THE CORPORATION

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THE CORPORATION

The study that we have thus far made of the various kinds of businesses would be incomplete did we not briefly outline the different types of organization by which modern business is conducted. This will naturally lead us to a discussion of stocks and bonds, which are of great importance in every big business and of interest to individuals as means of investment. However, as the subjects are probably outside the experience of most students, we shall treat them as simply as possible, letting the chapter stand rather for the information it contains than for its application to the study of English expression.

Business to-day is carried on in three different ways; viz., by individuals, by partnerships, and by corporations. The grocer, the butcher, the baker, or any one man who carries on a business is an example of the first. If, however, the grocer and the butcher, or the grocer and the baker, combine their businesses for the good of both, they form a partnership. When the amount of capital necessary for carrying on the business becomes so large that the money of many people is needed, a corporation is formed. The amount of money which any one individual invests in the company is represented by a certain number of shares of the capital stock of the company, entitling him to his portion of the dividends, or interest on the money he has invested. These shares of the capital stock are transferable and can be bought and sold like an automobile or a house. Since there is no time limit as to how long a corporation may do business, a change in the ownership of part of the stock, or the death of a stockholder, is not accompanied by the same result as in a partnership, where the death of one of the partners sometimes breaks up the business. Furthermore, in a partnership each one of the partners is personally liable for any debts made by any of the partners in behalf of the business, whereas the personal possessions of a stockholder in a corporation cannot be held as security for any debts incurred by the corporation. These are two of the more important advantages of corporate organization over partnership.

The Finances of a Corporation

It has been estimated that if one were to count money, dollar by dollar, one dollar every second for eight hours six days a week, it would take him six weeks to count one million dollars, and over one hundred years to count a billion dollars. This may help us to appreciate the sums of money spoken of in the following: In 1914 the market value of the Commonwealth Edison Company of Chicago was over $83,000,000. The valuation placed on the properties of the Chicago Railways Company in 1914 exceeded $79,000,000. The Union Pacific Railroad Company had invested in its properties in 1914 approximately $500,000,000. The capital obligations of the United States Steel Corporation in 1914 were over $1,500,000,000. There are hundreds of such organizations in our country, the investments in which run to and beyond $50,000,000 each. It must be plain that, except in a very few cases, these vast amounts of money do not represent the investment of one, or of a few, but of many persons. In uniting their capital, these persons decrease the cost of making or distributing the product and so increase their profits.

Stocks

When a large company of this kind is organized, a certain amount of money is agreed upon to be the capital of the company, and it is divided into small portions, ordinarily $100 each, called shares. The total of the shares is called the authorized capital stock. These shares are sold, the purchasers of the shares being called shareholders, or stockholders, of the company. The number of shares a person holds determines what part of the profits he is entitled to. For example, if a company is organized for 1000 shares of $100 each, or a capital stock of $100,000, and you owned 100 shares, you would be entitled to one-tenth of the divided profits of the company. Such profits of the company, divided proportionately among the stockholders, constitute the dividends.

Often the capital stock is of two kinds, preferred and common, as in the case of the Union Pacific R. R., which has $200,000,000 of authorized preferred stock and $296,178,700 of authorized common stock. As the names signify, preferred stock is ordinarily better than common stock, the dividends on preferred stock being paid before any dividends are paid on common stock and usually at a stated rate of interest; as, 4, 5, or 6 per cent. In the case of the Union Pacific, this rate is 4 per cent. If the company earns only enough profits to pay the dividends on the preferred stock, the common gets no dividends. On the other hand, if the profits are enormous, the common occasionally gets more than the preferred.

