known as stockholders, who are financially liable only to
the value of the amount of stock held individually. It is
a fictitious person before the law, that is, it can sue or be
sued, incur debts, make contracts, and in short do anything
which an ordinary individual can do. The corporation
derives its right to exist from a state charter, which when
granted in one commonwealth must be recognized in all
the others. In the past, because of lenient regulations,
New Jersey was sought by many associations desiring to
incorporate. Recently, however, this commonwealth
together with most of the other states, have added con-
stitutional or statute restrictions concerning the granting
of franchises to new companies. Many commonwealths
have passed "blue sky laws" to protect the public by
restricting the activity and preventing the incorporation of
financially unsound organizations.

The corporation enjoys a number of advantages over the
other forms of business organization. This artificial crea-
Economic ture has a perpetual existence, if its life is not
advantages. ]j m ited ^y ^ e j-{ me c l ause m the franchise.

Stockholders may die and officers resign, but the corpora-



Modern Capitalistic Organization 251

tion may go on forever. Its chief advantage lies in its
ability to get together an enormous mass of capital, which
makes possible large scale production. The fund for such
enormous organizations as the Pennsylvania Railroad and
the United States Steel Corporation must be obtained col-
lectively. Corporate stock can generally be purchased in
large or small amounts to fit the needs of the individual
investor. The fact of limited liability gives the corpora-
tion an advantage over the partnership. If the corporation
fails, the individual stockholders cannot be called upon to
make good its losses out of their own pockets. National
bank stockholders, however, have a double liability, that
is, they are responsible for twice the value of the stock
which they hold. The purpose of this unusual arrange-
ment is to protect the depositors in a national bank.
Another advantage of the corporate form of business
organization is the great flexibility of management.
Reorganization is possible by the election of a new set of
officers or another board of directors. Experts can also
be obtained for the management of the various depart-
ments by the payment of large salaries.

New corporations are continually being organized as
new enterprises are launched. The promoter is the man
who organizes and directs combinations of The
capital. He secures funds for the development motion of

A c a new

of our natural resources. Let us take as our enterprise:

'11 , ,• ,i r .. j- .<• The promoter.

illustration the formation of an oil company.
The professional promoter hears that oil has been struck
ill a new section of the country. He may go there only to
discover that the report of the oil possibilities has been
much exaggerated. On the other hand, the field may
seem so promising that the promoter may decide in favor



252 Problems of American Democracy

of the venture. He may have sufficient funds of his own
for the early steps, or he may require the assistance of other
and larger financiers. Geological experts and mining
engineers are employed to give an opinion as to the best
probable locations for the prospective wells. The pro-
moter then buys options upon some of these sites, that is,
the right to purchase the land for a certain sum at the
expiration of a given time. In the meantime he has secured
all the information possible concerning the new prospect.
More funds are now needed, and the promoter gathers
around himself a small group of financiers. If he is unable
to convince them of the possibilities of the oil fields, the
proposition is dropped for lack of funds. The promoter
bears the burden of the initial expenses.

If he is successful in convincing the bankers of the ulti-
mate success of the undertaking, a new company is incor-
Thenew porated by securing a charter from the state.
company. T k e stoc k Q f fa e ne w company may be directly
subscribed by a number of wealthy investors. More
likely, however, the issue of securities is "floated" by
some banking or bonding house. For a certain bonus such
financial institutions will underwrite an entire issue, that
is, guarantee its sale to the general investing public. The
salesmen of the new securities then sell the stocks or bonds
to individuals and corporations throughout the country.
The promoter of a new enterprise generally receives as
his reward a generous slice of the securities.

