Doctor Dorau is a consultant on business economics. He was a member of the President's Conference on Home Building and Home Ownership, 1931. He is a member of Phi Beta Kappa, the American Economic Association, and the American Statistical Association. In addition to contributions to The Journal of Land and Public Utility Economics, he has published the following works:

Real Estate Merchandising (with A. G. Hinman), 1926
Urban Land Economics, 1928
Municipal Ownership in the Electric Light and Power Industry, 1929
Materials for the Study of Public Utility Economics, 1930
Economic Principles and Problems (with others), 1932

F. S. BURROUGHS, Vice President.



An opinion by Herbert B. Dorau, Ph. D., Associate Professor of Economics,

New York University


The following analysis of the place of the holding company in the organization and functioning of the electric and gas industries represents in substance the conclusions freely expressed upon several occasions.

After reading substantial portions of the testimony presented for and against the Holding Company Act of 1935, it seemed unfortunate that more attention was not given to some of the more fundamental economic considerations. In the belief that the long-run consequences of the proposed or substitute legislation dealing with holding companies will be good or bad to the extent that it recognizes or fails to recognize such fundamental economic considerations, this opinion is offered, with the permission of the Committee, as a part of the testimony and record of the hearings on the Holding Company Act of 1935 before the Committee on Interstate Commerce of the Senate of the United States.



The holding company has proved to be, and still is, a useful legal-economic device for the most effective organization of the public-utility industries. Every good thing has been sooner or later abused. The holding company is not an exception. Because it has proved so genuinely and generally useful, the holding company may have been more abused than institutions of less consequence. The corporation itself, which is by many acclaimed as the most significant and useful legal-economic invention of man, while widely abused, is nevertheless on net balance accepted as a socially desirable institution. Progressive thought looks toward its perfection rather than its destruction. Continuous adaptation of such institutions to changing social needs and circumstances is the method of steady reliable progress, but to follow the cry for the destruction of all imperfectly functioning economic institutions can only lead to economic disorganization and decadence.

The issue between the desire to destroy and the need for regulation has rarely been more clearly drawn than in the proposed act to abolish holding companies in the electric and gas industries. In order to see this issue clearly, and not be confused by words and phrases, it must be understood that it is very easy also to destroy in the name of and by the method of regulation. To regulation, honestly and intelligently conceived to perfect the working of an economic institution, there should be no disinterested objection. Destruction however, that needs to parade in the form of regulation is properly open to suspicion.

The holding company is a device which can and should be made to serve socially desirable economic ends more effectively rather than be destroyed or regulated out of existence. The method of abolitionism and prohibitionism has so frequently created more problems than it has solved that as a general principle it deserves little adherence.

11. THE PRIMARY FUNCTION OF THE ROLDING COMPANY In the broadest sort of way the holding company is a device for bridging the gap (a period of time) between the stage of industrially isolated plants and the stage of more or less complete industrial integration. Its peculiar usefulness is as an instrument for business combination where unified industrial operation is either, (1) not technically feasible or economical, or (2) is prevented by law.

The gas and electric industries are characterized by decreasing costs, increasing returns, and thus the possibility of lower prices to the consumers. They are, therefore, industries where increasing size is accompanied by generally lower costs. The substantial and comparatively consistent decrease in the cost of electric service, even during periods of generally rising prices, is largely attributable to the increasing scale of industrial and business organization.

In the first instance it is of course recognized that economies arise out of im. provements in technology. Most of the improvements in technology were, however, limited in their most economical application to the large-scale undertakings. While economies of large-scale undertaking in the utility industries are well recognized by those acquainted with the technique of these industries, the fact is however frequently overlooked that these economies are of two distinct types:

1. Industrial economies: Those arising in the course of plant construction and operation,

2. Business economies: Those arising in the course of business management as distinguished from industrial operation. Here would be included the economies of transactions—buying and selling, bargaining for capital, for materials and supplies, and all relations with consumers.