Par and Market Value

The par value of a stock is the face value of one share of stock, indicated on the face of the certificate. This may be $10 or $50 or $100, whatever the amount agreed upon for one share when the company is organized. The amount most commonly used as par is $100. The market value of the stock, however, need not be this amount, but may be greater or less, dependent on how successful the company is and what rate of dividends it pays. If a company's standing is very good and the dividends are high (over 6 per cent), the stock will probably sell on the market above par. If the company's finances are in a doubtful condition and there are evidences that the company will pay small dividends, if any at all, the market price of the stock will fall below par. For example, in January, 1914, Union Pacific R. R. common stock sold for about $158 per share, because the finances of the company were in good condition and the company had paid 10 per cent dividends steadily each year since July 1, 1907. If, however, any occasion should arise to make the public doubt the payment of future dividends at the same rate, the stock would probably decline. To go to the other extreme, in the same month Wabash R. R. common stock sold as low as $8½ per share, although the par is $100. This was because for some years the company had paid no dividends and was then in the hands of receivers. To take a middle case in the same month and year, Erie R. R. first preferred stock sold at about $45 per share, notwithstanding the fact that since 1907 no dividends had been paid. The reason for this seemingly high price was that the company had for some time been reconstructing its property, had gradually increased its business, had earned a $9,000,000 surplus in 1913, and had a good outlook to a dividend in the near future.

These are not the only influences that affect the price of stocks. The old factor of supply and demand has a great influence on price. If, for example, a financier decides to buy a large "block" of some stock, the market will almost immediately be affected, and that stock will go up. One example will suffice. In 1901 E. H. Harriman set out to buy $155,000,000 worth of Northern Pacific stock in the open market to gain control of the Northern Pacific railroad. Of course, the market felt the demand, and the price of the stock rose from a little above par until it touched $1,000 a share before it started back to normal. When Mr. Harriman unloaded that same stock in 1906, because he failed to gain control, the market went down so considerably that he lost $10,000,000 and almost caused a panic.

Often the stocks of a company sell below par because the stock is watered; that is, the company has issued more stock than there is value invested in the property. Many of our railroads, for example, were built on borrowed money—that is, from the proceeds of the sale of bonds—and, to make the bonds sell more readily, stocks were given away with them. This, of course, increased the capitalization greatly without increasing the value. The temptation in forming new companies, especially in mining schemes and wildcat ventures, is to water the stock heavily by voting a large block of stock gratis to the organizers. Before one invests in any of these companies, he should thoroughly investigate them. Sometimes companies water their stocks when their dividends have become very large and they wish to bring the rate down to that commonly paid. The Wells Fargo Express Company did this in 1910, presenting their stockholders with $16,000,000 worth of new stock without any new investment in the property.

Bonds

Suppose that A owns a house with a store in it, and in the store he carries on a grocery business. Suppose that by enlarging his store and putting in a bigger stock of goods he can make more money. The improvements will cost $1,000, but he hasn't the money. He goes to B to ask B to lend him $1,000 for five years, offering B the house as security. B gives A the $1,000 and in return gets a certain amount of interest each year and A's mortgage note against the property. This means that, if at the end of five years A cannot pay the $1,000, B has the right to sell A's house and collect the money due him.

When a corporation borrows money to extend its properties, plants, or rights, the transaction is really the same, although the form is somewhat different. Just as all the capital stock of a corporation is divided into shares owned by a number of people, so, when the corporation borrows money, the amount borrowed is divided into smaller parts of $500 or $1,000 each, called bonds, which the corporation sells through its bankers to people who have idle money to invest. Twice each year, as stated in the bond, the corporation pays interest on the borrowed money at the rate, probably, of 4, 4½, 5, or 6 per cent. After a definite number of years, as stated in the bond, the corporation is obliged to pay back the amount of money that it borrowed. This is called redeeming the bonds. To show that it intends to pay back the amount borrowed at the end of the time stated, or redeem the bonds when they become due, the corporation puts a mortgage on its real estate, buildings, machinery, and equipment. When the bonds become due—or mature, as it is called—if the corporation does not pay back the amount borrowed, the holders of the bonds may take possession of the company's real estate, buildings, machinery, and equipment on which the company has placed the mortgage and may sell them to recover the money they have loaned. Thus, while the stockholders of a corporation have no assurance that they will ever get their money back or will ever get any interest on it, the holders of carefully selected bonds are reasonably sure of getting a certain amount of interest each year and of getting their money back when the bonds mature. Shares of stock represent the investment made by the stockholders who own the company, whereas bonds represent the investment of those who loan money to the company. We can readily see, then, that the stockholders take the greater risk. For this reason it is expected that stocks should yield a higher profit than bonds, and this is usually the case.