The stockholders of a corporation are the ultimate

source of its authority. This means frequently, however,

Organi- the mere election of a board of directors, who

manage the undertaking supposedly in the best

interests of the stockholders. Each stockholder has as



Modem Capitalistic Organization 253

many votes as he has shares of stock, and the balloting is
generally done by proxy. Only too frequently the small
holder does not trouble himself to mail to the company
his choice of officers. As long as the dividend is paid regu-
larly, he cares little about the management of the corpora-
tion. The policy of the corporation is thus determined
by the directors, who are often the large share holders.
They decide what rate of dividend shall be paid, whether
the capitalization shall be increased, and if so, whether a
stock or bond issue shall be resorted to. The board of
directors may elect an executive committee where the
corporate responsibility is still further centralized. Other
necessary committees may be elected or appointed. The
administrative work is left to salaried officials who may
or may not be officers of the corporation. For illustra-
tion, the president of a company may also be the super-
intendent of the plant, and each of the vice presidents
may be in charge of a department. The organization of
a corporation is strongly influenced by the kind of industry
represented. In general there are three fundamental
departments; namely, the producing, the selling, and the
administrative departments. Each of these departments
has its own subdivisions and managers.

Securities, such as stocks and bonds, merely represent
the economic wealth which lies behind them. They are
paper certificates of the ownership of economic Nature of
wealth, such as land and capital. When we say securities:
that the United States Steel Corporation has a
capitalization of two billion dollars, it should mean that
this company has two billion dollars worth of land, build-
ings, machinery, etc. Stocks and bonds can be broken up
into convenient divisions more easily than the real wealth



254 Problems of American Democracy

represented. If Mr. Blank owns a thousand dollars' worth
of stock, it merely means that he owns that fraction of the
company's real wealth. A thousand-dollar bond would
make him a creditor of the company to that extent. The
stockholders are members of the corporation and are often
small inactive enterprisers. The dividend paid upon their
stock represents their share of the fluctuating returns of the
corporation. The stock itself represents the wealth
invested in the corporation.

A bond holder is a creditor of the company and not

necessarily a member of the corporation. Consequently,

he may have no voice in its internal manage-

Bonds. . i • i

ment. He receives interest upon his loan at
definite times and at a fixed rate of interest. When the
time of the loan expires, the owner receives the face value
of the bond. Bond obligations must be met before a
dividend is declared. If a corporation cannot pay the
interest upon its debts it is insolvent. Stock may be
divided into common and preferred, and the earnings of
the latter group of securities may be fairly constant like
the interest upon bonds. The elements of risk and profits
tend to balance each other, for the investor cannot get
maximum safety and maximum profit. Speculative stocks
will pay high dividends because of the risk involved. The
comparatively low rate of interest on municipal and gov-
ernment bonds is due to their high degree of security,
which makes them attractive to conservative investors.

Some of the very advantages of the corporate form of
business organization indicate the dangerous possibilities.
Limited liability and flexibility of management result in
indirect and absentee ownership. For this reason a great
corporation is said to possess no soul. Real, not fictitious,



Modem Capitalistic Organization 255

persons feel a sense of responsibility. In the story of Mrs.
Shelley, Frankenstein proved a dangerous monster after
his creation. The very size of the modern cor-
poration makes it a possibility for evil as well as dangers:
good. Its vast funds may be used for political F c °lf^ on
corruption, whereby undue power is wielded and
legislation inimical to social welfare is enacted. Internal
politics may be played within the corporation, while high-
salaried sinecures are not unknown.

Furthermore, a few influential members may organize
subsidiary companies and concentrate in them a portion of
the company's profits. For illustration, a few subsidiary
directors of a large automobile company may com $ ames -
organize an independent company to build automobile
bodies. By charging an exorbitant price for these bodies,
the small subsidiary company may make large profits at
the expense of the original corporation.

Officers may sometimes pay themselves high salaries at
the expense of dividends or to conceal the high profits.
Another abuse is connected with the borrowing Financial
power of the corporation. Bond issues may be Juggery -
floated which are far in excess of what the earnings of the
company warrant. Corporations can also be forced into
bankruptcy and then reorganized. A similar object may
be accomplished by giving out false reports to discourage
the stockholders, who sell out cheaply and leave the pro-
moter and his friends in control. After this purpose has
been accomplished, the price of the securities may then
rise to their proper value.

