§ 3. Dual character of investment profit. Even invest ment profit usually is subjected to a comparison which divides it into two elements. We have seen (Chapter 26, section 4) that it is of the very essence of the active capital function that it takes the financial risk of the outcome. When therefore at the end of the year (or income period) it appears that a certain profit has minified (say $1000), this is compared with the capital invested (say $10,000) and expressed as a percentage on the investment (thus 10 per cent). Now this in turn is compared with the rate of interest common on the safest loans (say 4 per cent) and the remainder is the amount (or rate) by which this active-capitalist investment exceeds the current rate of passive capital investments. This merely es timated division influences further choice of investment. The rate of interest is taken to represent about what capital can do by itself (or with a negligible amount of judgment and supervision—an abstract conception) and the excess above that is attributed to the successful act of investment. Thus, however far we attempt to eliminate the personal service element of management from profits, there always remains in any active capital income this one element of investing management together with the carrying of the financial risk. There is a dual character in investment profit; it is a capital income and a labor-income, combined. The distinctive fea ture of investment profit, which fastens our attention, is pre cisely this excess (or deficit) of income in active-capital as compared with the normal prevailing rate of time-price, which can be secured by the most conservative passive investor. It is the hope of an income more than ordinary interest that is the inducement to active capitalists to assume the risk. We may call the amount realized more or less than the imputed yield of passive investment, pure investment profit, attribu table to the exercise of pure investment function. The amount may be expressed as a rate on the investment. This is the utmost point that has been attained in the analysis of the complex elements of "profits" as popularly § 4. Enterprise and risk. To the person who exercised this function of active capital-investment various names have • been applied: its French equivalent entre preneur, adventurer (especially used in former times of one who embarked in foreign trade), and enterpriser. Each of these was meant to express the assumption of the financial risk in undertaking the ownership of the various factors and of their results embodied in the products, in paying off other claimants, and in waiting for an income indeterminable in advance, but contingent on all the various fluctuations of the market.
Enterprise is the act, or function, performed by the enter priser, and in a different but related sense is the particular business establishment, or undertaking, which is carried on by an enterpriser. Business management and enterprise are functions not embodied completely in any individuals, but diffused more or less among groups of men. The active-cap italist and the passive-capitalist are not in contrast absolutely but relatively; the passive capitalist is not, and can not be, completely freed from financial risk. Enterprise is merely in this particular business the assumption of the legal finan cial responsibility to the extent of the enterpriser's credit and resources, or in other cases to the extent of the special legal 2 See note on The source and cause of profits in economic writings, at end of chapter.
S The old English word undertaker, once so used, seems to have been driven out by a rival use; perhaps after "funeral director" displaces it there, it may be reclaimed by economics.
limited liability, as (in most stock companies) to the amount invested, or (often in banking) to double the amount invested.
Risk is more or less everywhere in human affairs, but among various kinds of investments there is a well recognized gradation in the uncer tainty of returns. The enterpriser in a business takes the more exposed frontier of risk, and the various senior securities have prior claims. For example, if the business of a corporation goes badly the first mortgage bonds, getting a low rate of interest, are the first claim on the income and, in case of insolvency, these bonds would be paid out of any assets of the company ; so in turn till we come to the common stock which gets noth ing until all the other claims are satisfied but which if the business is prosperous may get dividends at any rate permit ted by profits. There is thus an investment risk, an element of enterprise even in the safest investment, e.g., government bonds, but this becomes almost negligible in the case of many well-proven investments. This relativity of risk and of the enterprise function may be shown again in the interrelations of different enterprises. (See Figure 42.) § 5. Pure profit the most variable income. It is easily seen why the income to enterprise is the most variable from one establishment, and from one time, to another. It contains within it all the non-contractual elements of income. The laborer has taken a fixed wage, the passive capitalist has re duced his risk and accepted a fixed interest. Both wage workers and passive capitalists have taken the easy way, have "played safe," and have left the enterpriser to bear the brunt • The rates given are, of course, only illustrative of the proportions in which they might vary in a particular case. In fact the common stock might pay no dividends for years while dividends and interest on all the other classes of securities were regularly paid.
of the financial risk. The income of each of these classes tends to conform to a general market-rate, being a medium of the gains and losses when labor and capital are applied with various degrees of risk in various undertakings. Enter prise is the most movable element. It is specialized risk-tak ing. Enterprise has well been called an economic buffer, Let enterprise A be tenant farming, for which are needed farm-land and buildings, borrowed money, and the uses of various rented machines. Enterprise B consists of buying land and constructing a house, shop, store-building upon it to let to enterprise A. The enterpriser in this case takes the risk in deciding on the right place, kind of house, ma terials, etc., and runs a chance of letting it or being without a tenant. Enterprise C is private money lending, or a bank-business, lending to A. The other enterprises receiving contractual payments from enterprise A are not free from all risk. There is a chance that the agreed payment will not be made, and if it is that loss will result from other causes (e.g., a fire destroying the buildings). Enterprisers B to F, however, in relation to the incomes they receive from and through A, are rela tively protected against risk. Enterpriser A in paying a 'fixed rent, a fixed interest, etc., is, to the extent of his credit, putting up a margin of security against the failure of crops, of profits, etc.