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The Corporate Pyramid Fable

  • Steven A. Bank (a1) and Brian R. Cheffins (a2)

Abstract

Although corporate pyramids are currently commonplace world-wide and although there have been “noteworthy pyramiders” in American business history, this controversial form of corporate organization is now a rarity in the United States. The conventional wisdom is that corporate pyramids disappeared in the U.S. when New Deal policymakers began taxing dividends paid to corporate shareholders. This version of events is more fable than truth. The introduction of the intercorporate dividend tax did not foster a rapid dismantling of corporate pyramids. Instead, pyramidal arrangements were already rare in the U.S., other than in the utilities sector, and the demise of utility pyramids was prompted by the Public Util- ities Holding Company Act of 1935 rather than by tax reform.

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References

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1 Allen, Fredrick Lewis, The Lords of Creation (New York, 1935), 248.

2 See Berle, Adolf A. and Means, Gardiner C., The Modern Corporation and Private Property (New Brunswick, N.J., 1997, originally published in 1932), 69.

3 Ibid., 72.

4 There has been some historical research done on pyramids elsewhere. See, for example, Morck, Randall K. and Nakamura, Masao, “Business Groups and the Big Push: Meiji Japan's Mass Privatization and Subsequent Growth,” Enterprise & Society 8 (2007): 543.

5 Larson, Henrietta M., “Business History: Retrospect and Prospect,” Bulletin of the Business Historical Society 21 (1947): 173, 195.

6 McDonald, Forrest, Insull (Chicago, 1962) ; Harwood, Herbert H., Invisible Giants: The Empires of Cleveland's Van Sweringen Brothers (Bloomington, 2003) ; Morck, Randall, “The Riddle of the Great Pyramids,” National Bureau of Economic Research Working Paper No. 14858 (2009), 14.

7 Morck, Randall and Yeung, Bernard, “Dividend Taxation and Corporate Governance,” Journal of Economic Perspectives 19 (2005): 163, 174, 177 ; see also , Morck, “The Riddle of the Great Pyramids,” 3.

8 Villalonga, Bellen and Amit, Raphael, “How Are U.S. Family Firms Controlled?Review of Finance 22 (2009): 3047, 3062–63, 3075–76.

9 “Pharaoh Capitalism,” Economist, 14 Feb. 2009, 90 ; Almedia, Heitor V. and Wolfenzon, Daniel, “A Theory of Pyramidal Ownership and Family Business Groups,” Journal of Finance 61 (2006): 2637.

10 Masulis, Ronald W., Pham, Peter Kien, and Zein, Jason, “Pyramids: Empirical Evidence on the Costs and Benefits of Family Business Groups around the World,” European Corporate Governance Institute Finance Working Paper No. 240 (2009), 8, Table II.

11 Ibid., 3.

12 Morck, Randall, “How to Eliminate Pyramidal Business Groups: The Double Taxation of Intercorporate Dividends and Other Incisive Uses of Tax Policy,” in Tax Policy and the Economy, 19th ed., ed. Poterba, James M. (Cambridge, Mass., 2005), 135, 136.

13 , Morck, “The Riddle of the Great Pyramids,” 17.

14 , Almeida and , Wolfenzon, “Theory,” 2638.

15 Bank of Israel, Annual Report, 2009 (Jerusalem, 2010), 174.

16 , Morck, “How to Eliminate Pyramidal Business Groups,” 145.

17 Mundstock, George, “Taxation of Intercorporate Dividends under an Unintegrated Regime,” Tax Law Review 44 (1988): 1, 7.

18 “Seligman Reports on War Finances,” New York Times, 28 Dec. 1918, 14.

19 Internal Revenue Code § 243 (1996) (70 percent exemption if the corporation receiving the dividends has an ownership stake of less than 20 percent, 80 percent for ownership stakes from 20 percent to 80 percent, and 100 percent for ownership stakes of 80 percent or more).

20 , Morck, “How to Eliminate Pyramidal Business Groups,” 152.

21 Ibid., 168.

22 Ibid., 164.

23 , Morck and , Yeung, “Dividend Taxation and Corporate Governance,” 174.

24 Temporary National Economic Committee, Taxation of Corporate Enterprise (Washington, D.C., 1941), 59, 63.

25 Roe, Mark J., Strong Managers, Weak Owners: The Political Roots of American Corporate Finance (Princeton, N.J., 1994), 107–8.

26 Khanna, Tarun and Yafeh, Yishay, “Business Groups in Emerging Markets: Paragons or Parasites?Journal of Economic Literature 45 (2007): 331, 341.

27 , Villalonga and , Amit, “How Are U.S. Family Firms Controlled?” 3075.

28 , Morck, “How to Eliminate Pyramidal Business Groups,” 153 , discussing Twentieth Century Fund, Committee on Taxation, Facing the Tax Problem (New York, 1937).

29 , Morck, “How to Eliminate Pyramidal Business Groups,” 153.

30 Moody's Corp., Moody's Manual of Investments, American and Foreign; Banks, Insurance Companies, Investment Trusts, Real Estate, Finance and Credit Companies (New York, 1935), 2009 ; “Atlas Corp. Head Traces Acquisitions of Other Trusts,” Wall Street Journal, 30 June 1937, 3 ; Moody's Corp., Moody's Manual of Investments, American and Foreign Public Utility Securities (New York, 1935), 1405 (Electric Bond & Share). General Electric, which founded Electric Bond and Share, exited in 1924: Bonbright, James C. and Means, Gardiner C., The Holding Company: Its Public Significance and Its Regulation (New York, 1932), 106.

31 In 1935 Central Power and Light dissolved two subsidiaries that had recently transferred away their assets. See Moody's Corp., Moody's Manual of Investments, American and Foreign Public Utility Securities, 638. Northern New York Utilities, which was intended to be the survivor of a consolidation of a utility group organized around the Niagara Hudson Power Corporation, cited in its application to the New York Public Service Commission for regulatory approval “the elimination of the necessity for maintaining such separate records and the economies in operation by the consolidated company.” See “Stockholders Back Merger of Utility,” New York Times, 22 Jan. 1936, 31. The Commission rejected the application: “Merger Plan Withdrawn,” New York Times, 15 Aug. 1936, 20.

32 Moody's Corp., Moody's Manual of Investments, American and Foreign Public Utility Securities, 1432 ; Electric Power & Light Corporation, Annual Report (1937), 4. “Atlas Securities Would Merge Units”, New York Times, 10 June 1932, 29 ; “Atlas Expansion Near Completion,” Wall Street Journal, 11 June 1932, 7 ; “Atlas Corp. Proposes Final Step to Complete Consolidation Plan,” Wall Street Journal, 29 Sept. 1936, 3.

33 49 Stat. 803.

34 “Investments Cut by Bond and Share,” New York Times, 6 Dec. 1935, 39.

35 Utility Act Forces a Huge Divestment,” New York Times, 2 Dec. 1935, 31.

36 “Central Maine Power Classified as Strictly Operating Unit Now,” Wall Street Journal, 4 Oct. 1935, 6.

37 , Morck, “How to Eliminate Pyramidal Business Groups,” 136.

38 48 Stat. 881.

39 Securities and Exchange Commission, Official Summary of Holdings of Officers, Directors, and Principal Stockholders: As Reported to the Commission on Forms 4, 5, and 6, Pursuant to Section 16 of the Securities Exchange Act of 1934, as of December 31, 1935 (Washington, D.C., 1936).

40 Securities Exchange Act Release No. 989, ¶ 3, at 4 (26 Dec. 1936).

41 The total was higher once preferred shares were taken into account. See Smith, Frank P., Management Trading: Stock Market Prices and Profits (New Haven, 1941), 73 , Table II (abstracting data from Table I of the materials prepared to support Securities Exchange Act Release No. 989).

42 , Morck, “How to Eliminate Pyramidal Business Groups,” 168.

43 Theoretically, the selling off of corporate stakes induced by the introduction of taxation of intercorporate dividends could have taken longer than just a few years as a result of inertia or transactions costs, but this sort of postponed effect seems unlikely due to the economic dislocation associated with the start of World War II.

44 , Smith, Management Trading, 101–2.

45 Baskin, Jonathan Barron and Miranti, Paul J., A History of Corporate Finance (Cambridge, U.K., 1997), 22, 195, 233 ; Wilbur, Donald E., “A Study of the Policy of Dividend Stabilization,” Harvard Business Review 10 (1932): 373.

46 Wilson, Jack W. and Jones, Charles P., “An Analysis of the S&P 500 Index and Cowles's Extensions: Price Indexes and Stock Returns, 1870–1999,” Journal of Business 75 (2002): 505 , 529 (see figures listed under payout percent).

47 Temporary National Economic Committee, Taxation, 60.

48 Ibid., 40; Bureau for Internal Revenue, Statistics of Income for 1937, Part 2: Compiled from Corporation Income and Excess-Profits Tax Returns and Personal Holding Company Returns (Washington, D.C., 1940) , Table 5, 82–83. The amount of the tax on intercorporate dividends can be ascertained from Table 5 by calculating 15 percent of the figure in line 24 and multiplying by 0.15, the corporate tax rate in 1937.

49 “Finance, Business, Economics,” Washington Post, 26 Dec. 1934, 18.

50 Ellis, Charles D., “Repurchase Stock to Revitalize Equity,” Harvard Business Review 43 (1965): 119 (urging companies to change their approach).

51 , Morck, “How to Eliminate Pyramidal Business Groups,” 148.

52 , Berle and , Means, The Modern Corporation, 8485 , Table XIII; Brian Cheffins and Steven Bank, “Is Berle and Means Really a Myth?Business History Review 83 (Autumn 2009): 443, 453.

53 , Berle and , Means, The Modern Corporation. Their data on ownership and control drew heavily from Means, Gardiner C., “The Separation of Ownership and Control in American Industry,” Quarterly Journal of Economics 46 (1931): 68.

54 , Morck, “How to Eliminate Pyramidal Business Groups,” 138, 143.

55 Tippetts, Charles S. and Livermore, Shaw, Business Organization and Control, 2nd ed. (New York, 1940), 168.

56 See Securities and Exchange Commission, Report on the Study of Investment Trusts and Investment Companies, Part One: Origin, Scope and Conduct of the Study (Washington, D.C., 1939), 25 (distinguishing “investment companies proper” from an invest ment company/ holding company hybrid the SEC labeled “management-investment holding companies”).

57 , Bonbright and , Means, The Holding Company, 810, 12–14.

58 Wilson, G. Lloyd, “Book Review,” Annals of the American Academy of Political and Social Science 165 (1933): 236.

59 In the literature on pyramids, it is widely assumed that the outside investors will be shareholders in a publicly traded company, though theoretically a pyramid could exist without the relevant companies being traded on a stock market. See Villalonga and Amit, “How Are U.S. Family Firms Controlled?” 3060.

60 Some researchers do argue that a stake of 50 percent is required for control, but it is commonly assumed that a smaller stake will suffice (e.g. 20 percent). On this point, See , Morck, “The Riddle of the Great Pyramids,” 2 ; Levy, Marc, “Control in Pyramidal Structures,” Corporate Governance: An International Review 17 (2009): 77 , 78–79, 81, 87.

61 , Berle and , Means, The Modern Corporation 69.

62 Compiled from ibid., Table XIII. Berle and Means's basic control taxonomy was “management control,” “legal device,” “minority control,” “majority ownership,” and “private ownership.” Pyramiding was treated as a means of control by “legal device,” and for those companies where there was any doubt about the ownership categorization (i.e. there was no majority shareholder and ownership was not highly diffuse), Berle and Means specifically indicated whether ultimate control was achieved by pyramiding or was of a different sort. Compiled from Berle and Means, The Modern Corporation, Table XIII; on the particular companies see 93–94.

63 , Bonbright and , Means, The Holding Company, 77.

64 Ibid., 79; see also “Holding Firm Abuse Mostly in Utility Field,” Chicago Daily Tribune, 30 Jan. 1938, B5.

65 , Bonbright and , Means, The Holding Company, 8182.

66 Ibid., 80; see also 87.

67 Tippetts, Charles S. and Livermore, Shaw, Business Organization and Control: Corporations and Trusts in the United States (New York, 1932), 229.

68 Compiled from Berle and Means, The Modern Corporation, Table XIII.

69 , Bonbright and , Means, The Holding Company, 227–28.

70 Pub. L. No. 768; The Investment Company Act of 1940,” Yale Law Journal 50 (1941): 440 , 444, 455; Securities and Exchange Commission, Report on the Study of Investment Trusts and Investment Companies, Part Two: Statistical Survey of Investment Trusts and Investment Companies (hereafter Report Part Two) (Washington, D.C., 1939), 365.

71 See Securities and Exchange Commission, Report Part Two, 414–15.

72 Securities and Exchange Commission, Report Part Two, Table 123. The New York Stock Exchange officials, when they issued guidance in 1931 cautioning against pyramiding in the investment trust sector, were targeting this sort of three-tiered structure: “Cross-Holding of Trust Shares,” Wall Street Journal, 8 May 1931, 9.

73 Morck acknowledges the point, writing “the largest U.S. pyramids were built around utility companies.” “How to Eliminate Pyramidal Business Groups,” 148.

74 Compiled from Berle and Means, The Modern Corporation, Table XIII.

75 , Bonbright and , Means, The Holding Company, 91 , 95. Bonbright and Means said ten groups dominated electric power output, but indicated that one (Consolidated Gas of New York) was not oriented around a holding company (p. 114).

76 , Tippetts and , Livermore, Business Organization and Control, 2nd ed., 184. See also “Holding Firm Abuse”; EBASCO Services, Inc., Electric Utility Financing (New York, 1948), 2223.

