War, have money for 
investment for the first time. They are ignorant of the dis- 
tinction between stock and bond, and the legal and economic 
barriers that separate the partner from the creditor of a busi- 
ness enterprise. They are therefore easily deluded into buying 
preferred stocks of industrial enterprises because of their 
greater apparent yield. Then, too, this same argiunent appeals 
strongly to the more conservative investors of the community 
who find that the rising level of commodity prices renders 
it necessary to obtain a higher net return on their investments. 
Present necessities color and befog their judgments of the 
permanent and intrinsic values of securities. 

Another and perhaps more important explanation of the 


increased offerings by bankers of preferred stocks is the great 
prosperity of manufacturing establishments since the opening 
of the Great War, as compared with the railroad, local public 
utility, and traction industries. In fact, the effect of the 
abnormal demand for merchandise of all descriptions has been 
to bring prosperity to industrial enterprises and depression 
to public utilities. Industrials could raise the prices of their 
products in accordance with their increased costs ; utilities had 
their rates held down by commissions, yet were forced to pay 
increasing prices for labor and materials. Consequently the 
profits in industrial enterprises were very large, those in public 
utility enterprises very small. In many cases they disappeared 
altogether and receivers assumed the administration of utili- 
ties which, until the period of the Great War, were fairly 
prosperous. In consequence, the market value of the securities 
of public utilities — even underlying first mortgage bonds — 
registered conspicuous declines, whereas the market values of 
industrial enterprises — especially common stocks — registered 
conspicuous advances. These were matters of common ob- 
servation. Bonds had never been issued by industrials, so 
that if investors would participate in their apparent prosperity 
they must purchase their stocks. In consequence bankers 
showed no hesitancy in directing the attention of their cus- 
tomers to the advantages of stocks, and the customers fell 
easily into believing these advantages sound and permanent. 
But probably the deepest reason for this change was a 
change in the attitude of the bankers themselves. Their judg- 
ment became befogged by the lure of the long profit. The 
bankers' margin of gross profit on stocks, both preferred and 
common, has always been higher than that on bonds. In 
addition to the merchandising profit on the preferred stock, 
there is usually a surreptitious bonus of common stock. And 
such was the scarcity of capital, and such the necessities of 
corporations, that bankers could obtain profits on these Indus- 


trial stocks all out of proportion to the customary profits on 
the purchase and sale of bonds. The increased cost of doing 
business has affected investment bankers quite as much as 
other business men. They found themselves deluded by the 
fictitious industrial prosperity resulting from the Great War, 
and succtmibed to the narrow expediency of a large, imme- 
diate, but temporary profit. As a result, old-established, con- 
servative bankers, who had confined their purchases to 
municipal and high-grade corporation bonds, rushed to the 
opposite extreme and purchased low-grade industrial stocks. 

With the growing use of preferred stocks as a substitute 
for bonds in obtaining capital from the public to pay for 
extensions, there has been a conscious and studied effort on 
the part of bankers to give these issues the appearance of 
bond security. Advantageous as the issue of a preferred stock 
may be to the expanding corporation, the value of these pre- 
tended safeguards must be weighed from the point of view 
of the investor. Especially is this true since these recent 
preferred stocks have sought to obliterate the distinction be- 
tween creditor and partner, seeking to retain certain of the 
outward characteristics that belong to stocks, while they grasp 
for the strength and security — the substance, as it were — 
that goes with bonds." These efforts have proved only par- 
tially successful for the simple reason that preferred shares, 
however named and however hedged in by covenants, cannot 
be given a priority in case of the failure of the enterprise. 
This is the real substance of mortgage bonds, a substance 
which modern reorganization procedure has somewhat weak- 
ened it is true, but a substance which gives the bond the 
priority not only over the stocks but also over most of the 
notes and current obligations.^'^ It is this priority which the 

" Tendencies in this direction have been noted already in the treatment of 
preferred stocks in general (Volume I, Chapter VI). 

>* For status of holders of notes and current obligations in railroad reorganizations, 
■ee Volume V, Chapter IV. 


recent issues of preferred stocks do not possess. For if they 
did possess it they would cease to be stocks, and become direct 
obligations of the issuing corporation and thus defeat the very 
purposes which the directors seek in issuing stocks rather than 
bonds. One of the chief motives in the minds of corporation 
officials in issuing stocks is to increase the company's borrow- 
ing capacity at the banks. Above all else it is essential that 
nothing in the preferred stock contract can be interpreted as 
giving the new stockholders an actual lien on the corporate 
assets ahead of the notes and current obligations which they 
propose to negotiate in the future. All the other provisions 
of the preferred stock issue are innocuous "safeguards" which 
help the sale of the stock among public investors, without 
embarrassing the contemplated policy of corporate expansion 
on the one hand or giving real security to the stock on the 
other. They are the showy trappings of the advertising 
manager — mere trimmings. 

These elaborate safeguards are attached, in more or less 
profusion, to all issues of preferred stock that have been 
offered to investors since the Great War.^^ In no instance, 
however, is there any provision to protect the preferred stock 
issue from the emasculation of its value through the unbridled 
issue of notes with a claim to the corporate assets ahead of 
the preferred stock. In some cases^* there is a pretence of 
this kind of protection in the provision which restricts 

^* A study was made of one hundred issues of preferred stocks, all sold for the 
purpose of securing capital for expanding industrial enterprises and all issued 
between November n, 1918 (Armistice Day), and May 11, 1920— a period of a 
year and a half. This period covered the fashions of immediate postwar finance. 
The group is a random selection including a very wide range of enterprises. The 
corporations were engaged in business all over the United States. The issuing 
banking bouses were located in New York, Boston, and Chicago. A small proportion 
(about 23) could be said to be local industrials. Over 60 per cent had been 
established before 1900; all had been successful over a period of years; and all 
could show the record of a liberal margin of earnings over the dividends of the 
new preferred stock. In a few instances the war earnings were as high as :oo 
per cent on the new preferred stock. The list is, therefore, representative of well- 
established, successful American enterprises, fully able to justify a policy of 

" Forty-three per cent of the cases studied. See preceding note. In some cases, 
like the Fisk Rubber Company's preferred stock, this provision is reinforced by 
giving the preferred stock a voting power when the net assets fall below the specified 
percentage of the outstanding preferred . stock. 


dividends on the common stock if such payments reduce the 
net quick assets below a specified percentage of the outstanding 
preferred stock." But such a provision merely protects the 
preferred shareholders against a dissipation of the quick assets 
to pay common stock dividends. As long as no such dividends 
are paid the margin of quick assets above current liabilities 
can be cut into until it vanishes, and the preferred stockholders 
are impotent to protect themselves. 

Probably the feature of the recent issues of preferred 
stocks that is in most striking contrast to the older issues, 
especially those created at the time of the reorganization or 
promotion of a corporation, is the provision requiring the 
gradual retirement of the preferred stock. This is usually 
called the "sinking fund," from a seeming analogy to the 
sinking fund provision of bond issues. Such a provision was 
practically unknown in preferred stock issues down to 1910; 
it occurred with increasing frequency during the period of 
the Great War and has been well-nigh universal among pre- 
ferred stock issues since the armistice.^" Besides constantly 
decreasing the proportion of preferred stock liability standing 
against the available assets, such a retirement fund provision 
stimulates a market for the preferred stock in so far as the 
company itself is forced to purchase each year some of the 
stock. This is especially important to the investor in small 
issues of preferred stock which would have, under ordinary 
circumstances, a limited and narrow market. The annual 
retirement fund of these modem preferred stocks is determined 
by one of three provisions — a percentage of the net earnings," 

i»This percentage varies. The commonest is loo per cent. Sometimes the dividend 
rate on the common stock is more specifically limited, as, "Dividends on common 
stock not to exceed 5 per cent per annum can be paid only when net quick assets 
equal 75 per cent of the par value of the preferred stock outstanding, and in 
excess of 5 per cent per annum only when net quick assets are equal to 100 per cent 
of the preferred stock outstanding" (Stollwerck Chocolate Company). 

'•Approximately 03 per cent of all the cases of recent preferred stocks had some 
form 01 sinking fund or retirement provision. 

" In more than 50 per cent of the cases studied the percentage was 1 s per cent 
Very often there is both a lower and an upper limit, and often the percentage of 
net earnings that must be set aside increases as the net earnings increase. The 


a percentage of the total outstanding preferred stock," or a 
definite par value of stock." By the operation of any one 
of these provisions the preferred stock is gradually retired, 
provided, of course, the corporation is successful. But, as a 
matter of fact, as long as the corporation is successful and 
able to carry out the provisions of the sinking fund, there 
is no -particular need for its retirement 

The other safeguards attached to these recently issued 
preferred stocks strengthen their lien on earnings and assets, 
as against the common stock. They are invariably entitled 
to cimiulative preferred dividends and as invariably^" have 
a claim to the corporate assets in case of the liquidation of the 
business that ranks ahead of the common stock. In the vast 
majority of cases^^ the preferred stockholders acquire some 
measure of representation in, or even control over the board 
of directors in case of a continued default in the preferred 
stock dividends. 

