Corporation finance : an exposition of the principles and methods governing the promotion, organization and management of modern corporations
'nf^^^"^^^ "^ y^nf^^^^^^^^ ''^rC^n'r^^^ii^^^ \y''Wiv^^^^^&3 v^''^" y^^^ 'M'^^^^^^ ^^"^r^^^^il^^ ^^'' Wn°^ . "J^Ki-Vi /^I'/M •.o-»V^'C/.\ ; 'o'SH, (J /S^^R^^S"^ 0 JL° ??s^ ^ ^^^K^^^SLo ^° ?V^ " ^^^F^^S^ » J?r?°«k y^ ^^S^fe^^M^o J^ ;°'^>' <^TSi0^'*S^'' ''f^^^mi^. ^^i^^^mi^. ^t^^^^my. Mi^^^^mf, f^H^^^^im^j v Digitized by the Internet Archive in 2007 with funding from Microsoft Corporation http://www.archive.org/details/corporationfinanOOIougrich MODERN BUSINESS THE PRINCIPLES AND PRACTICE OF COMMERCE, ACCOUNTS AND FINANCE PREPARED AND EDITED UNDER THE DIRECT SUPERVISION OF JOSEPH FRENCH JOHNSON, A.B., D.C.S. DEAN NEW YORK UNIVERSITY SCHOOL OP COMMERCE, ACCOUNTS AND FINANCE AUTHOR "money AND CURRENCY," " SYLLABUS OF MONEY AND BANKING," ETC, Copyright, 1909 BY DE BOWER-ELLIOTT COMPANY TABLE OF CONTENTS INTRODUCTION. CHAPTER I. THE CORPORATE FORM. ECTION PAGE 1. " Non-Stock " Corporations t.. . 1 2. ** Stock " Corporations 2 S. Definitions 2 4. The Fiction of " Corporate Entity/' 3 5. Corporations in Ancient Nations 4 6. Popularity in Modern Times 5 7. Adaptability to Raising Large Amounts of Capital . . 5 8. Permanence 8 9. Centralization of Control ». . . . 9 10. Transferability of Ownership 10 11. Limited Liability 11 12. Disadvantages of the Corporate Form 12 CHAPTER IL LEGAL STATUS OF THE CORPORATION. AS, Defining and Controlling Instruments ., .. . . . 17 14. Common Law of Corporations 17 15. The State Constitution 18 16. Method of Creating the Corporation 19 17. Essential Features of the Charter . 20 18. A Sample Charter 22 19. The Corporate Name 24 20. The Corporate Purposes 24 21. Other Important Features of the Charter 28 22. The By-Laws. 28 23. Essential Features of the By-Laws . . . ^ . . 38 vii viii CONTENTS CHAPTER III. INTERIOR ORGANIZATION. SECTION PAGE 24. Rights of Stockholders 37 25. The Proxy and its Uses 38 26. The Right to Dividends 40 27. The Right to Information 41 28. Liabilities of Stockholders 42 29. Rights of Creditors 44 30. " Dummy " Directors 44 31. Powers and Liabilities of Directors 45 32. The Efficiency of Corporate Organization 47 CHAPTER IV. WHERE AND HOW TO INCORPORATE. 33. A Corporation May be Chartered in Any State and Do Business in Other States 49 34. The Regulation of " Foreign " Corporations ... .51 S5, Choosing the State of Incorporation ...... 52 36. Comparative Charges in Several States 53 37. Liberality of Corporation Laws in Several States . . 55 38. Permanence of the Laws 56 39. Reputation of Various States 57 40. Comparative Summary of the Advantages and Disadvan- tages of the Important States of Incorporation . . 58 41. Agreements Prior to Incorporation 63 4i2. The Wide Range of Choice in Incorporation .... 64 CHAPTER V. CORPORATE STOCK. 43. Stock Certificates Not Fully Negotiable . . . . .65 44. Par vs. Market Value of Stock 68 45. Nature of Preferred Stock 71 46. Uses of Preferred Stock 73 47. Cumulative Voting 75 48. Voting Trusts ,., . . 77 CONTENTS ix CHAPTER VI. TYPES OF BUSINESS  .... 81 51. Nature of a Holding Company 81 52. The Holding Company as a Means of Organizing "Trusts" 83 53. Complexity of Holding Companies 86 54. Organization of the Standard Oil Company .... 87 CHAPTER VII. THE SOURCES OF CORPORATE FUNDS. 55. Summary of Preceding Chapters . 91^ 56. Four Sources of Corporate Funds 91 57. The Investing Public as a Source of Funds .... 93 58. Difference Between Investment and Speculation . . 94 59. The Speculative Public as a Source of Funds , , , 95 60. Desirability of Borrowing Funds 96 61. Distribution of Security Issues 102^ CHAPTER VIII. SHORT TIME LOANS. 62. Trade Credit as a Source of Funds 105 63. What Reliance Should be Placed on Bank Loans ? . .107 64. Notes Sold to the Public as a Source of Funds . . .114* CHAPTER IX. THE CORPORATE MORTGAGE. 65, What Determines the Value of Fixed Assets? . « .119 66, Nature of a Mortgage Bond . . 121 67. Essential Features of a Deed of Trust 122 68. Classification of Mortgage Deeds of Trust . . . .125 s CONTENTS CHAPTER X. TYPES OF CORPORATION BONbS. SECTION PAGE 69. Classification of Bonds 127 70. Mortgage Bonds 129 71. Sinking Fund Bonds 130 72. Collateral Trust Bonds , . 133 '73, Equipment Trust Bonds 135 CHAPTER XI. TYPES OF CORPORATION BONDS {continued). 74. Debenture Bonds 141 75. Income Bonds 144 76. Other Types of Bonds 147 77- Purposes^ Manner of Payment^ and Conditions of Re- demption of Bonds 149 78. Convertible Bonds 151 CHAPTER XII. CORPORATE PROMOTION — THE NEW ENTERPRISE. 79. The Function of a Promoter 154 80. "Discovery" of a Proposition 156 81. " Assembling " a Proposition 157 82. Financing a Proposition — The Initial Development . 158 83. Foresight in Providing Funds 160 84. Advantages of a Wide Distribution of Stock . . . . l6l 85. " Starting Right " in the Sale of Stock l6l 86. A Concrete Illustration . 162 CHAPTER XIII. THE PROMOTER AND THE CORPORATION. 87. Professional Promoters 167 88. Lawyers and Bankers as Promoters 169 89. Engineering Firms as Promoters 169 90. Secret Profits are Illegal 171 91. Misleading Statements Constitute Fraud 174 CONTENTS XI SECTION PAGE 92. Contracts on Behalf of the Corporation and Their Ac- ceptance 175 93. The Promoter's Pay 175 94. The Promoter's Risks and Labors 178 95. Is the Promoter Over-Paid? 178 CHAPTER XIV. CORPORATE PROMOTION — FORMING CONSOLIDATIONS. 