Yesterday morning, I came across a TV program called The Men Who Built America. One of the episodes I watched followed Cornelius Vanderbilt’s dealings with the Eerie Railroad. Vanderbilt attempted a hostile takeover of the railroad by purchasing all of its outstanding stock. He purchased as much stock as he could get his hands on.
However, two mid-level employees at Eerie figured out what Vandy was up to. Fisk and Gould combated Vanderbilt’s takeover by printing excessive amounts of common stock in the company basement. They dumped these shares (more than 100,000 of them) into the stock market, meaning that Vanderbilt could never achieve his needed majority of stock ownership. In the process, Fisk and Gould made lots of money (from Vanderbilt’s attempted purchase).
I don’t get how this worked. First of all, printing lots of extra stock caused the stock’s value to drop. The TV show pointed out that this is illegal now. Why was it legal then? If all a company had to do was print more stock, then it seems to me that whatever stock exists would be valueless. Also, since Fisk and Gould were printing the stocks with the company’s equipment, doesn’t the stock then belong to the company. How did these two individuals make so much money?
I’m sure I must have missed important details of this story. The show was trying to portray Vanderbilt as being infuriated at being outsmarted by two ordinary guys. It didn’t seem to do into a lot of detail about how this mechanism was supposed to work, aside from F & G dumping more stock into the market than Vanderbilt could buy.
The price of the stock wouldn’t adjust instantly; in fact, in the era before computerized trading, you’d expect prices to adjust a lot slower than they do now, which explains why the glut of new certificates would all be expensive enough to prevent ol’ Corny from buying them up to regain his majority.
OTOH, in today’s stock market, being a few inches closer to the exchange computers can give your computers a measurable advantage because information travels at a fixed speed down whatever medium you’re using to communicate (glass fiber is the fastest in practical use now, I believe).
Your documentary was, well, lying. Fisk and Gould, along with their partner Daniel Drew, were not “mid-level employees,” they were major (and majorly unethical) financiers, and controlled the board of directors of the railroad. Their issue of stock was not legal, and they were forced to flee New York until they could bribe state legislators (including Boss Tweed, who switched allegiance from Vanderbilt in exchange for cash, stock, and a seat on the board) to push through special legislation to legalize the issue.
That’s a coincidence: I listened to this same story the other day, on a 1977 documentary on the history of economics, The Age of Uncertainty by John Kenneth Galbraith.
As Galbraith told it, Vanderbilt wanted to rob the public by holding a monopoly and figuratively granting himself a license to print money. Fisk and his cronies wanted to rob the stockholders by literally printing stock certificates.
Fisk won, and compared to Vanderbilt appeared to be the public’s champion. But many of his investors were English and couldn’t be squelched as easily as Americans, and also none of the profits were reinvested in the railroad; which became a rolling death trap for passengers and employees.
Did anyone ever suggest to Ayn Rand that Atlas Shrugged would be great? if the wealth creators would self-exile, it would save the public the cost of imprisoning them.
I’m still confused. Let’s say that Acme Widgets, Inc. has 100 outstanding shares and I own 40 of them, so I have a 40% interest in the company.
Now, I understand that this was before the SEC, but how could it possibly be legal for the company to decide to “print” 900 more shares of stock, lowering my ownership to 4%? That seems like common law theft.
While the specifics of that incident might have been illegal, the general concept is sound and is used all the time–it is known as a poison pill. Because actually activating the pill would so negatively affect stock price, it is only used as an emergency measure to block a takeover.
Your understanding is correct, what Fisk and Gould did was illegal. After the scheme was found out they had to flee to New Jersey to escape the police and hire armed guards to keep the Vanderbilt’s men away. They had to bribe the New York legislature to vote that the shares were legal. Since the shares were suddenly legal, Vanderbilt had no legal right to protest.
Diluting shares isn’t unethical in and of itself. Assuming that each share was worth $10 pre-dilution and that the 900 new shares each sold for $10 as well (a big assumption, of course), then you went from being a 40% owner of a company worth $1,000 to a 4% owner of a company worth $10,000 (since the company has $9,000 in cash sitting in its coffers).