It is well understood that in public utilities, as in other industries, the size and character of the market determines the economical size of the undertaking, i. e., the size of the industrial establishment. It is thus obvious that a public-utility operating company will have access to the economies of large-scale production in proportion to the size of the market which it can economically serve. Thus an operating utility controlling a large compact market will have substantial access to both (1) the industrial economies and to a considerable extent (2) the business economies which flow from large-scale organization,

By the same token, then, an operating utility having economical access to a small or thin market cannot have access to the industrial economies available to the large-scale undertakings. This handicap of the small electric market and the enterprise serving the small market was somewhat reduced in the years following the war by the building of transmission lines. Transmission and interconnection have progressively made some of the economies of large-scale centralized production available to the smaller market. The cost of transmission and interconnection obviously stood in the way of passing all the economies of the large-scale central production on to the consumer in the smaller market. In fact it is probably true that interconnection in the electric industry has contributed more to improving the quality of the service than to reducing its cost. It is therefore probably also true that cost reduction for the interconnected, small, distant, markets is due more to the business economies that have been achieved by centralized management than to the economies of large scale central production which remained after deducting the cost of transmission and interconnection.

There are thus two ways in which an operating utility controlling a small market may secure access to the economies of large establishments.

1. Secure some of the industrial economies of large-scale production by distributing electricity or gas produced under the more economical conditions of large scale centralized production.

2. Secure the business economies of large establishments as part of a holdingcompany system or under contractual arrangements with large-scale management firms. The latter alternative is obviously incomplete since it cannot offer the economies of large-scale financing with diversified risk.

Public utilities differ markedly from industrial concerns in their economic characteristics. It is largely because of these differences that the holding company has served a more necessary and useful purpose in the organization of the utility industries than in other classes of industries. It is to be noted that industrial concerns, producing more or less readily transportable products, can, within large limits, choose the size of the market within which to operate. The size of the market which they can establish determines in a large way the profitable and economical size of the undertaking. Industrial concerns, moreover, are not limited by franchises and political boundaries. In contrast, public utilities are

far more limited in the profitable and economical size of industrial plant by the natural factors of distance and area.

The electric and gas utilities have been called "local service industries.” The scope of "local" has however changed materially. It is a simple matter of observation that where the market is substantial and uniform over a wide geographic area this local service industry may cover territory several hundred miles in extent. Similarly there are large portions of the United States where markets for utility services are small and separated by long distances in which little or no demand for the services exists. Accepting the dictionary definition of “local", these industries are and are not local service industries depending upon the economic character and size of the market for their services. Much of the testimony in favor of the Public Utility Holding Company Act of 1935 has emphasized the fact that these industries were local industries. Insofar as this testimony accurately represents the fact it is the most effective argument in favor of the retention of the holding company. To the extent that this local industry is industrially small scale it does not have access to economies of production for larger markets. But these circumstances, largely natural in character, need not however bar the smaller market from the benefit of all the economies available in the larger markets. The business economies of large-scale undertakings can be brought to the smaller (local) markets through the facilities of the holding company.

The Holding Company Act of 1935 appears completely to have overlooked this fundamental economic basis for the existence of holding companies. This legislation proposes “eliminating therefrom (holding companies) properties not economically and geographically related in operations." Whatever may be meant by "economically related" certainly the reference to "geographically related" indicates a lack of understanding of the place and service of the holding company.

The absolutely contrary view is here offered, namely that the special function of the holding company is to unite in a business way those operating utilities which are not geographically contiguous and which are therefore not economically integratable on an industrial or operating company basis. Incidentally, it may be pointed out here that there are some useful ends to be gained by not having one company control all the service in a given territory, particularly where this does not involve sacrificing the substantial economies which could be obtained by physical integration. Such is not infrequently the case outside of the more densely populated territories. Some division of ownership and management, under these circumstances, may indeed introduce a desirable form of service competition in an industry where other competition generally is so wasteful and therefore properly avoided.