96. The Importance of Small Industrial Combinations . .180 97. Difficulties in the Promoter's Task 181 98. " Discovery " of a Small Consolidation 182 99- Basis of Consolidation 183 100. The Necessity for Cash 190 101. One Method of Raising Cash 191 102. Problems in Forming a Large Consolidation . . . .194 103. Basis of Consolidation .195 104. The Interborough-Metropolitan Consolidation . . .196 CHAPTER XV. THE UNITED STATES STEEL CORPORATION. 105. Preparing the Ground 199 106. The Steel Consolidations Preceding the Formation of the United States Steel Corporation 200 107. A Condition of Unstable Equilibrium 201 108. Method of Promotion 205 109- Prospectus of the Corporation 206 HO. Profits of the Promoters 209 111. Capitalization at the Beginning 209 112. Additions to the Steel Corporation 211 113. Financial Changes ........... 213 114. Basis of Capitalization 215 115. Operating Policy of the Corporation 218 116. Securities of the Corporation and Their Standing . .219 CHAPTER XVI. SELLING SECURITIES — THE PROSPECTUS AND THE BANKING  Typical Speculative Prospectus ., 226 120. A Typical Investment Prospectus 228 121. The Ideal Prospectus 230 122. Selling Through Banking  STREET MARKET. 125. The Principal Stock Exchanges of the United States . 239 126. Listing Securities .... t. ..... . 240 127. The Curb Market 242 128. Stock Exchange Methods 243 129. Importance of Speculative Dealings 245 130. Buying on Margin 246 131. Selling Short 247 132. Stock Exchange Houses vs. Bucket Shops .... 248 133. The Classes of Wall Street Speculators 250 134. A Summary View of the Stock Market 251 135. Stimulating Speculative Interest 251 136. Syndicate Operations 253 137. Stock Market Manipulation 254 CHAPTER XVIIL SELLING SECURITIES — THE UNDERWRITING SYNDICATE. 138. Origin of Underwriting 256 139. Advantages of Underwriting to the Corporation . . . 257 140. Advantages to the Buyers of Securities 258 141. When is Underwriting Advisable? 259 142. Why Underwriting Syndicates are Formed .... 262 143. Three Types of Syndicates 263 144. A Fourth Type — Pooling the Sale of the Security . . 268 145. A Fifth Type — Distributing the Security .... 265 146. The Large Underwriting Houses 267 CONTENTS xiii CHAPTER XIX. MANAGEMENT OF THE UNDERWRITING SYNDICATE. SECTION PAGE 147. Informal Agreements 269 148. A Formal Syndicate Agreement 269 149. Characteristics of Syndicate Agreements 277 150. Functions of Underwriting Syndicates 278 151. Underwriting Speculative Securities 279 152. An Example of Speculative Underwriting .... 280 CHAPTER XX. INVESTMENT OF CAPITAL FUNDS. 153. Importance of Wise Investment 284 154. The Installment Method of Getting Cash as Needed . 284 155. Disadvantages of this Method 286 156. Other Possible Methods 287 157. How Much Shall be Invested in Fixed Capital? ... 288 158. Forms of Working Capital 289 159. HowMuch Working Capital Shall be Carried? . . . 290 160. The Practice of Large Corporations 291 161. Factors that AiFect Working Capital 293 162. The Working Capital of the Pennsylvania Railroad . . 294 163. General Conclusions as to Working Capital .... 295 CHAPTER XXI. DISPOSITION OF GROSS EARNINGS. 164. Determination of Income 297 165. Honesty in Stating Gross Earnings 298 166. What Are Operating Expenses? 298 167. Necessity for Depreciation Reserves 299 168. Income From Other Sources and Deductions . . . 302 169. HowMuch Shall be Paid Out in Dividends? . . . .303 170. Variability of Profits 304 171. Regularity of Dividends Deeirable 308 172. Prudence in Paying Dividends 309 xiv CONTENTS CHAPTER XXII. BETTERMENT EXPENSES. SECTION PAGE 173. Two Classes of Betterments . .311 174. Sources of Funds for Betterments 312 175. Appropriations from Earnings 313 176. Objections to This Method 314 177. The Attitude of Stockholders 314 178. The Case of the Lehigh Valley Railroad 316 179- Policy of the Union Bag and Paper Company . . . 320 180. Borrowing Funds for Betterments 321 181. Policy of the Pennsylvania Railroad 322 182. General Conclusions as to the Financing of Betterments 323 CHAPTER XXIII CREATION AND USE OF A SURPLUS. 183. Definition 325 184. Four Sources of Surplus 326 185. The Fifth Source — Saving 327 186. Policy of the " Trusts '* 329 187. How Should Surplus be Invested 330 188. The Surplus as a " Rainy Day Fund " 330 189. Putting the Surplus Back Into the Property ,.. . . 333 CHAPTER XXIV. DISTRIBUTION OF THE SURPLUS. 190. Effect of a Surplus on Assets and Dividends . . .335 191. Distribution Through Stock Watering 337 192. Distribution Through Subscription Privileges . . . 339 193. An Opportunity Thus Given for Cheap Investment . 340 194. Cashing the Privilege — The Subsequent Sale . . . 841 195. " " " —Short Selling 342 196. " " " — Sale of Old Stock .... 343 197. " " " — Sale of " Rights " . . . . 343 198. Theoretical Value of a Right 345 199. Privileged Subscriptions as a Method of Stock Watering 347] CONTENTS XV CHAPTER XXV. MANIPULATION BY CORPORATION OFFICERS. SECTION PAGE 200. Ought We to Study Manipulation ? 349 201. The Corporate Form Favors Manipulation .... 349 202. Is Manipulation a Necessary Evil.^ 350 203. Scope of the Chapters on Manipulation 351 204. Exorbitant Salaries 352 205. Fraudulent Contracts 353 206. New Companies for Profitable Business 355 207. Misuse of " Inside " Information 358 208. Is Manipulation by Officers Common? 360 CHAPTER XXVI. MANIPULATION BY DIRECTORS. 209- Usual Methods 361 210. Fraudulent Contracts 362 211. Attitude of the Courts 365 212. New Companies for Profitable Business 366 213. Juggling Accounts 367 214. An Accountant's Observations 370 215. Remedies for This Kind of Manipulation .... 