The role of financial and legal innovation in the rise of the modern credit economy : evidence from the American merger movement, 1870-1904

At the close of the nineteenth century, the organization of American businesses underwent a profound transformation from closely held partnerships and proprietorships to the widely held corporation. The rapidity of this change was largely possible through the development of horizontal mergers in a wide range of manufacturing industries. The academic consensus concerning this stage of evolution has focused on the role of scientific management and the emergence of new technologies. While the question of how much impetus financial and legal innovations provided to merger has received attention for more recent merger periods, this perspective has not been fully applied to the turn-of-the-century merger movement. To judge the significance of changes in the legal and financial sectors of the economy, a detailed comparison of the financial plans for merger has been undertaken for the period 1870 to 1904. Utilizing the theories of Thorstein Veblen, the process of an emerging credit economy has been presented as proof of the role played by the changing business environment. The results of this analysis show that changes in corporation law altered the use of the corporate charter and were necessary for the implementation of financial practices associated with merger activity. The ability to consolidate was predicated on the ability to incorporate a new business with an authorized capitalization large enough to provide the funds necessary to acquire control over the assets of constituent companies. During the time studied, a new method of valuing assets was being applied to the industrial sector of the American economy, which allowed for the large capital values of the new corporations. The values so created were tangibly represented by securities that provided a new form of purchasing power to the management of industrial concerns. By exchanging the property titles or existing securities of independent concerns with the newly issued capital of a corporation, effective centralization of management became possible. While these techniques and practices first appeared during a small merger wave from 1889 to 1894, it was not until after 1895 that these new methods became widely accepted and applied. The legal and financial environment of business in America therefore experienced several fundamental changes during this period of industrial evolution. In presenting evidence of financial and legal innovation in merger activity, it is apparent that the application of Veblen's theory and a realization of the importance of changing business practices provides a valuable perspective for the study of industrial organization.