ties; it was an open board where anybody by paying a small fee could trade. The broker could make such charge as he pleased for his services. Margins were not always required. Under the circumstances many undesirable elements entered the exchange.

The commission was composed of governmental officials, merchants, bankers, manufacturers, professors of political economy, and journalists. Its report was completed in November, 1893. Although there had been a wide-spread popular demand that all short selling be prohibited, the commission reported that such a policy would be harmful to German trade and industry. They were willing, however, to prohibit speculation in industrial stocks.

The Reichstag, however, rejected the recommendations of the commission, and in 1896 enacted a law much more drastic. The landowners, constituting the powerful agrarian party, contended that short-selling lowered the price of agricultural products, and demanded that contracts on the Exchange for the future delivery of wheat and flour be prohibited. The Reichstag assented to this demand. It also prohibited trading on the Exchange in industrial and mining shares for future delivery. It enacted that every person desiring to carry on speculative transactions be required to enter his name in a public register, and that speculative trades by persons not so registering be deemed gambling contracts and void. The object was to deter small speculators and to restrict speculation to men of character and capital.

The results were quite different from the intention of the legislature. Men of character and capital declined to advertise themselves as speculators. The small fry found no difficulty in evading the law. Foreign brokers flocked to Berlin and established agencies for the purchase and sale of foreign stocks. Seventy such offices were opened in Berlin within one year after the law was passed and did a flourishing business. German capital was thus transferred to foreign markets. The Berlin Exchange became insignificant and the financial standing of Germany as a whole was impaired.

There was, however, even a more serious consequence of the new law. While bankers and brokers were required to register, their customers were not compelled to do so. Consequently the latter could speculate through different brokers on both sides of the market, pocketing their profits and welching on their losses as gambling contracts. Numerous cases of this kind arose, and in some the plea of wagering was entered by men who had previously borne a good reputation.

Another consequence was to turn over to the large banks much of the business previously done by independent houses. Persons who desired to make speculative investments in home securities applied directly to the banks, depositing with them satisfactory security for the purchases. As the German banks were largely promoters of new enterprises, they could sell the securities to their depositors and finance the enterprise with the deposits. This was a profitable and safe business in good times, but attended by danger in periods of stringency, since the claims of depositors were payable on demand. Here again the law worked grotesquely, since customers whose names were not on the public register could, if the speculation turned out badly, reclaim the collateral or cash they had deposited as security.

The evil consequences of the law brought about its partial repeal in 1908. By a law then passed the government may, in its discretion, authorize speculative transactions in industrial and mining securities of companies capitalized at not less than $5,000,000; the Stock Exchange Register was abolished; all persons whose names were in the commercial directory were declared legally bound by contracts made by them on the Exchange. Other persons, while not legally bound by such contracts, could not reclaim deposits of cash or collateral security for speculative contracts, on the plea that the contract was illegal.

Germany is now seeking to recover the legitimate business thrown away twelve years ago. It still prohibits short selling of grain and flour, although the effects of the prohibition have been quite different from those which its supporters anticipated. As there are no open markets for these products, and no continuous quotations, both buyers and sellers are at a disadvantage; prices are more fluctuating than they were before the passage of the law against short-selling.

F. THE CORPORATION

90. The Nature of the Business Corporation 28

BY HARRISON S. SMALLEY

Superficially considered, a corporation is an association of persons for the accomplishment of certain purposes. While non-commercial motives lead to the organization of corporations, most of them are formed with money-making ends in view. These last are

23

Adapted from a textbook entitled The Corporation Problem, privately published (1912).

called business corporations. Persons become members by acquiring one or more shares of stock, on which account they are called shareholders.

A share of stock represents an interest in the business; hence a stockholder is an entrepreneur. All the shares of stock represent all the interests in the business; and thus if there are 1,000 shares of stock outstanding, one who owns 100 shares has a onetenth interest in the business. A nominal value, called the "par value" is assigned by the corporation to its stock. In most cases the par value of a share is $100, though many companies have chosen other sums. The total par value of all the stock does not necessarily equal the value of the corporation's property.

All net earnings, treated as profits, are distributed among the stockholders pro rata, and are called dividends.

The price of a share of stock depends largely upon the rate of dividends customarily paid on it. If six or seven per cent. per annum is paid, the price will be about par; if twenty per cent. can be paid each year, the price will be far above par. But numerous other factors, for instance, the general credit and standing of the company, the apparent future prospects of industries of that type, the condition of the money market, the general business situation, all share in determining the price of the stock.