The greater portion of the bonds that are issued by corporations run for long periods—twenty, forty, fifty, and even one hundred years. At times when money rates are high, corporations that need funds are reluctant to pay a high rate for so many years, and so they issue short time bonds to run from two to five years, in the hope that at the end of the time money rates will be lower and more favorable to their issuing long time bonds. Many companies, especially industrial corporations and railroads, have issued obligations to pay, notes running from six months to five years. They are not usually secured by a mortgage on the property but are merely the company's promise to pay, the interest and the principal taking precedence over the dividends on the preferred and the common stocks.

Corporate Organization

Before a corporation can carry on its business, it must obtain a charter from one of the states of the United States, whose laws it must obey. The laws of some states are more lenient than those of others, allowing the corporations more privileges. New Jersey is thus lenient; consequently we find many large corporations—such as the United States Steel Corporation, the American Sugar Refining Company, and others—organized under the laws of New Jersey. After the charter is granted and the stock bought by the stockholders, the latter have a meeting, at which they elect a small number of men to be directors, who, as the name signifies, conduct the business of the company for the stockholders. They choose a president, one or more vice-presidents, a treasurer, a secretary, and any other officers necessary to carry on the business under the control of the directors. The term of office of the directors is usually so fixed that the term of a part of them expires each year, so that each year the stockholders have an annual meeting at which they elect new directors or re-elect the old ones whose term has expired.

The Railroad

Corporations divide themselves into three large groups; viz., railroad companies, public utility corporations, and industrial corporations. Of these, the group composed of the largest and most powerful corporations is the railroad group.

Railroads have two general sources of income, the larger being the revenue received from operating trains, both freight and passenger; and the smaller being the return from investments in other companies, from real estate, and from the rental of lines, terminals, stations, and cars to other railroads. To carry on the second or smaller part of its business, the company needs an organization much like any other business, but to conduct the first part it requires a special organization. This divides itself into four departments, usually with a vice-president at the head of each: (1) the traffic department, (2) the operating department, (3) the finance and accounting department, and (4) the legal department.

It is the duty of the traffic department to get the business for the company and adjust all traffic claims. In short, it does everything to increase the business and the earnings. This department naturally divides into the freight traffic and passenger traffic departments, with a superintendent or manager at the head of each.

After the traffic department has solicited the business for the company, it is the duty of the operating department to render the services required by the traffic department. The work is done by four large divisions: (1) the engineering or construction department, whose duty it is to build the roads over which the company may operate; (2) the maintenance-of-way department, whose duty it is to see that the roadbed and rails are kept in good order and repair; (3) the equipment department, whose duty it is to see that the[361] company is supplied with proper locomotives and cars and to see that such equipment is kept in repair; and (4) the transportation department, which has to do with the operating of the trains.

The financial policy of a railroad is usually in charge of one of the vice-presidents, who must be a man of experience in financial matters and who acts with the approval of the directors. The accounting department is more important than may appear at first sight. Railroads are now under the supervision and regulation of the government, and one of the rights that the government has is to examine the books of the company at any time and to require all companies to submit a monthly report to the government.

The legal department of a railroad is especially important for two reasons: (1) In performing its services, the company has business dealings with a large number of persons, and in the adjustment of claims against the railroad, expert legal advice is constantly necessary. (2) The railroad, as stated above, is under the regulation and control of the state and the national governments, and the enforcement of this regulation makes the railroad a party to numerous proceedings in the courts and before the Interstate Commerce Commission. The large railroads operate in from ten to twenty states. It can thus easily be seen that the legal department has a great deal more to do than if the railroad operated under but one political power.

