The Holding-company Device

Disadvantageous Corporate Structure: The Holding-company Device

In the 1920s, there were many holding companies. These were enterprises organized to acquire voting control of previously existing concerns.

In most cases, the holding company issued its own senior securities (bonds and preferred shares) to pay in whole or part of the common shares it acquired. The process was repeated, in many instances, by the formation of new holding companies, with new layers of senior securities, to acquire control of existing holding companies. In this way, there were rapidly created a number of heavily pyramided capital structures - nearly all in the public-utility, railroad and "investment-trust" fields.

After the crash of 1929, most of these structures collapsed, with tremendous losses to speculators and misguided investors therein.

The moving spirits behind these astonishing examples of "high finance" were actuated by the twin motives of making enormous profits out of such corporate manipulations and of wielding personal power over great financial and industrial empires. Their motives were extremely popular with the public, until the day of reckoning, because there provided continuous fuel for the speculative fires.

As might be expected, the subsequent debacle created a complete revulsion of feeling. Holding companies became, and are still, highly unpopular with both investors and speculators.

For many years past, the existence of a holding company, instead of adding to the value of the underlying assets, has constituted a definite drawback and detriment. The market has been emphatic on this point. Holding-company securities have consistently sold at substantial discounts from the concurrent market value of the securities they own.

Discounts Disappear in Dissolution

All the evidence points clearly to the conclusion that, since 1929, a holding-company setup has been disadvantageous to the outside shareholders, and that they benefit significantly from the dissolution of such companies and the consequent direct ownership of the underlying securities.

It has been the standard experience that the shares sold at substantial discounts from their true value as long as the holding company continued as such,k and that these discounts disappeared when the holding company disappeared.

The attitude of managements in this matter deserves to be recorded. In nearly all cases, they opposed the dissolution of the holding companies; in a number of instances they waged bitter and costly legal battles, with their stockholder's money, to prevent the step. In their communications to stockholders they insisted that continuance of the holding companies would be to the stockholders' advantage.

We believe that most of their arguments were disingenuous and that in this matter they were defending their own interest - in some cases unconsciously, no doubt - in preference to that of the public stockholders.

We make these statements with considerable reluctance; but we believe it essential that the fact be brought home to stockholders, as forcibly as possible, that in matters in which management's interests may be opposed to the stockholders', the latter cannot rely upon receiving fair treatment from management and must be prepared to recognize and do battle for their own advantage.

A number of holding companies still existed at the end of 1950. The market persisted in its considered judgment, voiced through year-after-year prices, that such arrangements are detrimental to the outside stockholder. The fact they are permitted to continue we consider to be a monument to the inertia and bad judgment displayed by the American investor in his capacity as continuing shareholder.

Ref: Security Analysis by Graham and Dodd