The value of the stocks and bonds of a corporation should
equal its real wealth. Such is not always the case. The
franchise, certain privileges granted the company, and



256 Problems of American Democracy

various intangible assets are sometimes capitalized, that is,
given a monetary value, and stock issued to that amount.
Overcapitai- Up to a certain extent this is legitimate, for
many of these things have proper commer-
cial value. Great evils, however, result when the privileges
are capitalized at an exorbitant figure. This has been
illustrated in the consolidation of street car companies.
Again, stock has sometimes been issued which has had no
physical basis at all. Promoters have been given large
shares of stocks which have no paid-in value. Such a pro-
cess is known as overcapitalization or stock watering. The
more a stock is diluted the less becomes the value of each
share. All the stockholders may suffer for the benefit of
a few. Sometimes all the stockholders may receive a grant
of stock. If this is equal in value to, and in lieu of, a cash
dividend, the process is legitimate. It merely means that
the corporation is saving and expanding. Often, however,
stock dividends are largely water. Overcapitalization may
be sought to conceal high profits. If a dividend of ten dol-
lars is paid upon a share of stock valued at a hundred dollars
the profit is ten per cent. If the capitalization is doubled,
it now means ten dollars upon every two hundred and thus
the corporation shows a profit of but five per cent. It is
easier to add water to stock than to squeeze it out, for those
who profited by the process of overcapitalization may have
sold the stock later to legitimate investors. Numerous
laws have been passed attempting to restrict this evil of
overcapitalization.

The ease with which corporate securities can be bought
and sold in almost any denominations makes speculation
possible. Stock brokers are middlemen who buy and sell
securities for their customers. The stock exchange is the



Modern Capitalistic Organization 257

market in which they operate. The most important stocks
and bonds are listed on the New York Exchange where the
business is largely concentrated . The daily papers

. 1-11 r Speculation.

record the closing prices obtained there for the
chief securities. The more conservative investment securi-
ties fluctuate but slightly. Fluctuating securities, however,
afford greater possibility for gain or loss and are known a&
speculative stocks. Speculators watch the stock market in
order to buy stocks when they are low, hold them for a rise
in value, and then sell them for a profit. Fortunes have
been made and lost on the floor of the stock exchange. If
the security has been actually bought, such speculation can
hardly be called gambling. Frequently, however, but a
small portion of the money for the purchase is advanced
by the buyer. This practice is called buying on margin. A
relatively small sum will give a claim upon a considerable
number of shares. If the stock rises in value, the gain is
much greater than if a small number of shares had been
bought outright. If the stock falls in value, the loss is
equally great and may wipe out the entire margin. The
speculator must either put up more margin or be sold out.
The broker, who carries the stock for his customer, charges
him interest upon the difference between his margin and
the entire value of the security. By demanding a sufficient
margin, he usually protects himself against a fall in the
value of the security. Selling short is the reverse of buying
on margin. Here the speculation is based on a fall in the
market value, and the speculator sells for future delivery
what he really does not possess. Here a rise in value means
the loss of the margin. It is difficult to draw the line
legally between legitimate speculation and gambling. How-
ever, laws have been passed against some of the worst

R



258 Problems of American Democracy

evils of the system, such as the "bucket shop," which tempts
the small speculator to gamble on the stock market.

QUESTIONS FOR DISCUSSION

1. Who is the enterpriser and what are his economic functions?

2. Give some qualities and characteristics of the successful
enterpriser.

3. Explain the advantages and disadvantages of the partnership.

4. Define a corporation. Give its characteristics.

5. What advantages does the corporate form of business organi-
zation possess?

6. Outline the steps by which a new corporation would be formed.

7. Sketch the usual form of organization.

8. Explain the differences between stocks and bonds.

9. Enumerate some of the possibilities for abuse under the cor-
porate form of business organization.

10. Show the dangers of subsidiary companies.

1 1 . Explain what is meant by stock watering.