Willys Corporation contract provides for lo per cent — ^after preferred stock dividends 
— on earnings not in excess of $3,000,000; 5 per cent on the next $3,000,000, and 
3 per cent on the balance in excess of $6,000,000. 

" Two per cent of total preferred stock is the commonest percentage. 

'• In extreme cases this operates to retire the whole of the stock within a short 
time. Such an agreement on the part of the corporation would hardly constitute 
a prior lien on the assets in case of failure, however. In a few cases the provision 
is strengthened by an independent guarantee, and this guarantee could probably 
be enforced against the guarantor, provided the latter were solvent. Thus the 
Winnsboro Mills agrees to retire $500,000 of its preferred stock each year from 
1922 to 1926, and $1,500,000 — all that will remain — in 1927 and the execution of 
this part of the preferred stock contract has been indirectly guaranteed by the 
United States Rubber Company. 

^ All of the cases studied. 

^ Over 80 per cent of the cases. 



Conditions of privileged subscription, 202; Terms of offer, 203; 
Value of the right, 210; Effect of the privileged subscription on the-^ 
market price of the stock, 213; Methods of taking advantage of 
privileged subscription, 214; The profits from privileged subscription, 
217; Underwriting privileged subscription, 218. 

"Privileged subscripton" is the term used to refer to the 
offer by a corporation to sell a new security, usually a stock,^ 
to its stockholders for less than the current market value. 
It is only by the special inducement of a low price that a 
corporation can be sure of securing capital from its own 
stockholders, for the loyalty of the great body of stockholders 
to their corporation does not extend to making pecuniary 
sacrifices; there must be the compulsion of permanent self- i 

In order that an issue of stock may be successfully sold 
to stockholders, the corporation must meet at least three essen- 
tially different conditions. These conditions, it should be 
noted, are of the utmost importance because they define a 
set of practical tests to determine whether or not, in a given 
case, a sale of stock to stockholders is likely to be successful.* 

1 This generalization is of course subject to innumerable exceptions. The Detroit 
Edison Company, for example, alternated between the two — ^first a privileged stock 
issue, then a privileged debenture bond issue. In 1910 the American Gas Company 
offered stockholders the right to subscribe to either new stock or convertible debenture 
bonds. All things considered, however, privileged subscriptions to bond issues are 
relatively uncommon, and throughout the present chapter such cases will, for the 
most part, be ignored. 

' Burgunder, in his study of privileged subscriptions, lays great emphasis on the 
financial period at which these subscriptions are offered. For example, "The presence 
of a large number of stock authorizations today (1910) point significantly to the 
fact that those companies are on the whole compelled to adopt this mode of raising 
capital. Money is dear, bond issues are difficult to float, and the average investor 
is unwilling to put any more money into construction unless a little larger return, 



Most important of all is the price at which the old stock 
is selling at the time the new is offered. In order that the 
stock may be taken by the old stockholders, the market price 
of the outstanding stock must be well above the price at 
which the new stock is offered. Ordinarily the new stock is 
offered at par.' Unless, therefore, the market price of the 
old stock is above par, stockholders will not take the new. 
On the other hand, if the corporation is very successful and 
its shares are valued highly by investors, it may be sure that 
an offering to its stockholders will be highly prized, and that 
the "rights," so-called, which enable the stockholder to buy 
the stock, at less than its customary market value, will com- 
mand a liberal price on the open market.* 

speculative though it may be in character, is apparent to him. Whenever such a 
state of affairs is general in the country, we have the corporations, and particularly 
the railroads, applying to their stockholders for aid." Burgunder, S. S^ "The 
Declaration and Yield of Stockholders' Rights," 35 An. Am. Ac. Pol. Soc. Sci. 558 
(May, 19 10). This presumption does not seem to have the generality that the 
u^riter would imply. True, if earnings are fully maintained during the period when 
bonds cannot be sold, it is perhaps conceivable that there may be an unusually 
large number of privileged subscriptions offered. But even this does not seem 
to work out in practice. In the spring of 1920 bonds could be sold only with 
great difficulty, and the earnings of industrial corporations were conspicuously large, 
yet there were relatively few privileged subscriptions. The United Gas Improvement 
Company, with much effort, sold a new issue of preferred stock to its stockholders, 
and one or two public utilities practically forced their stockholders to subscribe to 
an issue of first preferred stock in order to refund maturing current debt. Such 
subscriptions could hardly be called "privileged," however. Otherwise the privileged 
subscriptions were unusual. The reason was that stock prices quite as much as 
bond prices were depressed. Public utility corporations were compelled to issue 
notes and quick-maturing debentures or else forego new capital for extensions. 
Industrials sold Liberty bonds, if they had them, and issued special preferred stocks. 
In all these cases the aid of outside bankers was enlisted rather than the stockholders. 

* Few corporations are willing to fix a price on their own stock at less than 
par. Furthermore, many state laws prohibit the sale of stock of a corporation by 
Itself at less than par, although in some instances a state commission has authorized 
a public service corporation to offer its stock at less than par. See note 11. 

* A good example of the vet^ heavy prices realized for these rights is afforded 
by the history of the Travelers Insurance Company of Hartford, Connecticut. 

Capital at Commencement of Business, 1864 $400,000 

Increased in 1865 to 500,000 

Increased jn 1875 to 600,000 

Increased in 1892 to 1,000,000 

The above three increases were made from the company's surplus. Further 
increases took place as follows: 

In 1908 to $2,000,000 

With rights selling at about $400. 
In 1910 to 3,500,000 

With rights selling at about $200. 
In 1913 to 5,000,000 

With rights selling at about $550. 
In 1916 to 6,000,000 

With rights selling at about $120. 


It sometimes happens that at a time of emergency a cor- 
poration may force its stockholders to subscribe to new stock 
at a price considerably higher than the market.'' Such cases • 
are, however, very rare, as the ordinary stockholder is im- 
pelled by very slight motives of loyalty to his corporation. 
Yet it is sometimes possible to employ a subterfuge in order 
to make the offering of new stock appear attractive to the old 
stockholders.' A fairly common means of accomplishing the 
end, with less apparent deception, is for the corporation to offer 
bonds to its shareholders which are convertible into stock at 
a price less than the stock's par value.' In all such cases, how- 
ever, a security superior to the common stock must be offered. 
So that it may be laid down as a general principle that unless 
the market value of the common stock is greater than its 
par value, there can be no successful sale of the common 
stock to stockholders.* 

The second requirement of a successful sale of new stock ^ 
to stockholders is that the old stock shall be widely held by J 
stockholders. This is much more important than would appear 
at first sight, for it might be presumed that the size of a man's 

•An excellent illustration of this is offered by the operation of the so-called 
"merchandise creditors' plan" at the time of the receivership of the Westinghouse 
Electric and Manufacturing Company. The stock had, when the plan was first 
announced, a market value of approximately $30 a share (par $50), yet the committee 
undertook to force all the stockholders to buy the new stock at its par value 
of $50 on the plea that new money was imperative in order to save the business 
from liquidation. In all, $2,400,000 was subscribed in this way, in spite of the 
depression following the crisis of 1907. 

• For example, in April, 1913, the American Type Founders' Company wished 
to sell some preferred stock to its stockholders at par, notwithstanding the fact 
that the market value of the preferred was not above 95 per cent. To meet this 
condition the directors declared a dividend of 8 per cent in scrip, which could 
be used for the partial payment of the new stock. In this way the price actually 
paid by the stockholders in money was about the same as the market value of the 
old stock; yet the corporation could pretend, in the legal provisions of its stock 
issue and in its books of account, that the full par value was paid by the subscribing 
stockholders. CarefuUv drawn restrictions prevented a stockholder from using the 
scrip as a stock dividend, thereby getting the new stock without the full money 
payment of $92 a share. 

• It bas been done indirectly, by the sale to the stockholders of convertible 
bonds at less than par, or the permission to convert them into stock at a more 
liberal basis than one share of stock for $100 in bonds. The Erie Railroad sold 
its Convertible 4*8, Series D, Bonds to the stockholders at 85. Each bond was 
convertible into stock taken at $50 per share. Should such a conversion occur, the 
company would have sold its new stock for $42.50 a share. 

