Thorstein Veblen

The banks take over




This is an extract from chapter XII of Absentee Ownership. Thorstein Veblen describes the evolution from industrial to financial capitalism, when "the holding-company and the merger, together with the interlocking directorates, and presently the voting trust, were the ways and means by which the banking community took over the strategic regulation of the key industries, and by way of that avenue also the control of the industrial system at large." The financialization of the economy is even more pronounced now than then, with all the problems that follow insofar that the search for financial profit takes the precedence with respect to the production of goods and services.



A convenient point of departure for the rise of the new era in business enterprise may be found in the late nineties; and the new departure may be said to have been set afoot in the financiering of mergers and holding-companies during those years by the late J. Pierpont Morgan and those others who presently followed his lead.

In that time the holding-company came to stand as the advanced and perfected type-form of corporate ownership and control as employed in the conduct of industrial business. It was a well-considered advance over the earlier methods of absentee ownership and absentee management. In point of form, the holding-company is of a more perfect order of absenteeism, in that by this device the lawful owner draws back farther by one remove from any personal relation with the property which he owns and from which he derives an income; whether the property in question be tangible assets or a vested usufruct. At the same time the owner's claim on and control over his property shifts to a more impersonal or statistical footing if possible; to a footing of standardised quantitative allotment in terms of percentual units. His relation to property and its use thereby comes to carry a slighter effectual responsibility for any action taken, or for any tangible outcome of such action taken by the corporate .management to which he has in effect delegated his rights and powers. In the holding-company, even more obviously than in the ordinary corporation, the owner delegates the powers of ownership, and retains only its rights and immunities. So also it leaves him a correspondingly slighter chance of personally influencing any action taken by the management.

The holding-company has commonly been of a large size: and that fact has likewise had the effect of submerging the individual owner and his personal bias and initiative. The result is a pronounced degree of impersonality and standardised routine. So also, in the practical conduct of its affairs by the holding-company, the effectual control and management of any corporate business has passed into the hands of a relatively small minority of the ultimate owners, and at the same time the effectual control exercised by this relatively small minority of the owners has taken on a more unequivocally statistical character. So much so, indeed, that their effectual oversight and control will ordinarily touch nothing more tangible or more personal than certain figures supplied by the corporation's accountants; commonly numbers running to some half-a-dozen digits, having to do with certain price-totals.

The holding-company is no longer viewed with apprehension, as it once was; nor does it hold that dominant place in the business of credit and capitalisation which it held about the turn of the century. Not that it has gone out of use or out of mind. It has been proven and found good and has become a part of the standard apparatus of business, a commonplace formality of the routine. But at the outset, when the holding-company was coming into use, it was the effectual means of reorganising the business of the key industries on an enlarged, more elaborate and more manageable plan. It served to bring these industrial business concerns together into larger agglomerations than had been practicable up to that time, and it served also to detach the ownership of these concerns from their management more widely and effectually than before. By this move the whole apparatus and management of industrial business was placed on a foundation of credit in a more unqualified fashion than before, and thereby the management of the business was enabled to "trade on a thinner equity" [1] than had been practicable in the past. Corporation finance was enabled to take on still more of the character of standardised routine. So that the holding-company has been an instrument and an exemplar of that drift of things in the conduct of business which has brought on the current state of things, and which has made the difference between the situation of nineties and that of the present.

Much of the use which the holding-company has served has been that of standardising the routine of "big business" and familiarising the business community with that larger scale and wider detachment that is characteristic of the ordinary use of credit and the ordinary duties of ownership in this later time. In a very passable fashion men have learned all that now, so that it is no longer beset with the distrust of the unknown, - which is said to be a nearly universal infirmity of sound business men. What the use of the holding-company once served to drive them to has now become a familiar matter of course.

Something to much of the same effect is to be said for the of "interlocking directorates," which also once loomed up in popular apprehension as a formidable, if not a menacing, innovation in the conduct of business. The interlocking directorate has also not passed out of use. It too, is still a convenient arrangement for purposes of mutual understanding and support. But these purposes for which these devices were once resorted to as a means of constraint, have now become habitual matters of routine; and the devices therefore have ceased to claim that degree of attention which they were once presumed to merit. They are no longer of the essence of the case.