12. How and why does it happen?

13. Explain some other forms of financial jugglery.

14. Why is overcapitalization a pernicious practice?

15. What can be done by the state to prevent it?

16. Differentiate between investment, speculation, and gambling.

17. What is buying on margin?

18. AVhat is "selling short"?

TOPICS FOR SPECIAL REPORT

1. Great American captains of industry.

2. The charter of some industrial corporation, real or hypo-
thetical.

3. The corporation, a miniature society.

4. The detailed organization of some industrial corporation with
which you are familiar.

5. The work of the stock exchange.

6. Brokers and the marketing of securities^

7. Sound methods of capitalization.

8. Recent cases of overcapitalization.



Modern Capitalistic Organization- 259

REFERENCES

Burch, H. R. American Economic Life. Chapters XXVII and
XXXVII.

Clay, H. Economics for General Reader. Chapters IV and V.

Cleveland, F. A. First Lessons in Finance.

Ely, R. T. Outlines of Economics. Chapter XIII.

Hamilton, W. H. Current Economic Problems. Chapter IV.

Parts F and G.
Marshall, Wright and Fields. Materials for Study of Elementary

Economics. Chapter VI. Part B.
Meade, E. S. Corporation Finance; Trust Finance.



CHAPTER XXI
The Regulation of Monopoly

I. Economic aspects of monopoly
i. Definition

2. Influence of demand

3. Cost of production

4. Limitations on monopoly
II. Kinds of monopoly

1. Legal

2. Natural

3. Artificial:

a. Labor

b. Capital

III. The evolution of the trust

1. Pooling

2. Trustees

3. The holding company

IV. Social results

1. Advantages

2. Disadvantages
V. Political aspects

1. Possible public policies

2. History of regulation:

a. Sherman Anti-trust Law

b. Clayton Act

c. Federal Trade Commission

d. Supreme Court decisions

3. Other possibilities

260



The Regulation of Monopoly 261

Economic Aspects of Monopoly. — A monopoly exists
when there is sufficient control over the supply of a com-
modity, or service, to fix its price. The real
test of monopoly is not mere size, but this price-
determining power. Thus, the village grocer may be a
monopolist, if he is the only one in town and circumstances
make outside buying impossible. Monopoly price is that
price at which the greatest profit accrues to the monopoly.
A high price can only be maintained by restricting or con-
trolling the output. Hence the monopoly seeks to control
and regulate the supply.

The monopoly price may be a high price, but it is not so
necessarily. Competitive prices are said to be determined
by the so-called law of supply and demand, influence
The competitive price tends to increase with ° eman *
the demand for a good, and to decrease with its supply.
The monopolist must study the demand for his article,
and then regulate its supply and price accordingly.
Demand for a good is said to be elastic when its sale
responds quickly to any change in price. On the other
hand, the demand is inelastic when fluctuations in the
price of the commodity make comparatively little dif-
ference in the amount sold. The demand for necessities
is more inelastic than the demand for comforts and lux-
uries. The former must be had at any price. If the
demand for the article produced is very elastic, an increase
in the price may cause the sale to fall off to such an extent
that the profits of the monopoly will suffer. More sales
at a lower price may result in greater gains. When the
demand is inelastic, as in the case of necessities, the power
and danger of monopoly are increased.

Conditions of production must also be considered. The



262 Problems of American Democracy

monopolist must find whether the production of his good
follows the principle of increasing or decreasing cost, that
Cost of is, whether the cost per unit goes up or down as
production. ^ vo i ume f output increases. If the indus-
try is one which enjoys the economies of large scale pro-
duction, it may be good business to keep the price low.
It may cost so much less per unit to produce a larger quan-
tity than a smaller quantity, that greater profits may be
made with larger sales at a lower price.