• Privileged subscriptions at less than par are, however, not unheard of. For 
example, in 191 1 the Western Maryland Railroad offered new stock (par $100) 
to its old stockholders at $50 a share. 


holdings would have little to do with either his willingness 
or his capacity to take up his allotted stock. Yet the mere 
fact that the corporation has a very large number of share- 
holders, increases the possibility of a successful sale, because 
the failure of a few to buy their proportional shares does not i 
jeopardize the whole subscription. Nor is it correct to assume 
that the size of a man's holdings is immaterial to his capacity 
to acquire new stock. In order that the stock offering may 
prove a success each old stockholder must take up his allotted 
ntunber of shares. If he cannot or will not do this he will 
throw his "rights" to subscribe to the new stock upon the / 
market. In consequence, the abnormal supply of these "rights" 
will force down the market price for them and the price of ' 
the full shares will decline correspondingly. It may decline I 
so low that no stockholder will subscribe and the new sub- 
scription prove a failure.* 

Large stock holdings with slight general distribution are 
inimical to the success of the offering, because the proportion 
of "rights" that will be thrown on the market will almost 
surely be greater than if the old stock were widely distributed 
in small lots.^° Most investors believe in a very considerable 
diversification of their stock holdings, and this diversification 
is made without regard to the sale of stock by the corporation. 
When, therefore, the new stock is offered for subscription, 
the large stockholders will conclude that the comparatively -j 
heavy increase in their holdings of this particular security is J 

* It is an interesting commentary on the business intelligence of many stock- 
holders that there are always a certain number of rights tnat go by default in 
every large stock subscription, even when these rights command a substantial 
premium during the entire subscription period. In 1910 the West End Street Railroad 
offered its stock (par $50) for $75 a share. During the subscription period the 
market price did not fall below $84 a share and the rights commanded a substantial 
market price. Yet 1,049 out of 27,800 shares were not subscribed for. In every 
one of the large privileged subscriptions of the American Telephone and Telegraph 
Company there were always a certain number of the stockholders who neither 
subscribed nor sold their rights. It has been reported that stockholders have mis- 
interpreted the subscription warrants for assessments and thrown them into the waste- 

i°To avoid this, an agreement is sometimes effected among the largest stockholders 
— commonly the directors — that they will subscribe to their allotments, whatsoever 
the hazards of the market. This was done in one of the subscriptions to the 
preferred stock of the United States Rubber Company. 


/ contrary to some preconceived plan of distribution. At least 
some of the large stockholders will conclude that it is wise 
to sell such a portion of their "rights" as will enable them 
to meet their subscription on a few shares without increasing 
the actual money investment — in other words, change the 
privileged subscription to a large number of shares into a 
stock dividend of a few. The small stockholder, on the 
contrary, will seldom be influenced by theories of the proper 
diversification of his investment holdings but will base his 
decision as to whether he will subscribe to the stock or sell 
his rights solely on the availability of sufficient funds. Since 
his new subscription will call at most for only a few hundred 
dollars, with the payments, probably, distributed over a period 
of time, he will accept the new stock offering without further 
thought. And if he belongs, as probably he does, to what 
might be called the class of small but thrifty savers, he will 
welcome the chance of buying stock "at less than it is worth'* 
on "the instalment plan." 

Furthermore, the small stockholder will create a market 
demand for the "rights" offered for sale by large stockholders. 
Being a small stockholder he will probably require additional 
"rights" with which to even up his own holdings. And even 
though he does not himself enter the market in order to 
purchase "rights," he will be instrumental in drawing the 
attention of many outsiders to the apparent success of his 
corporation. Others will realize that by buying the rights 
offered and personally subscribing to the new stock, a valuable 
investment will be obtained at a relatively low cost. This 
will create a demand from outside investors for the rights 
which, if the financial conditions of the corporation be sound, 
may entirely counterbalance the pressure of other stockholders 
to sell their rights. 

The third condition essential to a successful sale of new 
stock to the old stockholders is that the directors of the cor- 


poration shall fully justify the extensions to be made with the j 
new capital." This requires that the directors shall take the 
stockholders into their confidence with the utmost frankness." 
The reasons for coming to the old stockholders for further 
increases in their investment must be clear cut and thoroughly 
sound. The stockholders must be convinced that the prospec- 
tive earnings on the new capital are fully adequate, not only 
to pay dividends on the new stock, but also to increase the 
margin of safety of the dividends on the old. Unless it is 
made perfectly clear to the stockholder, without much investi- 
gation on his part, that the expansion requiring the new capital 
is wise and expedient, he will not co-operate.^^ 

" There have been exceptions to this rule. The directors of the New York, 
New Haven and Hartford Railroad, during the period of its notorious overexpansion, 
had only to "ring the bell" (to use a Wall Street phrase), when the stockholders 
would rush forward with subscriptions to any amount the management might ask for. 
" An excellent example of the evil results of not doing this is afforded by 
the experience of the Walpole Rubber Company in 1913. This corporation, formed 
from the merger of certain factories engaged in the manufacture of rubber goods — 
automobile tires, rubber heels, hot-water bottles, etc. — was unquestionably a success, 
if the steady increase in its gross earnings were the single criterion of success. 
On the basis of this success the company issued 7 per cent preferred stock. This 
was widely distributed among Massachusetts investors, largely because of its non- 
taxable character. The rubber business is of such a character that long-time 
mercantile credits appear to be the rule. In the stress of the summer of 1913 
the company was unable to secure sufficient capital from the banks, and accordingly 
offered short-term notes to its stockholders; but in the meantime suspicion had 
arisen regarding the conservatism and the wisdom of the managers, and the stock- 
holders refused to subscribe to the notes. As a result the corporation passed into 
the hands of receivers. 

" An excellent example of frankness on the part of a corporation toward its 
stockholders is afforded by the circular of the New York Central Railroad Company 
offering them the privilege of subscribing to its 6 per cent Convertible Debentures 
of 1935- The whole .circular is a model of the kind. After stating in brief the 
conditions of subscription, the circular states, in part: 

"The proceeds of the sale of the bonds will be used to fund an equal amount 
of the company's now unfunded debt which has been incurred for the betterment 
and extension of its railroads, and in the acquisition of property. 

"The convertible bonds will carry an interest charge substantially the same as 
that heretofore paid on the notes to be funded. 

"The more important improvements made on the lines now comprising the 
New York Central Railroad since January 1, 1910, include: 

Further construction at the Grand Central Terminal, at a cost of $30,000,000 
(including commercial buildings), in order to meet the requirements of an 
increasing passenger business, and to develop the valuable real estate within 
the terminal area. The annual rentals received from the Grand Central 
Terminal amount to more than $2,000,000, which should increase as further 
improvements^ are completed and become productive. 
Acquisition of important links in the company's main line previously held on 

lease, $14,18^,000. 
Four-tracking between New York and Albany, including improved signaling 

and new stations, $15,931,000. 
New passenger stations at Rochester and at Utica, including new engine 

terminals, new yards and appurtenances, $6,886,000. 
Elimination of grade crossings and enlargement of Gardenville yard, $3,276,000. 
Electrification work between New York, Croton and White Plains, $3,783,000. 
Enlargement and improvement of facilities west of Buffalo, $14,000,000. 


If the corporation can meet none of these conditions and 
yet its directors believe that their own stockholders afford the 
best source of new capital they may authorize a new kind of 
security, such as a preferred stock or a debenture bond, to 
be sold among the stockholders. In such cases the new 
security, never having been offered before, has no market 
price. It becomes, therefore, merely a matter of nice invest- 
ment judgment for the stockholders to decide whether or not 
the new security is worth the price at which it is offered 
by the corporation. Very often the issue is considerably con- 
fused by the circumstances of the offering — a high dividend- 
bearing preferred stock offered at a premium" so that an 
intelligent judgment by the rank and the file of the stock- 
holders is very difficult to make. As a result the corporation 
is often able to get more from its offering than the new 
security is actually worth, judged from the probable values 
investment bankers would pay for it." These observations 
apply with conspicuous force to a period such as 19 19 and 
1920 when investment bankers were loath to underwrite any 
new issue of securities except for a very high commission. 
Many public utility corporations which had made extensions 
to meet the demands of war, but which could not afford to 
meet the demands, reasonable or extortionate according to 
the point of view, of investment bankers, sought to sell special 
issues of securities to their own stockholders. Their earnings 
were liberal and their businesses firmly established, yet these 
new securities could not be sold in the open market. The 

"Since January i, 1900, the New York Central and Hudson River Railroad 
Company, the Lake Shore and Michigan Southern Railway Company and their 
subsidiaries, now consolidated into the New York Central Railroad Company, increased 
their resources by $658,000,000, of which over $122,000,000 came from the sale 
of capital stock and over $114,000,000 from earnings. The remainder came from 
the sale of honds, equipment trust certificates, and notes." New York Central 
Railroad Circular to stockholders, dated February 23, 191 5. 

>*The Virginia-Carolina Chemical Company offered in July, 1911, its 8 per cent 
preferred stock to its stockholders at $115 a share. 

•» Several years ago the American Pneumatic Service Company whose credit 
had never been particularly good (common stock, par $50 a share, was then selling 
at $7 a share) offered its stockholders 7 per cent preferred stock at par. 


stockholders, with a direct interest in the company already, 
afforded the best market." 

If it is decided by the corporation to offer new stock at 
less than its probable market value, the old stockholders will 
have the privilege of subscribing to the new stock in propor- 
tion to their holdings. This privilege is usually offered under 
carefully specified conditions. The time, for example, over 
which the right of subscription extends is very carefully 
defined, although the period varies considerably. In close 
corporations, where the privilege is of great value, the directors 
usually restrict the offering to stockholders of record at the 
time and allow them only a short time within which to sub- 
scribe. In large corporations, with widely diversified stock- 
holdings, the privilege is often made to apply to the stock- 
holders of record some days after the vote and the period 
during which the new stock may be acquired extends over 
some months. If it is necessary to obtain the consent of the 
stockholders themselves by a vote at a special meeting, or the 
consent of some regulative commission the whole proceeding 
may be considerably protracted.^*^ Usually the stockholders 
are allowed to pay for the new stock in instalments,^^ and 

*'Thus the United Gas Improvement Company, Sn old-established, prosperous 
and on the whole conservatively managed public utility company (Chapter V, 
pages 110-113 sold a large issue of 7 per cent preferred stock to its stockholders 
at par. Other high-grade holding company preferred shares were then selling 
in the open market at a price to yield the investor over 8 per cent. The Southern 
Utilities Company sold its stockholders an issue of 8 per cent first preferred stock 
in the summer of 1920, when the earnings of the company during the preceding 
year hardly admitted of the sale of preferred stock at any price. 

