# Popular Science Monthly/Volume 37/July 1890/Concerning Corporation Law

Layout 4
* CONCERNING CORPORATION LAW.
By AMOS G. WARNER,
PROFESSOR OF ECONOMIC AND POLITICAL SCIENCE IN THE UNIVERSITY OF NEBRASKA.
IF ten Americans desire to engage in ten distinct business enterprises, it is conceivable that they will incorporate ten joint-stock companies, and each, belong to all of them. While other countries have granted the privilege of existence to private corporations with extreme caution, if not reluctance, the many Legislatures of the United States have vied with one another in making it easy for them to be born. To adapt words heretofore applied to another matter: "The whole system of the free incorporation of private companies in the United States, with all its excellences and all its defects, is thoroughly characteristic of the American people. It grew up untrammeled by any theory as to how it ought to grow, and developed with mushroom rapidity."
We have no "system" of corporation law in this country; we have, instead, a tangled mass of statutes, which is yet further amended and ensnarled at the recurring sessions of our various Legislatures. We have a still larger mass of judicial decisions, which all the ingenuity and industry of the many writers on the subject can never quite systematize and reduce to order. Even when this feat may be approximately accomplished for a moment, the growth of judge-made law is so rapid that any treatise is speedily out of date. A redeeming feature of the situation is that the mimetic tendencies of our States lead the new ones to follow the examples set by the older, and thus a certain degree of uniformity is introduced into the different codes of law. The many sources of legislation also make it possible that a large amount of experimenting may be done without danger to the country as a whole. The immediate and disastrous consequences of the Granger railroad laws were thus limited to a few States in the Northwest, while their more general influence, as examples of what can but should not be done, has been of use to the whole country. One railroad president has gone so far as to say that in their results these laws have made a solution of the railroad problem possible.
The diversity of regulation has two effects—one commendable, the other not. The first is that when companies do business in all or many of the States at once, and in any line, like that of insurance, where ascertained corporate soundness is the best advertisement, a good code of laws in any one State makes the fact that a company does business there a helpful recommendation. The Massachusetts law regulating insurance is an ​example of this. Its stringent requirements do not hamper the companies of that State, but are, on the other hand, an introduction and a guarantee that distinctly aid the Massachusetts companies when they carry their operations into other commonwealths. The same influence is apparently at work in the case of mortgage investment companies; a few of the best established among them priding themselves on complete and ostentatious compliance with the rigid but wise laws regarding publicity of accounts.
The second effect of the diverse rules regarding corporations in the different States operates in an exactly opposite direction. Since it is quite well established that a corporation may incorporate in one State and do all its business in another or others, there is a tendency for dishonest companies to take out charters in that State which bothers them with the fewest restrictions. A charter granted by the Legislature of Pennsylvania incorporating a company to do business in any State except Pennsylvania was held to be void; the Kansas court holding that no interstate comity permitted one commonwealth "to spawn corporations" upon other States which it would not allow to operate within its own borders. But the same thing is accomplished if a State, by a general act, permits companies to organize without specifying the place of business. Under some laws one corporation is not allowed to hold the stock of another; but, on the other hand, there are States that will willingly incorporate a company for the express purpose of holding the stocks of other companies. This is a very convenient fact when a "trust" is to be formed. A State noted for the laxity of its laws in this regard can serve as the birthplace of any number of companies. At present, according to Mr. W. W. Cook, "the snug harbor of roaming and piratical corporations is the little State of West Virginia. Under its laws a corporation may be created for any purpose for which a partnership may be formed, except speculation in land; the capital stock may be five millions of dollars or less; there is no tax except fifty dollars annually; residents or non-residents, aliens or citizens, may be directors; the principal place of business and directors' or stockholders' meetings may be in or out of the State; there is no liability of directors or stockholders except on unpaid subscriptions, and no public reports are required. . . . The incorporation of companies for the purpose of enabling them to do all their business in other States seems to be one of the chief industries of West Virginia." States can only guard themselves against the invasion of hordes of these irresponsible artificial persons by strict statutory regulation of "foreign corporations," but for the most part they have not taken any general precautions of this character.
​Besides the defects in the corporation law of the United States which originate in its formless heterogeneity, there are other specific evils quite generally present, which it seems not impossible to lessen. It is the purpose of this paper to present suggestions, drawn from the experience of this and other countries, regarding four points that seem to be of strategic importance in the reform of corporation law:
1. The prevention of "frauds in founding" (Grundungsschwindeln). It is a suggestive fact that we have in English no recognized equivalent of the German word here parenthetically introduced. Neither is the English term "promoters" commonly used by American writers. Our examination of the problems of corporate management has been so superficial that we must make or borrow a nomenclature when we wish to discuss the evils connected immediately with the creation of companies. Yet a large portion of the evils connected with the existence of corporations originate at just this point. Men organize companies, at times, for the sole purpose of unloading upon them an unprofitable business. Let the experience of Eastern capitalists with Western mining stocks be put in evidence, and no one will question this statement. Mining companies with a nominal capital of fifty million dollars that have never declared a dividend are not uncommon; and very frequently the stock of mammoth companies sells at one cent on the dollar for some time before it becomes worthless. But the experience in mining is only an extreme case of what takes place in many departments of industry.