77 , Bonbright and , Means, The Holding Company, 91, 101–2 ; Buchanan, Norman S., “The Origin and Development of the Public Utility Holding Company,” Journal of Political Economy 44 (1936): 31, 32–33, 43.

78 Hausman, William J. and Neufeld, John L., “The Market for Capital and the Origins of State Regulation of Electrical Utilities in the United States,” Journal of Economic History 62 (2002): 1050, 1053.

79 , Bonbright and , Means, The Holding Company, 98108 ; Hughes, Thomas P., Networks of Power: Electrification in Western Society, 1880–1930 (London, 1983), 395–98.

80 “The Insull Utility Empire: Its Amazing Rise and Fall,” New York Times, 9 Oct. 1932, xx3 ; Sobel, Robert, The Big Board: A History of the New York Stock Market (New York, 1965), 243–44.

81 , Bonbright and , Means, The Holding Company, 127–36 ; , Hughes, Networks, 400–1.

82 , Bonbright and , Means, The Holding Company, 3132.

83 Bank, Steven A., “Federalizing the Tax-Free Merger: Toward an End to the Anachronistic Reliance on State Corporation Laws,” North Carolina Law Review 77 (1999): 1307, 1355.

84 , Bonbright and , Means, The Holding Company, 33 ; Ripley, William Z., Main Street and Wall Street (Boston, 1927), 296–97 ; Flynn, John J., “Pyramiding of Holding Companies,” Annals of the American Academy of Political and Social Science 159 (1932): 15, 16.

85 , Bonbright and , Means, The Holding Company, 3637.

86 The number of instances where companies subject to PUHCA held stakes sizeable enough to require disclosure was greater than the number of holdings relating to issuers we classified as utility companies (59). This was largely because there were various instances where a company falling within the scope of PUHCA owned a stake of 10 percent or more in a public issuer that was not a utility.

87 “American Cities Power and Central States Sell Electric Shareholdings,” Wall Street Journal, 30 Nov. 1938, 3 ; “Many Public Utilities Affected by Williams's Divestment Plan,” New York Times, 13 Nov. 1938, 61.

88 Energy Information Administration, Public Utility Holding Company Act of 1935: 1935–1992 (Washington, D.C., 1993), 9 (quoting a 1947 study of the utility industry).

89 Public Utility Holding Company Act of 1935, §§ 5, 11(b)(1); Section 11(b) of the Holding Company Act: Fifteen Years in Retrospect,” Yale Law Journal 59 (1950): 1088, 1095.

90 Public Utility Holding Company Act of 1935, § 11(b)(2); Anderson, William H., “Public Utility Holding Companies: The Death Sentence and the Future,” Journal of Land and Public Utility Economics 23 (1947): 244, 247.

91 Energy Information Administration, Public Utility Holding Company Act, 11 ; Markham, Jerry W., A Financial History of the United States, Volume II: From J.P. Morgan to the Institutional Investor (1900–1970) (Armonk, N.Y., 2002), 206.

92 Electric Bond & Share Co. v. SEC, 303 U.S. 419 (1938).

93 Energy Information Administration, Public Utility Holding Company Act, 11.

94 “The Utility Industry,” Wall Street Journal, 18 Oct. 1944, 7.

95 North American Co. v. SEC, 327 U.S. 686 (1946); Energy Information Administration, Public Utility Holding Company Act 11.

96 , Anderson, “Public Utility Holding Companies,” 251 ; Seligman, Joel, The Transformation of Wall Street: A History of the Securities and Exchange Commission and Modern Corporate Finance (Boston, 1982), 257–58.

97 Morck, Randall K. et al. , “The Rise and Fall of the Widely Held Firm: A History of Corporate Ownership in Canada,” in A History of Corporate Governance Around the World: Family Business Groups to Professional Managers, ed. Morck, Randall (Chicago, 2005), 65, 97–101 ; Morck, Randall K. and Nakamura, Masao, “A Frog in a Well Knows Nothing of the Ocean: A History of Corporate Ownership in Japan,” in History of Corporate Governance, ed. Morck, , 367, 381–97.

98 38 Stat. 730 (1914). On this point, See Gugler, Klaus, Mueller, Dennis, and Yurtoglu, B. Burcin, “Insider Ownership Concentration and Investment Performance: An International Comparison,” Journal of Corporate Finance 14 (2008): 688, 696 (citing, though, §8, which deals with interlocking directorships, rather than §7). There remained, however, substantial scope for complicated corporate structures to emerge involving non-competing companies: , Bonbright and , Means, The Holding Company, 7576, 78.

99 , Masulis, , Pham, and , Zein, “Pyramids,” 3540.

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