Sometimes special inducements are offered to persuade stockholders to avail 
themselves of these backhanded privileged subscriptions. In 1914 the directors of 
the Standard Screw Company proposed to offer the holders of the 6 per cent 
preferred stock new 7 per cent preferred stock to the extent of 50 per cent of 
their holdings, and the directors proposed to convert the old 6 per cent stock 
into 7 per cent stock for any shareholder who subscribed to his allotment. 

" Sometimes the proceedings are dragged into the courts. During the latter 
part of 1906 the Great Northern Railway offered its stockholders $60,000,000 of 
new stock at par. The attorney-general of Minnesota secured an injunction against 
the issue on the ground that it required the consent of the Railway and Warehouse 
Commission. The attorney-general won his case in the lower court, but the Great 
Northern Railway won on an appeal to the Supreme Court. Meanwhile the date 
on which the stockholders could subscribe was put forward seven times. 

" Sometimes these cover a considerable period. Thus the Northern Pacific 
Railroad in 1906 offered $93,000,000 of new stock to its stockholders to the extent 
of 60 per cent of the par value of each stockholder's holdings. This required a 


interest is allowed them on all payments preceding the actual 
delivery of the stock. When there are two classes of stock 
the practice varies considerably. If the privilege is valuable, 
it is usually confined to the controlling common shareholders ; 
if it is not very valuable and some difficulty is anticipated in 
securing subscriptions it is invariably extended to both classes 
of stockholders. Instances exist in which it has been extended 
to bondholders.^' 

The specific privilege that goes to all the old stockholders 
to subscribe to the new security is called a "right." ^° Rights 
are bought and sold on the stock market in the same manner 
as shares are bought and sold. Their market price depends 
on the relative advantage of acquiring the stock of the cor- 
poration by subscription over the ordinary purchase in the 
open market. The market value of a right is determined 
theoretically with reference to the price of the old shares. 
If r represents the number of shares carrying one right, s the 
subscription price, and m the market value of the old stock, 
we may express the theoretical value, v, of a right by the 


For example, the American Telephone and Telegraph Com- 
pany offered new stock at 120 at the ratio of one new share 

considerable outlay of money. But the corporation allowed the new stock to be 
paid for in nine payments covering a period of more than two years. 

'• In 1909 the New York, New Haven and Hartford Railroad offered new stock 
at $125 a share to the old stockholders to the extent of 25 per cent of their holdings. 
The 354 per cent debenture holders were permitted to subscribe to the extent of 
i6J< per cent of the par value of their bonds, and the 6 per cent debenture holders 
to the extent of 25 per cent of theirs. Unregistered holders could subscribe, provided 
their bonds were presented and stamped. 

* Care should be observed in the use of the term "right." In Boston a "right" 
is the fractional privilege that belongs with each old share; in Philadelphia it is 
the privilege of buying a new share. In New York the word is used in both 
senses. This difference in usage will appear from a single illustration. If the 
stockholders of a certain corporation are permitted to subscribe to one new share 
at par for every five shares already held, the Boston nomenclature would call the 
fractional privilege adhering to every old share a right, whereas the Philadelphia 
usage would call five of these separate privileges a right. 


for every five shares already held, and the stock was selling 
at the time of the announcement at 151 J^ a share. Then 
the theoretical value of the right is given directly by the 

Many people presume that the value of a right is given directly 
by dividing the difference between the subscription price and 
the market price by the ratio. This is incorrect, because it 
should be remembered that the reduced subscription price of 
the new stock is going to act as a dilution of the value of 
the premium on the old shares. 

The market price of a right is seldom equal to its theoretical 
value. The assumption that the two are equal would presume, 
in the first place, that the subscription to the new stock through 
the medium of the purchase of rights would represent a cost 
equivalent to the stock bought on the open market. Yet the 
purchase of the stock through the rights involves more trouble. 
Most men therefore would prefer to buy the stock outright 
on the market rather than through subscription to the new 
stock unless the latter method were the cheaper. In order 
to establish a free market for the rights they would have to 
be offered at a slight concession under their theoretical value, 
even though there were no other reasons to depress the value 
of the rights. But there are other reasons. 

There has always been, among brokers, a feeling that rights 
sell for most at the beginning of the subscription period, and 
least at the end. This feeling has amounted to little more than 
an assumption on the part of the brokers, supported by a few 
examples culled from their own experience. But when the 
assumption is tested by the facts available, it is found to be 
true. As a result of an elaborate study of 91 cases of privileged 
subscription the tabulated results showed that in somewhat 
over half the cases studied, the stocks and with them the rights 



sold for the highest price at the beginning of the subscription 
period. In one-half of the remaining cases — one-fourth of 
all — the stocks and rights sold for most at the middle of the 
period, and in the remaining cases — again one- fourth of all 
studied — they sold for most at the end of the period.^^ 

There are numerous reasons which may account for the 
fact that both the old stock and the "rights" sell for most 
at the beginning of the period. In the first place, the price 
of both is determined by the law of demand and supply. 
Clearly, a sudden increase in the supply of the stock, without 
a correspondingly sudden increase in the demand for it, would 
inevitably depress the price of the stock, and with the price 
the market quotations for the rights. But this will not react 
on the market price for some period of time, or until the 
influence of the new stock begins to be felt in the increased 
offerings, so that there will be a short period during which 

" The statistics referred to were those of E. G. Mears incorporated in a thesis 

Presented for graduation to the Graduate School of Business Administration of 
[arvard Universitjr in 1912. The 01 cases include the privileged subscription to 
the stock of 47 railroads and 44 industrials. The effort was made to compare the 
prices of stocks at the beginning, middle, and end of the subscription periods. 
Mears also compared the changes in the price of the privileged subscription stocks 
with the general current of the stock market during the periods of subscription. 
But the relative results obtained from this comparison in no wise altered the results 
obtained from an absolute comparison. The following table is abridged from these 
statistics : 

Fluctuations in Masket Pkice During Period of the Right to Subsckibb in 
Privileged Subscriptions 

(91 cases, between 1906 and 1912) 

Changes in Stock Prices 


Highest Values of Rights 

No. of 







Broad Market 

Narrow Market . . 


Broad Market 

Narrow Market. . 


















Percentages. . 











Practically identical results were reached by an independent study of the market prices 
of "rights" during the periods for which they were quoted. 


the new stock, although its existence is known, will not be a 
factor in determining the price of the old. But as the new 
stock begins to be bought and sold in anticipation of its issue, 
it will begin to exert a depressing effect on the price of the 
stock and incidentally on the rights. Another direct reason, 
more obvious but less potent, that explains the gradual decline 
in market price of the rights and with them the stock during 
the subscription period, is the general inertia of the stock- 
holders, which leads them to put off the selling of their rights 
to the last minute; meanwhile the "odd lots" of rights held 
by the small investors have been "evened up," so that the 
regular sale of small lots will have become negligible. Under 
these circumstances, the rights that are offered are bought 
only by speculators who see a temporary profit in this purchase. 
Naturally such a class of buyers will acquire them only if 
the purchase of the rights permits the subscription to the new 
stock at a price appreciably lower than its general market price. 

Closely connected with the question of the value of the 
privileged subscription itself is its effect on the permanent 
value of the stock. This is extremely difficult to discover. 
Unquestionably whenever there is a privileged subscription 
by means of which the stock is sold to stockholders for less 
than its market value, there follows an immediate dilution 
of the stockholders' surplus. This is involved in the very 
idea of buying stock of the corporation for less than its pro- 
portional valuation of the corporation's assets. But the general 
impression existing among brokers and investors is that the 
market value of the stock — that is the new and the old stock 
together — soon recovers the loss that resulted directly from 
the stock issue. Brokers advise their customers to buy very 
desirable stock as soon as it has gone "ex-rights" on the 
assumption that it will soon be selling on the same level as 
before the privileged subscription. In the case of bank, in- 


surance, and many mill stocks that command a high premium, 
this is probably true. There seems, however, to be no well- 
established evidence to prove that it is generally true for the 
average railroad and industrial stock.^^ 

There are several ways in which a stockholder may take 
advantage of a privileged subscription by turning it directly 
into money without increasing his stock holdings. The most 
obvious is the immediate sale of the rights. In this way 
the proceeds may be looked upon as an extra dividend, and 
some corporations offer new stock for the purpose of dis- ] 
tributing, or rather diluting, a large, embarrassing surplus.''' 
If this method is to be followed, past experience requires that 
the sale of the rights be made immediately on the announce- 
ment of the subscription.^"* In case the actual rights have 
not been received by the stockholder, the prospective rights 
may be sold on the so-called "curb" market "w.i.," — "when, 
as and if issued." 