In England, turning thither solely because the facts have there been made accessible and have not in this country, it is found that certain men make a business of acting as "promoters." They are skilled in the writing of prospectuses of companies, and know all the arts by which stock can be sold. They devote their energies especially to small companies and small investors. For a time their activity was turned largely to organizing "single-ship companies," the shares of which could be placed among country parsons, serving-women, and other classes of small investors likely to know very little about commerce, and therefore likely to believe anything a well-printed "prospectus" might tell them. Many of these small companies never went so far as to build even a single ship, but enough ships were built by them to materially increase the number of "ocean tramps," and to call for much adverse criticism from the committee appointed "to investigate the loss of life at sea." The "commission appointed to inquire into the depression of trade" also had much to say of the influence of the creation of such great numbers of limited liability companies, of the direct loss to investors, and of the general demoralization of trade resulting from it. In fact, many English ​investigators have laid great emphasis on the idea that overs-peculation is due largely to the formation of joint-stock companies that have no real excuse for existence except the furtherance of the personal aims of the "promoters." It is a little curious that, among the three hundred real or alleged causes of "hard times" brought to the attention of our National Bureau of Labor, the reckless creation of limited liability concerns was not mentioned. In 1886 a writer estimated that there were afloat in the English stock market fully two billion pounds of speculative securities, of which at least a fourth were mere gambling counters. It is to such a state of things that a recent law review attributes the fact that real investors now shun the stock exchange, and speculative operators are compelled to live on the plan of "dog eat dog."
The stock exchanges of this country have had a somewhat similar experience, and the self-limiting nature of the speculation fever is indicated by the fall in value of a place in the Chicago Stock Exchange of three thousand dollars within a few years. As yet few steps have been taken to restrain the incorporation of absurd or fraudulent companies. Wasteful and semi-piratical paralleling of railroad lines is encouraged; incipient railroads are preyed upon by construction companies; companies of all sorts are bound hand and foot by the contracts entered into by an initial board of directors, and are brought into existence that they may be so bound.
None of the leading commercial countries seem to be quite satisfied with the attempts they have made to remedy such evils as these. Germany allows definite payment from the corporation funds for the trouble and expense properly incurred by the men who organize a joint-stock company, but guards very carefully against the illicit gains too often made by "promoters." The provisions for registering new companies are especially stringent in all cases where a private business or factory is to be sold to a corporation organized to buy and manage it. The fullest possible publicity is sought regarding all the initial acts of a new company, and some matters where the first decision must be final are reserved for a second meeting of the stockholders. Shares may run either to "bearer" or to a particular name. The latter can not be issued for a less amount than fifty thaler per share and the former for less than one hundred thaler per share. By forbidding the issue of shares of less amount; it is hoped to make investors consider more carefully the subject of investing, and to prevent the floating of small shares in worthless companies among the class of very small investors, who are most likely to be swindled. Some companies designed to engage in what are considered especially hazardous enterprises are forbidden to issue shares of less ​than one thousand marks each. The opinion of the United States consul-general at Frankfort-on-the-Main is that all these restrictions have not availed to prevent a regular "incorporation fever," from which he expects 'very disastrous results ere long.
In France there has been some agitation in favor of returning to the old system in operation till 1863 of "special concessions" by which the right to organize a joint-stock company was a favor granted by the Government, and not a right conferred by general statute. The weight of authority and influence is, however, against this retrograde movement. Leroy-Beaulieu, in considering it, recalls the fact that the prefect of police of Louis Philippe refused Leclaire permission to organize the great profitsharing company which was afterward established with signal success and which still bears his name. Leroy-Beaulieu adds, "We can bear the guardianship of law, but not of government." Certainly there should be no wish in this country to go back to the old system of special legislative charter, under which men made a business of lobbying for charters which were afterward sold to the highest bidder. One of the things upon which we can especially congratulate ourselves is of having got rid of this old source of legislative corruption, which gave us our wild-cat banks, and numberless other reasons for dreading it.