You certainly lost some voting rights, though. That’s why the concept of voting and non-voting shares exists. And diluting shares without telling the other shareholders is certainly unethical and illegal!
It doesn’t. In this case nobody is manufacturing anything except pieces of paper which represent ownership in a corporation. If an ownership interest can be “hyper-inflated” in that manner, then it is worthless.
I envision it like a car that we each own half of: We have 1 share each. Then I decide to print certificates of ownership in the car, say 100 more all with equal value to your one share. Didn’t I “steal” a huge portion of your ownership interest in the car?
The difference is that its not the other person printing new shares, its the company itself. If there are two shares of the company, and I own one and you own one, then we both own half the company. If the company creates a third share, then the shares we own are now just worth a third of the company. But we also each own half the companies assets, including the share that’s still owned by the company: 1/3+1/6=1/2. We still own half the company.
If the company sells that third share to raise capital, then we each own half that capital, which is equivalent to the same thing.
So, how does this practice work today? For instance, why didn’t General Motors raise needed capital by printing lots of new shares? Even if this had an overall depressing effect on the price of shares, wouldn’t still raise capital for them? In your example above, if I’m understanding correctly, the hypothetical widget company created $9000 cash simply by printing stock certificates. If that’s possible, how can stock ever be worth anything?
Companies do indeed do this where appropriate; it’s usually called a “rights issue” or an “open offer”. The purpose, as you say, is to raise capital for the company. The downside is that more shares are issued, which means the value of the existing shares (all else being equal, which in practice of course it is not) goes down. If the existing shareholders don’t believe that the additional investment that the company is asking for is going to be worthwhile, the company will not raise much money and in fact could end up with costs (of the rights issue) exceeding the money raised. Presumably, GM was in such a state that they felt this was likely and so a rights issue was not a viable alternative for them.
The reason this is legal is because all shareholders are notified that this is happening, and they can choose to sell their rights (which usually have some value) instead of paying to take them up. If they don’t take them up, of course they will own a (slightly) smaller percentage of the company, but then they have not had to spend anything extra and usually get a cash payment for their rights.
I see what you are saying now and agree. However, wouldn’t it still dilute our voting rights? Before we had 50%. Now we have somewhat less depending on the number of shares printed.
Yes. That’s why shareholders must approve the issuance of new shares. If you don’t want to dilute your voting rights, then you might want to issue a new class of stock with less voting rights, which is common. Of course, you won’t be able to sell these lower class shares for as much, since investors value voting rights.
Normally, the issuance of new shares is done to raise capital (more money).
The company has 100 shares worth $100 each - $10,000 is the worth of the company. (I.e. the stock trades at that price, $100 on the open market, because investors think that that is what the company is worth. Maybe you din’t pay $100, but you could sell it for that today.
Then the company decides to issue 50 more shares. Maybe they are going to pay the bank loan off. maybe they will buy a new widget-stamping machine. Either way, they sell 50 more shares, hopefully netting $5,000 - assuming the market believes their plans will add $5,000 worth of value to the company. If not, if they are just printing shares, if the extra money just pays the president a bigger salary, say - then 150 shares will be valued at $10,000 (or less) and each share is worth $67.
This is usually the case - a new issue of shares is to raise money for a project or to clear up a financial problem (like too much debt). Convert interest payments (fixed) into dividends (depend on profits) and people who have faith in the company’s fundamental business plan will invest to get a cheap share of future profits.
Issuing new shares has to be voted on by the board, widely announced. Also, there are SEC rules today to protect minority shareholders from this sort of scam. Plus, shares are mostly registered in computer lists, wheras in the 1800’s it was probably easy to hand out pieces of paper that looked as good as the real deal (or were just too many of the real deal). As mentioned by others, if the market did not figure out what was going on for a while, those Erie stock would sell for a lot more than they were really worth if everyone knew the whole truth. We have the laws we have today, thanks to Wall Street shennanigans of the last 150 years.
And of course, like in The Producers, the chickens come home to roost when you have to distribute the profits if you’ve lied about share count. The trick is, like the play, to not make a profit - spend it all as president’s salary and consulting fees.