The Steel Tycoon: Andrew Carnegie, late 1890s.
Carnegie immediately wrote his closest partners and Schwab that Frick had to go, and that he was coming to Pittsburgh to take charge of the ouster. For his part, Frick had no interest in staying on; he quickly submitted his resignation and left on a short vacation. But Carnegie was now in fullblown attack mode and was determined not just to oust Frick but to lock in the coke rate and take control of the coke company. His weapon was to be the “Iron Clad Agreement” that he and his partners had signed after Tom’s death in 1886. The Iron-Clad permitted the expulsion of a partner by a three-quarter vote; in such a case, the expelled partner got only the book value of his stock, which would have wiped out about 80 percent of the fair market value of Frick’s holdings.
Carnegie pushed through the expulsion vote. It was clearly vindictive, since Frick had already resigned, but only Phipps and another small holder refused to sign it. When Frick returned from his vacation in early January 1900, Carnegie delivered his ultimatum personally: produce the coke deal he wanted or get expelled under the Iron-Clad. Listeners on the other side of the door heard Frick’s explosion: “For years I have been convinced that there is not an honest bone in your body. Now I know that you are a god damned thief!” Accounts differ on whether Frick actually chased Carnegie from the room. It was the last time the two men ever met or communicated directly.
As it turned out, for one of the only times in his life, Carnegie was forced into a near-total retreat. Frick beat him to the courtroom and sued for a fair valuation of his holdings. It quickly emerged that the Iron-Clad didn’t apply to Frick, that it may have been improperly executed in the first place, and that it had not been consistently enforced. Frick’s lawyers also subpoenaed Carnegie Steel’s books and records, so enterprising reporters started publishing details of the company’s extraordinary profits, at a time when America’s very high steel tariffs were under attack by Democrats in Congress. Both Carnegie and Frick were deluged with pleas to stop the idiocy—Mark Hanna, the Republican kingmaker, and George Westinghouse each weighed in personally.
A settlement was finally worked out in March, one that was all that Frick could have hoped for. A new corporation, the Carnegie Co., was created as a New Jersey holding company, with a market capitalization of $320 million, half in 5 percent bonds and half in stock carrying a 5 percent dividend. All the shares in the old companies were converted fifty/fifty into Carnegie Co. bonds and shares. The Carnegie Co. was a pure holding company: it held the shares of the coke and steel companies, and twelve other steel-related businesses, most of them quite small, and collected dividends to service the payments on its own securities. Carnegie was still the real boss, but his long-suffering partners finally got their payday. The yearly interest and dividend payments were nearly $1.8 million for Phipps and just short of $1 million for Frick, while Carnegie’s own 60 percent interest brought a whopping $9.6 million.
Just before the deal closed, Carnegie was beset by doubts on the valuations, for he wrote an anxious note to the company treasurer, Lawrence Phipps, asking how he could be sure the securities were really worth so much. The return answer was soothing, but hardly reassuring. The company’s shares did not trade on an exchange, and Phipps quite correctly wrote that “The Directors have recorded their opinion that the Stocks of the Operating Companies are of full value . . . so that the Carnegie Company books must be opened on that basis.” Absent a public market, that is, the shares were worth whatever the directors said they were worth.
In truth, the valuations were far too high. The write-ups over book value were aggressive enough. The coke company was valued at $70 million, or Frick’s high estimate, for a thirteenfold write-up, while the steel company’s write-up was a more modest 3.7 times. What really mattered, however, was the interest and dividend burden, which, at $16 million, could have been crippling. The record-breaking $21 million of profits in 1899 left a comfortable margin, but it was the first year ever that earnings would have been sufficient to cover the new level of payouts.* (Dividend payments, of course, unlike interest, are not mandatory. But contemporaries attached great importance to living up to dividend commitments, and Carnegie would have been a laughingstock if it were discovered that he had missed a dividend immediately after the deal.)
