Trust (industrial combination)
From Hobson's Choice
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Trusts are a common legal instrument used to delegate control over financial assets to a professional manager (or trustee). In modern usage, they are used to manage assets passed on to one's heirs. In the past, they have been used to circumvent laws against industrial combinations or monopolies. In a typical trust, shareholders with a controlling interest in different firms in the same market are persuaded to put the management of their shares in a trust, with the expectation of getting larger returns. The trustees' object is to use their trustee status over the shares of multiple companies in the same market to impose either their own business management or their own pricing regime. The firms controlled by a trust can behave as if they were a single monopoly, without the legal liability of being one.
Trusts were first used as methods of industrial combination in 1863 and grew to control much of the industrial system of the developed world. During the three administrations of William McKinley, Theodore Roosevelt, and William H. Taft, most of the major trusts were broken up. The 1914 Clayton Antitrust Act further crippled the trusts. At the same time, holding companies and investment banking superseded the trust as a form of industrial combination.
Alternative Legal Meaning
The heading for this entry is "trust (industrial combination)"; as such, that implies that trusts (as a noun) can have different meanings. In addition to the sense of industrial combination, there is the commonplace legal form. While trusts in common law are entirely outside the scope of this site, the idea is fairly simple: a person ("settlor") may opt to create a trust to manage an estate after death, on behalf of one or more heirs. The estate is managed by trustees, possibly as a pool of investments yielding interest. The trustees enforce the terms of the trust, by paying out distributions and ensuring that the estate is properly managed. This form of trust is an "express trust," and it is not necessary for the settlor to die for the terms to take effect. In fact, we have merely mentioned the scenario of a deceased, a will, an estate, and heirs as a familiar scenario. A fundamental parallel between the two, however, is the goal of retaining wealth by the wealthy.
Express trusts are also set up as part of some loan agreements. The borrower can agree to become a trustee to the lender, so that (in the event of a default by the borrower), the lender becomes a secured creditor because she has secured equitable property, which will be protected from the claims of the general creditors. This is a method of vesting property from A to B, making the settlor a beneficiary, and this is the form of trust that was used in the latter 19th century as a mode of industrial combination.
Origins and Structure
Nearly everywhere that trusts appeared (including Europe) they began as cartels or pools. Subsequently, the need for (a) a legally valid form of combination and (b) problems with the temporary character of pools (as a strategic tool for industrial development) led to the creation of trusts. Trusts typically were designed to allow many firms in the same market to behave as a single firm, chiefly for the purpose of ensuring that investment in plant and inventory did not exceed what was optimal for the investors. During the 1880's, for example, there was a tremendous boom in steel output owing to new technologies. These technologies required very large plants to use economically. In order to make certain that output preserved a price level such that the new large plants could be economical, it was necessary to form such a combination. The approach used with the trust was to arrange for owners of shares in the relevant firms to deposit them with a trust organized for the purpose. The trust was a legal arrangement in which a board of trustees was legally entrusted with management of a pool of assets (in this case, shares representing a controlling interest in collaborating firms). It flourished in the United States but not, it appears, in other industrial systems (see syndicates).
The most famous trust was that of Standard Oil, which was formed in 1882 soon after the failure of previous efforts to set up a pool for oil producers. At this time (specifically, 1871-1875), there existed three times as much refining capacity as was actually produced. Even after the failure of the pools, Standard Oil continued to rely on its dominance of rail transit, and then on its control of pipelines. It formed a trust in 1882. Interestingly, the Standard Oil Company already owned much of the outstanding stock of the companies in its "alliance"; it possessed unique abilities to buy output and have it shipped at reasonable rates through its (real) alliance with the Erie and New York Central Railroad. The trust agreement was facilitated by the fact that Standard Oil already owned 57% of the stock of its allies; but it also permitted a contractual arrangement to permit actual business supervision of the forty associated companies. Standard Oil's de facto keiretsu arrangement was widely mimicked during the 1880's; it controlled over 90% of US refining capacity, even before the creation of the Standard Oil Trust. Sugar, tobacco, and industrial explosives were also subject to major trust arrangements at this time.
The principal object of the trust was to fundamentally restructure the capital outlays of the oil industry, from large numbers of refineries to a small number of large refineries connected by modern pipelines. Also, the Standard Oil Trust poured money into the creation of a truly global distribution network, with the purchase of subsidiaries abroad, the restructuring of the Standard Oil Company itself into state-chartered companies (protected from hostile action by the state legislatures in Pennsylvania or Iowa), and vertical integration.