Public Utility Corporations

Public utility corporations supply services without which the people of to-day could not very well live. They are those supplying water, light, heat, power, telephones, local transportation, gas, etc. They may properly be called public necessity corporations. The nature of these businesses practically gives them a monopoly in their locality; this is the reason that they have grown so enormously during the last thirty years. The Commonwealth Edison Company, which supplies a large part of Chicago with light and power, began in 1887 with a capital of $500,000 and in 1914 its capital obligations had a market value of over $83,000,000. The American Telephone and Telegraph Company began in 1885 with $12,000,000 of capital stock and in 1914 had practically $340,000,000. The other public service corporations have kept pace, according to the growth of the locality they serve. In the depression of 1907 this class of corporation kept steadily increasing the volume of its business when all others went back a step. Since these corporations are dependent on the local community for their business, if the community grows the company must grow, and usually faster than the community. For this reason the stocks and bonds of these companies are usually a good investment.

It is a common practice for municipalities to demand a share of the profits of the company, by way of a fixed sum, a certain percentage of the gross profits, or a share of the net profits. For example the city of Chicago receives, from the Commonwealth Edison Company each year 3 per cent of its gross receipts from the sale of current and 10 per cent of its gross receipts from the rental of conduit space, amounting in 1913 to more than $300,000, quite a considerable sum. The Chicago Railways Company and the Chicago City Railway Company, the two large street car companies of Chicago, after deductions for expenses and charges and 5 per cent on the amount invested are made from the gross income, pay to the city 55 per cent of the surplus earnings, keeping for themselves 45 per cent. Whenever these companies pay part of their earnings to the municipality, they are really under municipal supervision, and their books and accounts are open to examination[363] by the city at any time. These companies are called quasi-municipal corporations.

Industrial Corporations

As the name indicates, industrial corporations are those that carry on our industries. They are by far the largest class of corporations and have among their number some very powerful companies, whose assets run up toward the billions. This class of corporations has not had the gradual, steady growth of the public utility corporations, but in the case of the most successful, the growth has been amazing. The Standard Oil Company for many years prior to its dissolution had paid dividends on its capital stock of about $100,000,000 at the rate of 40 per cent a year. The Steel Corporation is said to have produced a thousand millionaires and is still producing them. This class of corporations has not been so closely under the supervision of the federal and municipal authorities as the railroads and public utility corporations, and their financing has been carried on in a looser fashion than that of the other two classes. For this reason the securities of these corporations are not generally regarded as highly as those of the other two. However, the federal government has taken and is taking steps to regulate these corporations, and this will tend to bring them eventually to the standards of the railroad and public utility corporations.

Exercise 307

Oral

Explain carefully:

1. What is a corporation?

   
   

2. What is a share of stock?

   
   

3. What is a bond? a security?

   
   

4. Explain the difference between par and market values.

   
   

5. Why do stocks and bonds vary in value?

   
   

6. What is the difference between preferred and common stock?

   
   

7. What are dividends?

   
   

8. What is meant by watered stock?

   
   

9. What are the advantages of a corporation over a partnership?

   
   

10. The following was copied from a morning paper. Explain it.

    
    

"The Canadian Westinghouse Company, Ltd., declared its regular quarterly dividend of 1½% and an extra dividend of 1% on its stock, both payable Jan. 10."

11. Explain the following bond quotations:

Municipal Bonds

Railroad Bonds

Public Service Corporation Bonds

12. Why are the bonds of successful public utility corporations a good investment?

13. Which company do you think would grow faster, a light and power company or a gas company? What effect would the growth or the failure to grow have on the price of the stocks of each?