A second method of realizing on the rights is by subscrip- 

s'On this point Mears (see previous note) prepared some statistics. Of the 
91 railroad and industrial privileged subscriptions studied d.8, or 53 per cent, showed 
an increase in value during the two months following the close of the privileged 
subscription, 39, or 43 per cent, showed a decrease in value during the succeeding 
two months, and in 4, or 4 per cent, instances there was no appreciable change. 

** Some state laws have frowned on privileged subscriptions for stocks of public 
service corporations on the ground that such subscriptions are only indirect means 
for declaring extra dividends — means that deceive the public as to the true earning 
power of the corporation. The state commissions in Massachusetts have fixed the 
price at which the shares of public service corporations shall be offered to the 
shareholders, or have required that the new stock be sold at auction. The policy 
pursued by the Boston and Maine Railroad during the long period of its mismanage- 
ment shows an alternation of the two methods. 

Number Method Net 

Year Shares of Sale Price Dividend Return 

1901 14,643 Allotted $190 7 3.68% 

2,709 Auction 196^ 7 3.56 

1903 2,000 Auction 190^ 7 3.67 

1905 8,000 Auction 170^ 7 4.10 

1906 36,337 Allotted 165 7 3.24 

1910 3,699 Auction 143J4 6 4.«8 

iQU 104,364 Allotted 110 6 5.45 

J913 2>273 Auction 105^ 4 3.81 

The fact that the commission fixed a price of $165 a share for the Boston and 
Maine Railroad stock as late as 1906, is evidence of the intelligence and wisdom 
shown by public service commissions in protecting the interests of small investors 
in railroad property. 
** See note 21. 


tion to the stock and then by the sale of the new stock some 
months after the subscription period has closed. For if the 
available supply of the stock has been suddenly increased by 
the privileged subscription, it follows that the market price 
will probably be lowest during the time of the subscription 
or immediately after its close, so that no sale of the stock 
should, be made at or near this critical period. After the new 
stock has been absorbed, the normal increase of the demand 
without a corresponding increase of the supply will probably 
bring about a rise in price, so that the new stock may be 
sold advantageously. The difference between the price real- 
ized and the subscription price will be the profit received 
through the privileged subscription, and ought, theoretically, 
to be equal to the amount that could be realized from the 
sale of the rights. Often it is more. (See note 22.) 

The most profitable way for stockholders to profit through 
a privileged subscription is, in the majority of cases, through 
the immediate sale of the stock and the subsequent purchase 
of sufficient rights, at the end of the subscription period, to 
reproduce the original holdings.^^ Thus, if a stockholder 
owned shares in a corporation and the privilege of subscribing 
to new stock was offered him, the most profitable way for 
him to realize on his privilege would be for him to sell his 
entire holdings immediately on the announcement of the pro- 
posed subscription, before the anticipated burden of the in- 
creased supply of stock began to depress the market. He 
would obtain a price but little below that prevailing on the 
basis of the old supply. Later when the rights were lowest 
in value, just before the termination of the subscription period, 
he should purchase a sufficient number of rights to enable him 

" The judgment that this is on the whole the best method of realizing on a 
privileged subscription is clearly stated by Mitchell in his exhaustive study of the 
subject. Mitchell, T. W., "Stockholders' Profits from Privileged Subscriptions," 
19 Q. J. E. 238^ (Feb., _ 1905). It is also suggested by Burgunder in the study 
in which he considers privileged subscriptions from the point of view of the stock- 
holder. Burgunder, S. S., ''The Declaration and Yield of Stockholders' Rights," 
35 An. Am. Ac. Pol. Soc. Sci. 559 (May, 1910). 


to reproduce his original holdings. And the cost of these 
rights, together with the subscription price, and possibly the 
adjustment of interest during the period of waiting, would be 
less than he received for his original shares. The difference 
would be, indirectly, the proceeds realized from his privileged 
subscription. Ordinarily it would be more than that realized 
through either the sale of the rights or the sale of the new 

By inference it might be concluded that a speculative profit 
is to be obtained by selling "short" the security on the an- 
nouncement of a new issue of stock.^' Theoretically this is 
true, and in the great majority of cases it will prove true in 
practice. Yet, sometimes, by a kind of inverted reasoning, 
the speculator is caught in the meshes of his own snare. Other 
speculators likewise inferring that money may be made by 
the sale of the stock on the announcement of a privileged 
subscription, will create a sudden and artificial selling pressure. 
A heavy short interest is thus created. And if another member 
of the speculative fraternity acquires these short contracts, 
he will be able to force the stock upward, instead of down- 
ward, through the mere pressure of the short interests to 
purchase stock to cover their contracts.^^ 

^•This method of realizing on a privileged subscription is discussed by W. H. 
Lough. He seems to look with favor on the method. "The stockholder who sells 
'short' under these conditions is taking very little risk inasmuch as he is certain 
to be able to make delivery when the subscription privilege takes effect, and is 
usually able to sell under the most favorable conditions." Lough, W. H., Business 
Finance, 308 (1917). This statement is on the whole true, since the new issue 
probably lowers the previous price of the share by more than the rights, in so 
far as it increases the supply of stock without ordinarily increasing the demand. 
Hence the speculator is able to realize a profit through immediate short sales. This 
is a phase of the principle, already discussed, that the rights sell for more at 
the beginning than at the end of the subscription period. See note 21. 

The method is disapproved of by Mitchell (cited in previous note) because of 
the risks incident to the short selling and the fact that it involves brokers' interest 
charges and the danger of a continual call for margins. 

" An interesting example of exactly this thing occurred in connection with the 
acquisiti9n of the control of the Louisville and Nashville Railroad by the Atlantic 
Coast Line. In the spring of 1903 rumors became current that the Louisville and 
Nashville Railroad was about to increase the issue of its stock. The Wall Street 
bears began to sell the stock short on the assumption — almost invariably true — 
that the market price would decline on the official announcement of the new stock 
issue. On the announcement of the new issue of $>; the short sales increased; 
meanwhile Gates, a speculator, formed a "pool" to quietly buy stock as rapidly as 
it was oflFered by either the short sellers or the actual holders of the stock. The 
price of the stock rose steadily, in the presence of the heavy selling, the represen- 



The profits that come indirectly to stockholders of cor- 
porations accustomed to offer privileged subscriptions afford 
a substantial addition to the regular dividends.^* Owing to 

tatives of the "pool" buying all that was offered. In the end, apparently without 
any intention on their part, the members of the Gates "pool" found themselves 
in possession of the stock control of the Louisville and Nashville road. Ultimately 
the pool turned over the control to J. P. Morgan and Company. The Morgan firm 
in its turn passed the control to the Atlantic Coast Line. This somewhat dramatic 
incident has been recounted many times. See brief reference in Chapter IV, 
page 9or Also Ripley, W. Z., Railroads, Finance and Organization, 214 (1915); 
Dozier, H. D., The History of the Atlantic Coast Line Railroad (1920). Also 23 
Rep. R.R. Com. of Ky. 

*■ There have been two exhaustive studies of this subject, each writer using 
specific cases. T. W. Mitchell studied the profits to stockholders in 1905, using 
chiefly railroads as his data. S. S. Burgunder made a similar study in 1910, using 
the same data. There has been no exhaustive study of the privileged subscriptions 
of industrials. Since 1910 the privileged subscriptions of industrials have been more 
numerous and important than in the case of railroads. 

Burgunder gives an interesting table showing the number of times privileged 
subscriptions have been offered between 1880 and 1910 for eleven corporations. 


No. of Times 


Owner of 100 Shares in 

1880 Would Have in 


American Telephone and Telegraph Company. . 

Baltimore and Ohio Railroad 

Canadian Pacific Railway 

Chicago, Milwaukee and St. Paul Railway. . . 

Cleveland, Cincinnati, Chicago and St. Louis 


Great Northern Railway 

Illinois Central Railroad 

New York Central and Hudson River Railroad 

Pennsylvania Railroad 

Northern Central Railway 

United Gas Improvement Company 

200 . 00 
269. S7 

253.69 (together with 
101.48 pfr.) 


693 . 00 (together with 495 

ore certificates) 
245 . 20 
559. 6S 

Burgunder then goes on to say: "In addition to the greater increase in 
the amount of stock procured, in a railroad like the Great Northern, the subsequent 
rise in price of the stock made those new shares worth more than when issued." 
He then goes on, by elaborate calculations to show the net yield to the stockholder, 
provided a stockholder had bought stock at the time a privileged subscription was 
first offered. The results are somewhat arbitrary in that they stop at 19 10 and 
assume, throughout, that the interest value of investment funds is 5 per cent. 
Burgunder, S. S., "The Declaration and Yield of Stockholders' Rights, 35 An. 
Am. Ac. Pol. Soc. Sci. 560-578 (May, 19 10). 

