“But how about the directors?” it will perhaps be asked. “How can they be parties to these obviously unwise undertakings? They are themselves shareholders; they gain by whatever benefits the proprietary at large; they lose by whatever injures it. And if without their consent, or rather their agency, no new scheme can be adopted by the Company, the classes interested in fostering railway enterprise are powerless to do harm.”
This belief in the identity of directorial and proprietary interests, is the fatal error commonly made by shareholders. It is this which, in spite of bitter experiences, leads them to be so careless and so trustful. “Their profit is our profit; their loss is our loss; they know more than we do; therefore let us leave the matter to them.” Such is the argument which more or less definitely passes through the shareholding mind—an argument of which the premises are delusive, and the inference disastrous. Let us consider it in detail.
Not to dwell on the disclosures that have in years past {85} been made respecting the share-trafficking of directors, and the large profits realized by it—disclosures which alone suffice to disprove the assumed identity between the interests of board and proprietary—and taking for granted that little, if any, of this now takes place; let us go on to notice the still-prevailing influences which render this apparent community of aims illusive. The immediate interests which directors have in the prosperity of the Company, are often much less than is supposed. Occasionally they possess only the bare qualification of £1000 worth of stock. In some instances even this is partly nominal. Admitting, however, as we do frankly, that in the great majority of cases the full qualification, and much more than the qualification, is held; yet it must be borne in mind that the indirect advantages which a wealthy member of a board may gain from the prosecution of a new undertaking, will often far outweigh the direct injury it will inflict on him by lowering the value of his shares. A board usually consists, to a considerable extent, of gentlemen residing at different points throughout the tract of country traversed by the railway they control: some of them landowners; some merchants or manufacturers; some owners of mines or shipping. Almost always some or all of them are advantaged by a new branch or feeder. Those in close proximity to it, gain either by enhanced value of their lands, or by increased facilities of transit for their commodities. Those at more remote parts of the main line, though less directly interested, are still frequently interested in some degree; for every extension opens up new markets either for produce or raw materials; and if it is one effecting a junction with some other system of railways, the greater mercantile conveniences afforded to directors thus circumstanced, become important. Obviously, therefore, the indirect profits accruing to such from one of these extensions, may more than counterbalance the direct loss upon their railway investments; {86} and though there are, doubtless, men too honourable to let such considerations sway them, yet the generality can scarcely fail to be affected by temptations so strong. Then we have to remember the influences brought to bear upon directors having seats in Parliament. Already these have been noticed; and we recur to them only for the purpose of pointing out that the immediate evil of an increased discount on his £1000 worth of stock, may be to a director of much less consequence than the favours, patronage, connexions, which his aid in carrying a new scheme will bring him. So that here too the supposed identity of interests between directors and shareholders does not hold.
Moreover, this disunion of interests is increased by the system of preference-stock. Were there no other cause in action, the raising of capital for supplementary undertakings, by issuing shares bearing a guaranteed interest of 5, 6, and 7 per cent., would destroy that community of motives supposed to exist between a railway proprietary and its executive. Little as the fact is recognized, it is yet readily demonstrable that by raising one of these mortgages, a Company is forthwith divided into two classes; the one consisting of the richer shareholders, inclusive of the directors, and the other of the poorer shareholders; of which classes the richer one can protect itself from the losses which the poorer one has to bear—nay, can even profit by the losses of the poorer one. This assertion, startling as it will be to many, we will proceed to prove.
