Why Corporations Leave Home

I

A STRANGER, dropping into the large and impressive dining room of the Du Pont Hotel in Wilmington, Delaware, might find cause for surprise in the numerous company around the tables and the metropolitan air pervading the place. These diners are manifestly not traveling salesmen. There is something about them which recalls the types to be seen lunching in Savarins near Wall Street — prosperous men, with the self-possessed bearing of those who are accustomed to deal in large affairs. The simple truth is that from forty or fifty to a hundred or more corporations, good and bad, are holding their annual stockholders’ meetings, and these gentlemen, their pockets stuffed with proxies, are on the scene to vote the proxies and reëlect themselves to office in their respective corporations.

What is more, there is nothing particularly unusual about all this. It is an everyday occurrence. And if the visitor will step across the street to the Industrial Trust Building he will begin to perceive the significance of it.

This building, like all others devoted to business offices, has in its lobby, near the elevators, the inevitable black frame enclosing the names of its tenants in small white block letters. It is not a very large building, and one would expect to find a modest frame containing fifty or sixty names. Hence it is difficult to suppress surprise when one sees that the directory frame fills all the walls, on all sides, right up to the ceiling. One notices that the Standard Oil Company of New Jersey is a tenant, and that this is its principal office. That ought to take up the building all by itself, to say nothing of such huge concerns as the National Dairy Products Corporation, the Pennroad Corporation, the Pullman Company, Remington Rand, Transamerica, William Wrigley, Warner Brothers, which are also nestling somewhere under this same roof. And if one cares to do a bit of counting he will be amazed to discover that more than 12,000 corporations have their home offices here — all of them on one floor!

For this is the corporation homeland of America. This is Delaware — ‘The Little Home of Big Business,’as its newspapers like to speak of it. That is why the Du Pont Hotel is full of men who have forgathered from all over the country to attend stockholders’ meetings. In Wilmington alone there is an average of a hundred of these meetings a day; and, since each of them involves the attendance of from two to half a dozen men, it will be seen that the city has daily as many visitors as an ordinary convention would bring. Every day is convention day in Wilmington.

The business of issuing corporation charters to companies to ply their trade in any part of the country has attained mammoth proportions in Delaware, and it is a business that is impressive and peculiar in at least one particular: it is perhaps the only one in which a whole state, in its sovereign capacity, engages, with great profit to itself and to certain classes of its citizens, and with immense mortification and embarrassment, financial and spiritual, to its sister states. Delaware, however, did not invent it, nor does she have a complete monopoly of the business. New Jersey, Maine, West Virginia, Maryland, and Arizona also have their shingles out. But Delaware is now the leader, even though it was New Jersey that began it.

II

Away back in the early days of the Republic, Alexander Hamilton learned how to use the ‘liberal’ public morals of the free-and-easy State of New Jersey to organize several corporate enterprises which could never have found root in the sterile soil of New York. And, with the advent of the era of big business, the state began, about 1875, to do a good deal of trafficking in charters. By the late eighties, when the trusts were being mercilessly badgered by most of the states and were hunting for a hospitable harbor, New Jersey had already established herself as a pioneer in the benevolent work of adjusting her laws to make things comfortable for them. By this time, however, Maine and West Virginia were also in the market place. Indeed, in 1890 the Secretary of State of West Virginia arrived in New York with the great seal of the state, opened headquarters in a downtown hotel, and announced that he was ready, upon the shortest notice and at the lowest prices, to issue charters to all and sundry who wished them.

At about this same time Mr. John B. Dill, then a rising corporation lawyer, had a bright idea, and went to the Governor of New Jersey with it. He proposed that the state authorize the creation of a corporation which could act for all outside corporations in securing charters for them at the lowest rates, and which could also act for them as resident agent after incorporation. In other words, he proposed to reduce the whole matter to the basis of a highly organized business. The new corporation would be able to advertise in other states, solicit business, and bring the trade to New Jersey.

The state legislature, ever on the alert for ‘liberal’ laws, promptly adopted the idea. Immediately several such corporations were formed. The advantages of New Jersey as a habitat for the trusts that were being persecuted by other states were widely trumpeted. The new corporations born of Mr. Dill’s idea set up for business in Exchange Place in Jersey City, and very soon that small dingy street became known as West Wall Street, and some 1500 outside corporations were being regularly represented there.

