So far, in the transactions described, water ing the securities has accomplished only use ful results. Can we retain these advantages and not suffer the evils alleged ? Heretofore the doctrine of caveat emptor has enjoyed pretty general application to securities. A consideration of how far the state should go in protecting the individual gets on debatable and long and much debated ground. Would not a publicity requirement, calling for a statement of the manner of issuing the stock, with an independent certified valuation of assets turned over for securities, — some thing, in short, along the line of the English law covering prospectuses, — afford all the protection the state ought to give the un sophisticated investor ? Even without this publicity, would not a removal of the dollar mark from the stock certificate put the unin formed purchaser of stock sufficiently on his guard? In the matter of rates, would not the removal of the dollar mark take away the ob scurantism of watered stock? The rate ques tion raises another question difficult, if indeed possible, to answer, that must be settled first: What constitutes an adequate return on in vested capital ? When beginning this discussion of watered stock, we stated our intention of not getting into controversial areas. Just as a matter of opinion, however, it may be said that the re moval of the dollar mark from stock certifi cates seems to accord with the logic of the facts and to promise greatly to improve the situation. Even if the state should see fit to enforce the transfer of assets really worth $100 to the corporation for every share issued, it would still seem worth while to remove the statement from the certificates, "of the par value of $100." I also incline to the opinion that the real usefulness of stock-watering outweighs the possibilities of harm resulting from it. Probably a requirement of further publicity would prove beneficial.
In the problem we have just been consider ing we will assume that owing to the nature of the project the promoters could not en gage in it with funds of less than $3,500,000. They have only $500,000 available and feel so confident of its soundness that they want to trade on as thin an equity as they can. We
have seen that the proposed capitalization of $3,000,000 71 per cent bonds and $500,000 common stock does not work out as safe a financial plan as the one including the watered stock. If the enterprise is not capable of sub sequent extension, the promoters must ar range for their thin equity at the start. We are not stating essentially preposterous con ditions at all in assuming that an enterprise may, on the one hand, require at least $3,500,000, and, on, the other hand, cannot profitably employ more than that amount. An illustration we have already used will show this. A hydraulic electrical company might require that amount to develop a water power at all, and might not be able subse quently to use essentially more than that. The stream might not afford any more power to develop, or the communities within reach of the company's transmission lines might not offer a market for more power than that already developed. Unless the promoters ar range now to trade on a thin equity, how can they do so later ? Suppose they can get the $3,000,000 they require on this plan: -- 6 per cent bonds, $1,750,000; Common stock, $1,750,000.
Notice that under this plan the promoters have less than a third (28 per cent) of the vot ing power and under the watered-stock plan they kept nearly a half (42 per cent). This takes in the $500,000 of the promoters and places a dollar of assets back of every dollar par value of securities issued. When the cor poration reaches an earning power of 8 per cent on this capitalization, let us say that a majority of the shareholders want to trade on a thinner equity. Since the company cannot use any more funds, they cannot get a thin ner equity by issuing preferred stock or more bonds. They might form a new corporation with a capitalization arranged for trading on a thin equity and sell the plant out to it. On the basis of "replacement value" this plan would water the stock just as frankly as the original plan, and besides would run into legal difficulties, questions of authority, etc., that might make it hard or impossible to carry out.