The late J. Pierpont Morgan saw an opportunity and turned it to account. It is not likely, and it does not appear, that he rated himself as a path-finder or in any sense as the pioneer of a new era in business enterprise or that he harbored any ambition or design to change the face of the business community. For all his large initiative and his large powers and responsibilities, he was a notably unassuming person; being apparently driven by nothing more spectacular than the habitual incentives of safe and sane business of the larger sort [2]; although his larger initiative led him beyond his contemporaries and associates, and at times, indeed, led him close to the frontiers of sound business practice.

The undertakings which are associated with his memory at this point, and which played a typical part in leading over to the new era, may be described in general terms somewhat as follows. At that time (late nineties) there were a large number and variety of established business concerns doing business primarily in certain of the key industries, notably steel, ore, coal, and railways. Many of these concerns were in a moderately bad way financially, for one reason and another. They were, not uncommonly, unable to command such a volume of credit as was needed in the conduct of their business. They were commonly over-capitalised-in excess of their market value as going concerns and notably in excess of the value of their tangible assets. So they were carrying overhead charges somewhat in excess of what their current earnings would warrant; and their earnings were declining rather than otherwise.

This state of their affairs was due in some measure to a more or less pronounced obsolescence. It was in part an obsolescence of their industrial plant, but with more critical effect these concerns also suffered from a rapidly growing obsolescence of locality, particularly as related to the means of transportation on which they depended for their supply of raw materials and for the delivery of their marketable output. In some instances their business facilities were also going out of date; their markets were in process of obsolescence, through a shifting of the population, through changes of custom and usage, trough being cut under by other concerns doing business in the same market. There had been ceaseless change in the technique of these industries during the life-time of these business concerns; and more particularly during the lifetime of the "underlying companies" and industrial plants on which these industrial business concerns were based; for the greater number of those concerns that are in question here were composite organisations, built up out of previously existing corporations and firms, by merger, purchase, and consolidation. And throughout this period of industrial growth, changes in the processes of industry and in the localisation of the various industries had been going forward; due in great part to the growth and redistribution of the population and to continued extensions and enlargement of the transportation systems. New natural resources also continued to be drawn into the industrial system and to be engrossed by certain of the larger owners. All of which conspired to put these business concerns out of date and out of joint with the conditions of the market. Perhaps the gravest of the factors which contributed to this obsolescence and perplexity of these industrial business concerns was the competitive character of their market, both for raw materials and labor and for disposal of the output; and this competitive market was all the more precarious because the productive capacity of the existing plants was already greater than the market would carry off at a profitable price, even within the shelter of a high protective tariff. The most embarrassing appears to have been the inconsiderate competitive position taken by those Carnegie properties which presently came to play so magisterial a role in precipitating the formation of the U.S.Steel Corporation. [3]

Not infrequently the management of these previously established industrial business concerns was in the hands of elderly and opinionated owners, who had an old-fashioned sentimental interest each in his own corporation, as being his own creation, and whose occupation would be gone in case their own concern were to be merged with others or sunk in an inclusive holding-company. These survivers of an earlier business regime were by way of being "captains of industry" of the obsolete sort, in that they commonly combined some degree of technical training, experience, and aspiration, with a customary knowledge of the markets and of corporation finance. And they were commonly out of date in both respects, by force of what may be called obsolescence by displacement in technical practice and in financial usage. They were patriarchal holdovers, with much of the intolerance that will commonly invest the self-made patriarch. Things had been moving forward in matters of knowledge and practice during the lifetime of these elderly captains and their establishments, and among the forward changes were such as made imperatively for a larger scale and a more far-reaching team-work in the processes of production, a larger use of credit, and for a more carefully guarded competition in the markets. And none of this fell in readily with the settled habits of these elderly captains or with the standing business relations among their several concerns.

These industrial business concerns, and their underlying companies and plants, had in their time been projected with a view to the traffic of a fairly open competitive market, and they had expanded by successive extensions and accretions, and so had grown to maturity under conditions which that traffic had created. With the progressive filling-out and closing-in of this market they found themselves, progressively, in the position of competitive producers for a closed market of variable volume. They were consequently somewhat overstocked with industrial plants of a fair productive capacity, which not unusually duplicated one another, and which had been placed somewhat hastily by rule of thumb in somewhat haphazard locations, and had grown from relatively small beginnings by a process of patchwork and extension. And all the while their combined productive capacity rather exceeded the capacity of their market - at any such price as would afford them a "reasonable profit" on their output. In this sense the market was closing in. It was becoming too narrow for a free run of output at the price-level at which these enterprises had been projected. The period of competitive business in the key industries was closing. So that continued open competition among them became "cutthroat competition"; such as to entail present prospective decline of their earning-capacity. As one consequence of this situation, they were greatly in need of additional credits for use in their business, at a time when their credit capacity was falling off and their liabilities were already becoming distressingly burdensome.

