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his own profit." * But this is after all an incidental phase of the bigger problem of obtaining an adequate supply of investment and working capital as the most essential means of increasing profits and extending markets. The promoter was not really the power behind the throne of America's big business developments. He was rather the midwife than the parent. The real dynamics in this industrial growth was the world's faith in the future of America faith that took our securities and salted them away in the investor's boxes of Europe and America, or temporarily held them for expected enhancement in value. In this work of issuing and distributing securities the banking and the speculative agencies of the world played a much larger and a more enduring rôle than the promoter.
Nothing but confidence in the earning power of American industries could have attracted so vast an investment fund as flowed into largescale enterprises, especially from 1895 to 1902. According to Commissioner Luther Conant that was the most active period of consolidation. His estimate of the stocks and bonds issued by eighty-seven consolidations between 1887 and 1897 was $1,414,294,000. But within the next three years (1898-1900) 149 consolidations were capitalized at $3,784,000,000.
Corporation Finance, E. S. Mead. D. Appleton & Co., New York. Chs. II-III.
an informing study of the investment merits of industrial securities,* Dr. A. M. Sakolski summarizes the security situation at that period of "undigested" issues as follows:
2. Insufficient working capital
3. Insufficient integration 4. Inexperience with conditions
1. Conservative dividend policy
2. Build up capital surplus 3. Better knowledge of markets, etc.
4. Stability of earnings,
All of these defects were the marks of promotion bent upon manufacturing securities for the purpose of unloading them on the public. All of these merits were in no small part the result of banker and business management aiming to build safely out of the investors' supply of capital.
2. Capitalization and Promoter's Profits
Nevertheless, in spite of the odium attached, promotion of combinations between 1890 and about 1910, covering a period of twenty years, came to be recognized almost as a new financial profession. In rank the promoter stood on a par with the trust lawyer and the trust manager. It was the function of the promoter to bring various proprietors together on some scheme of consolidation to which the participants were will* Journal of Accountancy, July, 1911.
ing to affix their signatures. It was the function of the trust lawyer to see how near promoting genius could go to the quick of the law in effecting combination of maximum capitalization. The work of the third functionary, the supervisor, the commissioner, or manager of the combination, was to enforce penalties and maintain discipline both in the industrial and the commercial end of the business.
It was to the promoter's interest generally to work for a capitalization as large as was salable. All that the speculative appetite would take he would give it. On that account his estimates of the valuation of the separate plants invited to enter the trust were often liberal beyond the hopes of their owners. Price was not a question of his, so long as the public paid for it.
Much of this promoting was done in periods of extraordinary prosperity, and then on the basis of net earnings. The ill-fated American Bicycle Company was made up out of plants which for a given period had net earnings of $3,500,000. This sum added to the estimated values of the properties gave total assets exceeding $20,000,000. On this basis the authorized capital of the company was placed at $35,000,000 preferred and $45,000,000 common stock, of which $10,000,000 preferred was issued and $20,000,000 common together with $10,000,000 of five per cent twenty-year debentures. The organizer of the bicycle trust bought the prop
erties from the sellers with so much of the preferred and common stock as was required by his bargain with them, retaining the remainder in his own hands as promoter's profits.
One strong purpose, probably the strongest, in over-capitalization is to conceal profits. As Greene originally pointed out, the prejudice in the public mind against high rates of profit or dividends resulted in capitalizing the surplus assets by stock distribution. To this device the Standard Oil Company, for instance, never resorted. Its properties are in this sense generally under-capitalized. In other cases, the rule, in consolidating several companies, is to capitalize promotion services, good will of original owners, business connections and intangible assets by issues of common stock. Thus the future basis of claims on dividends is broadened while the necessity for working capital is ignored or scantily met.
It was much the same in other formations. The single industry on going into the first consolidation probably doubled its security capitalization. When the next step was taken into the trust proper, its promotion may have called for another increase, in order to capitalize opportunity for enhanced earning power due to a more complete control of the market. But that was not the end. The Tin Plate Trust, the Steel
* Corporation Finance, T. L. Greene. G. P. Putnam's Sons, New York.
Hoop, and the Sheet Steel were each so highly capitalized as separate trusts as to amount to a total of $144,000,000 late in the nineties. Yet within the next few years (1902) they were taken into the Steel Trust at $219,000,000.
One can easily see now how such a persistent inflation of security issues might cripple business in its borrowing of capital. If every reorganization were to call for a new dose of inflated issues, based on an earning power which left years of adversity out of account, then the premium is put on skinning the maintenance account for big book profits as a new basis for reorganization. Yet this whole method of procedure, Fay claims, "is honest enough, if the earnings justify the capitalization and the prices at which the shares are distributed."*
3. Risk Elements in Trust Capitalization
Yet over-capitalizing has its legitimate uses. In corporate issues bonds are taken to represent the value of the actual property as a going concern with a considerable margin of safety even in the least prosperous periods of business. The preferred stock is regarded as representing that portion of the demonstrated net earning power which can be certainly spared after deducting interest on bonds from net income. Where that
* A lucid exposition of over-capitalization in railway fields is given in Railroad Promotion, F. A. Cleveland. Longmans, Green & Co., New York. Ch. XVII.