Carnegie confidently expected $40 million, or even $50 million in earnings in 1900, which would have been ample cushion. But after getting off to a spectacular start, business slowed sharply in the spring and summer, and total earnings were not much above 1899’s.† There was a one-time $12.9 million dividend bonus on closing, which the company clearly hoped to pay out mostly in cash. But except for an initial pro rata cash distribution of $750,000, no further cash payments were made in 1900. Carnegie and several other wealthier directors agreed to take their dividend in paper, while payment was simply deferred for everyone else. Although the company had plenty of cash at the outset of the year, it was coming under strain in the fall. The steel company’s November earnings were only $362,000, or less than a tenth the average monthly profits in the first quarter, and not nearly enough to cover even the monthly interest burden. In July, Carnegie suggested delaying interest on the bonds to finance continued investment; Schwab and the other directors were politely appalled. In fact, Carnegie’s personal income statement for the year suggests that he collected considerably less than the full amount of interest he was entitled to, and no dividends.
It is amazing to see Carnegie, the sworn foe of watered balance sheets, signing on for such a burdensome structure. It can’t all be blamed on Frick. The $320 million valuation was among the very highest discussed within the company. And just a month before, Carnegie had rejected out of hand a settlement offer from Phipps and Frick for only $250 million. There was pressure from Carnegie’s partners for a high-cap deal—their thirst for a big payday, after all, had been building for almost thirty years. But he was used to that, and could easily have insisted on something lower. Quite possibly, he was sick of the publicity surrounding the string of $200-million-plus steel mergers by the Morgan syndicates, the Moores, and others. Putting together an even bigger deal may have salved an ego still bruised from the failed transaction of the previous summer.
Clearly, whatever fault lay with Carnegie and Frick, it was the stimulus of Pierpont Morgan’s megamergers that placed such lofty valuations within the realm of rational discussion. There were other players in the market, such as the Moores, but they would have had limited credibility unless Morgan had confirmed their valuations with deals of his own. During the decade from about 1895 to 1905, Morgan’s transactions, and those of lesser figures like the Moores, transformed the contours of American business; they will be the main topic of the next chapter. Another consequence of the sudden spate of giant corporations was a burst of activity under the rubric of antitrust.
Trust-Busting
No other country carried the animus against trusts to the degree that America did. All governments scratched their heads about the best way to deal with the very large companies that were popping up everywhere at the close of the nineteenth century, but nowhere else was trust-busting, as Richard Hofstadter put it, “a way of life and a creed.” Most other countries, especially on the continent, freely granted monopolies in railroads and similar businesses, and as often encouraged bigness in the name of national competitiveness.
The antimonopoly fervency in America traces back to Andrew Jackson and earlier. Hofstadter locates it in a culture of “farmers and small-town entrepreneurs—ambitious, mobile, speculative, antiauthoritarian, egalitarian, and competitive.” The path to salvation in mainstream American Protestantism was one of deep existential solitude: puny humans marching half-blind across a black plain buffeted by forces cold, cosmic, and violent. That was also a fair job description for a Minnesota wheat farmer, or for a small manufacturer caught in a Wall Street financial panic. The same mind-set assigned quasi-biblical status to a rigorous form of laissez-faire economics. Business competition fit
neatly within the metaphor of constant struggle: it forged the character and discipline required for the larger battle.
By the time of the Interstate Commerce Act (1887) and the Sherman Antitrust Act (1890), however, the force of religious millennialism and the agrarian reform impulse were both attenuating, especially with respect to railroads. Since farmers had been the beneficiaries of a prolonged, and very steep, fall in railroad freight rates, the question of maximum rates hardly came up during the hearings. The hot-button issue for Interstate Commerce Act (ICA) advocates was instead the glaring inconsistency between very low long-distance shipping rates and proportionately much higher short-haul rates. But by this time, the aggrieved parties were eastern merchants. Astute western businessmen-farmers had long understood that it was precisely such rate discrimination that kept them in business.
