Under this head we have to consider not the questions that arise in connection with the establishment or purchase of partly subsidiary enterprises, but those that arise in connection with using the surplus funds of a corporation partly for investment in the securities of non-related corporations. We shall see in a succeeding chapter, in discussing methods of util-izing surplus funds, that some corporations make it a practice to place a portion of these funds in salable securities. However, this is seldom carried to the extent of tying up in these investments a large proportion of the company's available capital. The policy to be considered here is that which involves transforming a company from an active transportation, public utility, industrial, or trading enterprise into a company that has for one of its main functions investment of capital in securities.

It is seldom that this transformation is effected through the desire or even with the consent of the great body of stockholders. It is much more commonly the case that the active officers or directors of the company have private motives of their own for desiring to make use of the company's credit and other resources. The results achieved may conceivably in the long run be beneficial to the stockholders, but they do not affect the underlying motive.

This appears to have been the situation with the Union Pacific Railroad Company at the time when it was under the domination of the late Mr. E. H. Harriman. Mr. Harriman's first efforts were directed toward making the Union Pacific an efficient and profitable railroad property. Having succeeded - or being well on the way toward success - in these efforts, his personal ambitions led him to invest the surplus profits of the Union Pacific more and more heavily in other railroad companies and to utilize the credit of the Union Pacific in raising great sums of money for the purpose of consolidating and extending these investments in other railroad properties. Thus, in the course of time the Union Pacific became half a railroad company and half an investment company. The decision of the Supreme Court of the United States in 1912, which compelled the Union Pacific to part with its holdings of the securities of certain other railroad companies, has in part remedied but has not completely changed this state of affairs.

The Adams Express Company has total assets of approximately $70,000,000, out of which "securities and investments" comprise $57,000,000. Its total earnings from investments average 25 to 50% higher than its earnings from its own operations.

On October 23, 1914, announcement was made of the appointment of a receiver for the Toledo, St. Louis and Western (Clover Leaf) Railroad. Undoubtedly the prime reason for the failure was the investment of $11,500,000, in 1907, in common and preferred shares of the Chicago and Alton Railroad Company. The dividend record on the acquired shares was as follows:

Common

Preferred

1907

• • •

4%

1908

1%

4%

1909

4%

4%

1910

2%

4%

1911

• • •

2%

1912

• • •

• • •

No dividends since.

When in 1906 Mr. E. H. Harriman was questioned by the Interstate Commerce Commission as to the status of the Alton Railroad, he replied quickly, "You will have to ask the Rock Island people; they are carrying the bag." The following year the Rock Island succeeded in unloading on the Clover Leaf. The loss to the Rock Island on this transaction, however, was heavy. It has been estimated at approximately $5,000,000.

Another painful experience in making investments fell to the lot of the Rock Island Company. In 1902 Rock Island purchased Frisco common stock to the par value of $28,930,-300, giving in payment $60 per share in 5% bonds and $60 in common stock. Seven years later the Rock Island management sold the Frisco stock back to the original vendors at $37.50 per share, or $10,848,250. But before the stock could be transferred, it was necessary to pay the collateral trust bonds, which were callable at 102 1/2 and interest. To pay off these bonds required $18,160,037 cash, which was $7,311,175 more than was received from the sale of the Frisco stock. To raise this additional cash, $7,500,000 of debenture bonds were issued. During the seven years the Rock Island owned the Frisco stock, it paid out in interest on the Frisco collateral trust bonds $6,077,000, and did not receive a cent of dividends on its holdings of Frisco stock. The actual money loss to the Rock Island Company was, therefore, $13,388,175. In addition, the Rock Island Company has outstanding $17,364,180 of its own stock, which was issued in part consideration for the Frisco stock.

In studying the records of large corporations which have made investments on a great scale, one is more and more impressed with the idea that the men at the head of these corporations seem at times to lose their judgment in the handling of the enormous credit power that is under their control. They are apt to imagine that ordinary rules of sound judgment and careful-figuring do not apply to them. They are in somewhat the same state of mind as the large clothing manufacturer to whom it was demonstrated that a big percentage of his product was being sold below cost, "Oh, that will come out all right," airily replied the manufacturer. "You overlook the great scale upon which our operations are carried on".

Another factor which makes for recklessness is the astonishing ease with which large corporations can issue stocks and bonds in exchange for property. It is apparently so simple and so tempting a thing to do - to have a few more pieces of paper engraved and given in exchange for railroads, factories, and control over the labor of thousands of men - that it requires a level head to keep clearly in mind that these new pieces of paper are so many additional obligations which sooner or later must be met.