More important, Tarbell did not understand that the great Gould–Vanderbilt–Scott trunk line battles were never primarily about oil; they were about dominating the grain traffic routes to Chicago and the Midwest. In the early days especially, oil freight was hardly more than ballast for the much bigger business of grain shipping. In 1882, the first year petroleum was broken out in the trade data, raw agricultural exports, excluding flour, were more than six times petroleum exports; if flour is included, they were almost ten times as great. Back in the time of the SIC, the ratios would have been even more lopsided in agriculture’s favor. Comparing export volumes actually overstates the importance of petroleum, since exports were a much larger share of oil production than in grain.
The railroads loudly lamented their losses on oil shipping, and given the still-primitive state of cost accounting, were probably not intentionally deceitful. But since they originally chased oil freight to use excess capacity, oil revenues needed only to exceed variable costs to be attractive. A careful review by the industry historian Harold Williamson suggests that the oil traffic was almost always profitable, which canny businessmen like Gould and Vanderbilt would have understood intuitively. The fact that both the Erie and the New York Central chose to build up Cleveland, therefore, was not a consequence of Rockefeller scheming. Gould and Vanderbilt were struggling for control of the western grain trade, and Cleveland was the natural hub for both of their systems. There was never the slightest chance of their investing to build up the oil regions as a competing transportation center.
The second part of Tarbell’s argument—that rebates were somehow “illegal”—is simply false. There was no law against rebates, on either the federal or state level, and they were standard practice among all carriers.* Nor were they especially “secret.” Railroads struggled to prevent disclosure of particular rebates, for obvious reasons, but freely conceded, and as frequently complained about, the generality of the practice. Nor is it true, as frequently claimed, that rebates violated “the common law” against contracts in restraint of trade. In the first place, under the common law, contracts in restraint of trade were not criminal, they were unenforceable, which is rather different.† And second, the rigid predisposition of Elizabethan courts against covenants restricting trade had given way to a much more relaxed attitude “as the exigencies of an advancing civilization demanded,” in the words of a British authority. British courts generally recognized such agreements so long as they were “reasonable”; and in particular, neither courts nor Parliament saw anything wrong with price cartels that were not aimed at “raising prices or annihilating competition to the detriment of the public.” British railroad law prohibited only the granting of “undue or unreasonable preference or advantage,” a rule that would seem to admit most of the discounts awarded the Standard, since they generally reflected economic substance, like volume guarantees.
In any case, it is especially misleading to suggest that common law provided clear guidelines for settling novel issues in the United States. When the Sherman antitrust legislation was passed in 1890, everyone agreed that it incorporated the common law, but it took twenty years of split U.S. Supreme Court decisions, usually registered in strikingly testy opinions and dissents, to reach a consensus on what the common law was. The law was finally resolved in favor of the “reasonableness” position by the Supreme Court in the 1910 Standard Oil breakup case: “[A]t a very remote period,” the Court wrote, “. . . all such contracts [in restraint of trade] were considered to be illegal. . . . [but in] the interest of the freedom of individuals to contract, this doctrine was modified so that it was only when a restraint by contract was so general as to be conterminous with the kingdom that it was treated as void”—in other words, “reasonable” restraints on trade would pass muster until they approached actual monopoly. Progressive justices, like Oliver Wendell Holmes, Jr., and Louis D. Brandeis, aimed at entirely jettisoning “common law principles” because they were so often a mask for untethered judicial prejudice.
Finally, the claim that rebates, even if legal, were “unethical” is meaningless; these were legal discounts negotiated with powerful vendors for the benefit of shareholders. Many people thought that rebates were wrong, but they had not managed to translate their views into legislation. The pressure for common carrier rate regulation finally gained ground in 1887, with the passage of the Interstate Commerce Act, and federal rate setting became a reality in 1906. The experiment was finally abandoned in the 1970s, as economists reached a near-consensus that regulation had resulted only in higher rates and unresponsive service. No one argued that regulated rates were the more ethical alternative.
There are additional ethical questions, however, related to Rockefeller’s rollup of the Cleveland refineries. Did he pay fair prices? And how important, and how improper, was the SIC pressure?