When the capital required for a branch or extension is raised by means of guaranteed shares, it is the custom to give each proprietor the option of taking up a number of such shares proportionate to the number of his original shares. By availing himself of this offer, he partially protects himself against any loss which the new undertaking may entail. Should this, not fulfilling the promises of its advocates, diminish in some degree the general {87} dividend; yet, a high dividend on the due proportion of preference-stock, may nearly or quite compensate for this. Hence, it becomes the policy of all who can do so, to take up as many guaranteed shares as they can get. But what happens when the circular announcing this apportionment of guaranteed shares is sent round? Those who possess much stock, being generally capitalists, accept as many as are allotted to them. On the other hand, the smaller holders, constituting as they do the bulk of the Company, having no available funds with which to pay the calls on new shares, are obliged to part with their letters of allotment. What results? When this additional line has been opened, and it turns out, as usual, that its revenue is insufficient to meet the guaranteed dividend on its shares—when the general income of the Company is laid under contribution to make up this guaranteed dividend—when as a consequence, the dividend on the original stock is diminished; then the poorer shareholders who possess original stock only, find themselves losers; while the richer ones, possessing guaranteed shares in addition, find that their gain on preference-dividends nearly or quite counterbalances their loss on general dividends. Indeed, as above hinted, the case is even worse. For as the large share-proprietor who has obtained his proportion of guaranteed stock, is not obliged to retain his original stock—as, if he doubts the paying character of the new undertaking, he can always sell such of his shares as will suffer from it; it is obvious that he may, if he pleases, become the possessor of preference-shares only; and may so obtain a handsome return for his money at the expense of the Company at large and the small shareholders in particular. How far this policy is pursued we do not pretend to say; though the table given some pages back suggests extensive pursuit of it. All which it here concerns us to notice, is, that directors, being mostly men of large means, and being therefore able to avail themselves of this guaranteed {88} stock, are liable to be swayed by motives different from those of the general proprietary. And that they often are so swayed there cannot be a doubt. Without assuming that any of them deliberately intend to benefit at the cost of their co-proprietors; and believing, as we do, that few of them duly perceive that the protection they will have, is a protection not available by the shareholders at large; we think it is a rational deduction from common experience, that this prospect of compensation often turns the scale in the minds of those who are hesitating, and diminishes the opposition of those who disapprove.
Thus, the belief which leads most railway shareholders to place implicit faith in their directors, is an erroneous one. It is not true that there is an identity of interest between the proprietary and its executive. It is not true that the board forms an efficient guard against the intrigues of lawyers, engineers, contractors, and others who profit by railway-making. Contrariwise, its members are not only liable to be drawn from their line of duty by various indirect motives, but by the system of guaranteed shares they are placed under a positive temptation to betray their constituents.
And now what is the proximate origin of these corruptions? and what is the remedy for them? What error in railway legislation is it that has made possible such complicated chicaneries? Whence arises this facility with which interested persons thrust companies into unwise enterprises? We believe there is a very simple answer to these questions. It is an answer, however, which will at first sight seem quite irrelevant; and we doubt not that the corollary we propose drawing from it, will be forthwith condemned by so-called practical men. Nevertheless, we are not without hope of showing, both that the evils laboured under would be excluded were this corollary recognized, and that recognition of it is not only feasible, but would {89} even open the way out of sundry perplexities in which railway legislation is at present involved.
We conceive, then, that the fundamental vice of our system, as hitherto carried out, lies in the misinterpretation of the proprietary contract—the contract tacitly entered into between each shareholder and the body of shareholders with whom he unites; and that the remedy for these evils which have now become so great, lies simply in the enforcement of an equitable interpretation of this contract. In reality the contract is a strictly limited one. In practice it is treated as altogether unlimited. And the thing needed is, that it should be clearly defined and abided by.