It was half a dozen years later that New Jersey passed her famous holdingcompany law, which permitted any New Jersey corporation to buy and hold the stocks of any other corporation of that or any other state. Singularly enough, it was passed at the very moment when the Standard Oil Company was being pressed by AttorneyGeneral Frank Monnett of Ohio to carry out the decree of the Ohio courts dissolving the original trust. John D. Rockefeller was able to find sanctuary within the broad shelter of this new statute, which became law, it is curious to note, over the signature of John W. Griggs, then Governor of New Jersey. Griggs was immediately thereafter called by Rockefeller’s old schoolmate and friend, Mark Hanna, McKinley’s alter ego, to be Attorney-General of the United States, and in this office was charged with the enforcement of the anti-trust laws. Thus did the curtain go up upon the first scene of the great comedy of American corporation law.

It was at this point that little Delaware looked with a jealous eye upon the new business which New Jersey had developed. In 1890, New Jersey derived an income of $292,000 from her corporation business. By 1896, this had risen to $707,000 — and these were 1896 dollars. So the following year Delaware amended her constitution to permit incorporation under general statutes, and the legislature passed a general incorporation law in 1899. This ushered Delaware into the charter-mongering business along with Maine, West Virginia, and New Jersey.

From the first, the state did well enough for a young charter breeder, but it was not until Woodrow Wilson became Governor of New Jersey that Delaware’s real opportunity arrived. Wilson put through the New Jersey legislature a series of reform measures intended to check various abuses in politics and business. Among them were his famous Seven Sisters Acts, which seriously impaired the ‘liberality’ of New Jersey’s corporation laws. This was Delaware’s chance, and she rose to it. She ‘liberalized’ her laws a little more, and the corporation traders and mongers at once

and set up in business there and in Wilmington.

This, in brief, is how it has come about that in all the seas of our home trade, wherever there is a dollar for a share of stock or a banker to recommend it, corporations by the thousand can be found cruising under the black flag of Delaware’s corporation laws in search of easy money.

III

As a business proposition, it has been an unqualified success for Delaware. The state has chartered more than 100,000 corporations. About 60,000 of them have vanished like the weird sisters into the air from whence they came, or have been conducted to their sepulchres through receiverships in the courts, to the happy chants of lawyers, appraisers, trustees, accountants, clerks, and attendants. About 42,000 of them still remain, some great and powerful, many of them all but dead, awaiting burial.

During the jolly days of the Coolidge administration, prosperity smiled upon the business. In 1927, some 5424 charters were granted, with fees to the state of $824,483. By 1929, the charters issued had risen to 7537, with fees of $3,309,698. The charter mill kept up its feverish pace to the very end of the great bull era. In September 1929, when the depression was just around the corner, nearly 600 new corporations set sail from Dover, most of them to founder before they had well begun their journey. And in spite of the depression, which, of course, has seriously interfered with the launching of new enterprises, Delaware is handing out charters even this year at the rate of about fifteen a day.

The fees for initial incorporation go into the general fund of the state, and at present this source of revenue is considerably curtailed; but there is also an annual franchise tax which each corporation must pay. The Radio Corporation pays about $4400 a year. Mr. Insull’s Middle West Utilities paid about $3888 a year. Mr. Ivar Kreuger’s International Match Company had to pay a tax of approximately $8000. A huge concern like General Motors pays about $39,000 a year. In 1932, the total of all these corporation franchise taxes will be about $3,500,000. The money is devoted to the support of the public schools. It has become such a lucrative business for the state that there are some who think that all realestate taxes might be safely done away with, and that the whole machinery of the state could be supported by the taxes paid by the corporations of other states which have a mythical domicile in Delaware.

It is not the state’s profits alone, however, that make the business attractive. Since there is an average of one hundred corporation meetings a day in Wilmington, as we have already observed, the hotels and merchants are greatly interested. Most of these meetings are perfunctory. The stockholders are in Wilmington to-day and gone tomorrow; but they are always succeeded by a new throng. Occasionally, however, there is a grand stockholders’ fracas for control. When the Transamerica Corporation staged its big battle for control last spring, there were one hundred and fifty stockholders on the scene, and they remained for many days. One set of combatants occupied two floors in the Du Pont Hotel, and some two hundred clerks and tellers were required to count and look after the details of the fight.

Then there is the business done by the lawyers, and by more than thirty of those special corporations which handle the details of organization and represent absent corporations in the state the year round. Finally, and richest of all, are the receiverships. One may well guess that receiverships of corporations such as Delaware permits must be numerous — and they are. At the moment some of our greatest enterprises are being operated by Delaware lawyers under the guidance of Delaware courts. It is no wonder that the bar of the state plumes itself upon the almost unbelievable liberalism of Delaware’s ‘progressive corporation laws.’

