We the Corporations

by Adam Winkler

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  UNDOUBTEDLY THE MOST INFLUENTIAL book ever written about the corporation in America was Adolf Berle Jr. and Gardiner Means’s The Modern Corporation and Private Property, published in 1932. Berle and Means, two Columbia professors who would go on to become key advisors to Franklin D. Roosevelt, detailed the changing nature of corporate business around the turn of the century. The distinctive feature of the modern, publicly traded corporation, they argued, was “the separation of ownership and control.” In contrast to the corporations of early America, which were typically owned and managed by a single family or small group of investors, modern corporations of the early twentieth century were more likely to have a dispersed class of passive stockholders who could not exert much control over management decision-making. A quarter of a century before Berle and Means’s book, however, the American public was first introduced to the separation of ownership and control by the Great Wall Street Scandal of 1905. The evidence adduced in Charles Evans Hughes’s highly publicized investigation made it clear that executives in the modern corporation had access to a tremendous amount of other people’s money—and that the law did little to stop executives from misusing it for their own purposes.24

  One reason Hughes’s investigation garnered so much public attention was the special place that insurance played in the American economy at the turn of the century. Insurance companies “were among the lustiest of American corporations,” according to historian Morton Keller, and only the railroads and a handful of trusts rivaled them in terms of accumulated capital. More than 10 million people had life insurance policies and, if beneficiaries are factored in, about half the nation’s population of 76 million had a stake in the companies. In an era before pensions, life insurance was the preferred retirement plan of most Americans who could afford it. If the policyholder died, life insurance would provide for the policyholder’s family. If the policyholder survived to retire, the policy would provide cash value. As Collier’s reported, “there is not a county or town in which somebody is not insured. No other business, therefore, can compare with insurance in the extent of the raw nerve surface exposed to every breath of scandal.”25

  That nerve was especially sensitive because insurance companies were understood as fiduciaries to the policyholders—holding, it was said, “the widows and orphans’ money” in trust. Richard A. McCurdy, the president of Mutual Life, promoted that view in his testimony before Hughes’s committee, calling his corporation “a great beneficent missionary institution.” Hughes, who responded, “the question comes back to the salaries of the missionaries,” revealed that while Mutual Life’s dividends to policyholders had dropped by 20 percent, McCurdy’s annual compensation had increased five-fold. All told, the McCurdy family had drawn a startling $15 million from the company (or $375 million in 2017 dollars).26

  Such excessive self-dealing was possible, Hughes discovered, because the policyholders had no effective way to control corporate management. Even where policyholders had a right to vote in the corporate elections, few ever did; in George Perkins’s company, with more than three-quarters of a million policyholders, only twenty-eight had voted in a recent contest. Widely dispersed throughout the nation, the policyholders were rendered powerless by their sheer numbers: they could not be easily organized, and any one vote against management was inconsequential. Nor could policyholders depend on the corporations’ directors to safeguard their interests. In the 1890s, insurance company boards had adopted a policy of deference to the firms’ chief executives—one that would become commonplace in public corporations in the following decades. Even though the boards of the major insurance companies were a “Who’s Who” of New York financial, business, and political elites, the directors acted powerless. “In fine,” the Nation observed, “directors do not direct.”27

  Had the policyholders somehow overcome their collective action problem, they faced a series of other hurdles created by the recent corporate law reforms. The “race to the bottom” that began when New Jersey loosened its laws to lure reincorporation by large corporations, like Standard Oil and American Tobacco, translated into increasingly lax rules of corporate governance. Older rules that held managers liable for negligent decision-making were replaced by the “business judgment rule,” which effectively immunized management from liability for bad decisions so long as those decisions were made in good faith to serve the business. Shareholders saw their legal right to inspect the books and records diminished. Laws requiring unanimous shareholder consent for fundamental changes in the business were watered down to allow rule by the majority. Even this became a mere formality due to the introduction of preferred shares that lacked voting power and the widespread use of proxy voting in shareholder elections—an innovation traceable to John Winthrop and the Massachusetts Bay Company back in the 1600s. With power concentrated in executives’ hands, each company, Hughes concluded, had been turned into “an autocracy, maintained almost without challenge.”28

  Given the separation of ownership and control in the insurance companies, the hurdles facing policyholders were “simply overwhelming,” according to Harvard economist Charles J. Bullock, writing in the midst of the scandal. Insurers, Bullock warned, had become typical of “ ‘high finance,’ which, whatever its form, always means irresponsible control of other persons’ money.”29

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  AMID CHARLES EVANS HUGHES’S discoveries of exorbitant salaries and cronyism in the insurance business in the Great Wall Street Scandal, the corporate wrongdoing that “most shocked the public” was George Perkins’s revelation that executives were taking from the till to contribute to political campaigns. This, too, was widely seen as a form of self-dealing. The contributions were thought to serve the selfish interests of executives rather than the true interests of the companies or their policyholders.30