T. W. Mitchell studied, in 1905, the cases of five railroads which had then made 
frequent use of _ the privileged subscription as a means of securing money for 
extensions — Illinois Central, eight issues between 1887 and 1903; Great Northern, 
five issues between 1893 and 1903; New York Central, three issues between 1893 
apd 1903; Baltimore and Ohio, three issues between 1899 and 1903; Missouri Pacific, 
six issues between 1886 and 1903. He summarizes the statistical study of these 
five cases as follows: "A review of the five sets of privileges set forth in the 
above tables will bring out several facts. First, a company which is in a sound 
financial condition, as are the Illinois Central and the Great Northern, and which 
pursues a liberal policy toward its stockholders, may greatly add to their annual 
income through the privileges it offers. Secondly the profits from these sources are 
not adequately reflected in the market price of the stock. Thus the Illinois Central 
stock, which has in recent years been yielding its holders from 8.25 to 11.9 per cent 
on its par value, has been .«!elHng at from $120 to $170, prices which should 

?o with a 6 to 8 per cent stock. Great Northern stock has been paying its holders 
rom 15 to 21 per cent per annum on its par value; yet its market quotations havo 


the fact that these privileges occur at infrequent intervals they 
do not increase the market value of the stock to the same 
extent nor in the same proportion as regular dividends. This 
is conspicuously true in the case of corporations which offer 
privileged subscriptions only infrequently; it is not true in 
the case of certain very prosperous banks which extend to 
their stockholders the privilege of buying new stock with 
almost perfimctory regularity. Then, too, the reasonable cer- 
tainty of privileged subscriptions has created an unusual 
demand, and possibly abnormal market price, for many stocks 
which would, without this expectation, possess merely a local 
market. This is conspicuously true of the stocks of Massa- 
chusetts public utility companies and Hartford insurance 

The uncertainty surrounding the privileged subscription 
and the effect which it is likely to have upon the market price 
of the stock often make it unwise for a corporation to trust 
implicitly in the success of the sale of stock to stockholders. 
The corporation requires the money, and does not care to 
have the success of its sale jeopardized by temporary or 
permanent declines in the market price of its stock.*® The 

ranged only from $136 to $200, prices which should naturally go with a ;^ to 12 
pel cent investment. This is naturally to be expected. The returns from privileges, 
though known to be large, came at irregular intervals and in irregular amounts. 
Consequently, the ordinary man who is not a mathematician does not know how 
these returns compare with the regular returns from current dividends. Further, 
although he may realize that past returns from these sources have been large, 
he has no means of judg^ing of future returns from the same sources." Mitchell, 
T. W., "Stockholders' Profits from Privileged Subscriptions," 19 Q. J. E. 357 
(Feb., 1905). 

This observation, although made a number of years ago would apply in general 
at the present time. Especially is it true with reference to industrial corporations 
which have issued privileged subscriptions as a result of inflated market values for 
their stocks consequent upon large war profits. 

"In July, 19 12, the United States Rubber Company offered its stockholders a 
new issue of preferred stock at par, the market price being then approximately $110 
a share. The sale was a success. A year and a half later the same offer was 
made at a time when the market price was approximately $106 a share, but the 
general investment conditions were unfavorable. The immediate effect of the offer 
was to depress the price to below par and the sale was a failure — stock to the amount 
of not more than a few hundred thousand out of a possible nine and a half 
million dollars was subscribed to by the stockholders. 

On November 15, 1916, the directors of the New York Central Railroad offered 

J be stockholders $25,000,000 new stock at par, subscriptions to be made between 
anuary 20, and February 13, 1917. The offer was not underwritten. Soon vfter 


corporation must therefore safeguard, or insure, the success 
of an offering of stock to its stockholders. This is ordinarily 
done by means of an underwriting syndicate, the function- 
ing of which was described at an earlier point.*" In actual 
operation a group of outside bankers, or quite commonly the 
more wealthy of the directors, insure the success of the offer- 
ing, agreeing to take all the stock not subscribed for by the 
stockholders themselves. For this service, or rather for tak- 
ing this risk, the syndicate receives a commission on the entire 
amount of stock offered, usually about 2 per cent. In case 
the stockholders take up their entire allotments the syndicate 
is required to take no stock, but if any remains unsubscribed 
the syndicate takes it from the corporation at the price which 
the stockholders would have paid. 

The risks of an underwriting syndicate of this character 
are considerable. The tastes of stockholders are fickle and 
the investment market uncertain. But a group of bankers is 
in a much better position to carry these risks than the corpora- 
tion itself. In 1903 the Pennsylvania Railroad, then in the 
midst of enormous expenditures on its New York terminals — 
expenditures which many regarded as of doubtful expediency 
— offered its stockholders new stock for $60 a share, the 
market price at the time being about $72. The amount to be 
subscribed was $90,000,000, an amount which it was assumed 
would be absorbed easily by the old stockholders. But the 
stock was not to be subscribed for until some months after 
the announcement of the subscription. Meanwhile financial 
conditions became unsettled, stock market prices of all securi- 
ties declined, and, in particular, doubt was cast on the wisdom 
of the Pennsylvania Railroad's heavy terminal expenditures. 

the offer was made the market price of the stock of the New York Central declined 

to less than par. Consequently most of the stock was left unsubscribed for. On 

February 15, the company, realizing that the privileged subscription was a failure, 

offered to return the subscriptions of those few of the stockholders who had 
subscribed for the new stock. 

"Underwriting syndicates of all kinds described in Volume II, Chapter VII. 
See particular type described on page 107 et seq. 


As a result of all these circumstances the price of the stock 
declined to a little less than $60 a share. If it should remain 
below $60 the sale to the stockholders would prove a failure, 
because the stock could be more cheaply bought in the open 
market. Finally a syndicate was formed which for a com- 
mission of 2^ per cent guaranteed to the railroad the success 
of the sale. Immediately after the formation of the syndicate 
was announced, the price of the stock advanced and ultimately 
most of the new stock was taken by the stockholders. The 
mere fact that corporations of the magnitude and strength 
of the Pennsylvania Railroad*^ have found it necessary to 
employ underwriting syndicates of independent bankers to 
insure a successful sale of stock to their stockholders, shows 
how difficult and, on the whole, precarious, is this method of 
obtaining money for expansion. 

** Other illustrations are given by Ripley, W. Z., Railroads, Finance and Org^aniza- 
tion, 137 (191 5). See also 35 An. Am. Ac. Pol. Soc. Sci. 558, and 54 Ry. Age Gaz. 
S17 (1913) 

Underwritings of Pennsylvania Railroad securities have not by any means been 
always successful. In 1905, when the railroads — particularly the Pennsylvania — 
were prosperous, bankers underwrote $100,000,000 354 per cent convertible bonds 
at a commission of 2^ per cent. The syndicate disposed of only $10,000,000 
immediately. A considerable part of the remaining $90,000,000 was held through 
the panic of 1907, when the bonds sold as low as 83 H> 


The following tables show comparisons of estimated and previ- 
ous earnings of industrial consolidations with the actual earnings 
during the first and succeeding years of the operations of the con- 
solidated company. 

The tables are prepared from a random selection of twenty-nine 
industrial consolidations. The selection includes companies that were 
notably successful, others that were notably unsuccessful, and still 
others which had merely a modicum of success. The list includes 
consolidations operating in the most diverse fields. 

Table I — Capitalization Figures 








Issued at 














American Agricul. Chem 






American Beet Sugar 






American Car and Foundry.. 













American Hide and Leather. 



7 (c.) 


American Window Glass .... 




* • 

• • 



American Writing Paper. . . . 





Crucible Steel Co. of America 






Harbison Walker Refractories 







International Steam Pump. . . 






International Mercantile Mar. 







* * 



National Enameling dtStamp'g 



National Salt 

* * 

• • 


7 (n) 


New England Cotton Yam . . 





Pittsburgh Coal 






Pressed Steel Car 











Rubber Goods Manufacturing. 













Universal Bag and Paper. . . . 






United Box Board Paper 







United States Envelope 







United States Leather 







United States Steel 







•(c.) signifies ctimulative preferred stock dividend; 
Stock dividend. 


(n.) non-<cumulative preferred 



Table II — ^Earnings 






for Ten 

















4.9 1 5. 6 70 












1. 187.750 














— 264,021* 


















































































1.494. 169 























American Agricul. Chem 

American Beet Su^r 

American Car and Foundry 

American Cement 

American Chicle 

American Hide and Leather 

American Malting , 

American Window Glass 

American Woolen 

American Writing Paper 

Crucible Steel Co. of America . . . 
Harbison Walker Refractories . . . 

International Steam Pump 

International Mercantile Marine 

National Candy 

National Enameling and Stamping 

National Salt 

New England Cotton Yam . . . 

Pittsburgh Coal 

Pressed Steel Car 

Quaker Oats 

Rubber Goods Manufacttiring, 


Standard Milling 

Universal Bag and Pa.per 

United Box Board Paper 

United States Envelope 

United States Leather 

United States Steel 

* This figure is approximate only. As no annual reports were printed for a period 
of years, the annual loss was constructed by prorating the total loss for the period. 



Table III — Comparisons of the First Year Earnings 
Ratios Expressed in Percentages 


Year to 


Year to 



Year to 


Year to Sum 

of Fixed and 



American Agricul. Chem 

American Beet Sugar 


77. S 




30. 5 






75. S 


71. 5 









• 90.7 



138. 1 



58. 7 
74. 5 









173- I 




93. 5 




330. 8 




American Car and Foundry 


American Chicle 




American Hide and Leather 

American Malting 

American Window Glass 

American Woolen 

351. 7 

American Writing Paper 

Crucible Steel Co. of America. . . 
Harbison Walker Refractories. . . 

