The development of the pulp and paper sector has been a highly controversial subject in Canadian business history. During the 1920s, there was a rapid growth of capacity (which reached twice the level of market demand) and a series of mergers as different firms sought to attain giant size. By 1928 several leading companies were experiencing difficulties, and by 1932 half of the producers were bankrupt while the remainder hovered on the brink of insolvency. These developments had their own logic and were driven by strategic issues and the formation of an institutional market for industrial securities. As corporate executives propelled their firms into dubious strategies characterized by excess production and unrealistic dividend policies, the status of the newsprint producers was obscured from investors by financial and accounting practices, thereby contributing to a flood of investment, which was followed by corporate collapse. The attempts to reorganize the companies began a complex process that lasted anywhere from several years to more than a decade.
the theory of managerial capitalism has critically influenced scholarly analysis about industrial enterprises and the evolution of dif
BARRY E. C. BOOTHMAN is associate professor of strategic management in the Faculty of Administration at the University of New Brunswick.
An earlier iteration of this article was presented at the 1999 conference of the Academy of Accounting Historians. Costs for the project, on which the essay has been based, were covered from personal resources and were not subsidized by any government agency. Monetary references are expressed in Canadian dollars except where otherwise indicated. Abbreviations: ANQ-M, Archives Nationale de Quebec A Montreal; AO, Archives of Ontario; AFR, Annual Financial Review; FP, Financial Post; FT, Financial Post; FT, Financial Times; PPMC, Pulp and Paper Magazine of Canada; MCLA, Mutual Life of Canada Archives; UTA, University of Toronto Archives. ferent business functions. Researchers understandably have focused upon positive accomplishments associated with the rise of modern business: the construction of new forms of manufacturing; the rise of knowledge-based administration; the dissemination of professional norms; and the diffusion of functional skills. The long-term success of corporate enterprise entailed the effective exploitation of new economies of scale and scope, the spread of bureaucratic rationality, and the utilization of superior institutional arrangements.' But the process of organizational transformation did not unfold as a simple progression. In various industries, the introduction of new modes of production was not necessarily followed by appropriate inventiveness in other business functions. Advances sometimes were followed by retreats or abandonments, and then by new waves of learning. Moreover, the evolution of modern societies has entailed shifts in several interconnected realms: economy and technology, polity and authority, and culture. Each proceeded with distinctive historical rhythms and themes. At any given time, they could be out of step with one other, if not radically disjunctive. Broad changes in economic organization, for instance, sometimes were not soon matched by parallel adjustments of institutional frameworks that would safeguard a society's traditions of trust and equity.2
Although the emergence of the visible hand brought power and prosperity for a select group of firms in each of the industrializing nations, it proved a calamitous passage for many others. In Canada, between 1900 and 1933, there were 55,021 recorded failures by firms with assets totaling $658 million and liabilities greater than $880 million. These cases tended to consist of small retailers, farmers, or entrepreneurs, who succumbed as industrialization progressed and large companies gained dominant positions. The average failure entailed less than $8,000 in assets and resulted from incompetence, market conditions, or lack of capital.3 A second group of cases (largely unrecorded by governmental agencies) comprised the big enterprises that also collapsed as their industries evolved. Many had dysfunctional practices and escaped the enforcement of external stakeholder concerns for considerable periods, especially those of capital markets. When failures occurred among this group, important or institutional investors often were able to resuscitate the firms and recoup their stakes through the legal process of corporate reorganization.
Since the appearance of large business enterprises during the latter half of the nineteenth century, creative accounting and finance have been periodically denounced as contributory factors to corporate failures because managerial capitalism created new vehicles for profit and enormous opportunities for greed, not just superior modes of rational administration. Because of its relevance for attaining economies of scale or scope, accounting became a respected profession within North America but was brought into disrepute during the interwar era by the reluctance of many of its members to question corporate actions or ensure the reliability of information distributed to investors. While financial misbehavior (especially the salacious features) has long attracted popular writers, the topic has been only recently probed through careful scholarship. The diverse literature comprises research concerned with failures, securities regulation, or the evolution of the accounting field.4 As the subjects of extensive litigation, business failures represent valuable raw material for the historian because those cases can provide numerous insights into managerial practices.
The decade of the 1920s frequently has been portrayed as a period characterized by questionable business conduct that encouraged over-- investment in productive activities and thereby contributed to the ensuing descent into the Great Depression. A backlash of antibusiness sentiment and demands for corrective action in the United States propelled New Deal politicians to investigate alleged abuses and then elaborate new regulatory frameworks.5 These issues, of course, extended well beyond the borders of the American republic, and one of the most spectacular cases occurred in the Canadian pulp and paper industry. Between 1919 and 1932, the industry added massive capacity and underwent a complicated set of consolidations. By 1928, the leading companies were experiencing serious difficulties, and by 1932 half of the sector was in receivership, while the remainder hovered near insolvency for more than a decade.