371 216. Inflicting Loss on the Corporation 373 217. The Danger in Losing Control of a Corporation . . . 375 CHAPTER XXVII. MANIPULATION BY AND FOR STOCKHOLDERS. 218. Cheating Creditors 379 219. The Chicago and Alton Deal 380 220. Manipulation Through Subsidiary Companies . . .382 221. Central of Georgia Income Account 383 222. Squeezing the Minority Stockholders 385 223. A Complicated Real Estate Proposition 387 224. Robbing a Partnership to Pay a Corporation . . .389 225. Remedies for Manipulation 392 xvi CONTENTS CHAPTER XXVIII. INSOLVENCY AND RECEIVERSHIPS. SECTION PAGE 226. Two Types of Insolvency 394 227. Causes of True Insolvency ... 395 228. One Cause of Legal Insolvency — " Lack of Capital " . S97i 229. The Case of the Detroit^ Toledo & Ironton Railway Com- pany 398 230. Additional Causes of Legal Insolvency 400 231. Two Methods of Handling Insolvency — Bankruptcy and Dissolution 401 232. A Third Method — Appointment of a Receiver . . . 403 233. Duties of a Receiver 404 234. Receiver's Powers 406 CHAPTER XXIX. PRINCIPLES OF REORGANIZATION. 235. Reasons for Reorganization 408 236. The Formation of Committees 410 237. Why Not Foreclose? 412 238. Problems Confronting the Reorganization Committee . 413 239. Necessity for Cash 416 240. Raising Cash by Assessments 417 241. Reducing Fixed Charges 420 242. Capitalization of the Reorganized Corporation . . . 422 243. Summary of the Chapter 424 CHAPTER XXX. THREE TYPICAL REORGANIZATIONS. 244. Growth of the Santa Fe System 425 245. First Reorganization of the Santa Fe and Its Results . 429 246. Second Reorganization and Its Results 431 247. Growth of the Rock Island System 434 248. Rock Island Reorganization 437 249. Westinghouse Reorganization 440 Quiz Questions 445 INTRODUCTION Twenty years ago a knowledge of corporation finance was not essential to the average business man. Only the larger concerns, roughly speaking, were organized in the corporate form. We have only to look around us to see that the situation to-day in this respect is en- tirely different. The corporate form, though not yet universal, is far ahead of partnerships and of individual proprietorships in popularity and in influence on busi- ness methods. As its advantages become better known we may expect to see it adopted even by small and back- ward concerns. This tendency is bringing to the front numerous problems of corporation law and management with which every man in business should be familiar. From this point of view the present volume is written. It is intended primarily for the information and guidance of business men of all stations and degrees. Most of what is said here will be found applicable both to large and to small corporations. The facts and illustrations, however, are largely drawn from the experience of the big industrial and railroad combina- tions. The chief reason for directing attention to the big corporations is that their methods are well developed and are worthy of study and imitation by the managers of smaller corporations. Most of us have a great deal to learn from the men who control the financial affairs of such companies as the United States Steel Corpora- tion, the Union Pacific Railroad Company, and the Pennsylvania Railroad Company, to mention three of our greatest and best managed corporations. INTRODUCTION While the first object of the volume is to serve business men, the author trusts that it will prove useful also to at least four other groups : (a) To stock and bond brokers and their employes, many of whom, the writer has observed, have only a fragmentary knowledge gained from experience, not a comprehensive knowledge, of financial operations. (b) To lawyers, all of whom should have a clear understanding of the financial as well as the legal phases of corporate organization and management. (c) To bankers, who are constantly dealing with all kinds of business corporations. (d) To accountants, to whom a comprehension of corporation methods and problems is almost as essential as a knowledge of strictly accounting principles. This list might be indefinitely extended. It is not too much to say that everyone directly or indirectly connected with modern business ought to possess for his own protection and advancement a correct understand- ing of the principles of corporation finance. The thirty chapters in the volume may be conveniently classified into seven groups: Chapters I-VI present the elements of corporation law. They may be omitted by lawyers, but are essential to all other readers. Chapters VII-XI describe all the methods and in- struments that are used in this country in raising funds for corporations. Chapters XII-XV explain how corporations are promoted, and give in illustration a brief account of the United States Steel Corporation. Chapters XVI-XIX discuss the four methods of selling the securities of a corporation. INTRODUCTION Chapters XX-XXIV deal with the problems of honest financial management of a corporation. Chapters XXV-XXVH discuss the schemes and tricks of dishonest manipulators. Chapters XXVIII-XXX are concerned with the causes of insolvency and the problems of reorganization. The reader should bear in mind that all these questions are treated from the standpoint of corporation officials, not from the standpoint of stockholders or of prospective investors. Additional light may be obtained from the volume on Investment and Speculation^ in which the interests of buyers of securities are kept to the front, and from the volumes on Accounting and on Commercial ■^'^^' W. H. Lough, Je. New York University School of Commerce, Accounts and Finance. CHAPTER I THE CORPORATE FORM 1. "Non-stock" corporations. — Everybody knows in a vague way that a corporation is an association of in- dividuals formed to carry on an enterprise. Compara- tively few people, however, understand just what the corporation is in the eyes of the law or the extent and the limitations of its activities. Obviously, the first step in the study of corporation finance should be an examina- tion of the powers and possibilities of this peculiar and wonderfully effective form of organization. Corporations fall into two distinct groups. There are, first, corporations without capital stock, or "non- stock" corporations; to this class belong almost all churches, hospitals, chartered clubs, universities and other strictly social and charitable organizations. The prime characteristic of such corporations is that the members share equally in all the privileges of member- ship without regard to the amount of money that each may have contributed. There is no arrangement for transacting a money-making business and distributing profits or losses. In fact, non-stock corporations exist either for the common benefit of all the members or for the purpose of serving the public at large. Many in- teresting questions as to the rights and powers of such corporations might be discussed; but the discussion would be out of place in this volume. 2. '^ Stock" corporations, — We are here concerned only with the second class, namely, "stock" corporations; i-i 1 ^''"'' • 'COftPOfeATION FINANCE Tto this class belong all business corporations. Two ap- parent exceptions, mutual insurance societies and stock exchanges, both of which are ordinarily "non-stock" corporations, may be noted; both organizations in their fundamental character, however, are simply clubs which, like many other clubs, offer to their members certain valuable privileges. "Stock" corporations, on the other hand, are formed with the object of carrying on busi- ness ventures; they have a capital stock divided into transferable shares; they are intended to make profits which are to be distributed to their members, or stock- holders, in proportion to the number of shares each one possesses; each stockholder secures his shares by pur- chase for valrable consideration from the corporation or by transfe. from some previous stocldiolder ; each stockholder is c owner of the corporation and its assets to the extent of the number of shares that he holds. 3. Definitions, — The most famous definition of a corporation, and a definition that in its main features is as sound to-day as it ever was, is that given in the Dart- mouth College case in 1819 by Chief Justice Marshall of the United States Supreme Court, who referred to a corporation as "an artificial being, invisible, intangible, and existing only in contemplation of law." Blackstone, author of England's greatest legal text-book, gives a definition that is almost as well-known as Chief Justice Marshall's in the following words: "A corporation is an artificial person created for preserving in perpetual succession certain rights, which being conferred on natural persons only, would fail in the process of time." You will note that this definition emphasizes the most striking distinctive feature of the corporation, namely, its artificial personality. The corporation is an entity or being in itself, apart from the persons who organize THE CORPORATE FORM S and own it. Let us review some of the results of this legal fiction that the creation of a corporation brings into the world a new person, — artificially created, to be sure, but yet endowed with many of the powers of an ordinary human being. In the first place, as the corporation has an existence apart from the lives of any or all its owners, it is not broken up by the death or withdrawal of any owner. In the second place, the corporation has the right to buy and sell and contract debts in its own name and for itself; it may even owe money or lend money to some or all of its owners. In the third place, it may sue and be sued in the courts, without thereby involving any of its owners. In the fourth place, it may enter into all kinds of legal contracts, just as an individual might do. 4. The fiction of ^'corporate entity" — Here, then, is the first and most fundamental fact about the corpora- tion for the student to grasp and keep always clearly in view, that itils a separate, distinct artificial person. It is true that within the last few years the courts of the United States have shown a strong tendency to go be- hind this artificial personality and to throw responsibility on the owners and managers of a corporation, especially in case of fraud. Clark, the author of a standard legal work, says: That a corporation is a legal entity, separate and distinct from the members who compose it, is a mere legal fiction, in- troduced for the convenience of the corporation in transacting business, and of those who do business with it ; and, when urged to an intent and purpose not within its reason and policy, the fiction will be disregarded, and the fact that the corporation is really a collection of individuals will be recognized, even at law. Courts of equity, in every instance, look behind the corporate 4 CORPORATION FINANCE entity and recognize the individual members and will do so when- ever justice requires. Yet the fact remains that the corporation's existence, property, contracts and debts all adhere to the