14. Should a street car company pay part of its earnings to the city?

15. If the population of a city doubled, what effect would there be on the price of public utility stocks?

Exercise 308

Topics for Investigation and Discussion

1. Harnessing our streams to secure electric power.

   
   

2. The growth of the Interurban.

   
   

3. In your own town:

   
   

a. Have gas rates increased or decreased? Can you explain the change?

b. Have electric light rates increased or decreased? Can you explain the change?

4. Street railway, electric light, and gas company franchises.

   
   

5. The earnings of the street car company in your city.

   
   

6. Municipal ownership of public utility corporations.

   
   

7. The effect of mergers and consolidations of big corporations.

   
   

8. The effect of a trust on competition.

   
   

9. Trusts and prices.

   
   

10. Government suits against trusts.

    
    

11. The tariff and the steel industry, the wool industry, and the sugar industry.

    
    

12. Railroad rate increases.

    
    

Exercise 309

Write the following from dictation:

1 In New London, Connecticut, stands the oldest grist mill in the country. It is a picturesque building, having a water wheel like the one that it originally used when New London was first settled. The town was in the center of an agricultural community, and a mill to grind corn was a need that soon manifested itself to the settlers. Accordingly, in 1650 at a town meeting, six men were chosen to build a mill. John Winthrop and his heirs were granted the right to carry on the grist mill as long as they maintained the building placed in their charge. This is one of the first monopolies recorded in New England history.

2 The same standards by which a farming or a manufacturing investment may be judged are not applicable to a mining investment. A farmer may earn eight per cent on his capital, and with care his investment may increase in value. A manufacturer[366] may earn eight per cent on his investment, and, if he keeps up his machinery, his business may be as valuable ten years, or even twenty years, hence; but a mine, after each dividend is paid, is that much nearer its end. Now, it is well known among mining men that the average life of a gold or silver mine is under, rather than over, ten years. There are exceptions to this rule, of course, but, granting that the life of a certain gold or silver mine is to be ten years, then, in order to pay back both principal and interest, dividends of at least sixteen per cent should be distributed. Copper mining, of which the statistics have been most accurately kept in New York and Boston, offers many inducements to the investor; but too much care cannot be taken in the matter of selection, for copper stocks, in not a few instances, have been boosted out of all reason. As with gold and silver mines, so it is with copper mines. They have so much ore to begin with, and after each dividend are that much nearer to the day when they will close down. For such mines, provided they have a good lease of life, eight per cent or even ten per cent may be regarded as only moderate returns. These are merely samples of some general principles to be followed.—Roger W. Babson.

3 Dear Sir:

At the close of a year which has presented many perplexing problems, not only to investors and dealers in bonds, but also to borrowing municipalities and corporations, there are several factors in the situation which in our opinion offer strong encouragement to every one in any way interested in bond investments.

Of special significance is the marked change in sentiment which has recently taken place. There is every indication that this country enters the new year with an unusually substantial feeling of confidence. While a notable increase in the demand for bonds would undoubtedly bring out a large amount of new financing, on the other hand, there has been an accumulation of funds during the period of depressed markets, and it is generally understood that investment dealers are carrying comparatively small amounts of bonds.

January has an almost unbroken record of higher average bond prices than the average prices in December. It is not our intention to predict an advance this January, although there are unquestionably many reasons for anticipating at least a moderate improvement; but, viewing the question in its broader aspects, we find many convincing arguments in favor of the purchase of[367] bonds at this time. It is recognized that the decline in prices has been due to a variety of causes, which, except in a few individual cases, are not the result of any depreciation in real values. Basic conditions are admittedly sound. We, accordingly, not only recommend the judicious purchase of bonds for the investment of surplus funds, but also suggest consideration of the advisability in some cases of converting short time securities into long time bonds.

What conditions could be more favorable from the standpoint of the purchaser of bonds than an extremely low level of prices; a wide-spread belief that fundamental conditions are sound; a general feeling of confidence that the problems which have tended to disturb business during the past year have been, or are being, solved; and a conviction that we are entering upon a period of probable ease in money rates?

Very truly yours,

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