The sector's collapse has represented the equivalent of a toxic spill for Canadian historians, a controversial and complicated subject best avoided. Despite its economic importance, analyses of the evolution of the industry have been surprisingly few because many records have been destroyed or scattered across less accessible locations. Moreover, researchers have found the subject extraordinarily difficult because corporate actions were guided by issues bridging the fields of management, business-government relations, law, and finance. Various arguments have surfaced in general histories of Canada, but these usually have amounted to several pages, at best.6 The most sophisticated presentation was advanced by H. V Nelles in a seminal study that appraised the relations between firms and provincial governments and stressed the role of weak political accountability as a factor that abetted a mismanagement of natural resources. Gilles Piedalue alternatively linked the industry's overdevelopment to a supposed rivalry among interlocking groups of financial executives.7 A fascinating monograph by Christopher Armstrong has examined the deficiencies of Canadian securities regulation. While thoughtfully documenting how cupidity or naivete propelled investment disasters, Armstrong's narrative tended to focus on mining ventures and sidestepped the notorious failures of newsprint producers.8
In this essay, which reexamines the collapse of the paper and pulp companies, I adopt a holistic approach, but one with a dual emphasis: on the factors behind their swift rise and the relevance of financial policies for understanding their subsequent descent. After tracing the background of the industry, I attempt to clarify the logic behind the wave of expansion and mergers that unfolded during the 1920s. I then discuss corporate reporting practices, which were compliant with regulatory constraints but masked the status of the producers, thereby facilitating the wave of overinvestment. In conclusion, I summarize the consequences of failure, the terms of reorganization, and the degree to which lessons were learned.
Building Paper Empires
Until the latter half of the nineteenth century, papermaking remained a labor-intensive handicraft entailing the conversion of rags rather than wood pulp. As newspaper and book publishing expanded in tandem with urbanization and the spread of public education, a growing shortage of raw materials triggered an escalation of newsprint prices, which reached a height of U.S.$442 per ton in 1863. Exploiting German mechanical and chemical techniques, American firms began to substitute willow or poplar as the main raw material, a change that cut the price by half.9 Based upon the utilization of the Fourdrinier paper machine, the manufacture of pulp and paper was concurrently converted into vertically integrated operations utilizing large, fixed investments. These conditions propelled an expansion of the American production of newsprint from 100,000 tons in 1870 to more than one million tons by 1914. After 1880, producers with sizable mills began to drive out smaller rivals, and, by the turn of the century, the American industry was commanded by nine firms with analogous capabilities that were manufacturing a homogeneous product. Research and further innovations led to the acceptance of groundwood pulp made from spruce as the least expensive ingredient. The minimum efficient scale for a newsprint mill stabilized at a rate of approximately ninety to one hundred tons per day, a threshold that lasted for several decades. Subsequent changes tended to be incremental: greater mechanization or the construction of larger, more efficient, machines. Nonetheless, rapid growth in newspaper circulation and the low output necessary for economic operation created opportunities for small enterprises to enter and gain stakes in regional markets. This competition drove the price level down to U.S.$36.00 per ton and propelled the formation in 1898 of a giant company, International Paper, as a vehicle for rationalizing activities. Although it operated as the price leader, the firm was slow to make further investments essential for entrenching a dominant status, and its share of the American newsprint market deteriorated from 65 percent in 1901 to 18 percent by 1929.10
Paralleling experiences in other countries, paper manufacturing in Canada initially was conducted by small, nonspecialized companies. A considerable export trade in timber was elaborated during the nineteenth century, but few firms moved beyond sawmill operations into sophisticated manufacturing. Rather, the potential for exports of processed goods was explored by a modest number of enterprises located in the province of Quebec. Founded in 1887 by American and Canadian capitalists, Laurentide Paper was the first to manufacture wood pulp for overseas clients. The exhaustion of its traditional stands of lumber after 1900 also forced Price Brothers Ltd., a prominent timber exporter, to shift into pulp production. These firms were emulated by companies like Belgo-Canadian, Chicoutimi, and Riordan, each of which exploited concessions near the Gulf of St. Lawrence or the St. Lawrence River and exported pulp to American or British customers.ll