corpora- tion itself and not to the individuals who together own the corporation. It is true, also, that this artificial per- son, the corporation, has neither mind nor body and can- not therefore think or act. The law, however, easily gets over this difficulty by treating the managers and officers of the corporation as agents empowered to carry on its operations. \ 5. Corporations in ancient nations, — This fiction of artificial personality seems to be at first sight an un- necessary and even absurd idea, and the results that fol- low from the adoption of this fiction appear more like the spinning of legal cobwebs than the working out of common-sense principles. But a little further study reveals that the corporate form substantially as it exists to-day has been used by many ancient and modern nations. It seems, therefore, that there must be some good reason or reasons for its widespread use. The archaeologists tell us that as far back as the prosperous days of Babylon the inhabitants of that ill-fated country in their commercial transactions used corporations some- what as we use them now. The Romans also developed and made great use of the corporate form of organizing enterprises. Indeed, it is asserted by Blackstone, and was at one time universally believed, that our modern corporations are descendants in a direct line of the ancient Roman corporations. Although this theory is no longer fully accepted, it remains true that the Roman law with regard to corporations has had considerable influence in the development of our modern corporation law. Without going further into this historical survey. THE CORPORATE FORM 5 which is a little outside the scope of this book, we may lay down this generalization, that in almost every great active commercial nation the corporate form of organ- ization has sooner or later come into existence. It must, then, we may be sure, have some clear and important business advantages. 6. Popularity in modern times, — This conclusion is confirmed when we reflect that along with the marvelous business development of the last century there has been apparent a more than proportional increase in the num- ber and importance of corporations. At first only large enterprises, such as railroads, steamship companies and great manufacturing establishments were so organ- ized. Later the smaller factories and wholesale estab- lishments followed the lead of the larger concerns. Finally within the last few years we have witnessed both in Europe and particularly in this country the extension of the movement to small manufacturing and retail establishments. The drift in this direction is so apparent that it need not be dwelt upon at any length. Every reader of this book may look around and see with- in his own circle numerous concerns in corporate form which were conducted a few years ago by individuals or partnerships. Unless this tendency receives some unexpected check it will not be many years before the corporate form will be adopted by almost every business, large and small, in the United States. 7. Adaptability to raising large amounts of capital, — Evidently there must be great advantages in the corpo- rate form; otherwise the landslide toward it would long ago have been stopped. It will be worth while to review briefly some of these advantages. Originally, as has been said, corporations were con- fined almost altogether to large enterprises and ^^re used 6 CORPORATION FINANCE principally because of the facilities which they afforded for raising and handUng large amounts of capital. In this respect they are obviously far superior both to in- dividuals and to partnerships. Not even the richest individual — ^not John D. Rockefeller nor Andrew Car- negie nor Lord Rothschild — would be able out of his own ^ resources to build and operate one of the great railroad systems of the United States. Even if one of these men were able individually to take care of an enterprise of this size, he would not care to do it. Men of great wealth do not consider it advisable to put all their money into one business. They scatter their investments, so that if one proves a failure profits on the others may more than counterbalance the loss. Nor would a partnership, great and wealthy as some partnerships have been, be an efficient method of bring- ing together the vast amounts of capital that are re- quired for every great enterprise. It would be an extraordinary coincidence if several men of immense wealth, who might conceivably construct and own in partnership a big railroad or a big industrial trust, were able to harmonize inevitable differences of opinion and to co-operate efficiently in a partnership arrangement. It is probably safe to say that in the whole commercial history of the world we could not find a single instance of, say, a billion or even half a billion — perhaps even a hundred million — dollars of capital raised and man- aged under a partnership agreement. It is well to remember in this connection that even the greatest in- dividual fortunes are mere dots compared to the total wealth of a vast country like the United States. Furthermore, of these individual fortunes only a small part ordinarily is free at any one time to be used or in- vested as the owner wills. THE CORPORATE FORM 7 The corporate form, on the other hand, has infinite possibiKties so far as the raising and managing of capi- tal is concerned. Any number of people, large or small, may contribute funds. The American Tele- phone and Telegraph Company, for example, has