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91. Corporate Distribution of Risk and Control24

BY W. H. LYON

The corporation makes possible a parceling-out of the incidents of ownership in many combinations, an allotment of management, risk, and income in varying proportions. The line of apportionment becomes very flexible.

The corporate form marks the line of division of management into administration and control. Shareholders possess control, but through directors delegate administration to officers. Varying rights given special classes of stock make a widely varying apportionment of income, control, and risk. Common stockholders accept a maximum of risk in expectation of a maximum of income. They may share the incident of control equally or in varying proportions with other classes of stock. If two classes of stock enjoy exactly equal rights, except that one has preference as to income, they do not divide control, but risks, and the combination of control plus risk in one as compared with the combination of control plus risk in the other makes the ownership represented by one class entirely different from the ownership represented by the other.

We may speak of these divisions and combinations of income. control, and risk, creating different kinds of ownership, as horizontal divisions. But there is another division of ownership, that represented by the number of shares of stock or the number of bonds. It makes a division into amount of ownership rather than kind, into quantity rather than quality, a perpendicular division.

Now these two kinds of division of ownership accomplish two very different results. The perpendicular division of amounts of ownership makes possible the fitting of every man's pocketbook or financial ability. The horizontal division into kinds of ownership results in an even more difficult fitting, that of his type or state of mind. For one man may be more or less willing to take a chance than another. The same man may be more willing at one time than another. He may be unwilling to take any risk without having some control.

A corporation's stock regularly carries the largest share of present control and also regularly the largest share of risk. The stock may itself divide into two or more classes having obviously divergent interests, with the result that each class will exercise for different purposes the amount of control it possesses. If there is common stock and preferred stock with a limited dividend, the common share

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Adapted from Capitalization: A Book of Corporation Finance, 6-16. Copyright by the author. Published by Houghton, Mifflin & Co. (1912).

holders may throw their influence in favor of a more hazardous conduct of the enterprise with an expectation of greater profit accruing to them. Since the preferred stockholders get only limited dividends, they will throw their influence in favor of a safer conduct of the business. Interests of both classes of stockholders might coincide. If the corporation should not earn enough to pay full dividends on preferred stock, the preferred stockholders might desire the more hazardous conduct of the business. If the amount of preferred and common were the same, and each had the same voting power, each class would enjoy control equally. In practice this might not lead to a dead-lock in policy, for one shareholder owning a large amount of common and a small amount of preferred might vote his preferred to favor his common. If the amount of common were twice as great as the amount of preferred, and a share of each class had the same voting rights, the quality of control would in a way differ just as truly as if the amounts of each class were equal but a greater voting power were given the common than the preferred. In either case the common shareholder in a clash of interests would be more likely to have the corporation's policy incline to his advantage.

A corporation having only one class of stock, and no other securities, offers the simplest type. Such a security carries all the control, all the income, and all the risk. It effects only a vertical division of ownership. This form is proper if a satisfactory division of income, management, and risk cannot be made. A mining company especially cannot well divide the peculiar hazards of the enterprise. Since any class of mining securities must retain so much. risk, investors will not sacrifice anything of income or control. So it follows that nearly all mining corporations, including oil companies, have only one class of stock and no other securities. Coalmining companies have issued bonds to some extent, but this business rests upon a more assured basis than mining for metals. Manufacturing companies frequently issue no securities but their common stock. This is probably due to the fact that they are engaged in established kinds of business and follow the precedents set by the older partnerships. So far our financial ingenuity has directed itself for the most part to the comparatively new forms of business. railroads and other public-service corporations. With the coming of the big industrial concerns more complex forms of financing appear, and will probably make their way generally into industrial corporations. Though a holding company may have only common stock, that fact does not necessarily imply simplicity, for the subsidiary companies may have complex capitalizations.

92. The Management of the Corporation 25

BY WESLEY C. MITCHELL

The classical economists assumed that there stood at the head of the typical business enterprise a capitalist-employer, who provided a large part of the capital invested, assumed the pecuniary risk, performed the work of superintendence, and pocketed the profits. Many enterprisers of this versatile type remain today; but the extraordinary growth in size and influence of the joint-stock company has given greater prominence to another form of business manage

ment.

The large corporation, dominant in business today, is owned by a miscellaneous and shifting body of stockholders. The funds required for fixed investment are provided in some measure by these owners, but in larger part by bondholders, who may or may not own shares as well as bonds. The work of management is usually disassociated from ownership and risk. The stockholders delegate the supervision of the corporation's affairs to the directors and they turn over the task of administration to a set of general officers. The latter are commonly paid fixed salaries.