There is, however, another side to it. ‘The suspicious,’ says a pamphlet advertising the state’s liberalism,’harking back to the muckraking days when every corporation was guilty — of something — until proved innocent, might say that the Delaware laws must be “wide-open” laws, attractive to “blue sky” operators.’ The pamphlet assures us that ‘a study of corporations with Delaware charters promptly squelches any such hypothesis.’ It then goes on to point to some of the types of corporations which boast of Delaware’s great seal. There is the Goldman-Sachs Trading Corporation, the Commonwealth and Southern Corporation, the Blue Ridge Corporation, the Continental Chicago Corporation, and the Petroleum Corporation of America. There is the Lehman Corporation, the Prince and Whitely Trading Corporation, and the Winslow Lanier International Corporation.

This boast was made, of course, in 1929. Certainly no one can say that these were ‘blue sky’ concerns. But many intelligent students of finance are now willing to admit that the peculiar forms of capitalization employed by these concerns, and specially authorized by the Delaware law, were responsible for the loss of billions of dollars to investors — dollars which are gone as completely and effectually as if they had been invested in blue sky. The pamphleteer might have added the Insull Middle West Utilities and Kreuger’s International Match Company, as well as a number of other corporations which have either failed or been seriously crippled because they suffered from the organic weakness inherent in the forms of capitalization especially favored by Delaware laws.

In the various ways I have mentioned, Delaware manages to get for herself an income of four or five million dollars every year. This, of course, is the final reason and explanation of her legal laxity. It would really pay the other states of the Union, which suffer from Delaware’s delinquency, to tax themselves enough to pay the cost of running the Delaware government, absolutely free to that state, if she would just agree to go out of the business of breeding corporations.

IV

Why do corporations leave home and go to Delaware? There need be no speculation about the phenomenon. The boosters for Delaware will tell you. Mr. Robert Pennington, who has written a book about the state’s corporation laws, observes that ‘the liberal provisions of the law are being more constantly taken advantage of by the legal profession and corporate interests generally.’

That is it — the ‘liberal’ provisions of the law; liberal, indeed, to the point of glaring laxity. Almost anything goes in Delaware, and here are some of the things that go: —

1. Directors need not be stockholders. A collection of office boys would do quite as well.

2. No officer or director need reside in the state. All that is required is a resident agent and an office with a sign out. We have already seen that some 12,000 corporations meet this simple requirement by having, all of them, the same resident agent and the same office on one floor of the Industrial Trust Building in Wilmington, with their signs displayed in its burlesque building directory. This is a part of the jolly system by which one of the most serious and important underlying facts of our business life — the management of all the vast tools of industry —.is reduced to the level of opéra bouffe.'

3. Directors’ meetings may be held outside the state, but stockholders must meet there. This is an important advantage for promoters, for, as a prospectus from Wilmington puts it, ‘if stockholders’ meetings were held in a populous place like New York, where so many stockholders would chance to live, a good many might be led to attend the meetings, if only from curiosity.’ They seldom show up in Wilmington. This explains the gentlemen with pockets stuffed with proxies whom one sees in the Du Pont Hotel.

4. The directors may issue new stock, and, indeed, affect the preferences on old stock, without the approval of the stockholders. They may make by-laws without the approval of stockholders. In fact, a careful study of Delaware’s statutes indicates that directors can do almost anything with their corporation — which is a highly prized privilege.

5. Better than this, the right to elect all or a majority of the directors may be limited to one class of stockholders. I am quite ready to grant that there is something to be said in favor of this provision. Our economic structure is so complex that no man holding widely diversified securities can hope to keep adequately informed about every company in which he owns an interest. There may be good reason, therefore, for providing two distinct classifications of ownership: one which carries with it the right to participate in the direction of the enterprise, and another which relieves the holder of this responsibility. I repeat that there may be some justification for such an arrangement, although there is always a danger in divorcing ownership from responsibility. Even at best, however, no one can doubt that this plan is subject to grave abuses.

In the old days, such amateur promoters as E. H. Harriman thought themselves quite clever when they discovered that 26 per cent of the stock of a company could control the whole, through the indifference and lack of unity of the remainder. But under Delaware law it is possible to arrive at the same result by actually investing little or nothing in the enterprise. Who is not familiar with the Class A and B stocks, Founders stock, and the like? In one of the largest holding companies, 10,000 shares of Founders stock, which cost almost nothing, controlled several million shares of cashpaid common. In another, the property was controlled with the Class B common stock, all of which was given as a bonus with the preferred shares. The promoters bought the preferred shares and got the controlling Class B stock. Then they sold the preferred shares at par and retained the common, so that they acquired the actual ownership of a $150,000,000 corporation without investing a cent.