If the foregoing constitutes a sound analysis of the place and function of the holding company in the public-utility industries, it must also be recognized that the significance of the holding company is less as these conditions disappear. Increases in the size of operating utility companies decrease the significance of the economies which can be obtained in association with a holding company. This does not mean that operating units would necessarily reach the point where a holding company could not be of some, or even material, service, particularly in matters involving broad managerial policies and above all the provision of equity capital. There are already instances at hand where the holding-company form of organization has been superseded by the unified operating company after the market and territorial development justified this step. There are other well known cases where operating company consolidation would undoubtedly take place if the laws of the State or the provisions of franchises permitted this natural tendency to work itself out.

The question is often asked, How large must an operating utility become before it can by itself have access to both the industrial and business economies of large scale production? The answer seems to be that this depends on the nature of the business transactions involved. Some holding companies, whose subsidiaries are small operating units, have found it economical to handle billing and accounting and in fact almost every business activity of their subsidiaries.

This would appear quite justifiable where operating properties were very small. In other cases, where the operating properties were large and where they are apparently able to carry on most of their routine business transactions for themselves it was nevertheless found that the holding company could most economically perform certain financial functions such as providing increased equity capital. În general the trend has been for the operating unit to do more and more for itself as it grew in size. It has been noted that holding companies whose subsidiaries were small tended to perform a great variety of functions while holding companies


whose subsidiaries were large restricted the variety of their services, rendering primarily the financial, public relations, and legal services. Actually, some of these holding companies have evolved into a form quite accurately designated as investment company. In this connection it is also worth noting that, in its normal development, a utility-operating concern would easily achieve most, and possibly all, of the economies of industrial bigness before it was sufficiently large to have access to all or most of the business economies available.

Taking the point of view that the holding company has proved a useful device in facilitating the transition of the electric industry from a small scale to a large scale and better integrated industry, the question may properly be asked, Has this function now been completed?

In some territories the holding company has been in transition for a number of years. In the interest of economy many managements have progressively simplified their corporate structures by eliminating the holding company where it was no longer needed. In some instances this process has ended in single unified operating companies. In other cases single unified operating companies in effect have been a result even though corporate entities had to be maintained for legal

In other cases where operating properties were too widely distributed, the holding company evolved into the investment company.

But the United States is not uniformly developed. The market for publicutility services has not grown uniformly, as intensively and extensively, nor as rapidly in all portions of the country. There are still large sections of this country where almost all of the diverse functions of the holding company constitute useful economic services. Moreover there are very few sections so developed and integrated that the holding company cannot perform some useful service. In general the less urbanized, the less industrialized and less densely populated sections evidence a lower degree of industrial integration among utilities and therefore a larger scope of service for the holding company.

As yet there remains a substantial place and function for the holding company. May it not be expected that the holding company will continue to eliminate itself in extent and reduce the functions performed as the necessity for its existence and service declines? In other words, may not the holding company be expected to eliminate itself as rapidly as the need for its transitional services disappears?

To organize numerous operating companies into a single unified operating company, even after that is fully justified from an economic point of view, unavoidably takes time. Usually the opportunity to absorb one company does not coincide with the appropriate or strategic time to do so in respect to another. In any case the lag in the transition from holding company to operating company (assuming the properties to be so located as to make this feasible) beyond the time when the holding company no longer is useful, will, it is believed, be largely explained by circumstances beyond a company's control or not immediately under its control. Important among the external factors which often account for the existence of a holding company where one might not otherwise exist are contractual restrictions in security agreements often not readily adjustable or economically changeable until the securities mature; and restrictions on the sale or transfer of franchises. It is well known that the sale of assets or the transfer of franchises, if permitted at all by the political jurisdiction, tends to imperil existing privileges. State control over the transfer of assets may impose burdens or involve concessions on the part of the company which are postponable as long as the status quo maintains. Substantial reorganization from the holding company status to that of a consolidated operating company frequently depends or waits upon favorable security markets or opportunities for financing or securities exchange.