In such an organization it is difficult to find anyone who corresponds closely to the capitalist-employer. Neither the typical stockholder, who votes by proxy, nor the typical director, who gives his attention to routine affairs, fills the bill. The general officers, remunerated largely by salaries, and practicing among themselves an elaborate division of labor, have no such discretion and carry no such risk as the capitalist-employer. The latter has, in fine, been replaced by a "management," which includes several active directors. and high officials, and often certain financial advisers, legal counsel, and large stockholders who are neither directors nor officials. It is this group which decides what shall be done with the corporation's property.

In other cases, however, a single enterpriser dominates the corporation, and wields full authority. The stockholders elect his candidates, the directors defer to his judgment, the officials act as his agents. His position may be firmly intrenched by an ownership of a majority of the voting shares, or may rest upon personal influence over the owners of voting shares. In the "one-man" corporations the theoretical division of authority and function becomes a legal fiction. Practically the dominant head corresponds to the old capitalist-employer, except for the fact that he furnishes a far smaller

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Adapted from Business Cycles, 32-34. Copyright by the author (1913). Published by the University of California Press

proportion of the capital, carries a far smaller proportion of the pecuniary risk, and performs a far smaller proportion of the detailed labor of superintendence. These limitations do not restrict, but on the contrary enhance, his power, because they mean that the individual who "owns the control" can determine the use of a mass of property and labor vastly greater than his own means would permit.

While the corporate form of organization has made a theoretical division of the leadership of business enterprises among several parties at interest, it has also made possible in practice a centralization of power. The great captains of finance and industry wield an authority swollen by the capital which their prestige attracts from thousands of investors, and often augmented still further by working alliances among themselves. Among the enterprisers of the whole. country, this small coterie exercises an influence out of proportion not only to their numbers but also to their wealth. The men at the head of smaller enterprises, though legally free, find their field of initiative limited by the operations of these magnates.

In large corporations the few individuals in control have an opportunity to make money for themselves at the expense of the enterprise itself, or at the expense of the other parties at interest. By giving lucrative contracts to construction or repair companies in which they are interested, by utilizing their advance information of the corporation's affairs for speculation in the price of its shares, by rigging its accounts for the same purpose, by making loans or granting rebates to other companies in which they are interested, it is possible for an inner ring to make profits out of wrecking the corporation. There are certainly instances enough to invalidate the easy assumption that every business enterprise is managed to make money for the whole body of its owners.

93. The Ethics of Corporate Management2

BY HENRY ROGERS SEAGER

It is probably within the truth to say that one-half of the business of the United States is now controlled by corporations and there is every indication that the proportion is increasing. This makes important the recognition of certain drawbacks attaching to the corporate form of organization. Chief among these is the fact that responsibility for the management of corporations is diffused. In one-man businesses and partnerships the men who organize and

"Adapted from Principles of Economics, 161-163. Copyright by Henry Holt & Co. (1913).

manage the enterprise are the ones most vitally interested in its success. In corporations the stockholders, who usually furnish the capital required and have to bear the loss if things go wrong, intrust their interests to the board of directors. The board of directors in turn deputes the actual management of the business to a salaried president or manager who may not, and often does not, have any further interest in the business than that his reputation depends upon the honesty and wisdom with which he manages it. The enterpriser function is thus divided in the corporation between three parties no one of whom has the same vital interest in the business that a single enterpriser or partner feels in businesses conducted under other plans. Moreover, few directors or managers have not, at times, private interests in conflict with the corporate interests they are supposed to promote. This diffusion of responsibility and interest causes corporate management to be often wasteful and sometimes corrupt. The salaries are frequently higher than they need to be to secure the required grade of labor, appointments are often determined by personal rather than by business considerations, and inflated prices are sometimes paid for materials in consequence of the fact that particular directors are interested in their production. More common than these clear violations of trust are misrepresentations in regard to the affairs of the corporation intended to influence the stock market and to enable those interested to carry through deals for their own benefit.

Another abuse is connected with the borrowing power of corporations. When this power is used to secure money by the sale of bonds the law gives to bondholders no voice in the management of the corporation so long as their interest is paid and the principal is not defaulted. The larger the proportion of the capital required for any enterprise that is secured through the sale of bonds, the smaller is the interest in the business of the stockholders, who nevertheless continue to control it. It has often happened in connection with railway corporations in the United States that the entire capital has been secured by selling bonds and that the stock has represented merely a bonus paid to the promoters of the company. This is a situation fraught with danger, as American experience has abundantly proved. To give a fictitious value to their stock, promoters are only too apt to pay dividends out of earnings that should be expended for renewals and replacements. Before the corporation is reduced to bankruptcy they can usually sell their holdings to unsuspecting investors and retire, leaving to them the task of reorganizing the business.

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