Earnings are always mentioned as the basis of cap italization, even in the wildest dreams of mining corn pany promoters. In this case, a great deal of talk about estimated earning power is used to cover up a capitalization that really is based upon another prin ciple, namely, the maximum amount of stock which the promoters think the public can be induced to buy. This is actually the basis of capitalization in a large percentage of speculative companies, numerous ex amples of which might be mentioned. The writer has in mind one such recent company which issued stock to the extent of a million and a half, par value, upon assets costing only a few thousand dollars. The rest of the capitalization represents hope. It is plain that earnings, cost, cost of reproduction, and cost of replacement had nothing to do with determining this capitalization, but of course the prospectus talked mainly about earnings.
4. Objections to ob jections are made to the practice of stock-watering, especially that it: 1. Results in higher prices, charged to pay divi dends on excessive capitalization 2. Encourages unnecessary competition, with con sequent duplication and waste of capital 3. Results in the sale of many worthless securities to the uninformed public.
Let us examine these contentions briefly. Prices are fixed by demand and supply. When a normal competition exists in supplying any commodity or service, all demands will be amply filled until profits fall below the minimum which the owners of capital in that business are willing to take. Under these conditions prices are fixed by the cost of production and the necessities of competition, and not by each producer arbitrarily to meet his own dividend require ment. If producers can raise prices merely because their capitalization is increased, there is nothing to prevent them from raising prices without increasing capitalization. If we adopt the stand, therefore, that stock-watering increases prices, we must assume that producers who have not watered their stock are charg ing less than they can get, from purely philanthropic motives. It is safe to assume that corporations always charge about all they are able to get for what they have to sell, regardless of the number or amount of outstanding shares of stock.
5. Stock-watering by public utility companies.— Under monopoly conditions, however, competitive prices do not exist, and charges are based upon what the controlling company is able, or permitted by the government, to charge. 'Unless artificial restraints are introduced, the monopoly will collect all that the traffic will bear. This explains why the laws of the United States prohibit monopoly and restraint of trade, and why public utility corporations, operating essentially under monopolistic state charters granted by the state, are subject to special legal restrictions and to close supervision in the public interest.
In this connection, it should be noted that stock watering has often been resorted to by public utility companies for the purpose of covering up excessive charges which they already have the power, but not otherwise the nerve, to collect. Public service fran chises are almost always monopolies, of necessity. It would be ridiculous, for instance, to have more than one water company, or more than one street-railway company, in a city, duplicating each other's facilities, and engaging in cutthroat competition. It would be equally foolish for capital to engage in the duplica tion of railway service which is already adequate. Such public utilities, however, are practical necessities of business life, and since they are owned by private capital, their service, rates, and capitalization must be subject to careful public regulation.
Stock-watering is no longer of much service to pub lic utility companies in covering up excessive rates, as the public utility commissions and courts now re strict rates to a reasonable return upon the actual valuation of the property and franchises, without re gard to the amount of outstanding securities or the desire to pay dividends upon watered stock. This fact is gradually becoming known to the investing public. Altho in many states watered stock may still be issued by public utilities, the commissions have been granted power in several of them to supervise the capital investments of such companies and to prevent the further issue of watered stock. The water is gradually being wrung out of their capitalization. It is doubtful whether anything more is needed to pre vent stock-watering by public utilities than a whole some and gradual continuance of the present develop ment of commission control, accompanied by full publicity in the affairs of such companies.
That the ability of any company with watered stock to pay large dividends is an inducement to others to enter into competition, cannot be doubted, but the same inducement exists whether the stock is watered or not. It is not the stock-watering, but the large profits resulting from the discrepancy between de mand and supply, that causes the new competition. The writer believes that stock-watering has nothing whatever to do either with the unnecessary tion of competing facilities or with the fixing of prices.