There was no mystery to railroad rate-setting: the roads charged whatever they thought the traffic would bear. When long-haul west–east lines first opened, railroads marked up their rates proportionate to the distances and got very little business. Western wheat came to dominate world markets only after railroads made it very cheap to get to the coast. New York farmers and grain merchants were the big losers, but the chances of Congress requiring the roads to raise rates from the west were approximately zero.* What farmers did care about, on the other hand, was rate volatility, since the perennial price wars frequently caused a violent seesawing of tariffs. The Eastern Traffic Association, the large eastern rail pool that Albert Fink managed with great competence through most of the 1880s, had brought a measure of stability to eastern rates, at least while times were prosperous. While few congressmen could openly contradict the years of reformist antipooling rhetoric, many had come to believe that regulated pooling might offer the most reasonable path to achieving rate stability.
Much the same ambivalence surrounded the passage of the Sherman Antitrust Act. Grass-roots worries about “monopoly” had temporarily subsided: Free Silver was the only Populist platform plank William Jennings Bryan needed to adopt to gain the Populist party’s endorsement in 1896. At the same time, rising academic lights, like John Bates Clark and Richard Ely, the founder of the American Economics Association, were beginning to question the validity of the traditional laissez-faire canons, and at least some congressmen were aware of their thinking. There was also a groping appreciation that in industries like steel and oil, global competitiveness required large-scale production and distribution units. Just as with the ICA, many years of reformist momentum had finally built to the point where the public expected action, but it was suddenly not at all obvious what a legislative program should look like.
In short, it wasn’t necessarily corruption or incompetence that produced such toothless compromises in both the original Interstate Commerce and Sherman Antitrust acts. Congressmen may have consciously crafted “wait and see” bills. The new commission that emerged from the ICA had extensive surveillance powers on whether rates were “reasonable and just,” but no rate-setting power or powers of enforcement other than bringing an action in federal court. While there was a proscription against long-haul/short-haul rate discrimination, it was vitiated by the qualifier that it applied only under “substantially similar conditions or circumstances,” which courts proceeded to read very narrowly—merely the presence of competition was enough to defeat the “substantially similar” test. Only rebates and pooling were quite definitely disallowed. As an indication of the bill’s fragmented support, one of its sponsors, New York senator Orville Platt, who had been educated in railroad rate-making by Fink, refused to sign it over the anti-pooling clause.
The language of the Sherman Act was similarly cautious. The first draft’s prohibitions against actions that would limit “full and free competition” were replaced with traditional common law formulations: the law forbade only contracts or combinations “in restraint of trade or commerce” or attempts “to monopolize any part of . . . trade or commerce.” Sophisticated congressmen were fully aware of the flexibility of the common law precedents. Reformers thought they won a round by imposing horrific penalties for violations—prison terms, huge fines, and forfeit of corporate property. But when it became clear that courts would never impose them, even the reformers lobbied for reductions.
The unintended effect of both laws was to speed the pace of mergers. For the first decade or so after the Sherman Act’s passage, the Supreme Court, by narrow majorities, followed a strict interpretive line: if the Act barred “any” combination in restraint of trade, it meant any—while the minority insisted that even the strict interpretation implied a reasonableness standard, since every contract theoretically acts as a restraint on trade. In the early 1900s, the Court gradually swung behind an accommodation-ist position more akin to the British common law approach. By the time of the 1911 Standard Oil breakup, the “reasonableness” banner had carried the field, although the company’s assumed “90%” market share was taken as sufficient evidence of unreasonable concentration, while U. S. Steel’s roughly 50-percent-plus market share passed muster. (In a triumph of prejudice over logic, for many years the Court not only insisted that labor unions were “combinations in restraint of trade” but also refused to apply the same reasonableness tests they used for business combinations.)