When the affairs of the corporations in the key industries had reached this pass, the dean of the banking community saw his own occasion in the present needs and the dubious prospects of these industrial business concerns. Of course there were others, too, and not a few, who were ready to see the same opportunity and to profit by it so soon as it had been placed before them in an object-lesson. The conjuncture was essentially that of a sweeping transition and realignment, incident to the passing of the common run of the key industries from a footing of competitive business in an ample market to a footing of collusive traffic in a closed market too narrow for unguarded competitive production. [4]

As the event has taught, the executive use of the country's credit resources in a large way and on a reasoned plan was the appointed means by which the due reconstruction of the business was to be worked out, and also the means by which the needful running collusion in the further conduct of the business was to be enforced and regulated. The holding-company and the merger, together with the interlocking directorates, and presently the voting trust, were the ways and means by which the banking community took over the strategic regulation of the key industries, and by way of that avenue also the control of the industrial system at large. By this move the effectual discretion in all that concerns the business management of the key industries was taken out of the hands of corporation managers working in severalty and at cross purposes, and has been lodged in the hands of that group of investment bankers who constitute in effect a General Staff of financial strategy and who between them command the general body of the country's credit resources. This general staff, or inner group, command the credit resources of the country at large; although it would presumably not do to say, at least not just yet, that they - the large business financiers and their banking houses - own or comprise or constitute the credit resources of the country.

Out of this drift of things the "Investment Banker" has emerged, to serve as a powerful instrumental factor in working out the new alignment of ownership and industrial business, and presently to take his place as one of the essential workday institutions of the business community. It should perhaps be remarked that he is not yet in existence de jure, but only de facto. Just yet he is still in process of standardisation as regards his precise nature and uses; so that no sharply defined description of him and his work can be drawn, just yet, although there is some thing to be said of him and his functions. [5] He is the source or the channel, as the case may be, of capitalisation and of corporation credit at large, - a source if he amounts to a banking-house of the first magnitude, a channel if his place in the economy of Nature is that of subordinate. At the same time and in his appropriate degree he is the standard container of such credit and the standard repository, original or vicarious, of the larger intelligence and discretion in these fiscal matters. He initiates movement or pressure in the conduct of business, or he transmits initiative and pressure. In point of pedigree, considered as an institution, his formal line of descent out of the past traces back to the business of underwriting, as it ran in the time before the banking community had taken over the general initiative and foresight in the conduct of industrial business. But he is also rooted in the business of commercial banking and banks of issue, as well as in the trust-companies that have come up and grown great in his own time; and then there is about him, too, a broad hint of the bill-broker of earlier times. In point of form, he is affiliated with his client-corporations as creditor, underwriter, sponsor, banker, broker. In effect, he is the comptroller of their fiscal affairs and, within reason, the master of their solvency; being custodian of their absentee owners' interests at large.

Hitherto, and in so far as it has touched the larger contingencies of business, this work of initiative, discretion, foresight, and control, which has become incumbent on the country's investment bankers, has habitually taken effect by way of collusion or concerted action. This concert of action is of the essence of the case. It is by virtue of such concert among the larger and more responsible ones that they constitute in effect the General Staff of the business community - what may be called the One Big Union of the Interests. Under the surveillance of this general staff, it has become incumbent on the investment bankers as an organized body to deal with the run of business as an organic moving equilibrium. This highly responsible task enjoins a collusive sobriety, a collective and concerted moderation, such as is intended in the colloquial phrase, "sitting tight." The investment bankers collectively are the community custodians of absentee ownership at large, the general staff in charge of the pursuit of business. And since the conduct of industry is incidental to the pursuit of business, the state industry and the rate, volume and balance of production also are dependent on their sagacity and goodwill. So that it is here, if anywhere, that responsibility for the country's material welfare may be said to rest.