  In the public eye, the money given to candidates belonged to the policyholders. Yet executives had used the policyholders’ money to support political candidates many of the policyholders would not themselves support. As the New York Herald put it, “An insurance company has a vast number of policy holders of all shades of political belief. To take money in which a rabid Democrat has a beneficial interest and devote it to the election of a Republican is unfair on its face.” Campaign contributions forced policyholders to associate with partisan politics against their will, and thus were different in kind from other types of business decisions about how to spend the company’s money, such as whether to open a branch office or launch a marketing campaign. Political donations also served to undermine the value of the individual policyholder’s own vote. Humorist Finley Peter Dunne captured it well with “Mr. Dooley,” his inimitable Irish working man, in a piece published shortly after Perkins’s testimony: “Th’ joke iv it was that half th’ money belonged to dimmycrats. . . Haw, haw! There they were out West losin’ their jobs an’ havin’ their morgedges foreclosed all f’r love iv Bryan, an’ here was their money down east fightin’ again thim. They beat thimsilves. An’ they didn’t know it.”31

  The corporate executives involved insisted that the political contributions were just smart business. Echoing Mark Hanna, Perkins said a company “ought to contribute . . . 25 cents, 50 cents, a dollar or 10 cents from each policyholder to protect his interests” when threats arose, “as in the McKinley campaign” to defeat Bryan. Yet if the contributions were made to protect the policyholders’ interests, why were they kept secret, hidden in the accounting books such that policyholders might never discover them? New York Life had even filed a sworn affidavit to Texas lawmakers denying having made any political contributions. According to Hughes’s Final Report, “The devious methods taken to conceal the payments of this sort are confessions of their illicit character.”32

  The facts uncovered by Hughes’s committee also undermined the executives’ defense that they had given to defeat Bryan. In fact, the companies gave more in the 1904 campaign, in which Bryan was not a candidate, than in the 1896 or 1900 campaigns, i
n which he was. The Democrats in 1904 had run instead Alton Parker, a bland New York judge, chosen largely because he was the antithesis of the radical, antibusiness, and twice-defeated Bryan. With no shortage of sarcasm, Hughes wondered, “The size of contribution I suppose indicates the remoteness of the danger?”33

  Questions turned to what benefits the insurance executives were really receiving for their generosity. The suspicion was that the contributions were not to help the company or the policyholders but to help management. Company executives used the money to gain access to elected officials—and to secure favorable legislation that protected them in their jobs. Newspapers seized upon a prominent illustration, the recently enacted reform of New York’s insurance law known as “Section 56.” The new law required policyholders who wanted to sue insurance executives for breach of their fiduciary duties to first obtain the permission of the state attorney general. This “reform,” like the larger changes occurring in corporate law, only made it harder for policyholders to hold management accountable. Parker, whose earlier charge that Roosevelt had received corporate money was vindicated by the Perkins revelations, said the contributions from business were designed to guarantee the “triumph of that party which will better serve [the executives’] personal financial interest and will—for contributions, past, present, and future—continue to protect their interests by lenient legislation.” The result was “unfettered management.” Old protections that had once guarded the interests of policyholders had been “removed by the legislature at the instigation of the Wall Street insurance corporations and gamblers,” noted muckraking journalist B. O. Flowers. Executives had perfect freedom “to use the trust funds of policy holders recklessly and wastefully.”34

  The contributions to Roosevelt were seen in a similar light. In 1905, Republican senator John Dryden of New Jersey had introduced a bill with Roosevelt’s backing to give regulatory authority over insurance to the federal government. Insurance had been traditionally regulated by the states, but company executives were growing weary of having to comply with (then) forty-six different state insurance regimes. They backed Dryden’s plan, hoping for a set of uniform, national laws through a federal Bureau of Insurance. As Dryden himself admitted, this would “make it so much easier to shape policy.” Lest there be any doubt, the companies handpicked the bureau’s first would-be superintendent even before the bureau was voted on in Congress. The bill was never passed, in part because life insurance contributions confirmed the suspicion that a federal takeover of insurance law could, in the words of the usually business-friendly Independent, “render impregnable the position and power of a comparatively small number of men in the insurance business.”35

  Few people thought that the problems of accountability and political misuse of company money were truly unique to the insurance business. According to the New York Times, the money “contributed by the life insurance companies” was “but a drop in the bucket as compared with the total contributions by railroads and other great corporations.” The “indications” were that “many insurance secrets are also Wall Street secrets.”36

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  THE EMBODIMENT OF THE populist opposition to Wall Street and big business was Louis D. Brandeis, who was first inspired to focus on the organizational dynamics and dangers of the modern corporation by the Great Wall Street Scandal. Building upon Hughes’s discoveries about the nature of political and corporate corruption, Brandeis would become the nation’s most astute and nuanced thinker about corporations.

