States Supreme Court in 1894 in the Knight case. But the heyday of the holding company did not dawn until the outburst of industrial promotion in 1898, to which reference has already been made. The success of the first combination in the iron and steel business, the Federal Steel Co., pointed the way. Further impetus was given by the demonstration that if the terms of exchange for capital stock could be so arranged that the new shares had an apparent money value greater than that of the old certificates, the owners might be depended upon to "act naturally like a flock of sheep."1

For a brief period, owing to the advantages above mentioned, the holding company device assumed peculiar prominence in almost every branch of American business life. In mining, the Amalgamated Copper Co.; in merchandising, the Associated Merchants Co., with a made-over charter from Connecticut of the Columbian Construction Co., empowering it "to conduct any lawful business"; in transportation, the Northern Securities and the Rock Island companies for interstate business and a host of other combinations in the public utilities field within the separate states, were all built upon the principle of a parent corporation which controlled its subsidiaries by means of stock holdings. Without this device the United Steel Corporation, the climax of the whole movement, with its aggregate capitalization of $1,400,000,000 would have been impossible, to say nothing of the great tobacco combination constructed upon the same model. A minor outbreak of promotion occurred in 1908-1909 which brought into being a new crop of merchandising combinations and of such manufacturing concerns as the General Motors Co. Here again the holding corporation served to bind the various parties together.

By this time experience had demonstrated a large number of disadvantages inherent in the departure from the established legal practice that one corporation should not be permitted to hold stock in another. Investors refused longer to act like a flock of sheep, and began to discriminate between immediate and remote ownership of tangible property. The new practice was

1 Pamphlet, Holding Companies, by Robert F. Herrick, Esq., Boston, Jan. 20, 1909. Cf. p. 277, infra, on the Consolidated Tobacco Co. experience of 1901.

too apt to invite what Dewing characterizes as an "almost hopeless tangle of direct, indirect and contingent liabilities." This occurred in such unfortunate enterprises as the New England Cotton Duck, the United States Realty and Construction and the American Malting companies. The invitation to the manipulation of accounts and to secret profits for insiders is exemplified in our reprints dealing with the affairs of the ship-building combination. "The division of individual responsibility," as Dewing puts it, the divorce of control and responsibility from real ownership, the evil of padded accounts and particularly of the consolidated balance sheet, the conversion of contingent stock liability for dividends into fixed charges upon bonds, all demonstrated anew the danger to investors lurking in this radical departure from precedent. Furthermore the people at large were now taking a hand. The Northern Securities decision frowned upon the device in railroading. Legislative proposals, even to the extent of absolute prohibition of the practice, threatening to render the holding company vulnerable in the courts, finally resulted in the prohibition of the practice of intercorporate stock holding altogether by New Jersey, the pioneer, in 1913. Is this the beginning of the end or not?

One of the gravest financial objections to intercorporate stock holding is the ease with which a minority of stock ownership may perpetuate itself in control by means of a series of holding companies one upon another. Where the holding company owns practically all of the stock of the constituent corporations this evil is absent. In the Steel Corporation, the Agricultural Chemical Co., or the General Motors Co., there are practically no minority stockholders whose rights may be jeopardized. But the principle once admitted, there is no limit to the amount of involution; nor is there any safeguard against downright oppression of a large majority of shareholders by the few. Thus the United States Dry Goods Companies under the laws of Delaware controls the Associated Merchants Co., with a Connecticut charter empowering it to conduct any lawful business; while it in turn dominates the H. B. Claflin Co. of New Jersey through the ownership of 45,001 out of 90,000 Chapter XII.

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shares of stock. Under such circumstances what becomes of the essential obligations of managers to investors, to say nothing of the relationship of so devious a concern to the authorities of the different states? Fortunately the trend at the present time is distinctly away from both the holding company and the practice of incorporation in the charter-mongering states. Many concerns are simplifying their corporate structure. The Amalgamated Copper Co. in 1915 resolved itself into its constituent parts. The American Malting Co. is about to abandon its holding corporation. The American Woolen Co. has just deserted New Jersey and returned to Massachusetts, corporatively, where it belonged. And a number of other concerns now manifest a disposition to follow suit. The pure finance corporation may in time, as it deserves, come to be a specimen for preservation in economic museums.