An artificial limitation upon monopoly is governmental
interference. The two natural limitations are the forces
T . . . of substitution and competition. If the price

Limitations x m x

on rises too high, the consumer may cease his con-

monopoly. . .

sumption of that particular good and substi-
tute another in its place. Thus, if meat becomes exorbi-
tant in price, the thrifty housewife will be tempted to buy
more fish and eggs. Substitution is difficult, however,
with the cheapest necessities of life, such as salt or matches.
A rising monopoly price may sometimes stimulate action
upon the part of the producer, as well as upon the part
of the consumer. Competition may be revived. The
history of the sugar trust illustrates how a rise in price
made it possible for independent producers to enter the
market. A later combination secured another temporary
monopoly, and the price was again raised. Other inde-
pendent concerns, however, entered the field and the price
was lowered. In the background stands the State, when-
ever governmental interference becomes necessary. The
power to regulate price has been called "the gun behind
the door."

Kinds of Monopoly. — Numerous classifications of mon-
opolies have been attempted, but all seem to overlap.



The Regulation of Monopoly 263

Legal monopolies are those based upon law or govern-
mental privilege. The production of tobacco and matches
in France and salt in Saxony illustrates govern-
mental monopolies. The post office in the United
States is a legal public monopoly. Even where public
utilities are not owned and operated by the government,
there may be exclusive terms in their franchises which
make them' legal monopolies. Patents and copyrights are
illustrations of private legal monopolies.

Natural monopolies are those of location or organiza-
tion. Where the supply of a commodity is fixed, it is
fairly easy to establish a monopoly. The scarce

.,,-,., , ,. , „ Natural.

and rather localized sources of diamonds well
illustrate this point. Again, monopoly of supply may be
secured by obtaining control of the anthracite mines.
Many public utilities illustrate not only legal monopolies,
but also natural monopolies of organization. Competition
is wasteful when there is a large "overhead expense," that
is, fixed costs which must be met irrespective of the busi-
ness done. There is a tendency toward monopoly in many
industries of large scale production. This is especially
true when they operate under the principle of increasing
returns, that is, when profits increase relatively faster than
the business. This is illustrated by the railroads, where
a relatively large proportion of the freight charges goes for
fixed expenses of maintenance, which are rather inde-
pendent of the volume of business done.

The third group may be called artificial monopolies.
Although monopolies of organization, they are not in one
sense natural monopolies. They merely repre- Artificial:
sent the artificial organization of either labor Labor -
or capital. A labor union, for example, secures a mon-



264 Problems of American Democracy

opoly position if its membership includes practically all
the workmen of a given trade or craft. Some unions have
striven to limit the membership in the trade by a rigorous
apprenticeship. Such a practice may have its justification,
but the logical outcome of organization is monopoly. The
closed shop is one in which only union men are employed
and represents, to a certain extent, a monopoly of labor.

The trust may become an artificial, capitalistic monopoly.

Although a monopoly of organization, it is not a natural

monopoly unless it illustrates the principle of

Capital. . . ™ - . -

increasing returns. The secret of the power of
the trust is its bargaining strength, as much as its pro-
ducing efficiency. If monopoly is necessary to secure the
gains of large scale production, the industry may be termed
a natural monopoly. If, on the other hand, it has become
a monopoly merely by the process of capitalistic combina-
tion, the monopoly is artificial. From an economic point
of view, it is a colossus with feet of clay. Economists dis-
tinguish between two methods of combination, the ver-
tical and the horizontal. Vertical combination is an
attempt to get control of an industry through each of its
different stages. Control begins with the raw materials
and ends with each of the finished products. Vertical
combination may, however, not be a monopoly because
there may be powerful independent producers. But a
tendency toward monopoly is sure to manifest itself.
Horizontal combination is an attempt to combine all the
producers of a given article in a given stage of production,
as, for illustration, all the weavers of woolen cloth or all
the rollers of steel.

The Evolution of the Trust. — The trust is the corpo-
ration of corporations. Such a superorganization naturally



The Regulation of Monopoly 265

developed through a gradual process of combination. The
first stage in its development was known as pooling and
originated with the railroads. Agreements

11 • 1 • Pooling.

were made between independent corporations
to cease the competition that was ruining their profits.
Prices were fixed, and the market divided by some sort of
"gentlemen's agreement." It was found difficult in many-
cases to carry out such an agreement, because some con-
cerns would secretly undercut the price. No contract had