International Steam Pump 

International Mercantile Marine. 
National Candy 

59. S 

114. 3 

National Enamelingand Stamping 
National Salt 

186. s 

172. S 


New England Cotton Yam 

Pittsburgh Coal 

Pressed Steel Car 

Quaker Oats 

132. 1 

Rubber Goods Manufacturing. . . 

Standard Milling 

Universal Bag and Paper 

United Box Board Paper 

United States Envelope 

United States Leather 


SI. 8 

United States Steel 




* WithoQt the Americaa Window Glass Company, 99.9%. 



Table IV — Comparisons of the Previous Earnings 
Ratios Expressed in Percentages 


■ Previous 








American Agricul. Chem 

American Beet Sugar 

American Car and Foundry 

American Cement 

American Chicle 

American Hide and Leather 

American Malting 

American Window Glass 

American Woolen 

American Writing Paper 

Crucible Steel Co. of America 

Harbison Walker Refractories 

International Steam Pump 

International Mercantile Marine 

National Candy 

National Enameling and Stamping 

National Salt • 

New England Cotton Yam 

Pittsburgh Coal 

Pressed Steel Car • 

Quaker Oats 

Rubber Goods Manufacturing 


Standard Milling 

Universal Bag and Paper 

United Box Board Paper 

United States Envelope 

United States Leather 

United States Steel 



59. o 

75. o 







58. S 

258. 5 







57. S 












132. O 

570. o 
146. 5 
III. 5 












311. o 











123. S 


The averages of these percentages are not significant. 
• A negative quantity. 



Table V — Comparisons of Estimated Earnings and 


Ratios Expressed in Percentages 






116. s% 








72. 5 

45. 5 










179. S 






149. s 









147. S 









112. 8 



















Sum of 

Sum of 



land Con- 

and Con- 













72. S 

52. 5 

IS. 5 








19. 1 





78. S 












32. 5 










26. 5 





83. S 








III. 3 






Sum of 
and Con- 

American Agricul. Chem 

American Beet Sugar 

American Car and Foundry. . . 

American Cement 

American Chicle 

American Hide and Leather. . 

American Malting 

American Window Glass 

American Woolen 

American Writing Paper 

Crucible Steel Co. of America. 
Harbison Walker Refractories. 
International Steam Pump . . . 
International Mercantile Mar.. 

National Candy 

National Enameling & Stamping 

National Salt 

New England Cotton Yam . . . 

Pittsburgh Coal 

Pressed Steel Car 

guaker Oats 
ubber Goods Manufacturing 


Standard Milling 

Universal Bag and Paper 

United Box Board Paper 

United States Envelope 

United States Leather 

United States Steel 









113. o 

110. o 

so. 7 
153. o 
102. 5 















57. o 

70. S 





SI. 5 
192. S 




The avera^s of these percentages are not sig:nificant. 
* A negative quantity. 



NoTKS ON THS Aiovs Tablks. The figures for the previous earninn were all 
taken from puJalished sources. In many cases they were given in the bankers' 
circulars making the initial offering of securities. In other cases the statements 
were made to the reporters for one or another of the financial periodicals, particularly 
the Commercial and Financial Chronicle. 

The figures for the estimated earnings were derived from the same sources 
as the previous earnings. In three cases, however, the "gossip" of promoters had 
to be taken, as no published data was found. No one of these three cases was 
essentially different from others in the group, and the omission of these three 
made practically no difference in the medians or averages. 

The earnings for the first year were, in every case, reduced to a twelve-month 
basis in those cases in which the initial earning statement of the company covered 
more or less than twelve months. 

The earnings for each of the ten years were separately computed. When there 
was a change in the beginning of the fiscal year, the year of the transition was 
reduced to twelve months by dead reckoning. In four cases the earnings of 
certain years were not published. The lacunae were filled in by adding algebraically 
the known capital receipts and payments to the changes in the profit and loss 
accounts on successive balance sheets. 

All the earnings are, so far as published data permitted, net, that is after 
repairs and depreciation. The conspicuous lack of consistency in the policy of 
charging depreciation is a serious defect in the accuracy of the figures. 

As the computations in these tables were being prepared for the presSj a somewhat 
interesting and perhaps significant fact was noted. Omitting the American Window 
Glass Company, the figures for which were distinctly abnormal because the company 
had suffered unusual losses, it was found that the average earnings of the other 
28 consolidations — distinctly a random selection — for the first year was equal 
exactly (99.9 per cent) to the average earnings for the ten-year period. In other 
words, in spite of fluctuations in trade conditions and in management, in spite of 
additions to property, improvements in technical processes, and widening of markets, 
the earnings of the first ten years averaged the same as the first year and the value 
of this conclusion is somewhat strengthened, from the statistical point of view, by 
the fact that the median percentage falls within 3 points-percent of this average 


district, 146 

organizations of, 146 

purposes of, 146 
trade, 146 

organization, 151 

purposes of, 151 


Balanced return, law of (See "Law 

of balanced return") 
Bankers, investment, 
bonds, sale of by, 181, 188 
effect of competition between on 
marketing new securities, 193 
stock, sale of by, 181, 196 
Banking connections, advantages of 
in sale of new securities, i8g 
Banking holding companies, 134 
advantages of over stock issues in 
expansion, 181 
continuation of control, 183 
lower rate, 181 
sale of large blocks, 183 
collateral trust, issue of by public 

utility holding company, 127 
debentures, issue of by public 

utility holding company, 127 
disadvantages of in expansion 
(See "Stocks, advantages over 
bonds in expansion") 
public utility holding company, 
percentage owned by public, 132 

Bonds — Continued 
public utility holding company — 
subsidiaries of, percentage 
owned by public, 132 
sale of by bankers, 188 
Business organization, 
evolution of, periods, 139 
first stages of, small unit, 139 
intermediate stages of, 
community of interests, 151 
gentlemen's agreement, 141 
pools, 142 

trade associations, 146, 151 
Buying, wholesale, chain stores, 61 

factor of production, 11 
increase of, effect on produc- 
tion, 14, l8 
sources of in expansion, 
reinvestment of surplus earn- 
ings, 168 
sale of permanent obligations, 

sale of securities to banks, 180 
sale of temporary obligations, 
Chain stores, 
articles most successfully sold by, 

economical operation of, 61 
"short-cut" devices in admin- 
istration, 61 
wholesale buying, 61 



Chain stores — Continued 
successful type of industrial com- 
bination, 57 
types of, 60, 63 
Collateral trust bonds, issue of by 
public utility holding company, 
Combinations ( See "Industrial 
combinations and consolida- 
Common stock of public utility 
holding company, percentage of 
owned by public, 132 
Community of interests, 154 
foreign trade corporations, ex- 
ample of, 160 
formed by, 
common ownership of minority 

stock interests, 157 
interlocking directorates, 157 
General Electric Company, il- 
lustration of, 163 
purpose of, 154 
Consolidations (See also "Indus- 
trial combinations and con- 
formed by, 
lease, 74 
merger, 73 

outright purchase, 92 
nature of, 137 

railroad (See "Railroad con- 
Contingent rentals (See "Leases") 
continuation of by bond rather 

than stock issues, 183 
stock, how effected in railroad 
consolidations, 82, 83 
Cimimins Bill, effect upon operation 
and financial control of rail- 
roads, 69 
Cycles of industrial combinations 

Debentures, issue of by public 

utiUty holding company, 127 
Diminishing returns (See "Law of 

diminishing returns") 
Directorates, interlocking, form of 

community of interests, 157 
District associations, 146 
organization of, 146 
purposes of, 146 


comparison of estimated with 
actual earnings of industrial 
consolidations, 221 
gross, as basis of computing con- 
tingent rental, 75 
industrial combinations, com- 
pared with previous earnings 
under competitive conditions, 
net, as basis of computing con- 
tingent rental, 75 
surplus, reinvestment of as source 
of capital, 168 
Economic motive of expansion, 6 
Equipment, economy of large-scale 
purchase of, advantage of pub- 
lic ultility holding company, 1 18 
Estimated earnings, comparison 
with actual of industrial con- 
solidations, 221 
Evolution of business organization, 
139 (See also "Business or- 
Expansion, (See also "Consolida- 
increased profits test of expedi- 
ency of, 9 
industries, effect of increased 
labor costs, 21 



Expansion — Continued 

creative impulse, 5 
desire for large business, 4 
economic, 6 
speculation, 6 

point at which unprofitable, 10 

problem of, 
finance, 4 
organization, 4 

railroads, 70 

sale of new securities to stock- 
holders, requirements of suc- 
cess, 203 

sources of capital for, 
reinvestment of surplus earn- 
ings, 168 
sale of permanent obligations, 

sale of securities to banks, 180 
sale of temporary obligations, 
Exporting companies, successful 
type of industrial combinations, 

Finance, relation of to expansion, 4 
Financial aid to subsidiaries by pub- 
lic utility holding company, 122, 
124, 125 
Fixed capital, effect of varying 
cost of under constant labor 
costs, 16 
Fixed property, financing of, 177 
Fixed rentals (See "Leases") 
Foreign trade, 
effect of Webb Act upon, 67 
illustration of community of 
interests, 160 
industrial combinations to foster, 