The Court’s benign view of mergers, however, was paralleled by a very strict standard for reviewing agreements between companies aimed at dividing markets or maintaining prices. In the Northern Securities Co. v. U.S. case (1904) the Court did not permit a Morgan-brokered holding company designed to resolve a years’-long war between the E. H. Harriman and James J. Hill lines to the far Northwest. One of the offending features of the structure, according to the Court, was that it was not the “real owner of the stock in the railroads” but merely “the custodian or trustee.” Northern Securities culminated a long string of decisions that left no doubt of the Court’s hostility to “loose” combinations like Albert Fink’s railroad pools. You didn’t need a genius lawyer to figure out that if you wanted to combine, a genuine “tight” merger had the best survival prospects, as long as you merely stayed under a Standard-scale “unreasonableness” threshold.* The national railroad system eventually consolidated around six or seven large networks, and the Interstate Commerce Commission (ICC) was finally empowered to set all interstate railroad tariffs in 1906. Once the Commission began prescribing tariffs, rates generally rose.
Spotlight on the Standard
The Standard, like no other company, was a magnet for intense, angry antitrust scrutiny, especially after Ida Tarbell’s History of Standard Oil completed its nearly two-year serialization run in McClure’s Magazine in 1903. Between 1904 and 1906, at least twenty major antitrust suits were filed against the Standard by various states’ attorneys general, and in late 1906 the United States Bureau of Corporations filed its own enforcement suit, triggering the case that eventually led to the breakup of the Standard five years later.
By the time the case got to the Supreme Court in 1910, the record, in the Court’s words, was
inordinately voluminous . . . aggregating about 12,000 pages, containing a vast amount of confusing and conflicting testimony relating to innumerable, complex, and varied business transactions, extending over a period of nearly forty years. . . .
Both as to law and as to the facts, the opposing contentions pressed in the argument are numerous, and in all their aspects . . . irreconcilable.
Thus on the one hand, with relentless pertinacity and minuteness of analysis, it is insisted that the facts establish that the assailed combination took its birth in a purpose to unlawfully acquire wealth by oppressing the public and destroying the just rights of others . . . . [with the result that the Standard] is an open and enduring menace to all freedom of trade, and is a byword and reproach to modern economic methods. . . .
On the other hand, in a powerful analysis of the facts, it is insisted that . . . [the Standard is] the result of lawful competitive methods, guided by economic ge
nius of the highest order, sustained by courage, by a keen insight into commercial situations, resulting in the acquisition of great wealth, but at the same time serving . . . to widely extend the distribution of the products of petroleum at a cost largely below that which would have otherwise prevailed.
(The Court neatly ducked deciding between those polar positions, basing its breakup ruling merely on the fact that the Standard had achieved a practical monopoly.)
Unlike the Court, many historians appear to take the government’s anti-Standard case as proven, although the actual record is not nearly so clear. One of the major threads in the government’s case, for example, was the charge of predatory pricing, or below-cost price strategies to drive specific independents out of business. When the historian John McGee examined every alleged case of predatory pricing, however, he could not find “a single instance in which the Standard used predatory price cutting.” While there were a few cases that remained ambiguous, most stemmed merely from regional price differences, which McGee found almost always justified by local economics. In several cases where there had been price wars, they had been initiated by the complaining independents. Another major line of pricing charges involved a Standard experiment with self-service wholesale distribution centers for retailers, which local jobbers charged was a predatory attack on their businesses. But the Standard didn’t change its prices; rather, it set up stations where retailers could come and fill kerosene cans at the same prices charged to local middlemen—possibly an instance where the Standard was picking up distribution tricks from the meatpackers. The complainants, moreover, were often enough successful oilmen. Lewis Emery, for example, who later was a fiery anti-Standard Pennsylvania state legislator, made a career out of starting oil companies and selling them to the Standard; the Standard even provided start-up financing for one of his companies.* At the time of his complaint, Emery was a primary investor in the Pure Oil Co., one of the most successful of the independents. Jeremiah Jenks, the staff director for the 1899 Industrial Commission hearings, examined Standard pricing practices and concluded that “many instances” of arbitrary price shifting to disadvantage competitors “may be considered as established,” although in the one case he examined in detail he found that the facts did not support the charge.
The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould, and J. P. Morgan Invented the American Supercompany Page 27