Despite comparable rates of growth during the first decade of the twentieth century, the American sector grew much larger than its counterpart to the north. Entrepreneurs and speculators repeatedly tried to establish viable Canadian mills to service foreign demand, but (especially in the province of Ontario) dashed hopes and lost investments proved to be the norm. With pulpwood supplies still available near urban centers, by 1909 nearly 80 percent of American requirements could be met from domestic sources. Moreover, determined to protect their market, the American producers lobbied for protection against foreign suppliers and gained a series of restrictions that culminated with the Dingley tariff of 1897. In counterpoise, the province of Ontario tried to force local production with its "manufacturing condition," a set of regulations that banned exports of logs (and then pulp), but the policy proved ineffective as long as American suppliers could service the demand for newsprint. Exports of Canadian pulp to the United States during 1909 thus amounted to 142,000 tons versus American production of 1,179,000 tons.12
Escalating demand, owing to the rapid expansion of the size and circulation of urban newspapers, steadily depleted forest resources and compelled producers to draw upon less economic tracts or more distant areas, like Maine and Minnesota. During the first decade of the century, the manufacturing cost of newsprint rose from U.S.$25 to U.S.$35 per ton, almost exclusively in response to increases in the cost of wood. Subjected to intense lobbying from publishers who sought cheaper raw materials, between 1911 and 1913 the American government eased tariff restrictions and then sanctioned free trade for pulp and newsprint. Concurrently, the completion of two railways, the Canadian Northern and the National Transcontinental, allowed economic access to timberlands in northern Ontario and Quebec. American imports of unprocessed pulpwood from Canada rose to one million cords per year by 1914 and remained near that level until the 1930s, while annual imports of pulp reached two million tons. In addition, newsprint production expanded to 85 percent of the annual Canadian output of forest goods, with 80 percent shipped abroad-primarily to the American market. Newsprint exports to the United States rose from $1.2 million in 1910 to $100 million by 1930, when they came to represent nearly 30 percent of the value of all Canadian exports (see also Table 1).13
The sector developed against the backdrop of a broader transformation of the Canadian economy. Although the country's early economic growth had been predicated upon exports of agricultural or raw resources, between 1867 and 1913 there was a shift toward the production of semiprocessed and finished goods. Abetted by the availability of cheap hydroelectric power, the percentage of the gross domestic product (GDP) represented by manufacturing increased from 22.5 percent to 40 percent, with new activities concentrated in southern Ontario and Quebec. Canadian governments assiduously encouraged foreign investment as a means of both accelerating this shift and overcoming the weaknesses of domestic capital markets. The United Kingdom still accounted for more than 70 percent of foreign funds as late as 1914, but the significance of American investment steadily waxed. By 1930, it accounted for 61 percent of the annual influx of foreign capital, while the British contribution had declined to 36 percent. The American share of Canada's imports increased from 41 percent to 60 percent between 1900 and 1930, while its share of total exports grew from 34 percent to 43 percent. Across the same period, while it remained a major trading partner, the United Kingdom's share declined from 31 percent to 15 percent of Canadian imports and from 57 percent to 25 percent of the country's exports.14
British investors had favored bond and other portfolio instruments, whereas the influx of American funds predominantly took the form of equity capital. Firms like International Nickel and Alcoa vertically integrated across the border and established subsidiaries as reliable sources of raw materials or semiprocessed goods. Numerous manufacturers, having developed significant competitive advantages, made Canada their first major international foray and formed branch plants in order to circumvent tariff restrictions. Foreign capital by 1930 represented 35 percent of total investment in manufacturing, a higher level than occurred among most of the industrializing nations. In particular, American first movers dominated many of the new technologically intensive industries: chemicals, electrical goods, oil refining, rubber, and transportation equipment. A mix of domestic and foreign investment characterized sectors like mining and forest products. Large firms controlled by domestic entrepreneurs tended to arise in areas where foreign firms were less pervasive: cement, steel, textiles, financial services, merchandising, railways, and utilities.15
The pulp and paper industry was restructured after 1914, as Canadian plants became the primary suppliers to the United States and as American mills were reconfigured toward higher-value paper goods.
Distinctive types of companies emerged as prices rose in response to market demand and wartime restrictions. To bolster their supplies, several American publishers constructed their own mills. Those enterprises operated independently of market forces and became significant operations, such as Ontario Paper (owned by the Chicago Tribune) and Spruce Falls Paper (controlled by the New York Times). Several companies, like Price Brothers and Belgo-Canadian, completed the process of vertical integration into newsprint production, but, owing to either shortages of capital or a lack of secure contracts, few others successfully completed the transition by the early 1920s. Rather, most of the Canadian firms concentrated on pulp exports.