In his time, the great pioneering creator of mergers and holding-companies came to stand as the chief of investment bankers and the dean of the congregation of corporation finance. And from that time on, the investment bankers have progressively taken over the control of industrial business in the large. Investment-banking as it is conducted now, owes its rise and character to the circumstances of that time, and it has continued to work along much the same lines to which it was then brought by the experience of Morgan and his associates. The financial enterprise may therefore be said to have arisen out of the mobilisation of those banking resources which were already employed in underwriting corporate capitalisations, and to have arisen as an enterprise in mergers, recapitalisations, and bonuses; but it presently fell into settled lines as a standardised routine of investing funds and allocating credits. This standardised routine of investment and allocation is what engrosses the energies of the community of investment bankers. It is also the ways and means by which they, working together as a general staff of financial strategy, govern the country’s business at large and so regulate the ordinary rate and volume of productive industry. In all this, the continued merging of old concerns and creation of new ones goes forward as a routine matter of administration incident to the allocation of credits. And the credits are - also as a routine matter-of-course - allocated with an eye single to the greater gain of the investment bankers who see to the allocation of them.

In its beginnings, in the nineties, this enterprise in mergers and recapitalisation was primarily concerned with bringing certain elderly units of the industrial business community to terms, by a persuasive use of financial pressure; to prevail upon them to surrender their several corporate powers and enter into some arrangement in the way of a merger, commonly under the form of a holding-company. By this means these concerns cease to govern their own affairs individually, were drawn in under a centralised management, and so ceased to be effectual competitors in the market. In the main this reorganisation had to do with business concerns which were in the position of holdovers in the key industries, and more particularly such of them as were in financial straits, as a good proportion of them were.

In this connection it has also been believed, on circumstantial evidence, that the great financier, and after him also the lesser ones, would now and again take pains to manoeuvre such an embarrassed concern into financial extremities; such as would incline its management to surrender the controlling interest and to allow a suitable "bonus" to the captains of finance who managed the reorganisation.

During the early years of the period it was this bonus that was the immediate object sought by the reorganising financier, and the chief incentive to the reorganisation. The bonus commonly took the form of a block of securities issued in the name of the new incorporation. And it was commonly quite a substantial bonus, so as to take up a very appreciable percentage of the new capitalisation. This bonus which the underwriter of the new corporation securities came in for appears to have been the valuable consideration sought by these financiers in undertaking these early mergers and recapitalisations. It does not appear that these financiers commonly set out with the purpose of taking over the management of the incorporations which they created. But the transactions which they entered into in their pursuit of the bonus entailed commitments and obligations which stood over after the initial transactions had been concluded. The recapitalisation and its endorsement at the hands of the financier, or investment banker, together with the practice of taking over his bonus in the form of a block of securities issued by the new incorporation, entailed a continued community of interest between the investment banker and the new incorporations which he had created. A community interest of a special sort, in that it committed the investment banker - the financier and his banking-house - to a continued responsibility for the success of the new incorporation; which in turn vested the banker with power to act, and lodged in his hands a virtually plenary discretion in the oversight and management of the new incorporation. The outcome has been that the banking-houses which have engaged in this enterprise have come in for an effectual controlling interest in the corporations whose financial affairs they administer. And it is this outcome that has proved to be the enduring and decisive factor in the new business situation created by this recourse to mergers and recapitalisations under the auspices of the investment bankers.



[1] The expression, "trading on the equity," as employed in this connection, is borrowed from W. H. Lyon, Capitalisation, where a very competent discussion of this principle is to be found in chapter ii.

[2] As is related of Jakob Fugger, "Er wollte verdienen dieweil er könte."

[3] For descriptions and argument on this movement in the nineties and after, Cf. the testimony of various witnesses before the U. S. Industrial Commission, in the Commission's Report, vols. I, IX and XIII.
See also W. Z. Ripley, Trusts, Pools and Corporations; E. S. Meade, Trust Finance, and Corporation Finance; W. S. Stevens, Industrial Combinations and Trusts; C. W. Gerstenberg, Materials of Corporation Finance; A. S. Dewing, Corporate Promotions and Reorganization.

[4] There is, of course, no sharp date-line to be drawn in such a case, but 1897 will serve to mark this turn of affairs as well as any.

[5] Cf.. A. S. Dewing, The Financial Policy of Corporations, vol. II, ch. ii and vii. In the same connection see also The Same, vol. III, ch. ix, on the Voting Trust. Also Hastings Lyon, Corporation Finance, Part II, ch. ii and iii.


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