Demise of the Trusts
The trusts were mostly superseded after the 1890's because they either evolved to administrative integration (like Standard Oil itself, but also the National Lead Trust and the National Cottonseed Trust), or else shriveled as a result of passive exploitation of a monopoly. Nevertheless, it must not be denied that aggressive pursuit of the trusts by the administrations of Theodore Roosevelt and William H. Taft essentially forced companies to focus on seek economic rents only when they were sufficient to finance an acquisition, rather than a mere trusteeship.
- ↑ Holding companies learned to combine legally, while investment banks issued securities for many firms, potentially firms in the same market. For the early history of trusts as a peculiar legal form of combination in the USA, I am reliant on Stevens (1922), introductory note.
- ↑ Sarah Wilson, Todd & Wilson's Textbook on Trusts, Oxford University Press (2007), especially section 2.1, p.31ffp
- ↑ This is called an express declaration of trusteeship by the debtor.
- ↑ Stevens (1922), p.13
- ↑ Alfred D. Chandler, The visible hand: the managerial revolution in American business Harvard University Press (1977), p.316-331; Scale and Scope: the Dynamics of Industrial Capitalism, Harvard University Press (1990), pp.24-25.
- ↑ Chandler (1977), p.319. For a comprehensive review of the laws of Europe, see Johnson (1912). A section devoted to the German Empire (p.63), Austria (p.67), France (p.71), and the rest of Continental Europe (p.77, fn.6) indicates that cartels were mostly permitted for purposes of administration of capacity, but barred from price manipulation.
- ↑ For a definitive source on the history of the Standard Oil Trust, I used Rosenbaum (1998). For overcapacity in refining, 1870's, see p.13; attempt to form pools, see p.13-15. Consolidation of the oil industry in Ohio and Pennsylvania occurred despite the collapse of the pools; Standard Oil switched to pipelines as a result of its commercial struggle with Tidewater, p.19; Standard first formed a trust in 1879, but without actual managerial control; it formed one with managerial control in January 1882, p.20.
- ↑ For the alliance with the E&NYC RR, see Rosenbaum (1998), p.18; this was vital to the defeat of the Pennsylvania RR & Empire Refining Company's efforts to carve out a recovery-transport-refining network separate from the Standard monopoly. The alliance with the railroad was more like what we think of as an alliance, with mutual benefits and interdependence of action; the Standard "alliance" (as Chandler (1990) calls it, p.24) was more akin to fealty under extreme duress. The count of "forty companies" is from Chandler (1990), p.24, although I notice he mentions that number had been reached in 1880 (Chandler (1977), p.321); the figure of "57% of the stock" is from Chandler (1977), p.322.
- ↑ On the Sugar Trust (which was not actually a trust but a series of acquisitions paid for with exchanges of stock), see Control of corporations, persons, and firms engaged in interstate commerce: report of the Committee on Interstate Commerce, US Senate Volume 2, US Government Printing Office (1913), p.1633. & 2792; on tobacco, see Control of corporations,..., Vol.1 (1913), p.1215ff. On industrial explosives, see Stevens (1922), p.176ff. On Standard Oil's monopoly share of 90%, see Chandler (1977), p.322
- ↑ Chandler (1977), pp.324-326. During the 1870's through the '80's the main strength of the Standard Oil system was that it did not ship oil and it did not pump oil; it controlled the shipping of oil after it was pumped, and was able to squeeze producers and shippers at will. After the late 1880's the SO Trust began to acquire control over oil fields, so that it could use vertical integration to embargo competitors at each level.
- ↑ Control of corporations, persons, and firms engaged in interstate commerce: report of the Committee on Interstate Commerce, US Senate Volume 2, US Government Printing Office (1913), pp.2791-2792.
- Alfred D. Chandler, The visible hand: the managerial revolution in American business Harvard University Press (1977)
- Alfred D. Chandler, Scale and Scope: the Dynamics of Industrial Capitalism, Harvard University Press (1990)
- Fred Johnson, ed., Trusts in foreign countries: Laws and references concerning industrial combinations in Australia, Canada, New Zealand, and Continental Europe, US Government Printing Office (1912)
- Jeremiah Whipple Jenks, Walter Ernest Clark, The trust problem, Doubleday, Page & company (1917 )
- D. A. McGregor, "Industrial Combination" , Batoche Books (2001/1906)
- David Ira Rosenbaum, Market dominance: how firms gain, hold, or lose it and the impact on economic performance, Greenwood Publishing Group (1998)
- William S. Stevens, Industrial combinations and trusts, Macmillan (1922)