Our own experience may help us in dealing with frauds in founding if we will stop to consider the difference between the old State banks and our present national banks. The greater security of the latter comes largely from detailed legislation which prescribes the conditions under which artificial persons, designed for the transaction of a given business, will be permitted to be born. What we need at present as regards miscellaneous corporations is fuller knowledge of all the facts connected with their history, and especially of their genesis. Massachusetts is the only State that has collected statistics of private corporations at all comparable with those of the English register of joint-stock companies. Most of the States provide that all new corporations shall register with more or less fullness; but this is either a mere formality negligently performed, or else its sole object is to bring the corporation within reach of the tax-gatherer. The record is usually not published, or in some cases, as in Ohio, there is no way to trace in the published returns the outcome of the enterprises whose beginning is chronicled. In fact, our greatest need in preventing frauds in founding, as in preventing most other evils connected with corporate management, is completer publicity, and, as one result of this, fuller statistical data.
2. The proper regulation of the borrowing power. It has been stated on good authority, but is not true, that the evils of ​corporate management of property began when it was found that corporations could borrow. Abuse of the borrowing power is certainly a very common sin among artificial persons, and especially among American railways. When the holders of a small amount of stock, only partially paid in, build a road with borrowed money, the limitation of their liability shields them from personal loss; while their power of voting themselves salaries, and of concluding profitable contracts either with themselves or friends, gives them great opportunities for personal profit irrespective of the success of the road. The last report of the statistician of the Interstate Commerce Commission shows that many of the minor and branch lines of the country have been built wholly with borrowed money—that is, they are bonded to their full cost value. Many of the longer and independent roads are bonded at half to three fourths of their entire capitalization. The total bonded debt of the railroads of the United States is actually greater than the total of their share capital; and this, although the amount of water in the stocks is much larger than in the bonds. As the possession of the majority of the stock gives control over all the capital invested in the roads, it follows, from the figures given in the statistician's report, that the ownership of 81,932,234,128, or 2377 per cent of the total railway capital, insures complete direction over $8,129,787,731 of railway capital, or 136,883·53 miles of line. Massachusetts law forbids the bonding of a road to an amount exceeding the total of paid-up share capital, and this regulation is being introduced by other States. To forbid the issue of bonds that must be sold below par has been found to limit unsatisfactorily legitimate enterprises, but the effect of such a regulation is thought to be good if applied with care to specific classes of corporations. As to what is best in this matter, as in those that have gone before, we need more definite information.
3. How to secure a more representative and more responsible directorate. In regard to the election of directors it may be said that one device to prevent the tyranny of a majority of the stockholders has been frequently tried, and another frequently recommended. The former plan is to limit the number of votes which any one person may cast. In Massachusetts no person except a municipal corporation can vote over one tenth of the capital stock of a railroad corporation. The trouble with this plan, and the variations of it that have been tried, is that evasion is too easy. Dummy stockholders are very easy to manufacture, and it is difficult to unmask them. The much-recommended device for accomplishing a similar purpose is that of cumulative voting. By this device a shareholder is allowed to cast as many votes for any one director as the number of his shares, multiplied by the number of directors to be elected at the given time. Nebraska has a provision ​of this sort in her Constitution, but the domestic corporations in the State have not had a sufficient development to thoroughly test its influence. It will probably do but little good to secure minority representation on the board of directors, unless the laws are so drawn as to limit the tyranny of a majority of the directors. The State of Maryland and the city of Baltimore have derived but scant benefit from their privilege of appointing a minority of the directors of the Baltimore and Ohio Railroad. But if minority representation be backed by the proper legislation governing the actions of the directors, there is no doubt that it is an efficient way of checking the misdeeds of stock majorities..
In Germany there is a second body chosen, under special rules, by the stockholders, known as the board of supervisors (Aufsichtsrath). This board has the fullest possible power of investigation and report, but very little power of any other kind. Its usefulness must obviously depend on the rules governing its selection, since, if so chosen as to have interests wholly in common with the directors, it would be of no use as a check upon them.
Turning to the question of responsibility, we find that in this country the principle of limited liability is almost invariably the same for the director as for an ordinary stockholder, though the director is personally liable for all illegal or unauthorized acts. There has been a great deal of agitation of late for the introduction of the French plan of protecting ordinary stockholders by the grant of limited liability, but leaving the directors liable for the corporate debts to the full amount of their respective fortunes. The experience of France with these societés en commandite has proved that responsible men can be found to manage any legitimate enterprise under this plan. A recent English act permits the formation of such companies in England, but the companies decline to adopt this principle under mere permissive legislation. To make this form of organization mandatory upon certain selected classes of our corporations is an experiment that ought to be tried, and is much better than going back to the old plan of unlimited liability for stockholders, as California has done.