Two of this latter group, Chicoutimi and Riordan Limited, attempted to attain giant size quickly. During 1915, Chicoutimi merged with several New England firms to form the North American Pulp and Paper Trust, but the enterprise fell into receivership within three years. One of the oldest forest-products firms in Canada, Riordan was reorganized during 1920 with infusions of capital from Boston capitalists, and the firm undertook a major construction program. However, as a basic commodity, the price of wood pulp was quite volatile, and it dropped precipitously the following year. Overextended, Riordan collapsed in spectacular fashion. The common share price fell from $224 to $4, while the value of its securities plummeted to $1.04 million versus a declared par value of $43 million. Efforts by investment bankers to resuscitate the firm failed, and the Riordan properties languished in bankruptcy for four years.16 Virtually all the Canadian producers learned from these failures that long-term survival required integration into newsprint, and the number of firms concerned solely with pulp manufacture gradually declined. Still, prior to 1924, the companies remained very modest in scale relative to their American counterparts.
The dynamics of competition were altered by the entry of International Power and Paper into the Canadian industry. Restrictions by the provincial governments of Ontario and Quebec, first upon exports of unprocessed logs and then upon free trade in newsprint, had slowly weakened the American firm's competitive status. In counterpoise, during 1921 its executives approved the construction of a mill at Trois Rivieres in Quebec and started the process of transferring newsprint operations from the United States to that location. Three years later, a new president, A. R. Graustein, launched a massive effort to convert International Paper into North America's largest forest-products and hydroelectric company. As part of this initiative, he purchased the moribund Riordan properties in 1925, immediately providing the Canadian subsidiary with an extensive portfolio of sawmills, pulp and paper factories, hydroelectric facilities, and timber holdings. By the following year, the Trois Rivieres facility achieved a daily capacity of 680 tons-the biggest newsprint mill in the world and one capable of manufacturing more than the combined output of the three mills of Price Brothers (the next largest producer in Quebec). Further capacity was added through the construction of a 480-ton mill in New Brunswick, the acquisition of control over the E. B. Eddy Company and the Bathurst Power and Paper Company, and the purchase of a partially developed enterprise in Newfoundland. 17
These maneuvers triggered a set of interrelated developments that propelled first a burst of expansion and then a spiral into economic failure. An arms race was set in motion, as rival producers modernized their facilities with new and ever larger machines in order to offset International Paper's scale economies and concomitant ability to undercut competitors. Because of the high fixed costs associated with newsprint manufacture, profits tended to be earned on the final increments of production. Corporate officers consequently tried to operate their factories at or near full capacity.18 Each firm negotiated annual or biannual contracts with several newspapers that stipulated a basic price per ton, with different rates for various geographic zones in the United States. However, all the contracts had interlocking clauses requiring a supplier to match a lower price set in a geographic zone by a rival with an annual output of 100,000 tons. The need to secure contracts in order to sustain capacity operations precipitated several rounds of destructive price cutting from 1926 to 1932. Monopsonistic purchasers (like the Hearst group of newspapers) exacerbated this trend by playing the suppliers off against one another for concessions or secret rebates.
Most of the Canadian companies had not integrated into marketing but relied upon independent agents or joint ventures. The firms initially concentrated upon distinctive markets. Quebec producers tended to service the eastern seaboard or British markets, whereas Ontario firms focused upon the midwestern states. Equipped with its own sales force, International Paper sought out new clients, thereby breaking down the market groupings and spurring further price cuts.19 Finally, these alterations encouraged rival firms to jump to large size, either by internal growth or by merger. The initiatives were expected to create corporations with portfolios of facilities and resources, enterprises capable of squeezing out weaker companies, rationalizing production, and commanding supply from different regions. By 1931, six firms controlled nearly 80 percent of eastern Canadian production. Each firm followed a distinctive path toward those objectives, and the concerns can be revealed best by summarizing three cases (see also Figure 1).
Abitibi Power and Paper Ltd.
Organized in 1912 by a group of Montreal and Toronto businessmen, Abitibi Power and Paper represented the first successful newsprint venture in northeastern Ontario. Observers dismissed the initiative as speculative, but the firm's officers approached Peabody Houghteling, a Chicago-based venture capital agency that had originally emphasized utility issues but then facilitated the funding for Canadian resource companies. The investment bankers demanded Abitibi's integration into newsprint production and facilitated a doubling of the firm's capitalization in exchange for common stock, membership on the board of directors, and control over subsequent sales of securities. During the following decade, the company's Iroquois Falls mill became one of the most efficient operations in North America, but its top executives resided in the United States and only occasionally visited Canada. Although they handled some contracts, they hired George H. Mead of Ohio to serve as the American sales agent.
In 1923, Alexander Smith, a former Scottish surgeon and vice president of Peabody Houghteling, was appointed Abitibi's president. He launched an expansion drive, with the intent of making the firm a preeminent supplier to midwestern newspapers. Over the following four years, through joint ventures with Spanish River Pulp and Paper, Smith established mills in Manitoba, Ontario, and Quebec. The sales of securities for those enterprises were handled by Peabody Houghteling. In 1926, Abitibi purchased Mattagami Pulp and Paper, a bankrupt groundwood pulp producer. Despite periodic rumors about a merger with Spanish River, Abitibi did not acquire the larger firm until 1927.
Founded in 1899 by British investors who gained rights to extensive forest concessions near the northern shore of Lake Huron, Spanish River was one of the earliest Ontario producers. Canadian speculators took over the company in 1912 and engaged George H. Mead, the founder of Mead Inc., as a partner who would rehabilitate the property and amalgamate it with two moribund firms. A sellout by the leading investor, however, left Mead the major owner of the marginal enterprise, which he converted into a source of steady profits by the early 1920s. In 1927, anxious to focus upon his American companies, Mead agreed to a share exchange, and Abitibi acquired Spanish River, including its interests in Manitoba Paper, Ste. Anne Paper, Murray Bay Paper, and Fort William Paper, along with numerous water and timber concessions. With the consolidation, Abitibi dominated output from northem Ontario, and it was expected to realize greater economies by balancing production among the mills. An international sale of bonds and preferred stock (the largest ever by a Canadian manufacturer) covered a redemption of the securities issued by the subsidiaries. Subsequent purchases of Thunder Bay Paper and Provincial Paper (a fine-paper company), along with the formation of Ontario Power Service (a hydroelectric subsidiary), were expected to entrench Abitibi's status. Now the head of Canada's largest manufacturing enterprise, Alexander Smith, quickly created his own investment banking and securities firm, conveniently ensconced in the Brown Brothers Building on Wall Street.20
Canada Power and Paper Ltd.
Canada Power and Paper emerged from a complex process coordinated by a syndicate headed by two of Canada's most prominent financiers, Herbert Holt and James H. Gundy. Holt had garnered a reputation as a veritable captain of industry during the first wave of mergers in Canada after the turn of the century. He ruthlessly propelled the amalgamation of local utilities into a monopoly, the Montreal Light, Heat and Power Company. Holt then extended the firm's operations into contiguous regions and areas like chemical production, while also abetting the construction of other large firms, such as Calgary Power and the Steel Company of Canada. The best-connected businessman in the country, he settled down to managing his companies during the First World War, serving as the titular head of the Royal Bank of Canada and exploiting his many directorships. James H. Gundy had founded Wood Gundy, one of the leading Canadian securities dealers. During the postwar era, Gundy was a major promoter of reorganizalions and refinancing with ventures that included Nova Scotia coal and steel interests; Massey Ferguson, Canada's biggest farm equipment manufacturer; and Simpsons, the second largest department store.21
Perceiving newsprint as a ripe area for profit and the extension of their influence, the financiers created Holt, Gundy and Co., a closely held investment company, as the primary entry vehicle. In 1923, they bought the Bay Sulphite Company, a bankrupt concern formed to supply pulp to British newspapers. The financiers unsuccessfully tried to have Price Brothers or Abitibi buy the firm but were forced to take managerial roles. They configured the facility (renamed Port Alfred Pulp and Paper) toward newsprint production, while concurrently moving into an aggressive promotion of newsprint securities. By itself, Port Alfred was a minor operation, and the construction of a new mill was not completed until 1926. Nonetheless, the capitalization was built up from $10 million to $54 million through sales of equity and bonds. During 1925, via one holding vehicle, Holt and Gundy purchased the St. Maurice Valley Corporation for cash from an American concern; through another, they acquired 85 percent of the common stock of Belgo-- Canadian Paper. Holt became president (and Gundy, vice-president) of a reorganized St. Maurice, but the assets of Belgo-Canadian were not consolidated with the enterprise and were operated via a lease.22 This maneuver was followed during 1926 by the acquisition of Canada Paper (a fine-paper producer) and a one-third interest in Anticosti Corporation.
Holt and Gundy attempted to bring Laurentide Paper into the enterprise but were initially rebuffed. However, when newsprint prices weakened and the rationalization of production became a concern, Laurentide's board agreed to a merger via an exchange of shares. The motive for the consolidation, George Chahoon, president of Laurentide Paper, later observed was "principally the idea of keeping the industry from flying into a thousand parts. Everybody had started in just like a gold rush to exploit the paper industry... [If] the paper industry could be organized into three groups-a Quebec group, an Ontario group, and the International Paper Co.... the thing would be run in an intelligent, economic manner." Economies were expected from a rationalization of operations, since the facilities, "a beautiful group of mills," were within close proximity. Laurentide's hydroelectric subsidiary then was conveniently sold off to Shawinigan Power, a Holt-controlled utility.23
A new enterprise, Canada Power and Paper, took over the companies through an exchange of securities. None of the constituent firms built additional facilities after 1926. Almost all of the continuing expansion of output came from smaller producers or foreign investors. Essentially a holding company, Canada Power and Paper did not directly control the physical assets and left the operating managers in place. Many had been major investors in their companies and received liberal amounts of common stock as part of the amalgamation. They apparently expected the new company to pursue the historical pattern of dividends. The capitalization was raised from 750,000 to two million common shares as the process was replicated through mergers with Wayagamack (a kraft-paper producer) and Anglo-Canadian Pulp and Paper (a British company supplying the Daily Mail group of newspapers).24
Backus-Brooks Ltd.
Among the major enterprises, Backus-Brooks had the most difficult growth pattern. In 1884 Edward Wellington Backus, a Minnesota entrepreneur, acquired the lumber firm of Lee and McCulloch and over the following decade built it up into the E. W Backus Lumber Co. He then organized a syndicate to exploit timber lands in northern Minnesota and launched an array of enterprises, including railways, telephone companies, and a bank. During 1899, William F. Brooks gained a working interest and provided capital for the acquisition of water sites on both sides of the border near International Falls, Minnesota, thus enabling an expansion into northwestern Ontario. As part of a scheme to construct hydroelectric stations and paper mills, those activities were reorganized into Minnesota and Ontario Paper during 1908, with securities under-- written by Peabody Houghteling. From the beginning, Minnesota and Ontario was heavily leveraged with debt and preferred stock, and Backus repeatedly pledged his equity holdings as collateral. The enterprise remained under the control of the partners but evolved into a Byzantine structure comprehended only by Backus, a brilliant promoter and spellbinding lobbyist, known for lavishly entertaining trainloads of investors or politicians who toured his prospective developments.
Wartime restrictions on capital flows circumscribed those visions, and not until 1919 did Backus gain broad water and forest concessions from the government of Ontario. Two years later, in exchange for a promise to build a newsprint mill at Port Arthur by a new firm, Great Lakes Paper, the province ceded extensive resource rights. Although the firm was headed by two New York financiers, unbeknownst to the government, Backus was a silent partner. A game of bluff unfolded for nearly four years as the company delayed construction and attempted to extract additional territories that would allow Great Lakes to match Abitibi in midwestern markets. After new lands were received, the parent company was taken public with issues of securities to cover the construction of a mill with the largest paper machine in the world. Backus's partners sold out their interests for a considerable profit when Great Lakes became operational, leaving him as the largest shareholder. But concerns by American banking interests about the degree of leverage forced the incorporation of the subsidiary as a separate enterprise.25
Financing the Industry's Growth
If vertical integration, personal ambition, and oligopolistic reaction represented the "supply" side for expansion and mergers, demand for newsprint securities was a necessary concomitant. The relationship between manufacturing and financial capitalists represented a regular subject for debate as the sector developed. Pulp and Paper Magazine of Canada, the major trade periodical, stressed production as a source of value and the need for balancing new capacity against known demand. Just because a wave of prosperity facilitated sales of securities, the editor remarked, did not mean that the time is ripe for a flood of hastily devised illjudged paper enterprises to be placed before the investing public with its attention called more to the stock and bond end of the schemes than to the legitimate profits from a rising industry. So frequently it happens that great advances in an industry are followed by a regiment of stock-jobbing propositions from which nobody but the promoter and the broker reap any profit.26
The journal denounced "the use of pulp and paper shares as mere gambling counters, with the object of putting up prices without regard to the intrinsic value of the securities." By far "the greater part of the money put into the industry is for investment purposes... [but] an unsettling feeling must be produced on the minds of many investors by the periodical and violent see-sawing of values caused by speculation. . . . The industry, however, can only be maintained and extended by retaining the confidence of investors, who certainly do not desire it to be the football of Stock Exchange gamblers, whose only aim is to make money out of the rise or fall of shares."27 Newsprint should be made at mills, "not in the financial houses on St. James Street" of Montreal. Whenever there was a prospect of significant profits, "promoters and get-rich quick artists did irreparable injury . . . by promoting paper companies in all sorts of out-of-the-way places. Some of these have gone into liquidation simply because they were stock market flotations and not legitimate paper propositions." Thus, reputable business people would object to "the mergerer and stock market promoter running riot, and playing the chief emphasis upon the stock market end of the enterprise. Proper financing is necessary, but stock watering, stock jobbing, mergering and the professional promoter are unnecessary and hurtful."28
Nonetheless, the links between high finance and the newsprint sector were inextricable from the beginning. Like other North American industries during the 1920s, expansion and consolidation were pushed along by securities dealers and investment bankers. The players included all the significant Canadian enterprises: Royal Securities, Wood Gundy, and Dominion Securities. Royal Securities and Wood Gundy not only bought and sold securities for clients but also had extensive holdings of their own, and their senior officers acted as managers or directors within the industry. As the scale of financing increased, transnational syndicates were formed, since the Canadian market could not absorb the issues. Financing for Backus-Brooks was supplied by a syndicate of American institutions; Abitibi's needs were handled by Royal Securities in Canada and by Peabody-Smith and National City in the United States; the Quebec firms used a mix of British, American, and Canadian agencies. Some of the participants later claimed that they never made money on the transactions, but the profit opportunities were enormous. Like their American counterparts during the 1920s, Canadian investment bankers sought out new situations where their services could be applied. Their companies reaped standard commissions from flotations of securities, gained from the spread between the minimum price set by a client and the actual sale price, and frequently received contributions of common stock that later could be sold if the firms prospered. To reassure clients, the underwriters characterized newsprint securities as analogous to those of hydroelectric enterprises. This assertion resonated with investors because many of the producers, in fact, constructed electric-power subsidiaries to service their mills and nearby regions. Several were listed in American newspapers or Poor's Manual of Industrials not as commodity manufacturers but as "utilities" with stable earnings.
The emergence of large Canadian life-insurance companies represented a critical variable in the construction of a market for the securities. The amount of life insurance issued in Canada grew from $267.2 million in 1900 to $3.982 billion by 1930, while total annual income increased from $13.5 million to $405.3 million. Corporate assets multiplied concurrently, doubling or tripling with each decade.29 New business for the companies provided additional revenues, but these initially added little to the surplus, which provided returns for policyholders or shareholders. New business also created new liabilities in the form of policy claims and regulatory obligations for additional reserves. The firms traditionally had placed their capital in real estate, municipal bonds, or loans-investments that slowly appreciated. Insurance executives sought out larger, more reliable sources of income as their companies grew, and the portfolios were shifted toward railway, utility, and government bonds after assiduous lobbying compelled government authorities to ease regulatory constraints. The firms were allowed to buy not only industrial bonds but also preferred shares if dividends were paid regularly for five years. Common shares could be added if a 4 percent dividend or outlays of $500,000 were maintained for seven years.30
The problem of securing income-earning investments deepened after 1920 as a decline in interest rates raised the value of the firms' holdings and permitted their profitable liquidation. The major insurance companies decreased the proportion of mortgages and loans in their investment portfolios in favor of corporate securities.31 The most aggressive stance was taken by Sun Life Assurance, the largest Canadian enterprise. "We have enlisted many large groups of the brainiest, most experienced men on the continent to work for us to maintain our interest earnings," Sun Life's president, Thomas Macaulay, declared. "We get their co-operation by becoming stockholders in the outstanding basic corporations they direct, so that we share in all the profits they make." A firm's securities were added if the pattern of earnings make it almost a foregone conclusion that the position of the company ... will in ten years be higher than at present, and in twenty years higher still. We are extremely cautious and conservative in making our selections; once we have bought, however, we retain our holdings indefinitely, regardless of market fluctuations; looking for our profit not on the stock exchange but in the steady growth and gradually increasing prosperity of the corporation.32
Large firms had to offer new securities regularly if their operations were to keep pace with economic growth, Sun Life executives claimed. Established investors could purchase them at prices well under the expected market value. Full details were also published about financial affairs by major corporations, one officer defensively asserted, "and there are other important avenues through which desired information can be elicited," such as "the confidences extended to the Company by virtue of its position and reputation in the investment field." By the end of 1927, public utility, railroad, and industrial securities accounted for 55 percent of Sun Life's assets, and nearly half of that component of its portfolio was placed in common stocks.33
This perspective was not immediately followed by other companies because the demand for paper products slumped from 1920 to 1923, and several of Sun Life's holdings went bankrupt. However, the approach seemed to be legitimated by subsequent increases in returns and dividends. After 1924, other life-insurance companies added news-- print securities to their portfolios. Mutual Life of Canada's bond department characterized pulp and paper as a safe sector. Newspapers had become a necessity, with a capacity for long-term growth, while the exhaustion of American forest resources appeared to make higher prices inevitable. The industry was "Depression proof-When goods begin to move slowly, manufacturers and merchants increase their advertising space. Prosperity encourages advertising, depression makes it necessary." The interest rate on newsprint bonds was attractive: 6 percent or higher, versus government bonds, which averaged between 4 and 5 percent. Not only had the firms released "rather good statements," noted the bond department; they also were perceived as quasipublic utilities. "The management factor is not as important as in the average industrial concern. Due to the nature of the demand for their products, and the large percentage of their assets that are fixed, they should safely carry a large portion of bonded debt in their capital structure." Even when events proved those assumptions false, Mutual's officers insisted the capital had been directed to "a productive field where it was needed. The industry was sound and the companies were sound." Still, with the luxury of hindsight, they conceded "there was a speculative tinge" to the investments.34
Pulp and paper was the only manufacturing sector that attracted significant investment from the insurance companies, and they contributed a fifth of the new capital received by the newsprint producers. Equally crucial, those stakes legitimated the securities to other investors. Each insurance company diversified its investments among the manufacturers, trying to minimize its exposure should one firm encounter difficulties. Sun Life had the most extensive holdings, allocating 10.8 percent of the stock and bond portfolio (8.3 percent of the firm's total assets) to the sector. Mutual Life placed 9.3 percent of its bond and stock holdings in newsprint companies. Most of these stakes were elaborated between 1925 and 1928 as the merger wave unfolded and before the problem of excess capacity became apparent. The nominal value of the holdings by insurance companies amounted to $68.4 million by 1930. Although this sum represented only 8.7 percent of their portfolios of bonds and stocks, it took the form of large blocks, and the firms represented the largest holders of specific issues.