General Electric Company, illustra- 
tion of community of interests, 

Gentlemen's agreements, 141 

Gross earnings, basis of computing 
contingent rental, 75 

Gross income of public utility hold- 
ing company compared with 
net, 132 


Holding companies, 
banking, 134 
investment, 134 
management, 134, 136 
pubHc utility (See "Public utility 
holding companies") 

Income, gross and net of public 
utility holding company com- 
pared, 132 
Industrial combinations and con- 

comparison of estimated and 
actual earnings, 221 

cycles of, 
major, 36 
minor, 35 

earnings of compared with previ- 
ous earnings under competitive 
conditions, 42 

economic postulates pertaining to 
formation, 43 

end of movement, reasons for, 
attitude of the law, 39 
investment sentiment, 40 
lack of success, 38 

for foreign trade, 67 
Webb Act, 67 

integration a factor, 55 



Industrial combinations and con- 
solidations — Continued 
successful types, 54 
chain shores, 57 
exporting companies, 65 
industries where automatic 
tools substituted for hand 
labor, 54 
shipping companies, 65 
vertical combinations, 55 
weakness of, 
human defects, 47 
size, 48 

Industries, expansion of, effect of 
increased labor costs, 21 

Integration, factor in success of in- 
dustrial combinations, 55 

Intercompany securities, percentage 
of held by parent, 132 

Interests, community of ("See 
"Community of Interests") 

Interlocking directorates, form of 
community of interests, 157 

Investment bankers, effect of com- 
petition between on marketing 
new securities, 193 

Investment holding companies, 134 

high, effect on scale of pro- 
duction, 19 
increase of, effect on produc- 
tion, 20, 21 
low, effect on scale of produc- 
tion, 19 
effect on production of varying 

quantity of, 15 
factor of production, 15 
Large businesses, desire for motive 

of expansion, 4 
Law of balanced return, 10, 24 
application of, 33 

Law of balanced return— Continued 
extraordinary business ability a 

cause of exception to, 53 
social aspects of, 32 
Law of diminishing returns, 10 
application to manufacturing in- 
capital, effect on product of 

varying quantity of, 14 
effect of varying cost of fixed 
capital under constant labor 
costs, 16 
effect of varying cost of labor 
under constant capital costs, 
labor, effect on product of 

varying quantity of, 15 
possibility of, 12 
problem of, 15 

advantages of in forming con- 
solidations, 74 
consolidations effected by, 74 
contingent rentals, 
fairest form of, 78 
gross earnings basis of com- 
putation, 75 
net earnings basis 'of computa- 
tion, 75 
traffic interchange basis of 

computation, 76 
when specified, 74 
fixed rentals, 
advantages of, 91 
forms of, 80 
use in railroad consolidations, 

when specified, 74 
railroad consolidation effected by, 


Management holding companies, 
134. 136 



Manufacturing industries, 
law of balanced return (See 

Law of balanced return") 
law of diminished returns (See 
"Law of diminishing returns, 
application to manufacturing 
Marketing subsidiary's securities by 
public utility holding company, 


Market, width of, effect of, 
expansion on, 190 
sale of new securities on, 190 
selling new securities to bankers, 
Merger, use in railroad consolida- 
tions, 73 
Minority stock ownership, use in 

community of interests, 157 
Money advances to subsidiaries of 
public utility holding company, 
122, 124 


Net earnings as basis of computing 

contingent rentals, 75 
Net income of public utility hold- 
ing company compared with 
gross, 132 
New business, facilities for solicit- 
ing by public utility holding 
companies, 121 
New securities, 
sale of to bankers, advantages, 
assurance of successful sale, 

188, 219 
formation of banking connec- 
tion, 189 
increased width of market for, 

inexpensive, 193 

New securities — Continued 
sale of to stockholders, require- 
expansion justifiable, 206 
old stock widely held, 204 
price asked lower than open 
market price, 203 

Organization (See "Business or- 

Outright purchases, means of ef- 
fecting railroad consolidations, 

Overexpansion, point of, lo 

Pools, 142 
Preferred stocks, 
investment strength of, 
as regards priority, 198 
as regards "safeguards," 199 
sinking funds for, 200 
public utility holding company, 
percentage of owned by public, 
"Privileged subscriptions," 202 
effect on permanent value of 

stock, 213 
formula for finding value of, 210 
length of period, 209 
methods of realizing on, 
sale of old stock and subse- 
quent purchase of suflEicient 
rights at end of subscription 
period to reproduce original 
holdings, 215 
sale of rights, 214 
subscription to new stock and 
subsequent sale thereof, 214 
proportionate to holdings, 209 
theoretical value of, 210 



"Privileged subscriptions" — Con- 
varying value of during period 
subsequent to issue, 211 
factors of, 
capital, 14 
labor, 15 
maximum, law of balanced re- 
turn, 24 
scale of, 
effect of capital costs on, 18 
effect of labor costs on, 20 
Profits, increased, test of expedi- 
ency of expansion, 9 
fixed, financing of, 177 
self-liquidating, financing of, 177 
Public utility holding companies, 
advantages of, 113 
business dealings with public, 

economy in large-scale pur- 
chase of equipment, 118 
financial assistance, 122 
soliciting new business, I2l 
superior technical efficiency, 114 
as corporate consolidations, 109 
collateral trust, 127 
debentures, 127 
of subsidiaries. percentage 

owned by public, 132 
percentage of owned by public, 
common stock, percentage of 

owned by public, 132 
comparative gross and net in- 
come, 132 
financial aid to subsidiaries, 
indorsement of securities, 125 
marketing securities, 125 
money advances, 122, 124 
financial structure of, 129 

Public utility holding companies— 
form of, 109 
intercompany owned securities, 

percentage of, 133 
preferred stock, 
issue of, 127 
of subsidiaries, 132 
percentage of owned by public, 
types of, 128 
economy of large-scale, by public 

utility holding company, 118 
outright, consolidation effected 
by, 92 

Railroad consolidations, 
historical importance, 70 
how effected, 73 
lease, 73 (See also "Leases") 
merger, 73 

outright purchase, 74, 92 
stock control, 82 
methods of study, 70 
periods of, 94 
systems, 100 
factors in formation of, loi 
methods of building, 105 
of systems, 106 
through lines, 96 
Railroad expansion, 
historical importance of, 70 
methods of study of, 70 
Railroad systems, 
factors in formation of, loi 
methods of building, 105 
of systems, 106 
Rentals (See "Leases") 
balanced, law of (See "Law of 
balanced return") 



Returns — Continued 
diminishing (See "Law of dimin- 
ishing returns") 

"Rights" (See "Privileged sub- 

Scale of production, 
effect of capital costs on, 18 
effect of labor costs on, 19, 21 
Securities, (See also "Bonds," 
new (See "New securities") 
of subsidiaries, aid rendered by 
indorsement of, 125 
marketing, 125 

money advances to, 122, 124 
sale of to bank, source of 
capital, 180 
Self-liquidating property, financing 

of, 177 
Shipping companies, successful tjTpe 

of industrial combination, 65 
Sinking funds for preferred 

stocks, 200 
Size of business, cause of weak- 
ness of industrial combine, 48 
Skilled labor, success of industrial 
combinations not requiring, 54 
Speculation, motive of expansion, 6 
Stockholders, sale of new securities 
to (See "New securities, sale 
of to stockholders") 
advantages over bonds in expan- 
sion, 185 
better borrowing facilities at 

banks, 188 
better investment market in 
state taxing bonds but not 
stock, 188 
greater flexibility in purchase 
and sale of property, l88 

Stocks — Continued 
advantages over bonds in expan- 
sion — Continued 
represent contingent rather 
than fixed charge, 185 
common, of public utility holding 
companies, percentage of owned 
by public, 132 
control in railroad consolidations, 
advantages of, 83 
control, methods of retaining 
during expansion, 
collateral trust bond issue, 88 
exchange of stock, 85 
purchase of shares, 84 
methods of acquiring, 84 
disadvantages of in expansion 
(See "Bonds, advantages of 
over stock issues in expansion") 
increased sale of by bankers, 196 
preferred (See "Preferred 

privileged subscriptions (See 

"Privileged subscriptions") 
"rights" (See "Privileged sub- 
Subscriptions, privileged (See 

"Privileged subscriptions") 
financial aid rendered by parent, 
indorsement of securities, 125 
marketing securities, 125 
monej' advances to, 122, 124 
securities, percentage owned by 
bonds, 132 
preferred stock, 132 
Surplus earnings, reinvestment of, 

source of capital, 168 
Syndicated, imderwriting, functions 
in connection with sale of new 
securities bj' corporations to 
stockholders, 219 



Systems of railway systems, io6 

new securities by corporation 
to stockholders, 219 

Technical efficiency of public utility 

holding companies, 114 
Trade associations, 146 
organization of, 146 
purposes of, 151 
Traffic interchanged, basis of com- 
puting contingent rental, 75 


Underwriting syndicates, function 
of in connection with sale of 

Vertical combinations, successful 
type of industrial combination, 


Webb Act, effect on foreign trade 

corporations, 67 
Wholesale buying by chain stores,