BA107 Social and Political Environment of Business

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BA107 Social and Political Environment of
Business

• Spring 2004
• WEEK 3
• The Rise of Big Business

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Agenda for today

• Announcements
• Paper 1 postponed one week, topic this Monday
• Wonderful new GSI Helen fengliang_at_haas.berkeley.e
  du
• Big Business in America
• What are the conditions that enabled big business
  to grow in the US?
• What about big government (will be covered in
  lecture)?
• How has American ideology changed in the century
  since the passage of the Interstate Commerce and
  Sherman Antitrust Acts?
• Are there robber barons today in the sense of a
  few business leaders who enjoy immense economic
  power? How do trends of today compare to those of
  the late 1800s?

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Q1 What are the conditions that enabled big
business to grow in the US?

• Key characteristics of big business
• Large scale capital requirements
• Separation of ownership control

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Financing Big Business

• To expand, big factories needed capital, or
  money, for investment in raw materials, workers
  pay, and shipping and advertising costs. Many
  expanding businesses became corporationsbusinesse
  s owned by investors.
• A corporation sells stock, or shares in the
  business, to investors, who are known as
  stockholders.
• In return for their investment, stockholders hope
  to receive dividends, or shares of a
  corporations profit.
• Corporations also raised money by borrowing
  millions of dollars from banks. These loans
  helped American industry grow at a rapid pace.
• The most powerful banker of the late 1800s was J.
  Pierpont Morgan. He used his banking profits to
  gain control of major corporations. By 1901, he
  had become the head of the United States Steel
  Company, the first American business worth more
  than 1 billion.

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Reviewing the Agency Problem

• You and your two siblings own a pizzeria. Your
  older sister does the accounting, youre in
  charge of dealing with the suppliers, and your
  younger brother prepares the pizza.
• Are there any agency problems?

The separation of ownership and control in the
firm leads to an agency problem between
shareholders and management.
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Agency Problem in the Firm

• The CEO of a large airline will retire in 2
  years. What are her incentives? Are these
  incentives equal to the ones of the airlines
  shareholders?

• What if the CEO has stock options?

• How does the information that the CEO and the
  shareholders have differ?

Agency costs are incurred when

• Managers do not attempt to maximize firm value.

• Shareholders incur costs to monitor managers and
  to influence their actions.

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Q1 What are the conditions that enabled big
business to grow in the US? continued

• Key characteristics of big business
• Broad geographic scale Railroad
• Creation of new forms of management org.
• Standarization of work automatization
• Professionalization of management and investors
• Great wealth, power, and influence

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Railroads Video

• What is the significance played by the railroad
  industry in the development of the American
  economy?
• How did the involvement of the federal government
  in the project affect the political strategies of
  the players involved?
• How did the scale and scope of the project affect
  the honesty of the people involved in it?

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Railroads and Big Business

• Railroads were publicly-licensed corporations
• Build with government subsidies and land grants
• Became regional monopolies
• Natural oligopolistic tendencies
• Moved from novelty to necessity

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Railroad Linkages

• Backward linkages
• Iron industry
• Coal industry
• Forward linkages
• Farmers, miners, food processors

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Railroads and improvements in meat packing

• New efficient ways to slaughter mass numbers of
  cattle were invented
• Railroads at this point expanded all over the
  country
• These innovations created a demand for cattle
• Cattle ranchers, railroads bosses, and meat plant
  owners worked together integrating different
  businesses
• This is a great example of the trend of how
  business integrated into other businesses
• Meat packers owned ranches, trains, and meat
  plants, therefore there was no more need for
  middle men

Chicago meat packing plant and slaughter house
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Railroads first big business, but it also helped
spur innovation in other industries and even
create new industries

• Telegraph lines and operation stations were put
  up along with railroad track
• By 1883 40 million messages were sent over
  400,000 miles of telegraph lines
• Gustavus Swift invented the refrigerated railcar
  that allowed meat to be transported fresh

Laying of track and telegraph lines
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Railroads Contribute to the Growth of the
American Economy

• The building of rail lines created thousands of
  jobs for steelworkers, lumberjacks, miners, and
  railroad employees.
• The large railroads pioneered new ways of
  managing business, such as having separate
  shipping, accounting, and service departments.
  Other big businesses soon copied these management
  techniques.
• Railroads opened every corner of the country to
  settlement and growth.