over 25,000 stockholders, the Pennsylvania Railroad Company nearly 59,000, and the United States Steel Corporation not far from 110,000. A large num- ber of owners of a corporation does not tend to break up and render inefficient the management, for the control of whatever capital the owners contribute is kept in the hands of the officers of the corporation. Thus the corporation, without losing in efficiency, may reach out into the highways and by-ways of the land, draw its capital from a thousand or from a hundred thousand individuals and heap up vast aggregations of capital that could not possibly be obtained in any other manner. For this reason it is inevitable that the corporate form should be used in the financing of! practically every large enterprise. This advantage of corporations, that they are able to collect and to make use of the small contributions of many individuals, though most prominent in great undertakings, is by no means to be overlooked in the case of smaller enterprises. Frequently an inventor or a retail dealer or any small business man who needs a few hundred or a few thousand dollars, could not ob- tain it from his own immediate relatives and friends. The same man, perhaps, may easily raise the capital he requires by organizing a corporation and selling small interests to a considerable number of people. Many a business man has thus obtained necessary capital which he has made the foundation of a fortune. 8. Permanence. — The second important advantage 8 CORPORATION FINANCE of the corporate form is permanence. When an in- dividual owner of a business dies, his business dies with him. It may, to be sure, be carried on by his family or bought by strangers; on the other hand, it may be that no practicable method of disposing of it except at an enormous sacrifice will be found. This is largely a matter of chance, because no organization for carrying on the business is in existence. A partnership is almost equally subject to chance. When a partner dies, the firm is thereby automatically dissolved. The surviving partner or partners may, of course, form a new firm and take over the interest of the deceased partner. In so doing, however, disputes are liable to occur, especially in those lines of business where the earnings are irreg- ular and the value of the assets is not clearly defined. If the surviving partners are unable to continue the business properly or are disposed to drive a hard bargain, the estate of the deceased partner may be deprived of a large part of its rightful interest in the business. Here, again, there is no permanent machinery for managing the business. The partnership, like the in- dividual business, is subject to all the uncertainties and calamities that beset the lives of individual human beings. The corporation, on the other hand, exists until it becomes bankrupt, is allowed to lapse or is voluntarily dissolved. The death of any man, even if he owns 99 per cent, of the stock of the corporation, does not affect the corporation itself. It is an "artificial being," a creature of the law not subject to the infirmities of human existence. It is so organized that if one officer dies or withdraws, a successor may be quickly chosen. As the corporation exists apart from the persons who own it and as control is vested in its officers, the death or withdrawal of an owner does not at all disturb its THE CORPORATE FORM 9 machinery, and the death or withdrawal of an officer means simply that someone else must be found and ap- pointed to the position. 9. Centralization of control, — This brings us to the third important advantage of the corporate form, namely, its centralization of power and responsibility. In this particular feature it cannot be, of course, supe- rior to individual ownership, but it is far ahead of the partnership. As the law does not recognize in the part- nership anything but a group or association of individ- uals, it follows that each partner is empowered to conduct the business, to buy and sell the partnership assets, to make binding contracts and incur debts. Ordinarily, to be sure, the partners mutually agree to a fixed division of duties and powers, but this division is not supposed to be known or to be binding on outsiders. Each partner, so far as his dealings with outsiders are con- cerned, is the whole partnership. Obviously, therefore, no partnership should ever be formed except between persons who have entire confidence in each other; and even then a partnership often proves an unsafe and inefficient method of conducting business. Except by mutual agreement binding only on themselves, to repeat, there is no clear-cut division of powers and responsi- bilities. Under the corporate form, on the other hand, busi- ness can be transacted only by the duly appointed officers; no owner, unless he is also an officer — even though he hold almost all the stock — ^has any authority to transact business for the corporation. Each of the officers of the corporation, as is explained in the chapter on "Interior Organization," has his sphere of duties care- fully defined, both within the corporation and outside. Persons not connected with the corporation are expected 10 CORPORATION FINANCE to have their dealings only with the duly authorized officers, and if they do not exercise reasonable care in this respect may find whatever agreements or contracts they make invalid. This will be more clearly understood by the reader after a study of the chapters on agency in the volume on Commercial. Law. Furthermore, the