These elements must be so arranged in the scheme of capitalization as to compensate the investor for: 1. Use of his capital 2. Risk of losing it.
Let us examine what value each of these factors pos sesses for the various classes of investors.
8. How control is control we mean the power to direct the policy of the company. Con trol is exercised thru the voting power of security owners, and to some extent, in the case of bonds, thru the power to foreclose in the event of default. Ob viously, the chief advantage of control lies in the ability to prevent loss thru the mismanagement or manipulation of others. Actual control requires a ma jority voting power, altho, as we shall see, this does not necessarily require the ownership of a majority of the outstanding stock. Voting power may be ex tended to certain classes of securities and withheld from others, or it may be contingent upon a cer tain event. Preferred stock, for instance, may be given a vote if dividends are not paid, but not per mitted a vote when dividends are paid regularly. It often happens that even a minority of the voting stock may control, as when the shares are divided among a great many small holders, many of whom do not exercise the voting privilege. This leaves the few larger interests in control; altho having merely enough votes to carry a poorly attended election. Control may also be secured thru the voting trust, in which stockholders transfer their voting privileges to trus tees, or by gathering proxies from other stockholders.
9. Relation of controlling and minority inter ests.---A voice in the control is an important consid eration to security-holders who desire to lessen, or in some extent to govern, the risks of their investment. Sometimes, however, control is bought purely for the purpose of manipulating corporate affairs, or gaining prestige or some other outside advantage. Such a control is always dangerous for the corporation and the minority interests, because it gives opportunity of personal profit at the expense of the company. This has been frequently demonstrated in the railroad field, where certain large stockholders of railroad com panies, having become directors thru their voting power, have used their positions to secure exorbitant salaries or preferential contracts for other concerns in which they are interested, sometimes in the under writing of securities, sometimes in the purchase of equipment. Excessive personal profits have thus been
made at the expense of the railroad which they were supposed to represent. The practice became so gen eral that a clause was inserted in the Clayton Act to stop it by subjecting such contracts to open competi tion, under the supervision of the Interstate Com merce Commission.
Sometimes the controlling interests, while seeking no individual advantage, endeavor to secure prefer ences for their own classes of securities at the expense of other securities. This illustrates the importance of the other security-holders having a voice in the man agement, so that they may upset any such preferences and insure themselves a square deal. Ordinarily, ex tending a voice in the control to a certain class of security is merely intended to lessen the risk of that security, or to offset the natural risk which surrounds it. Common stockholders usually control the corpora tion, because they are given preferences in lien or in come over bondholders and preferred stockholders. The further application of the principle of control will be left until later chapters. It is sufficient here to point out that control is a factor of great impor tance in the financial plan.
10. Element of risk.—Every business and every security possesses an element of risk. Indeed, one cannot own wealth without assuming the risk of losing it in one way or another. One has only to scan the price fluctuations of the best bonds and stocks, and the record of mortgage foreclosures to be con vinced of this fact.
In the field of business thousands of failures occur annually, ranging from that of the large corporation with many millions of dollars invested, to that of small companies, partnerships and individual enterprises. The statement has often been made, and is probably true, that nine out of every ten corporations within ten years from the date of formation are either dis solved, failed, reorganized or swallowed up by other companies. "Very few companies survive a period of twenty-five years without financial difficulty. As a class, railroad securities have been, with the exception of government and municipal bonds, the most substan tial issues in the United States, and yet over half the railroad mileage of the country has Leen under re ceivership and reorganization within the past fifteen years. No wonder the owner of common stock lies awake nights.