  By all accounts brilliant, Brandeis began Harvard Law School at the age of 18, where he received the highest grades in the school’s history—a record held until the school changed its grading system nearly eighty years later. Neither his youth nor his Jewish identity affected him in the classroom, although the former did pose a problem when it came time for graduation. Harvard’s rules required students to be at least 21 to receive a low degree, and Brandeis was only 20. On the morning of commencement, Brandeis was surprised to learn the faculty had voted to waive the rule and allow him to be graduated with his class. The Harvard professors were only the first to be so impressed by Brandeis to rewrite the rules for him. It would happen again shortly after graduation when, with the backing of the chief justice of the Massachusetts Supreme Court, he was allowed to join the bar without taking an examination. Most notably, it would occur in 1916 when Woodrow Wilson broke from long-standing tradition and nominated Brandeis to become the first Jew on the Supreme Court.37

  The insurance investigation was a turning point for Brandeis, much as it was for Hughes. After Harvard, Brandeis had opened up a law office in Boston, where he represented local businessmen, such as Edward Filene of the eponymous department store, and worked sporadically on public interest matters. In his free time, he wrote scholarly articles with his law partner, Samuel Warren, on esoteric legal subjects; one was on “the law of ponds.” Another article argued for courts to recognize a novel legal right: the “right to privacy.” Published in the Harvard Law Review in 1890, Brandeis and Warren’s right to privacy article has been called “certainly the most influential law review article ever written.” After becoming involved with the Great Wall Street Scandal as counsel to the New England Policy-Holders Committee, Brandeis would focus ever more of his time on political activism. The controversy also exposed him to the dynamics of the corporation that would influence his most important intellectual contributions to the understanding of corporate capitalism.38

  In October of 1905, as Hughes’s hearings continued, Brandeis gave a speech at the Commercial Club in Boston, a half-century-old group formed to promote “the commercial prosperity and growth of the City of Boston.” In that speech, Brandeis articulated for the first time the two insights into the modern corporation for which he would become famous: “the curse of bigness” and “other people’s money” corruption.39

  INSPIRED BY THE LIFE INSURANCE INVESTIGATION, LOUIS BRANDEIS ARGUED THAT MODERN CORPORATIONS WERE TOO BIG AND ALLOWED EXECUTIVES TO MISUSE OTHER PEOPLE’S MONEY.

  The life insurance companies were becoming dangerously large, Brandeis warned. Like the “Bosses of the Senate” in Keppler’s political cartoon, these companies had achieved a size and level of influence dangerous to democracy. Insurance policies were valued at nearly $13 billion, greater than the value of all the nation’s railroads combined, and the companies held more than $2.5 billion in assets, three times the combined capital of all of the nation’s banks. Annual return on investment for the insurers was more than $600 million, greater than the annual budget of the federal government. Unlike industrial or manufacturing corporations whose assets were “permanently invested in lands, buildings or machinery,” the “capital of the life insurance companies, on the other hand, is mainly free capital.” This liquidity made insurance companies, more so than even banks, “the creditors of our great industries,” with the power to control not only insurance but nearly every other industry. Those “who control these great insurance companies” exert “a predominating influence upon the business of the country.”40

  Eventually, Brandeis would expand his criticism beyond insurance companies and apply it more generally to large corporations and the trusts, like Standard Oil and American Tobacco. He became nothing less than the “most influential critic of trusts during his generation.” Brandeis was convinced that huge, industry-dominant corporations were less efficient than smaller firms. In an era of unprecedented consolidation, nearly all segments of the marketplace were being controlled by one company or a few companies acting in concert. Brandeis, like Roosevelt, feared these firms became dominant not through natural growth but through market manipulation and the stifling of competition. Small-scale entrepreneurs, who in Brandeis’s view gave the American economy its traditional vitality and innovative edge, were being squeezed out. Moreover, companies were becoming so large and their businesses so diverse that no one could gain the necessary expertise to manage them well. Indeed, the same group of investment bankers was effec
tively directing the major companies in nearly all industries through interlocking directorates, leading to poor service at excessive cost.41

  Yet for the populist Brandeis, intellectual heir to Jefferson, the evils of enormity were not primarily economic; they were moral. Great size was noxious to democracy and individual liberty. “Half a century ago, nearly every American boy could look forward to becoming independent as a farmer or mechanic, in business or professional life,” Brandeis explained in a congressional hearing a few years after the Great Wall Street Scandal. “Today, most American boys” were destined to “work in some capacity as employees of others.” As a result, they will not build up strong and independent characters, forsaking freedom to make a living. “There cannot be liberty without industrial independence,” he believed, “and the greatest danger to the people of the United States is in becoming, as they are gradually more and more, a class of employees.”42

  Focusing on the curse of bigness also helped Brandeis to differentiate between “good” corporations and “bad.” Hardly the socialist critic of capitalism some of his opponents assumed, he was instead a Jeffersonian convinced of the virtues of economic and political decentralization. He saw his reform agenda as necessary to prevent the United States from falling victim to the socialistic and revolutionary zeal cascading through Europe at the turn of the century. American workers and consumers were accustomed to liberty and self-direction, two victims of the industrial workplace, where authority was concentrated in the hands of supervisors. In the absence of reform, the disempowered would eventually demand more and more benefits from the government. By refusing to change, Brandeis told the crowd at the Commercial Club, the “great captains of industry and finance” were “the chief makers of socialism.”43