CORPORATIONS Continued.
SUBSIDIARY CORPORATIONS; CONTROL AND MANIPULATIONS.
Subsidiary or auxiliary companies are those which are
formed or controlled by, or are dependent upon some large com-
pany. It frequently becomes necessary in order to promote the
success of a corporation to organize a subsidiary company as a
feeder or helper, for the purpose of carrying out a particular
part of the enterprise, such as supplying the corporation with
raw material, disposing of its finished product, called a "selling
company," constructing buildings or bridges, called a "construc-
tion company," etc. It may be that the parent company
has not sufficient means to properly carry out a subordinate pur-
pose or develop an enterprise which will be collat-
era ^ an ^ verv beneficial to the company. A new
and subordinate company may then be formed out
of the capital furnished by those stockholders of the parent com-
pany who may have money to invest, and the building or other
property of the subsidiary company may then be leased to the
parent company. Thus a railroad company, through a subsidiary
corporation, builds a hotel at a summer or winter resort where
one is needed, hoping thereby to increase its passenger travel, or
develops large sugar plantations along its line to add to its
freight traffic. An electric street car company needing a new
power house and not having the necessary funds with which to
build it, and not wishing to issue bonds or increase its capital
stock, forms a subsidiary company by which the power house
is built and leased to the controlling company. Nearly all of
our railway systems have branch lines, which at greater or less
300
SUBSIDIARY COMPANIES. 301
length reach from the main line into some agricultural section
or to mines or cities located away from the main line. In this
way transportation facilities are furnished to distant sections
and an outlet is afforded them for their products, while the
earnings of the main line are perceptibly increased by the busi-
ness brought to it. Sometimes these branch lines have been
expensive to build, where the attempt is to reach some min-
ing district, and the money for their construction was obtained
by issues of branch line bonds by the subsidiary company which
may have been guaranteed by the parent company or were made
valuable on account of a lease contract with the controlling com-
pany whereby the income of the branch road is assured, and the
interest on its bond issue and sinking fund is provided for.
Another reason for the formation of subsidiary or auxiliary
corporations is the manufacture and control of by-products.
Take, for instance, a corporation engaged in mining coal. It
frequently becomes necessary in developing the vein of coal to
remove a large quantity of fire-clay, also a red shale, which
products in themselves are valueless to the coal mining cor-
porations, but a subsidiary or auxiliary company is formed for
the purpose of manufacturing the fire-clay into fire-brick or
other marketable product, and another corporation
^ s f rme d ^ or * ne purpose of preparing and vend-
ing the red shale, which is a cheap and excellent
material used in the construction of roads. These companies
are, of course, dependent upon the "parent" corporation for their
raw material and are usually related by contracts specifying the
price to be paid for this material, and requiring that the parent
corporation shall furnish such quantity of raw material as may be
agreed upon as being sufficient for the purposes of the subsidiary
corporation.
Perhaps the reason most frequently met with for the forma-
tion of subsidiary companies is where a corporation owning
patent rights or franchises parcels out the territory which it
302 CORPORATIONS.
controls to various subsidiary organizations, which may pay
yearly royalties or percentages, or may pay for the privileges
they get hy giving a "lump sum" in cash, or by
gi^ ^e parent company a part of their capital
stock, or by a combination of all of these "consid-
erations/' In this way the stockholders of the parent company
avoid much of the risk, and also the neceeity of raising a large
cash capital. This method has been pursued by the American
Bell Telephone Company and other well known companies with
signal success. Subsidiary companies, while being distinct cor-
porations, are dependent upon the controlling company, usually,
for their existence, and almost universally for their financing
and management to a considerable extent.
Auxiliary companies are sometimes the medium through
which profits that should belong to stockholders of the parent
company are diverted to the pockets of the directors and their
associates. In the history of railroad building in the United
States there are many instances where the man-
agers of a railroad company have organized a so-
called "construction company" to build an exten-
sion to its lines, and have then formed a separate corporation in
which the ownership of the extension was nominally vested,
and which proceeded to make a contract with the construction
company to build and equip its line, paying for it with its bonds,
issued for an amount in excess of the actual cost, and also with
its entire capital stock, which by some fiction of bookkeeping was
made to appear paid up in cash. The extension having been
built with the proceeds of the bonds, or perhaps a part of them
only, the next step was to sell or lease the new line to the old
company on terms that made the stock held by the construction
company a valuable asset. This and the remaining bonds, if any,
could then be divided in kind or sold and the proceeds dis-
tributed in cash. The morality of such a transaction as this is,
to say the least, questionable, though judgment should not be
CORPORATE CONTROL. 803
passed in any specific instance without full knowledge of all the
facts.
Of late corporations have been organized for a new function,
i. e. that of holding a controlling interest of the stock of other
corporations. The validity of these "parasite corporations/' as
they have been called, is yet to be passed upon by
Securities f ne C0lir t s . If permitted to stand, they mav have
Companies "
far reaching consequences by giving a few men
control of large interests, although owning comparatively little
capital. Let us consider the case of a stockholding corporation
with, say, $60,000,000 capital and this capital invested in, say,
51 per cent, of the stock of a railroad capitalized for $100,000,-
000. The holders of a bare majority of the stock of the stock-
holding or parasite corporation would then exercise control
over both corporations. Thus $30,000,100 of stock would be
able to control $100,000,000 of capital. But let us carry this
one step further and suppose a majority of the stock of the
parasite corporation held by another company of the same kind
with a capital of, say, $31,000,000. The owners of only a little
over $15,500,000 of its stock would then exercise effective con-
trol of the $60,000,000 company, and through it of the $100,-
000,000 company. This is an instance of a lesser corporation
controlling a greater. It is diametrically the opposite of the
subsidiary corporation. An example of a parasite corporation
is the Northern Securities Company, recently organized for the
purpose of merging the control of the Great Northern, Northern
Pacific and Chicago, Burlington & Quincy Railroads. This
attempt of merger has been declared illegal by the
Merger niegai courts on the ground of public policy, since such
a combination would remove competition, the
three roads being nearly parallel. The method of controlling
a greater corporation by means of a securities company holding
a majority of the stock, however, is a legal proceeding, in all
of those states where one corporation is permitted by statute
804 CORPORATIONS.
to own shares in another. It is merely an extreme exercise of
the principle of "majority rule."
Stockholding corporations designed to control greater cor-
porations by means of the majority rule, as outlined above, savor
somewhat of the methods of the so-called "trusts," which will
be considered in the next chapter.
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