The trust movement has brought to light a number of evils in corporate finance, or rather it has magnified preexisting tendencies which had been apparent only on a small scale. The principal ones in our experience are imprudent or fraudulent promotion and subsequent speculative management. It is difficult at all times to draw the line clearly between recklessness, inefficiency and dishonesty. But a vast increase in irresponsibility of corporate management has certainly paved the way to financial practices which are highly objectionable, if not criminal. The examination of such matters forms part of any comprehensive treatment of the corporation problem.

The promotion of an industrial enterprise is a chancy operation at best. Where it is undertaken on behalf of others, that is to say, involving the use of their funds rather than the employment of the promoter's own capital, an added premium is set upon imprudence. Certainly many of the promotions of the period 1900-1901 impress the onlooker as unwise in the extreme. On the other hand, there is of course a substantial economic defense for the payment of large returns to those who incur the risks of novel enterprises. But even with full allowance

1 Cf. Dewing's diagram of the organization of the glucose combination. Op. cit

p. 111.

therefor, the returns of both organizers and banking syndicates during this period seem to be excessive. Where promotion occurred from within as in the harvester organization,1 no ground for criticism is afforded. More debatable is the warrant for the large returns which accrued to underwriters in the promotion of the U. S. Steel Corporation.2 In a different group belong the reprehensible practices in promotion, which merit the name of downright theft. Two notable instances are described in this volume by the official reports of receivers for the asphalt and shipbuilding combinations, respectively. The veil of secrecy thrown about the promotion of the Amalgamated Copper Co. has been sufficiently lifted at times to warrant the belief that exorbitant profits were made in this instance. Nefarious practices of this sort have already been condemned by the courts in several notable instances of late. But the removal of the incentive to reckless promotion through stringent regulation of the conditions of flotation, as is done in the excellent German law described herein,5 would seem to afford complete protection.

The payment of unearned dividends is another evil which in the past has not been curbed by a series of decisions in our American courts attempting to distinguish clearly between capital and income accounts. Nice questions of policy are involved in the determination of net profits. An unwise practice of many industrial combinations in failing to provide sufficient reserves before beginning the payment of dividends has frequently precipitated bankruptcy. Most unfortunately, downright deception often merging into fraud has at times been adduced in evidence. The asphalt companies clearly exemplify the lack of a conservative policy in accounting; as when, for instance, the Audit Co. of New York changed an apparent surplus of $758,000 to a deficit of $541,000. The United States Realty 1 Pp. 324 and 634.

2 Pp. 169 and 203.

Pp. 203 and 439. Dewing, op. cit., is the standard authority on matters of

this character.

On the liability of promoters for unrevealed profits, consult the review of cases by the editor in the Journal of Political Economy, Vol. VIII, 1900, pp. 535 et seq. 5 Chapter XXII, p. 774.

Co. is another case in point. Dividends were here paid on the basis of profits on uncompleted contracts, recalling the similar policy in the case of the U. S. Shipbuilding Co.1 Numerous other concerns have since been known to have followed the same practice, notably the New England Cotton Yarn and the Virginia-Carolina Chemical Co. Perhaps the worst offender was the American Malting Co., in a case so extreme and so clearly fraudulent that the courts in 1905 held the directors liable both to creditors and stockholders to the full amount of the unearned dividends declared.2 It is earnestly to be hoped that a few more judgments of this kind will serve to restrain the directorates of other great corporations.

The evil of speculative management falls into several distinct parts. The earliest form which it took was the buying and selling by its own officers of the securities of a corporation for speculative purposes. Of this sort are the events in the history of the Whiskey Trust, and a few scattered instances such as the manipulation of Diamond Match funds in 1896. American corporations, unlike those of England and Germany, fail in too many instances to prohibit dealings in the securities of a company by its own officers. The best of them certainly do so, and the scandals of a decade ago probably emphasized the desirability of preventing this evil. An unlimited power to contract loans without the approval of the directors or stockholders, as in the case of the American Ice Co., is also a constant menace to conservative management. Another phase of this matter concerns the temptation to industrial management with a view to its effect upon the stock market rather than upon the permanent welfare of the company. A classic example is afforded by the episode of the American Steel & Wire Co. in 1900. Secrecy is a constant invitation to the insider to take advantage of forthcoming events at the expense of the stockholders. is undeniable also that such speculative management greatly encourages speculative ownership on the part of stockholders. The old-fashioned investor, secure in his belief in the stability of his company, is replaced by a body of temporary holders 1 Pp. 403 et seq.

2 Dewing, op. cit., ably reviews this experience.