CHAPTER XXIX

COMBINATIONS AND CONSOLIDATIONS Reasons for Combination The primary purpose of the formation of a combination or a consolidation of two or more corporations, or of the taking over of a partnership business by a corporation, is to secure greater profits through unity of control. To this end the various parties to the consolidation agree to subordinate their own interests if the effectiveness of the larger unit is thereby increased. The main object in view is the control of any external or internal factors that affect earnings. Profit may be increased by economy of operation resulting from large-scale production, by economies in use of by-products, by the standardization of product and improvement of quality, and by the elimination of duplicate effort; or the control of sources of supplies or of a marketing organization, or greater ease in obtaining capital, or greater facility in dealing with labor, may be among the advantages obtained. In the past the most important of all factors has been the elimination of competition by the control of selling prices, thus securing a greater hold on the market and reducing selling expense. A consolidated enterprise enjoys the advantage of adding to its plant facilities and rounding out the scope of its activities without the expenditure of new construction or capital purchases entailing the raising of large sums of money. Types of Consolidation In the popular mind the terms, combination, trust, holding company, consolidation, and merger stand very much for one and the same thing. The end sought is generally the same, namely, the power to control in some degree the conditions surrounding a particular industry. The means used are dictated by the actual conditions governing the situation, such as the possibility of coming to an agreement, legal aspects, financial factors, etc. Where the elimination of competition was the main consideration, the end sought was most easily achieved by arrangements variously termed a “gentleman’s agreement,” an “interlocking directorate,” a “community of interest,” a “pool,” or a “voting trust”—the results of which were generally referred to as “combinations.” Like the earlier form of the holding company, the “trust,” they are known in the federal courts as “combinations in restraint of trade,” are illegal, and are no longer entered into. The trust derived its name from the fact that it was controlled by a board of trustees who issued trust certificates in lieu of the stock of the participating companies. Popular aversion to this form of control has led to the formation of another and better type of organization known as the “holding company.” While the holding company is generally classed among the combinations in restraint of trade and in a number of instances, like its predecessor, has come to grief through the enforcement of the anti-trust laws, its legality is recognized in those states where ownership of the stock of other corporations is allowed by law and where no restraint of trade or interference with competition is effected. A holding company organized in one state may control corporations organized under the laws of other states. The holding corporation can itself be controlled by the ownership of 50 or 51 per cent of its stock, and the control of its subsidiaries is obtained with stock ownership in the same ratio. Thus a relatively small capital investment may exercise a far-reaching control. A holding company as a rule buys up the controlling stock interest of the companies in which it is interested, and elects its own men on the board of directors of the subsidiaries. Frequently the larger stockholders of competing corporations get together and form the holding company. In this case very little difficulty is experienced so far as financing is concerned, which is usually a matter of exchanging the stock of the various companies for the stock of the holding company. One of the advantages accruing to the holding company, aside from the favorable financial and legal aspects of the enterprise, is that the subsidiaries remain as operating and business units. This is often desirable because of the value of the good-will accruing to the constituent companies from years of business dealing with their customers. The advantages of the close consolidation may be often obtained by stimulating rivalry between the various plants of the same industry and by exchanging information as to successful methods of operation. A holding company does not generally own all the stock of the subsidiary. Often, however, this is necessary because of the trouble that a small minority of the stockholders can create if the interests of the subsidiary and the holding company clash; such as might be the case if, for reasons of efficiency, the plant of the subsidiary were closed down. It would naturally be a gain to the holding company but a loss to the minority stockholders of the subsidiary if the productive capacity of another plant could be utilized to better advantage. Accounting for the Holding Company In Chapter XV where the principles of valuation of permanent investments were discussed, reference was made to the method of valuing the holdings of the stock of subsidiaries as carried on the books of the holding company. A distinction was there made between the accounting procedure in showing the holdings of the subsidiary stocks when the parent company has complete ownership, and when its ownership is only partial—though usually a controlling—ownership. If the ownership is complete, as there pointed out, to show the consolidated balance sheet and profit and loss summaries is the best and only intelligible presentation of condition. Where ownership is not complete the balance sheet of the holding company must carry the stock of the subsidiary at a valuation which varies in accordance with the earnings and dividend policy of the subsidiary. In addition to the method of showing the valuation of the holdings in the subsidiary, it may for certain purposes and particularly for internal use, be desirable to append to the statements of the holding company financial statements of each of the subsidiaries so as to give an intelligent view of the condition of the properties of all the companies. These appended statements are, of course, not an integral part of the financial statements of the holding company but are necessary as furnishing information which the officers of the holding company may need in their direction of the policy of the subsidiary. For a detailed discussion of the consolidated balance sheet and profit and loss summaries the student is referred to Chapter XXXIV. Aside from the financial statements, no special accounting problems or peculiarities arise in accounting for the holding company. Where, as is usual, accounts with the subsidiaries appear on the books of the holding company other than stock accounts showing the investment, the chief problem lies in the valuation of these accounts. That feature was also discussed in Chapter XV to which the student is referred. Distinction between Consolidation and Merger Consolidation, in the legal sense, refers to the complete union of two or more enterprises. It is a fusion whereby each company loses its identity in the larger unit of the new corporation. The prior corporations are dissolved and cease to exist. The stock of the old corporation is exchanged for that of the new corporation upon an agreed ratio. The usual procedure for statutory consolidation is as follows: