The Go-Go Years (22 page)

However, this decline was not in all stocks. Certain groups of issues not among the blue chips that made up the Dow—and one such group in particular—not only resisted the downward trend but actually bucked it. Among those in the most favored group, Ling-Temco-Vought was up almost 70 percent for the year, City Investing was up about 50 percent, Litton Industries and Textron were up between 15 and 20 percent, while International Telephone and Telegraph and Gulf and Western Industries were up by smaller percentages but were poised for huge rises early in 1967. The group, of course, was the one that comprised the new corporate Wunderkinder of the stock market, the conglomerates.

2

Nobody seems to know who first applied the term “conglomerate”—which in earlier times had usually meant a kind of mineral popularly called pudding stone—to corporations given to diversifying their activities through mergers with other corporations in other lines of business. At any rate, the new usage made its popular appearance in 1964 or 1965, shortly before conglomerates became the darlings of investors. Derived from the Latin word
glomus,
meaning wax, the word suggests a sort of apotheosis of the old Madison Avenue cliché “a big ball of wax,” and is no doubt apt enough; but right from the start, the heads of conglomerate companies objected to it. Each of them felt that
his
company was a mesh of corporate and managerial genius in which diverse lines of endeavor—producing, say, ice cream, cement and flagpoles—were subtly welded together by some abstruse metaphysical principle so refined as to be invisible to the vulgar eye.
Other
diversified companies, each such genius acknowledged, were conglomerates; but not his own. Roy Ash of Litton Industries thought “conglomerate” implied “a mess” and pleaded for the term “multi-company industry” to describe Litton; Rupert Thompson hoped wistfully that people would speak of his Textron as engaging in “non-related diversification”; Nicolas Salgo of Bangor Punta wanted his company known as a “
unique
conglomerate.” In vain. Wide-based or narrow, stuck together by synergism or chewing gum, they were called conglomerates, and for a time, almost everybody made money on them.

The aversion of the
conglomerateurs
(as
The New York Times
social page called their leading lights) to the term is understandable. Conglomerates, like prostitutes, had from the first a sufficiently shaky moral reputation to call for the use of euphemism. During their most flourishing years (roughly 1966–1969), they
were said to represent, variously, a forward-looking form of enterprise characterized by freedom from all that is hidebound in conventional corporate practice; the latest of a long series of means by which “ruthless capitalists practice the black arts of finance to their ends”; and “a kind of business that services industry the way Bonnie and Clyde serviced banks.” Their increasing prevalence, for better or worse, is indicated by the simple fact that in 1968 about forty-five hundred mergers of U.S. corporations were effected—far more than in any previous year, and three times as many as in any given year early in the decade. Also in 1968, twenty-six of the nation's five hundred biggest companies disappeared, permanently, into the bellies of other corporate whales through conglomerate merger, twelve of the victims being monsters with assets in excess of $250 million, and several of these same leviathans being swallowed by predators far smaller than themselves. By that time, at least ten of the nation's two hundred biggest industrial corporations were conglomerates, and the enthusiasts were saying that this was only the beginning—eventually all but a tiny fraction of national business would be conducted by about two hundred super-conglomerates.

The movement was new and yet old. In the nineteenth century, few companies diversified their activities very widely by acquiring other companies or by any other means. There is, on the face of it, no basic reason for believing that a man who can successfully run an ice cream business should not be able to successfully run an ice-cream-and-cement business, or even an ice-cream-cement-and-flagpole business. On the other hand, there is no reason for believing that he
should
be able to do so. In the Puritan and craft ethic that for the most part ruled nineteenth-century America, one of the cardinal precepts was that the shoemaker should stick to his last. American companies were as specialized in their product lines as the vendors of dog collars and nutmeg graters in Victorian London; diversification was considered irresponsible if not a form of outright immorality, and when it occurred it usually did so inadvertently, as when the Western railroads found that the land they had ac
quired for settlement and track right of way made them proprietors of mines, oil wells, and forests.

Early in this century, some of the biggest companies took to diversifying from within—adding new products not closely related to their old ones simply because they had the resources and the machinery to do so. General Electric and General Motors were notable examples. The tendency of companies to purchase other companies became prevalent for the first time in the boom of the nineteen twenties when many corporate treasuries were, for the first time, full of spare money. Between 1925 and 1930 du Pont, which had previously pretty well confined itself to making explosives, ate such indigestible-sounding corporate morsels as the Viscoloid Company, National Ammonia, Krebs Pigment and Chemical, and Capes-Viscose. In a limited way, it was a pioneer conglomerate. American Home Products, incorporated in 1926, had become an
Ur
-conglomerate by 1948, its product line by that time ranging from beauty preparations through foods to ethical and proprietary drugs. It was during a new spell of general affluence in the nineteen fifties that the phenomenon of really uninhibited diversification first appeared. During that decade, National Power and Light, as a result of its purchase of another company, found itself chiefly engaged in peddling soft drinks; Borg-Warner, formerly a maker of automotive parts, got into refrigerators, other consumer products, and electrical wares; and companies like Penn-Texas and Merritt Chapman and Scott, under the leadership of corporate wild men like David Karr and Louis E. Wolfson, took to ingesting whatever companies swam within reach. The results were the first genuine late-model conglomerates—but nobody had yet wrapped up the new packages in a catchy name. Among the first companies to be called conglomerates were Litton, which in 1958 began to augment its established electronics business with office calculators and computers and later branched out into typewriters, cash registers, packaged foods, conveyor belts, oceangoing ships, solder, teaching aids, and aircraft guidance systems, and Textron, once a placid and single-minded New England textile company, and eventually a purveyor of zippers, pens, snowmobiles, eyeglass frames, silverware, golf carts, metalwork machinery, helicopters, rocket engines, ball bearings, and gas meters.

3

Corporate affluence was only one element in the complex chemistry of the conglomerate explosion. Another was a decline of the stick-to-your-last philosophy among businessmen, parallel to a decline of the stick-to-anything philosophy among almost everyone else. Another was the rise in influence of the graduate business schools, led by imperial Harvard, which in the nineteen sixties were trying to enshrine business as a profession, and often taught that management ability was an absolute quality, not limited by the type of business being managed. Still another was the federal antitrust laws, which, as traditionally interpreted over the years, forbade most mergers between large companies in the
same
line of business and thus forced companies that wanted to merge at all to be, so to speak, exogamous.

But there was one more factor, less reputable and in economic terms more ominous, behind the trend. It was the fact that merging enabled a company to capitalize on its current stock-market value. The crux of the matter was that never before had a company's reported earnings per share meant so much in terms of its stock-market price. As we have seen, the average investor of the sixties was a comparative novice, interested in just three figures concerning a company whose stock he owned or was considering buying. One was the market price of the stock. The second was the net profit per share—the famous “bottom line” of the quarterly earnings report's financial summary (which, curiously, seldom actually appears at the bottom). Let the average nineteen-sixties investor be handed the latest annual report of his favorite company; his gaze would slide rapidly over the shiny four-color cover, over the glowing (but
perhaps a bit glutinous) prose of the chairman's report, over the pictures of happy employees and earnest, manly executives, and would fix raptly on that bottom line. (It may come as a surprise to some modern investors to learn that this was not always so. During the boom of the nineteen twenties, the big news for both brokers and investors was more commonly dividends than earnings. High taxes on ordinary income, and favored tax treatment of capital gains, were the principal factors in bringing about an historic postwar shift in public attention from dividends to earnings.)

The third figure that engaged our investor's interest was, of course, the relationship between the other two. Called the price-to-earnings multiple, or ratio, its function was to give the investor a yardstick with which to judge whether the stock was a bargain or not. A multiple of ten was usually considered a bargain, while a multiple of forty might be (but often wasn't) thought to be too much. In the absence of his friendly broker, the average investor had to calculate the multiple for himself, a feat he could easily accomplish provided he had the two other figures and a command of short division. Making this calculation marked the outer limit of his investment sophistication.

Unfortunately, in the case of conglomerates this degree of sophistication was inadequate. Where a series of corporate mergers is concerned, the current earnings per share of the surviving company lose much of the yardstick quality that the novice investor so trustingly assumes. The simple mathematical fact is that any time a company with a high multiple buys one with a lower multiple, a kind of magic comes into play. Earnings per share of the new, merged company in the first year of its life come out higher than those of the acquiring company in the previous year, even though neither company does any more business than before. There is an apparent growth in earnings that is entirely an optical illusion. Moreover, under accounting procedures of the late nineteen sixties, a merger could generally be recorded in either of two ways—as a purchase of one company by another, or as a simple pooling of the combined resources. In many cases, the current earnings of the combined company came out quite differently under the two methods, and it was understandable that the company's accountants were inclined to choose arbitrarily the method that gave the more cheerful result. Indeed, the accountant, through this choice and others at his disposal, was often able to write for the surviving company practically any current earnings figure he chose—a situation that impelled one leading investment-advisory service to issue a derisive bulletin entitled, “Accounting as a Creative Art.” All of which is to say that, without breaking the law or the rules of his profession, the accountant could mislead the naïve investor practically at will.

The conglomerate game tended to become a form of pyramiding, comparable to the public-utility holding company game that flourished in 1928, crashed in 1929, and was belatedly outlawed in the dark hangover days of 1935. The accountant evaluating the results of a conglomerate merger would apply his creative resources by writing an earnings figure that looked good to investors; they, reacting to the artistry, would buy the company's stock, thereby forcing its market price up to a high multiple again; the company would then make the new merger, write new higher earnings, and so on. The conglomerate need neither toil nor spin—only keep buying companies and writing up earnings. It was magic, until the pyramid became top-heavy and fell.

4

Accounting was and is an honorable profession, whatever its pretensions to creativity. One of the most dismal corners of what Carlyle called the dismal science of economics, accounting is seldom scrutinized by reformers or populist legislators; like a skunk, it acquires immunity against attack from its repellency. But it is of the utmost importance in an economy of affluence, so let us try to put the profession of accountancy into current perspective.

It began long ago—with a Franciscan monk of Renaissance Italy, Fra Luca Pacioli (
c
. 1445-1523), whose invention of double-entry bookkeeping was later acclaimed by Goethe as “one of the finest discoveries of the human intellect.” It did not become important to substantial numbers of people until the nineteenth century, when public ownership of private companies became common. It rose to eminence as an aristocratic occupation, calling for the qualities usually associated with judges: wisdom, learning, unassailable probity. The pioneer accountants—Turquand, Touche, Cooper, Deloitte, Waterhouse, Griffiths, Peat, Plender—were all gentlemen as well as scholars, above the battle because to the manor born. This tradition of disinterestedness and individual honor was imported, with democratic modifications, into the United States, where accounting first became important in the wave of reform that followed the chicaneries and depredations of the robber barons. Turn-of-the-century American accountants viewed themselves as crusaders and evangelists for the cause of accurate and honest business relationships. The new profession's first fall from grace came, however, during the boom of the nineteen twenties, when many accountants found devious and misleading ways of writing up companies' book value to inflate stock-market price. (Not earnings; accountants took little interest in earnings in those days, and indeed, many companies did not bother to report their earnings at all.) Then came the great crash and a new wave of high-mindedness and reform. A key section of the Securities Exchange Act of 1934 gave (and still gives) the S.E.C. all but dictatorial power over the accounting practices of companies under its jurisdiction; but, in line with the S.E.C.'s policy of encouraging Wall Street and industry to regulate themselves, those powers were never exercised. The American Institute of Certified Public Accountants became the instrument of accountancy's self-regulation. All through the thirties, forties, and fifties, the A.I.C.P.A. chipped away at the old abuses that had grown up in the twenties, and progressively tightened the lax rules that had permitted them. In 1959, it empanelled an Accounting Principles Board, consisting of eighteen members—eight from the leading accounting firms, six from smaller accounting
firms, two from corporations, and two from the academy—with effective power to set standards and rules for all accountants. With that step, the reforms were largely accomplished; the accounting profession sat back to congratulate itself on its wisdom and its good works.