In addition to a right to dividends, the shareholder is entitled to other privileges and advantages. If the business is closed out, he has a right to his proportionate share of the net assets. During its life he has a voice in the management of the enterprise. In addition to electing the directors, the stockholders have a right to decide such questions of exceptional character as the issue of stocks and bonds, the amendment of the corporate charter, the dissolution of the business, etc. Aside from these few extraordinary matters, the stockholders are without power, for the affairs of the company are in the hands of the directors, who, once elected, may manage the business as they see fit. All that the stockholders can do if not satisfied is to wait until the next annual meeting and then replace the directors with others.

In stockholders' meetings each stockholder has one vote for each share of stock held by him. In voting for directors he has as many votes per share as there are directors to be elected. Thus, if five directors are to be elected and he holds one hundred shares, he has five hundred votes. These he can distribute in any way he sees fit. He can cast all for one candidate, one hundred for each of five, or otherwise. This is called cumulative voting. He is privileged to vote by proxy.

In a majority of corporations, most of the stockholders take no active part. The control of the corporation is highly autocratic rather than democratic in character. Many corporations have thousands of members. Yet almost always it is dominated by less than a dozen men, who may own only a minority of its stock. Few persons attend the annual meeting of the stockholders. Parties particularly interested collect proxies of absent members. Thus it is relatively easy for a management to perpetuate its control and to carry out its policies.

In many corporations the stock is of two classes, common and preferred. The leading difference is that dividends at a certain. fixed rate must be paid on the preferred, before any can be declared on the common; but usually there are also other differences. If the business is closed up, the preferred stockholders usually have a prior claim. Not infrequently there is a difference in voting rights. In some cases preferred stockholders cannot vote unless their dividends are in arrears. In other cases the preferred stockholders are entitled to elect a certain number of directors, and the common stockholders the rest.

Cumulative preferred stock is stock upon which, in addition to current dividends, all arrears of dividends must be paid before any dividends can be declared on the common.

A corporation usually puts out bonds. The bond does not represent an investment in the business; it simply evidences a debt owed by the corporation to an outsider. A bond is, in effect, a formal promissory note, a promise to repay money with interest at a certain per cent. The bondholder is not an entrepreneur, but simply a capitalist. In consequence he has no vote in corporate affairs. Bonds are almost invariably secured by a mortgage upon a part or all of the corporate property. All the stocks and bonds of a corporation are known as its securities, and the sum of the par values of all the securities is called the "capitalization" of the corporation.

If a corporation is unable to pay interest on its bonds, or is otherwise insolvent, the proper court will, on application, appoint a receiver, who, as a temporary officer of the court, takes charge of the corporate property and business. In these days it is deemed inexpedient to terminate an established enterprise, except in rare cases, and the receiver continues the business and attempts to build it up.

While the receiver is thus engaged, the security holders form one or more "reorganization committees," to put the corporation on

a sounder basis. They must raise money to pay off back debts. Generally they must scale down the capitalization, so that the earning power will cover the bond interest and also a fair rate of dividends. This means that existing security holders must allow a portion of their securities to be cancelled, and the struggle to see how much. each class of security holders will sacrifice is often long and bitter. Preferred stockholders suffer more than bondholders, and common stockholders more than preferred. Sometimes the stockholders are wholly "frozen out."

A corporation can be formed only with the consent of the government, and upon such conditions as the government may prescribe. The instrument, granted by the state, and specifying the terms and conditions upon which the corporation may engage in the business for which it is organized, is called the charter. In this country the legislative branch of the government has always exercised the function of creating corporations. According to "general laws," now universally in force, any group of persons, not less in number than a fixed minimum, can become a body corporate under the conditions laid down in the law.

A few striking facts will show that in the eyes of the law the corporation is an entity distinct from the stockholders, having a legal status and legal rights and liabilities of its own. First, the corporate property belongs to the corporation itself, not to the members; a change in membership does not disturb the title. Second, a corporation's contract is not the undertaking of its members. Third, the transfer of shares by the members has no effect upon the life of the corporation.

Lawyers and judges have regarded the corporation as an artificial person. The trouble resulting from that concept has been evident in connection with the penal laws concerning corporations. We have attempted to punish the corporation for violations of law, when it is evident that in every offense the real actors are human beings. To inflict a fine on a corporation is to lay a burden on the whole body of stockholders. In reality a few men committed the offense. Such a method of corporate punishment is, therefore, as unjust as it is ineffectual. Consequently there has arisen the saying "guilt is personal," and we are now beginning to attack the responsible individuals themselves.

The true view of the corporation would seem to be that it is an imaginary entity which serves the association of persons as a convenient instrument through which they may conduct their business.