Our popular form of government has so habituated us to seeing public questions decided by the voice of the majority, and the system is so manifestly equitable in the cases daily before us, that there has been produced in the general mind, an unhesitating belief that the majority’s right is unbounded. Under whatever circumstances men co-operate, it is held that if difference of opinion arises among them, justice requires that the will of the greater number shall be executed rather than that of the smaller number; be the question at issue what it may. So confirmed is this conviction, that to most this mere suggestion of a doubt will cause astonishment. Yet it needs but a brief analysis to show that the conviction is little better than a political superstition. Instances may readily be selected which prove, by reductio ad absurdum, that the right of a majority is a purely conditional right, valid only within specific limits. Let us take a few. Suppose that at the general meeting of some philanthropic association, it was resolved that in addition to relieving distress the association should employ home-missionaries to preach down popery. Might the subscriptions of Catholics, who had joined the body with charitable views, be rightfully used for this end? Suppose that of the members of a book-club, the greater number, thinking {90} that under existing circumstances rifle-practice is more important than reading, should decide to change the purpose of their union, and to apply the funds in hand for the purchase of powder, ball, and targets. Would the rest be bound by this decision? Suppose that under the excitement of news from Australia, the majority of a Freehold Land Society should determine, not simply to start in a body for the gold diggings, but to use their accumulated capital to provide outfits. Would this appropriation of property be just to the minority? and must these join the expedition? Scarcely any one would venture an affirmative answer even to the first of these questions; much less to the others. And why? Because everyone must perceive that by joining with others, no man can equitably be committed to acts utterly foreign to the purpose for which he joined them. Each of these supposed minorities would properly reply to those seeking to coerce them:—“We combined with you for a defined object; we gave money and time for the furtherance of that object; on all questions thence arising, we tacitly agreed to conform to the will of the greater number; but we did not agree to conform on any other questions. If you induce us to join you by professing a certain end, and then undertake some other end of which we were not apprised, you obtain our support under false pretences; you exceed the expressed or understood compact to which we committed ourselves; and we are no longer bound by your decisions.” Clearly this is the only rational interpretation of the matter. The general principle underlying the right government of every incorporated body, is, that its members contract with each other severally to submit to the will of the majority in all matters concerning the fulfilment of the objects for which they are incorporated; but in no others. To this extent only can the contract hold. For as it is implied in the very nature of a contract, that those entering into it must know what they contract to do; and as those who unite with others for a specified object, {91} cannot contemplate all the unspecified objects which it is hypothetically possible for the union to undertake; it follows that the contract entered into cannot extend to such unspecified objects. And if there exists no expressed or understood contract between the union and its members respecting unspecified objects, then for the majority to coerce the minority into undertaking them, is nothing less than gross tyranny.
Now this almost self-evident principle is wholly ignored, alike in our railway legislation and the proceedings of our companies. Definite as is the purpose with which the promoters of a public enterprise combine, many other purposes not dreamed of at the outset are commonly added to it; and this, apparently, without any suspicion that such a course is unwarrantable, unless taken with the unanimous consent of the proprietors. The unsuspecting shareholder who signed the subscription contract for a line from Greatborough to Grandport, did so under the belief that this line would not only be a public benefit but a good investment. He was familiar with the country. He had been at some trouble to estimate the traffic. And, fully believing that he knew what he was embarking in, he put down his name for a large amount. The line has been made; a few years of prosperity have justified his foresight; when, at some fatal special meeting, a project is put before him for a branch from Littlehomestead to Stonyfield. The will of the board and the intrigues of the interested, overbear all opposition; and in spite of the protests of many who like him see its impolicy, he presently finds himself involved in an undertaking which, when he joined the promoters of the original line, he had not the remotest conception would ever be proposed. From year to year this proceeding is repeated. His dividends dwindle and his shares go down; and eventually the congeries of enterprises to which he is committed, grows so vast that the first enterprise of the series becomes but a small fraction of the whole. Yet it is in virtue of his {92} consent to this first of the series, that all the rest are thrust upon him. He feels that there is injustice somewhere; but, believing in the unlimited right of a majority, fails to detect it. He does not see that when the first of these extensions was proposed, he should have denied the power of his brother-shareholders to implicate him in an undertaking not named in their deed of incorporation. He should have told its proposers that they were perfectly free to form a separate Company for the execution of it; but that they could not rightfully compel dissentients to join in a new undertaking, any more than they could rightfully have compelled dissentients to join in the original. Had such a shareholder united with others for the specified purpose of making railways, he would have had no ground for protest. But he united with others for the specified purpose of making a particular railway. Yet such is the confusion of ideas on the subject, that there is absolutely no difference recognized between these cases!