Delaware law permits the issuance of these various classes of stock, and there is almost no limit to what can be done with this device.

6.Stock may be issued, not only for cash, but for property, services, rights, and ‘ the product of one’s brain,’ as an authority assures us. This may be called the waterworks department of the law. Since stocks may be issued for almost anything, the public investor is permitted to put up the cash while the promoters put in the product of their brains. If, subsequently, the investor discovers that the product of the promoters’ brains is literally without value, he has no remedy, because ' the judgment of the directors as to the value of the property for which the stock was issued is conclusive.’ Thus oceans of water may, by the magic process of ‘labeling,’ be changed into goodwill, and the goodwill may then become the basis for issuing millions of dollars’ worth of stock.

7. Stock, of course, may be issued without par value. This provision becomes a deadly thing when it is further provided that the no-par stock may be issued from t ime to time at such terms and prices as the directors may fix. They may issue a new batch of stock to the public at one price, to the stockholders at another, and to themselves at still another. It is within the power of the directors at any time, under this provision, to dilute the property of the stockholders, or, acting within the law, to rob them of their profits. This has actually been done on a large scale in countless instances.

8. The baleful system of issuing rights and stock purchase warrants, so generally abused before 1930, is permitted under the Delaware law. This is another method by which directors and insiders are enabled to gamble with the corporation’s money without taking any risk themselves. For instance, the directors of one large holding company were given rights to purchase, at any time within three years, 100,000 shares at $20 a share — the amount at which the common stock was issued. On its face this seems fair enough, but let us examine it more closely.

Within a year after these rights were issued the stock went to about 70. At this point all that the directors needed to do was to step in, exercise their rights, put up $20 a share, and get 100,000 shares which they could immediately have sold at a profit of $50 a share. If the stock had come down, of course, they need not have exercised the rights. They gambled to win a lot without risking anything. As it happened, these chaps were reserved for a singular doom. They were too greedy. They thought the shares would go far above 70, so they waited. Then came October 29, and almost before they could say Jack Robinson those shares had tumbled to 7. But they lost nothing.

9. Less than a majority of the board may constitute a quorum; in fact, provision may be made for alternate directors. ‘This,’ one is assured in Wilmington, ‘is a great convenience where some members of the board of directors have varied interests which from time to time prevent their attending meetings.’ Thus a gentleman who sits on from forty to sixty directorates is excused from paying any but the most cursory attention to the business of the companies over whose fortunes he is supposed to watch. Instead, he may spend his time in Wall Street, speeding up one side of the business cycle on the bull’s back with Coolidge and down the other side on the bear’s back with Hoover.

10. In Delaware a corporation can be conjured into existence almost as fast as a magician can produce a bouquet of flowers from his hat. A fast motor car stands before the door of the leading incorporating company in Wilmington, almost like an engine in a fire house, ready for action. An idea is born in Wall Street in the morning. A telegraphic appeal goes out to Wilmington— Quick! Quick! A charter! — and the papers are drawn with lightning speed. The waiting automobile races with them to the capitol at Dover. Only a few minutes are required in the office of the Secretary of State, then the car dashes back to Wilmington. The ‘incorporators’ hold their first meeting and elect directors as the sun starts downward. An express train speeds the precious charter to New York, and before twilight the directors of the new Delaware corporation are holding their first meeting in their penthouse on Park Avenue.

But, you ask, how can the incorporators meet in Wilmington? Simplicity itself. The trust company which makes a business of getting out charters ‘will furnish the necessary incorporators, when its services are being used by attorneys, enabling the election of directors and adoption of by-laws to be taken care of at Wilmington without necessity of forwarding waivers and proxies of the incorporators to us.’ Thus reads the prospectus of one of the charter-mongering companies. A batch of office-boy incorporators can be delivered along with other accommodations in much the same way that an Irish undertaker supplies mourners at a funeral.

In view of these ten specific points which I have enumerated, one need not marvel that most of our great utility holding companies, our largest railroad holding companies, and most of our great investment trusts have obtained their ’letters’ from the state of Delaware. It is but fair to add, however, that Maryland, Maine, Arizona, and West Virginia are also doing their share to make America safe for promoters and very insecure for investors.