The loudest complaints about Rockefeller’s prices came from men who received less than they had invested. Today we would take that for granted, even for businesses that weren’t designated for the scrap heap. We assume that a new breakthrough, as in telecommunications or the Internet, will cause a burst of business formation, followed by a harsh consolidation as the victors emerge. Businessmen in Rockefeller’s era, however, placed a much higher value on stability. A “fair return” from an established business was akin to a right in property, or as an influential congressman argued, “[E]very man in business . . . has a right, a legal and a moral right, to obtain a fair profit upon his business and his work.”
Rockefeller took the modern view. The game in Cleveland was over, especially after the merger with Payne. Rockefeller regarded almost all of his acquisitions as highly inefficient, and made no secret that he was going to shut them down. In his view, it was magnanimous to pay anything at all. He did so, it seems, primarily to save time, for he was marching to an insistent drummer—the quicker and cleaner the restructuring, the faster he could move on to the next arena. All the evidence is that his prices were based on fair, apparently scrupulously fair, appraisals of the purchased assets. Many sellers conceded the reasonableness of the prices, and those who followed Rockefeller’s advice and accepted Standard stock often became quite wealthy. Although Tarbell deplores a similar Rockefeller takeover of the oil region refiners a few years later, even she does not allege price-gouging. Her complaint is that, although refiners may have received large sums of cash, they had lost a valued way of life. Whether newly wealthy refiners would have agreed is not known.
Did Rockefeller use the threat of the SIC to exert pressure on sellers? Unquestionably. Was the threat unethical? In this instance, it does seem so. Recall that the coercive feature of the SIC was that if a refiner refused to join, he would not receive the SIC rebates, and his foregone rebates would be paid to the other SIC members. One cannot imagine that the second provision could pass even a common law test of reasonableness. The railroads insisted, however, that since all refiners would be welcomed in the SIC, there would in fact be no discrimination. But that was disingenuous. The whole point of the SIC was to reduce and rationalize capacity, so it would make no sense to admit small refiners unless they agreed to merge with their powerful bigger brothers. The SIC was all along intended as a pressure tactic, as Tarbell alleges.
Nor is there any way to defend the secret Standard stock grant to Peter Watson, the president of the SIC. It was a sizeable grant, with a book value of $50,000, or about what Rockefeller was paying for two modestly sized refineries. As Rockefeller and Watson surely expected, refiners looking for an independent opinion on a buyout offer often turned to Watson. A good test of unethical behavior is that you are ashamed to have it known. When Rockefeller was asked under oath whether Watson owned Standard stock, he lied. It is highly doubtful that the corrupt deal with Watson affected the ultimate outcome in Cleveland; but Rockefeller still had good reason to be embarrassed by it.
On balance, while there were skeletons aplenty in John Rockefeller’s closet, he was not a brigand, or embezzler, or sto
ck manipulator in the manner of the early Jay Gould. Most of the accusations against him are for violating standards as reformers wished them to be, not as they actually were. The best current analog may be Microsoft’s Bill Gates. He and his crew have played very rough over the years, often skirting the edges of the law. But they were also the first to understand the global opportunity in desktop software and executed their strategy brilliantly. As a committed Baptist, Rockefeller must have had long conversations with his God about the Watson perjury and his other bad deeds. But his misdeeds were not the reason he conquered his industry: he won because he was faster in apprehension and more deadly in execution than any of his contemporaries.
Carnegie Chooses a Career
During the years that Gould was making headlines with his Erie Wars and Gold Corner, and Rockefeller was executing the first phase of his takeover of the oil industry, Andrew Carnegie was bouncing from flower to flower—as if he were taking soundings on the limits of his talent.