relations of the corporate officers to each other are clearly defined and the gradations of authority are so marked that each one may understand clearly just how far he is empowered to act on his own judgment and what questions he should refer to his official superiors. The great advantage of this care in organization and in delegation of power is so obvious that it need not be dwelt upon at any length. A well-managed corporation carries on its affairs with the. precision and smoothness of a well-disciplined army. 10. Transferability of ownership, — ^A fourth advan- tage of the corporate form is the ease with which its ownership may be transferred. An individual owner who desires to sell his property must find a purchaser for all of it at one and the same time. A partner who de- sires to sell his interest in the firm must either make some satisfactory arrangement with the other partners, which may be a difficult matter, or must find a purchaser who offers satisfactory terms and is personally acceptable to the other partners, and that is likely to prove still more difficult. Altogether the problem of withdrawing funds that have been invested in an individually-owned prop- erty or in a partnership is almost always hard and frequently insoluble. Under the corporate form the problem is much simpler. The ownership of a corpo- ration is represented by shares, any or all of which may be transferred from hand to hand without interfering in the least with the stability of the corporation. An owner THE CORPORATE FORM 11 of several shares need not, therefore, find any one person to take all his property off his hands ; he may sell a few shares to one man, one or two to another, and so on, and thus dispose of his property piecemeal. Furthermore, as the corporation is managed directly by the officers, not by the owners, no consideration ordinarily need be given to the question as to whether or not a prospective buyer is a good business man or is acceptable to the other persons interested in the corporation. Women, old men, administrators and trustees of estates, institutions of all kinds — all are possible purchasers of corporate securities. Thus the owner of corporate shares finds his market much broader and his facilities for selling much better than does the owner of a partnership interest. The se- curities of large corporations are constantly dealt in on the stock exchanges of large cities, and thus a continuous and easily accessible market is afforded to every owner. 11. Limited liability, — The fifth and last important advantage of the corporate form is the fact that the liability and possible loss of each owner is limited. Gen- erally speaking, the owner of any corporation security is safe in reflecting that though the security may become worthless and he may lose all that he paid for it, he cannot possibly lose more than that amount. The reader may perhaps think that to the owner of the stock of a failed corporation this statement affords but cold com- fort; but compare his situation with that of a partner in a bankrupt firm. The partner may not only lose all that he invested in the firm, but in addition is personally liable for all the unpaid debts of the firm. As has been explained above^ it is possible that these debts may have been foolishly or even fraudulently contracted by some other partner; yet that fact would not relieve any other partner from his personal liability. No doubt* most la CORPORATION FINANCE readers of this paragraph will call to mind instances in their own experience of individual owners or of partners in disastrous enterprises who have lost everything they owned, including even their homes and most of their personal property, by the failure of such enterprises. If a corporation fails, on the other hand, and its debts prove greater than its assets, the creditors have no claim on the property of the stockliolders outside the failed business. An important exception to this principle of limited liability exists in the case of stockholders of national banks. They are individually liable in case of failure not only for their investment but for an additional sum equal to the -psiT value of their holdings of bank stock. A similar rule applies in California to stockholders of corporations of all kinds and there are one or two other exceptions which are referred to in Chapter IV. Even in such cases, however, though the liability of stock- holders is somewhat greater than with the ordinary cor- poration, it is still strictly limited. No doubt this principle of limited liability has been one of the main advantages of corporations that has led to their formation in a great many cases, and especially has encouraged in recent years the widespread move- ment to change partnerships into corporations. No business man, especially one who has considerable per- sonal property and perhaps is advanced in years, likes to reflect that at any moment, through the fraud or mis- management of some subordinate or partner, or through some unavoidable natural calamity, he may be compelled to give up his home and personal property in order to satisfy the demands of business creditors. The corpo- rate form of business relieves him of this haunting spectre. THE CORPORATE FORM 13 The prominent advantages of the corporate form, which have brought about its great extension in recent years, may then be summed up as follows: r( 1 ) Flexibility. The owners of a corporation may be few or numerous. This makes the corporate form especially well