V

There is a widely accepted notion that the corporation is just a business device — just an implement which enables business men to conduct their affairs with greater convenience. Along with this goes the notion that it is an invention of the lawyers, and that its development ought to be left to them. The truth is that the corporation is one of the most profoundly important facts in modern life. It has gone far to transform our whole economic civilization.

When two or more men unite their resources and abilities, they have an advantage over those who act singly in any business. Until the corporation was devised, the law always held men thus acting together to strict personal accountability for the acts of the partnership or association. The new form of corporate organization is quite different from mere union. In fashioning it, the government has tried its hand at outright creation. A corporation is a legal person that enjoys certain civil functions just as if it were a human being. This fictitious legal entity, endowed with the resources of a large number of men and yet acting as an individual, has enabled men to unite without compelling them to assume full responsibility for the acts of the group.

These are simple facts which must be acknowledged. The result has been to transform us completely from an individualistic people into a highly organized and collective industrial society; to take the tools of industry out of the hands of the individual entrepreneur and put them into the hands of the corporate entrepreneur. In its final form the corporation makes it possible for the men who control it to exercise a vast power. It gives them the opportunity, if they are not properly restrained, to make competition by single individuals utterly impossible, and, in certain cases, to put themselves almost beyond the reach of the law itself.

These facts are put forward, not to condemn the corporation, but rather to effect a clear statement of the problem — to point out that the development of the corporation is primarily an economic and a social problem. Here I do not speak of monopolies and trusts. I speak of corporations large and small, whether monopolistic or not. They are all charged with serious social and economic responsibilities. If this is true, — and I do not see how anyone can doubt it, — is it not strange that the economist has had almost no share in guiding corporate development in America? The economist himself has revealed an amazing indifference to the matter. Along with the social reformer, he has occasionally lifted his voice in loud protest against monopoly, and against corporations as instruments of monopoly, but aside from that he has tended to remain painfully silent.

The development of the corporation has been left, therefore, to the lawyer, and he has been moved almost solely by considerations affecting his client — some specific corporation. The early New Jersey laws and the laws still in force in Delaware were passed almost without public attention. The lawyers in the legislatures rushed them through noiselessly. As I searched through old files of New Jersey and Delaware papers in an effort to trace the history of this legislation, which has had a more important bearing upon our economic life than any other legislation ever enacted, I had difficulty in finding the meagre accounts of the laws.

Then, from time to time, changes in the statutes were made as corporation lawyers demanded them. In 1888, in New Jersey, lawyers wanted the state to permit corporations to purchase the stocks of other corporations that were necessary to their business, and the law was passed. At nearly every session this power was altered or enlarged as the corporation lawyers required. In New Jersey, Delaware, and West Virginia, the lawyers appeared each year with new proposals: to permit different kinds of stock, to increase the powers of directors, to permit proxy voting, to permit different classes of common stock, to permit multiple voting of stocks, to permit proxies for three years, to permit dividends out of capital surplus. Every suggestion was dictated by the convenience of promoters, who sought to make easier the flotation of corporate securities and the control of finances, but there was never a thought for the public interest, no consideration of the economic factors involved, no voice lifted on that phase of the question.

‘Here in Delaware,’ one of the leaders of the bar said to me, ‘we have an ideal system. Our legislature would never think of passing an amendment to our corporation laws without submitting the matter to the state bar association. Proposals for change are always brought to us first. Our committee considers them, and if we approve them the legislature adopts them as a matter of course. That ensures sound laws. Don’t you think it is an excellent system?’

‘Well,’ I suggested, ‘has it ever occurred to anyone to call all the economists of the state into session and submit the matter to them for an opinion? ’

The idea seemed to startle him because of its novelty, and, doubtless, its stupidity.

VI

Twenty-five years ago this whole subject was being gravely considered throughout the nation. At that time almost everybody — John D. Rockefeller, John D. Archbold, Joseph Choate, Samuel C. T. Dodd, Mark Hanna, on one side, and Theodore Roosevelt, James R. Garfield, William J. Bryan, and innumerable economists on the other side — favored national incorporation. If it was important then, it is imperative now; for then we did not have in their full flower the elaborate corporation systems of Delaware and her rival states.

Some people then thought that the states ought not to surrender their power over their own business affairs. That choice no longer confronts us. The several states of the Union must now choose between incorporation laws passed by Delaware, which affect all the states vitally although the others have no voice in their enactment, and laws passed by the national Congress, in which each state will have a voice. The only protection which remains for the people in the great majority of states which do not indulge in chartermongering lies in a Federal incorporation law.