Termination of Existence

Subsidiary or auxiliary companies are those which are formed or controlled by, or are dependent upon some large company. It frequently becomes necessary in order to promote the success of a corporation to organize a subsidiary company as a feeder or helper, for the purpose of carrying out a particular part of the enterprise, such as supplying the corporation with raw material, disposing of its finished product, called a "selling company," constructing buildings or bridges, called a "construction company," etc. It may be that the parent company has not sufficient means to properly carry out a subordinate purpose or develop an enterprise which will be collateral and very beneficial to the company. A new and subordinate company may then be formed out of the capital furnished by those stockholders of the parent company who may have money to invest, and the building or other property of the subsidiary company may then be leased to the parent company. Thus a railroad company, through a subsidiary corporation, builds a hotel at a summer or winter resort where one is needed, hoping thereby to increase its passenger travel, or develops large sugar plantations along its line to add to its freight traffic. An electric street car company needing a new power house and not having the necessary funds with which to build it, and not wishing to issue bonds or increase its capital stock, forms a subsidiary company by which the power house is built and leased to the controlling company. Nearly all of our railway systems have branch lines, which at greater or less length reach from the main line into some agricultural section or to mines or cities located away from the main line. In this way transportation facilities are furnished to distant sections and an outlet is afforded them for their products, while the earnings of the main line are perceptibly increased by the business brought to it. Sometimes these branch lines have been expensive to build, where the attempt is to reach some mining district, and the money for their construction was obtained by issues of branch line bonds by the subsidiary company which may have been guaranteed by the parent company or were made valuable on account of a lease contract with the controlling company whereby the income of the branch road is assured, and the interest on its bond issue and sinking fund is provided for.

Another reason for the formation of subsidiary or auxiliary corporations is the manufacture and control of by-products. Take, for instance, a corporation engaged in mining coal. It frequently becomes necessary in developing the vein of coal to remove a large quantity of fire-clay, also a red shale, which products in themselves are valueless to the coal mining corporations, but a subsidiary or auxiliary company is formed for the purpose of manufacturing the fire-clay into fire-brick or other marketable product, and another corporation is formed for the purpose of preparing and vending the red shale, which is a cheap and excellent material used in the construction of roads. These companies are, of course, dependent upon the "parent" corporation for their raw material and are usually related by contracts specifying the price to be paid for this material, and requiring that the parent corporation shall furnish such quantity of raw material as may be agreed upon as being sufficient for the purposes of the subsidiary corporation.

Perhaps the reason most frequently met with for the formation of subsidiary companies is where a corporation owning patent rights or franchises parcels out the territory which it

To Control By-Products controls to various subsidiary organizations, which may pay yearly royalties or percentages, or may pay for the privileges they get by giving a "lump sum" in cash, or by giving the parent company a part of their capital stock, or by a combination of all of these "considerations." In this way the stockholders of the parent company avoid much of the risk, and also the necessity of raising a large cash capital. This method has been pursued by the American Bell Telephone Company and other well known companies with signal success. Subsidiary companies, while being distinct corporations, are dependent upon the controlling company, usually, for their existence, and almost universally for their financing and management to a considerable extent.

Auxiliary companies are sometimes the medium through which profits that should belong to stockholders of the parent company are diverted to the pockets of the directors and their associates. In the history of railroad building in the United States there are many instances where the managers of a railroad company have organized a so-called "construction company" to build an extension to its lines, and have then formed a separate corporation in which the ownership of the extension was nominally vested, and which proceeded to make a contract with the construction company to build and equip its line, paying for it with its bonds, issued for an amount in excess of the actual cost, and also with its entire capital stock, which by some fiction of bookkeeping was made to appear paid up in cash. The extension having been built with the proceeds of the bonds, or perhaps a part of them only, the next step was to sell or lease the new line to the old company on terms that made the stock held by the construction company a valuable asset. This and the remaining bonds, if any, could then be divided in kind or sold and the proceeds distributed in cash. The morality of such a transaction as this is, to say the least, questionable, though judgment should not be passed in any specific instance without full knowledge of all the facts.

Of late corporations have been organized for a new function,, i. e. that of holding a controlling interest of the stock of other corporations. The validity of these "parasite corporations," as they have been called, is yet to be passed upon by the courts. If permitted to stand, they may have far reaching consequences by giving a few men control of large interests, although owning comparatively little capital. Let us consider the case of a stockholding corporation with, say, $60,000,000 capital and this capital invested in, say, 51 per cent of the stock of a railroad capitalized for $100,000,-000. The holders of a bare majority of the stock of the stockholding or parasite corporation would then exercise control over both corporations. Thus $30,000,100 of stock would be able to control $100,000,000 of capital. But let us carry this one step further and suppose a majority of the stock of the parasite corporation held by another company of the same kind with a capital of, say, $31,000,000. The owners of only a little over $15,500,000 of its stock would then exercise effective control of the $60,000,000 company, and through it of the $100,-000,000 company. This is an instance of a lesser corporation controlling a greater. It is diametrically the opposite of the subsidiary corporation. An example of a parasite corporation is the Northern Securities Company, recently organized for the purpose of merging the control of the Great Northern, Northern Pacific and Chicago, Burlington & Quincy Railroads. This attempt of merger has been declared illegal by the courts on the ground of public policy, since such a combination would remove competition, the three roads being nearly parallel. The method of controlling a greater corporation by means of a securities company holding a majority of the stock, however, is a legal proceeding, in all of those states where one corporation is permitted by statute to own shares in another. It is merely an extreme exercise of the principle of "majority rule."

Stockholding corporations designed to control greater corporations by means of the majority rule, as outlined above, savor somewhat of the methods of the so-called "trusts," which will be considered in the next chapter.