adapted to collecting large amounts of capital by means of small contributions from a great many people. (2) Permanence. The life of a corporation is not dependent on the life or on the caprice of any individual. (3) Centralization of control. Under the cor- porate form the officers of the corporation within care- fully defined limits exercise complete control. (4) Transferability of ownership. Corporate shares may be readily sold either in a block or piecemeal and have a wide market. (5) Limited liability. The corporation alone, with certain minor exceptions, is liable for its own debts and the shareholders cannot lose more than their orig- inal investments^ 12. Disadvantages of the corporate form, — In view of these advantages it maj^ be asked why all kinds of busi- ness without exception are not organized under the cor- porate form. The answer is that certain minor disad- vantages, which in some instances are sufficient to offset the advantages named, are inseparable from corpora- tions. These disadvantages may be briefly summed up as follows: \(1) Increased expense. All states impose certain incorporation fees and annual franchise taxes on corpo- rations, which taxes are in addition to the ordinary state and local taxes on property. These taxes are, however, uniformly small, as the reader may see by turning to the table of fees and taxes in Chapter IV. In addition. \ 14 CORPORATION FINANCE legal assistance is almost always necessary in forming corporations, and there may be an additional charge on this account of from $25 up. These corporate expenses are, of course, too slight to be worth much consideration, except in the case of very small enterprises, where they may sometimes be of sufRcient importance to prevent the adoption of the corporate form. (2) Limited POWERS. As the corporation derives all its powers from the state in which it is incorporated, and as all its powers should be distinctly stated in its articles of incorporation (see Chapter II), it may be somewhat hampered at times by lack of authority to carry on oper- ations that would be profitable. This, however, is a superficial objection that may be readily dismissed; for a good corporation lawyer will always find it possible to include in the statement of the powers of the corporation authority for every act that would be necessary in prac- tice. If not, it is always easy to form a new corporation for whatever specific action is desired, j This point also is further discussed in Chapter II. f(S) Limited credit. A lender of money would, of course, prefer, other things being equal, to lend to an individual or a partnership, rather than to a corporation, because the liability of the owners of the property in the former case is unlimited, and in the latter case, as has been explained, is limited. Thus a partnership which is converted into a corporation will sometimes be em- barrassed more or less by reluctance of its creditors to continue extending credit as freely as before the con- version. This objection, which is of importance usually only in the case of a small and closely held business, may be overcome, if desired, by the officers or certain stock- holders personally endorsing the corporation's notes and bills payable. By so doing they, of course, lose the THE CORPORATE FORM 15 advantage of limited liability, but they retain all the other advantages of the corporate form. There are some business activities, however, in which the personal element is so prominent as to make unhmited liability desirable. A firm of accountants, for instance, could not be changed to a corporation without forfeiting to some extent the confidence of the business public, for every public accountant is and ought to be personally liable to the fullest extent for the honesty and accuracy of his work. The same thing may be said of bankers and engineers, and to some extent of business advisers and systematizers ; for such activities the corporate form, on account of its limited liability feature, is ill-adapted. (4) Governmental control. Some concerns are strongly averse, for good reasons, to any publicity what- ever as to their operations and financial results. They may perhaps be making so much money that they desire to keep it secret in order to avoid attracting competitors ; or their real business may be quite different from their ostensible business, and they would not desire to attract attention to this fact by the inclusion of unusual powers in articles of incorporation. For fear of governmental supervision, therefore, they retain the partnership, even with all its disadvantages. The reader will readily see that this list of disadvan- tages of the corporate form does not include anything of great importance to most legitimate kinds of business. Certainly the disadvantages are of little weight in most cases in comparison with the obvious and substantial gains that may be had by adopting the corporate form. We are justified in concluding, therefore, that the tendency toward the corporate form of conducting busi- ness, which has been referred to above, will not dimin- ish, but rather will increase in the coming years. The 16 CORPORATION FINANCE corporation is the efficient twentieth centuiy means of conducting business. In city and in country, from the captains of finance to the smallest units in the army of business, in transportation, in manufacturing, in trad- ing, even in farming, the corporation has come to be recognized as the best form yet discovered for organizing the production of wealth. 