Assuming that there is a desire to recognize and to be guided by the fundamental economic factors which have governed the growth of the holding company as well as by an appreciation of the abuses which have crept into the use and administration of some of these concerns, the reasonable conclusion would seem to be that it is possible to prevent the abuse of the holding company without being arbitrary, punitive, and destructive of the useful function which the holding company device still can most effectively perform under many conditions. Any other conclusion seriously raises the question whether this legislation is really aimed at eliminating the undesirable practices that have crept into some holding-company organizations or whether these abuses are but an excuse for achieving other substantially unrelated ends. If the purpose of this legislation is not to take the power of regulating public utilities away from the States or if the purpose is not a surreptitious round-about method of achieving Government ownership, then the logic of the argument in favor of regulation rather than destruction of holding companies seems unanswerable.

III. THE HOLDING COMPANY AND BIGNESS IN INDUSTRY Not a little of the testimony offered by the proponents of this legislation leaves the impression that the purpose of the Public Utility Holding Company Act of 1935 is to attack “bigness as such." The real crime of the holding company seems not to consist of that catalog of malfeasances which is offered as the reason for this extreme legislation but rather hat of having created bigness, a bigness that is strong, efficient, and probably thought to be too powerful under a theory of government whose own expansive principle is the grasp for ever more power. If this is a part of a campaign against bigness at least two considerations should be clearly brought forward.

The economic characteristics of public service industries are such that here more than in any other significant group of industries bigness leads to economy. Business organization and combination in many classes of industry may well have gone beyond the size limits necessary to obtain all the available economies. It is rather well understood that the first stage in the consolidation of competitive industry is the result of the desire for economies of large-scale operation. Larger profits are to be obtained by lowering costs. The second stage commonly sets in when these economies have been substantially achieved. The way to get even larger profits at this stage is to get higher prices. Thus the second stage is characterized by combinations for the purpose of market control and price fixing. This is probably not the place to call attention to the details of this long developing trend in American industrial organization. It is entirely pertinent, however, to point out the absurdity of relating the public utilities to this situation.. Here we have a class of industries where control of the market is characteristic of most companies' operations. The last 20 years of the combination movement in the electric light and power industry afford a ridiculously small amount of evidence to support the idea that combination in that industry was motivated by the desire to eliminate competition and obtain control of the market. All these things the “local" utilities already had or were achieving by public recognition of the economy of one company serving one market. The competition which the electric industry has to face is competition of a very different sort.

Furthermore, the 20 years in which the electric industry has developed from an isolated to & substantially integrated industry has been the period in which public regulation of one form or another has assumed to fix and determine the prices for public utility services. Neither the conditions nor the inducements which have brought about the unjustifiable bigness in nonutility industries have been operative in the utility industries. When an industry reaches the stage of being as intimately regulated as the electric and gas utility industries are, mere bigness no longer constitutes a problem about which there need be much public concern.

If mere bigness were socially undesirable and a threat to public welfare, that threat should be looked for in unregulated bigness, a bigness which is uneconomic insofar as it is the result of a desire to control markets rather than achieve economy. We have the curious condition of uneconomical and unregulated bigness being passed over in favor of attacking the straw-man threat of bigness in an industry where the economies of bigness are yet far from being exhausted and where this bigness is already under substantial regulation. These things are hard to understand.

If such be the more remote purposes of this legislation against holding compan ies, thoroughly practical considerations must be responsible for beginning action against the utility industries. Possibly it has nothing to do with economics. Could it be that because of the long siege of propaganda to which the publicutility industries have been subjected for the purpose of establishing their villainous character, the public will more readily stand for such an undisciplined program, inapplicable though it is to the public-utility industries? The more than 7 years of purgatorial trial to which the electric industry was put have no doubt prepared the ground in the public mind for almost any kind of action. To take advantage of a properly conditioned state of the public mind would seem to be the only rational explanation for beginning with the public-service industries in an attack on bigness.


Arbitrary abolitionism applied to holding companies in the form of a death sentence, maturing in 1940, constitutes an unnecessary destruction of legitimate values and property. That such action as this legislation proposes will prove highly deflationary and thus add to the heavy losses which the people have already experienced appears to be the almost unanimous expectation of all not

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