A bare listing of his activities gives some flavor. By 1865, the year he left the Pennsylvania, he had recapitalized his original sleeping car investment, reorganized two iron companies into the Union Iron Mills, and organized the Keystone Bridge Co. During a nine-month world tour in 1865—part of his continuing quest for social polish—he encountered processes for putting steel caps on iron rails, and when he came home, started a company to experiment with the new Bessemer steel (unsuccessfully at this point). As competition between his sleeping car company and the interloper George Pullman heated up, he negotiated a tricky joint venture for a major Union Pacific contract, settled a contentious patent dispute, and merged the two companies in 1870. He went into the telegraph business in 1867, merged with the much larger Pacific & Atlantic Telegraph Co., executed major contracts with the Pennsylvania, went into the telegraph line construction business, and eventually sold his telegraph holdings to the Western Union, a deal in which he and a few favored insiders like Scott and Thomson did much better than the average shareholder. In all of these deals, Carnegie entered with a small stake, then came in with both feet as he saw an opportunity to scale up—reorganizing, reenergizing, and recapitalizing—almost always emerging as the lead shareholder. He was also becoming an accomplished bond salesman: by 1870, as if with his left hand, he had become an important investment banker for the Pennsylvania, structuring several imaginative transactions, and moving easily among major European investment houses such as J. S. Morgan, the Barings, and Frankfurt’s Sulzbachs.
Carnegie’s most famous project, perhaps, was the St. Louis Bridge, vaulting across the Mississippi in a single five-hundred-foot leap of iron and steel— “sensational and architectonic,” in the words of the great architect Louis Sullivan, who first saw the bridge as a boy. The bridge was especially noted for the first American use of pneumatic caissons for sinking the piers, a precedent even more famously followed by the Roeblings, père et fils, in the construction of the Brooklyn Bridge a decade later. The caissons were massive, hollow stone pylons footed by iron blades. They were floated to the pier site, overturned into the water, and sited on the bottom. An airtight roofed work area at the foot of the caisson was filled with compressed air to prevent water seeping in at the bottom. Workmen descended by a stairway, entered through an airlock, and as they excavated, the mud and silt was shuttled to the top through another air lock. Reporters were entranced by the caissons’ strange working conditions far under the water. The compressed air environment was fetid, working torches glowed strangely and flared unpredictably, and every moment was shadowed by the risk of sudden flooding from a compression failure. At depths of about sixty-five feet, the workmen began to suffer a mysterious, extremely painful, illness—what we now call the “bends.” None of the doctors had seen it before, so they decided it was the fault of the men’s drinking habits. Altogether, decompression sickness killed sixteen workers.
The organization of the St. Louis Bridge project offers a fine example of Carnegie’s methods. Railroad bridges were entrepreneurial ventures, usually financed by bond sales, which were repaid from railroad leases. The St. Louis Bridge Co.—primary owner Andrew Carnegie, silent partners Tom Scott and J. Edgar Thomson—clinched the St. Louis contract in 1867 mostly for its ability to deliver a long-term lease with the Pennsylvania. The company both financed the project and supervised construction on a total cost-plus-10-percent basis. The actual construction was carried out by the Keystone Bridge Co. (which had an excellent reputation as a bridge builder)—primary partner Andrew Carnegie, silent partners Scott and Thomson. The Keystone contract was also at cost-plus-10-percent. Moving farther down the chain, Keystone purchased its structural iron and almost all other iron supplies from the Union Iron Mills, primary owner Andrew Carnegie. The St. Louis Bridge Co.’s investment banker, finally, was one Andrew Carnegie, and he earned a handsome commission by placing the bridge bonds with Junius Morgan (who was much taken with Carnegie’s acuity and crispness), and then going on tour to sell them to investors. The St. Louis deal was by no means one of his most complex. On another Mississippi bridge deal at about the same time, his younger brother Tom, who was becoming a valued partner, protested because there were so many entities involved that he had never heard of. Another partner said not to worry: they were all Andy.