Under the head of the responsibility of the directors must also be treated the question of the relation of the corporation to its employés. Albert Fink one day called together the presidents of certain roads he was trying to organize for their mutual good, and told the gentlemen who responded to his call that he wanted them all to resign. He further explained that this was advisable in order that their general freight agents might thereafter be nominally, as then actually, in charge of the several properties. The Interstate Commerce Association went down very largely because the "gentlemen" who were partners to the agreement could ​not or would not control their subordinates. Part of this alleged powerlessness is no doubt assumed that the head may escape responsibility for the action of the members, but part of it is quite certainly genuine. The development in bulk of the ponderous artificial beings has exceeded the development of their nervous systems, and the monsters can only sprawl and plunge instead of going forward to a definite end. This condition, however, is progressively cured by automatic processes. We have as yet no economic treatise on corporation by-laws in general, but well-recognized rules are developing for the organization of specific classes of corporations.
In the narrower view the relation of the corporation to its employe's is merely a question of wages, of strikes, and lock-outs, and of relative losses from these disturbances to employers and employed. The statistics of strikes and lock-outs collected by our National Bureau of Labor show that almost the only industry in which the losses inflicted by strikes are heavier on the employers than on the men is that of transportation. The undetermined losses inflicted upon the general public by this class of strikes must be also especially large. Two ways of dealing with these evils have been tried in Europe, either of which seems to be a partial remedy, but neither of which seems likely to commend itself to Americans. The first is to impose a heavy per diem fine or even forfeiture of charter upon any corporation that fails to perform its public functions. This forces the company to make terms of some kind with the strikers. When strikers in this country have tried to secure the forfeiture of charters through the courts, on the ground that the companies did not discharge their public functions, they have met with little success, though in some cases a street-car company has thought it necessary to insist on running a single car each day in order to secure its charter against attack on this ground. The second European method of guarding the public against the loss of strikes is to make it a misdemeanor for any employé to quit work without giving (say) five days' notice. The trial of this method has been advocated in this country, but it may be doubted if our system of police could be relied on to enforce such a law, or if, at the critical time, public opinion would indorse it. That the great corporations see the necessity of acting in the matter, so as to avert the danger that continually hangs over them and the public, is seen in the rapid development of relief associations and other devices for making the position of the employé more stable than it has ever yet been in this country. The President of the Union Pacific Road has advocated the withholding from subordinate officials of the arbitrary power of dismissing the men, the object being to make the men an integral part of the corporation, and to give them security in their ​positions during good conduct, and a prospect of promotion if especially efficient. The problems that our Government must confront in the matter of civil-service reform are also to be dealt with by our corporations, and the conditions are enough alike so that the experience of each may serve for the guidance of both.
4. Adequate publicity of corporate transactions. The need of thorough publicity of corporation accounts has been already dwelt on at some length. Nearly all the abuses to which corporate management of property is liable originate and wax mighty only when concealed. On the other hand, secrecy, even when it does not cloak abuses, is commonly suspected of doing so. Most of the unreasoning and unreasonable attacks on corporations have been made when those in charge of the corporations insisted on the privilege of keeping their affairs entirely to themselves. The advantages of business secrecy to the individual business man who practices it are abundantly manifest, but its advantages to the public at large, while also manifest, are countervailed by very serious disadvantages. Experience seems to have demonstrated quite conclusively that a being at once so vulnerable and so powerful as a corporation can not afford to keep its affairs entirely to itself, and if it could afford to do so the public can not afford to let it. There is said to be a strong tendency toward "socialism" in this wresting of business secrets from the great managers of the world's industries, and bringing the most private of business transactions to the bar of public opinion. Many will no doubt answer that "the charge is true, and we glory in its truth." Many more will be inclined to say, with the present writer, that, while this objection should be given its due force, it has not nearly force enough to overrule the strong necessities of the case. The chief danger that legitimate enterprises have to fear from complete publicity is that of overtaxation. The wealth of the corporations lying fully exposed to public view, it is so easy for the politician to fill the public coffers from that source that we already find certain classes of corporations driven out of certain States by excessive taxation. But it may be doubted whether taxation is as likely to be excessive when the state of a company's accounts is definitely known, as when the politician and his constituents are free to draw upon their imaginations for the amount of wealth in the corporate coffers. In other words, it seems probable that in this country, as yet, we have less to fear from willful injustice than from mutual misunderstandings begotten of secrecy on the one hand, and suspicion on the other. European countries are distinctly ahead of us in this matter. They have by no means solved all the problems connected with the corporate management of property, but they have at least collected more of the data that will make a solution possible.
​When, in 1873, Adolph Wagner read before the German Verein für Socialpolitik an elaborate paper on joint-stock companies, he made many suggestions as to the reform of corporation law. But he concluded by defending the thesis that, while the reform of corporation law was indispensable, this alone, however perfectly accomplished, could not suffice to eliminate the evils of corporate management of property; he contended that corporations must continue to be mischievous until they are restricted to a narrower field of activity than that now occupied by them; that the state, in its various branches, must assume control of those enterprises that are of necessity monopolies.