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Q2 How has American ideology changed since the
passage of the Interstate Commerce and Sherman
Antitrust Act?
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Eliminating Competition

• With the overbuilding of rail lines in some parts
  of the country, railroad companies looked for
  ways to outdo or get rid of the
  competitionespecially in the West.
• Railroads granted secret rebates, or discounts,
  to their biggest customers. This practice forced
  many small companies out of business. It also
  hurt small farmers, who had to pay higher rates.
• Railroad owners looked for ways to end
  competition, including pooling. In a pool,
  several railroad companies agreed to divide up
  the business in an area. Then, they fixed
  shipping prices at a high level.
• Reaction to rebates and pools
• Rebates and pools angered small farmers in the
  South and the West. Both practices kept shipping
  prices high for them.
• Many farmers joined the Populist party. The party
  called for government regulation of rail rates.

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Interstate Commerce Act (1887)

• Goal
• Get rid of special privileges in transportation
• Provisions
• Outlawed special rebates rates
• Outlawed railroads charging more for shorter
  hauls
• Outlawed pooling
• Declared that rates should be reasonable just
• Established the Interstate Commerce Commission
• (ICC)

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Arguments For and Against Trusts
In a free enterprise system, businesses are owned
by private citizens. Private citizens decide what
to make, how much to produce, where to sell, and
what to charge. Some Americans said large
corporations hurt the free enterprise system.

• The Argument Against Trusts
• Trusts and monopolies reduce competition. Without
  competition, there is no need to keep prices low
  or improve products.
• New companies cant compete with powerful trusts.
• Trusts have too much political influence. They
  are able to buy favors from elected officials.

• The Argument in Favor of Trusts
• Competition can ruin businesses and put people
  out of work.
• The wealthy contribute the most to the community.
• Corporations bring lower production costs, lower
  prices, higher wages, and a better quality of
  life for all.
• By 1900, Americans had the highest standard of
  living in the world.

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Antitrust Legislation

• Designed to promote competition to preserve a
  free market
• By eliminating price fixing
• Removing barriers to entry of competition

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Sherman Anti-Trust Act (1890)

• Goal break monopolies and compel competition
• Provision
• declare illegal entities that restrict trade
• provide penalties
• Reality
• too weak
• language was too vague
• Business got around law through other
  combinations other than trusts
• Supreme Court decision favoring business

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Clayton Act of 1914

• Why Clayton?
• Big Business Getting Bigger
• Less Competition More Monopolies
• Clarify Strengthen Sherman Act of 1890
• Vague language Loopholes
• Forbid
• Wrongful acquisition of monopoly power
• The abuse of that monopolistic power
• Other business practices that improperly suppress
  free-market competition

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Clayton Act of 1914

• Prohibited
• Exclusive sales contracts
• Local price cutting to freeze out competitors
• Rebates
• Discriminating freight agreements
• Distribution of sales territories among natural
  competitors
• Interlocking directorates in corporations
• Certain forms of holding companies

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Business Strategies to Grow

• Vertical integration- owning the supply companies
• Horizontal integration- buying out competing
  companies
• Mergers- consolidation of 2 companies into a
  single corporation

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Business Strategies to Fix Prices

• Monopoly/Oligopoly- owing a a large portion of a
  commodity or service that makes it possible to
  manipulate prices
• Cartel explicit agreement to fix prices
• Tacit collusion price coordination through
  facilitating circumstances
• Trust- more consolidation than pool. Stock
  holders of competing companies hand over their
  stock to a board of trustees who can then control
  and manipulate prices.

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Examples today?

• Successful mergers
• Failed mergers
• Monopoly
• Vertical integration

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Q3 Are there robber barons today? How do the
trends of today compare to those of the late
1800s?
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1.) John D. Rockefeller

• 1839-1915
• Cleveland , Ohio
• Founded Standard Oil
• Received railroad rebates
• Ruthlessly drove out or bought out competitors
• Had 90 of the Oil business at its high point
• Became a great philanthropist

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2.) Andrew Carnegie

• 1835-1919
• Pittsburgh, Pa.
• Consolidated and brought principle of economies
  of scale to the steel industry
• Railroad and Steel Executive
• Owned iron ore deposits near Lake Superior
• Pioneered Bessemer process
• Undersold competitors
• By 1900 produced ¼ of countrys steel
• Gave millions away in philanthropic donations

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Carnegie Furnaces, Braddock, Pennsylvania
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3.) J.P. Morgan

• 1813-1890
• Started in railroad business
• Prominent banker
• Made fortune in steel
• Headed U.S. Steel Corp. 1st billion dollar corp.
  after purchasing Carnegie Steel in 1901 through a
  holding company

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4.) Cornelius Vanderbilt

• "I have been insane on the subject of moneymaking
  all my life."
• 1794-1877
• Made fortune in transportation (mainly railroads)
• Ruthless businessman

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Robber barons today?