In the case of the St. Louis Bridge, Carnegie actually may have earned his multiple layers of compensation. The local genius of the bridge was Capt. James Eads, a brilliant amateur engineer, who was usually either splendidly right or disastrously wrong. Carnegie’s operating partner in Keystone, Andrew Kloman, was a supremely talented bridge builder, who preferred a much lighter, simpler design. After a series of rows with Eads, Kloman simply walked away—Keystone had a lot of other bridge contracts—and left him to Carnegie to manage, which took all of Carnegie’s finely honed personal skills. Eads turned out to be right about the caissons; and he was right about the advantages of using steel in certain high-stress elements of the superstructure; but the bridge was grossly overbuilt, and was delivered years late and far over budget. In the spring of 1873, an exasperated Junius Morgan responded to a typically “unreasonably positive” Carnegie update with:
We are glad to hear there is some prospect of the St. Louis Bridge being ready for traffic during the present year. . . . We have been told the same story for the past three years; we shall therefore not encourage too strong hopes of the accomplishment of what we have been so long anxiously waiting for.
Carnegie held Junius in awe—he was the gateway to the race of godlings who dispensed world-shaking amounts of money. To be rebuked so stingingly must have twisted the little Scotsman’s bowels.
It got worse. The bridge company ran out of cash in the fall, and Carnegie had to arrange yet another financing through Pierpont. The barely concealed dislike between the two may have stemmed from this first transaction. Junius always liked Carnegie, but one can imagine Pierpont curtly dismissing the Scotsman’s tale-spinning when he set out his terms. The money came in two tranches, the second of which was contingent on the span being closed by December 18. The crews came within a whisker of missing the date: one span was badly misaligned, and they struggled for weeks to connect it, succeeding only on the day the financing was scheduled to expire. Pierpont had already proved himself a banker who could pull financings without a flicker of sympathy. Failure to receive the second tranche of funds would have bankrupted the St. Louis Bridge and conceivably threatened all the rest of Carnegie’s enterprises.
The bridge did indeed open to much fanfare, on July 4, 1874, and accounts were happily settled with all of Carnegie’s various enterprises. The bondholders did not fare so well, as the bridge company slipped into insolvency the very next year. (The Morgans managed an exit for their investors in 1881 by leasing the bridge to Jay Gould. The negotiations were characteristically painful, and when Pierpont finally wired his father the terms, Junius replied laconically, “Think Mr. Gould exercised usual sagacity,” and advised his bondholders that the terms were �
��somewhat less favorable than hoped.”)
Carnegie may have sensed that he’d been pushing his luck. The St. Louis Bridge had come close to being a financial disaster, and he and Scott had also suffered a major reverse in connection with the Union Pacific, the transcontinental railroad. Scott had been invited in as part-time president, and used Carnegie to arrange a clever financing in London, for which Carnegie earned stock and a board seat. It may have been the proudest moment of Carnegie’s life to that point—from telegraph boy to director so quickly! Then when the stock rose he arranged a quick-profit sale of most of his and Scott’s holdings. The rest of the board were astounded when they discovered the sale and asked for both Scott’s and Carnegie’s resignations. Carnegie, one imagines, was equally astounded to discover that there were business rules beyond the rapacious ones he’d learned from Scott.
Andrew Carnegie’s companies built the great St. Louis Bridge, a design forerunner of the Brooklyn Bridge. J. P. Morgan gave Carnegie a hard date for closing the span; missing it might have bankrupted the Scotsman. The crews made the deadline only by hours.
At the same time, his string at the Pennsylvania was clearly running out. Except for his oil field investment, his fortune had been built primarily from supplying services or goods to the Pennsylvania. Carnegie’s companies were always high-quality, high-performance vendors, but his real edge came from Scott’s and Thomson’s inside positions. But the same directors’ standards that had caught him and Scott short at the Union Pacific were spreading to the Pennsylvania as well. The Pennsylvania’s directors, in the aftermath of the strains from the Erie Wars, conducted a full-dress operational review, and were unpleasantly surprised at their executives’ extracurricular activities. It wasn’t just Thomson and Scott; other senior managers followed the same practice, investing in George Westinghouse’s air brake company, for example. They were ordered to stop, in no uncertain terms, in 1874. Executives could comply or resign, as some chose to do. (The report was particularly harsh on Scott, for fiscal mismanagement as well as his conflicts of interest. Quite likely he was on the brink of being fired.)
The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould, and J. P. Morgan Invented the American Supercompany Page 12