Parboiling the Books
Few observers questioned either the rapid addition of new capacity or the wave of mergers. Those developments, claimed the London Financial Times, illustrated a mathematical axiom: "that stability depends on broadness of base and relative lowness of center of gravity is generally true also of business." By combining mills, the firms shared personnel, laboratory, and engineering services, while economies could be realized through a reallocation of tonnage among plants in accord with their proximity to markets. Another journalist captured the popular mood, rhapsodizing that newsprint "dominates the earth. Canada rubbed an Aladdin lantern of pulp and paper, and now-behold!"35 Interested onlookers, however, faced several difficulties if they wished to gauge whether these speculative enthusiasms had substance. Largescale investment postdated 1912, and neither the Dominion Bureau of Statistics nor the Pulp and Paper Association of Canada collected data systematically prior to 1918. Efforts to determine trends were problematic because the available data encompassed two recessions (191314, 1921-23), wartime restrictions, a bout of inflation (1917-20), and two spurts of demand (1917-20 and 1924-28). Moreover, announcements of plans to raise capacity usually occurred two to four years before the projects could be completed.
Not only were the companies of moderate size, if viewed from a North American perspective; most had not manufactured newsprint for lengthy periods. Even appraising the status of the older enterprises was arduous because their capital structures were periodically reorganized. Laurentide, for example, was rechartered in 1911 and 1920 with concomitant issues of new equity and debt. Abitibi was reorganized in 1914, and its common stock was not publicly listed until 1917. During 1920, the issue was split with the expectation that the holders could reap gains from a sudden surge in demand for newsprint. The equity of Price Brothers similarly was reorganized in 1921 to attract investors. Unable to cover its obligations during the latter half of the First World War, Spanish River worked out arrangements for a suspension of payments, and those outlays were not fully resumed until 1922. The common stock of the initial producers also was closely held by the original investors and had a designated par value. The value of the shares available for trade in financial markets consequently soared between 1918 and 1920 as commodity prices escalated. The common share price of Laurentide rose from $151 to a peak of $254; Price Brothers, from $120 to $359; Abitibi, from $48 to $298. Most of the eighteen companies operating in eastern Canada during 1920 were restructured during the following decade, several two or three times. Not only did those actions eviscerate the ability of observers to appraise longitudinal performance objectively, but the firms concurrently also authorized new common shares for sale. Unlike earlier practices, these issues lacked par value and thus never attained the earlier price levels, even at the height of the bull market during the late 1920s.36
From 1925 to 1930, the aggregate capitalization of the industry increased by $243.5 million. Virtually all the expansion occurred among eastern Canadian companies, and a key element was a reliance upon bonds and preferred stock for financing development. Table 2 summarizes the capital structures of the publicly listed producers during 1925 and 1930. Contemporary observers claimed there had been a shift away from common stock, but the aggregate proportions of different types of securities were not different between the two sample years. The structures of certain firms, however, entailed a heavier dependence upon debt or preferred equity. Abitibi's consolidation, its executives declared, had not entailed "new" money, just the replacement of existing issues, but this was accomplished by issuing $55 million of bonds, as well as $16 million of preferred stock. As a result, common stock decreased from 32 percent to 18 percent of the capital structure. Canada Power and Paper (unlike Abitibi) did not retire most of the securities of its subsidiaries, but its common stock constituted only 26.3 percent of the capitalization because the promoters used bonds to replace the equity of several firms.
Whereas the aggregate capital employed in the sector rose by 52 percent between 1925 and 1930, interest expenses increased by 82 percent and preferred dividend obligations grew by 79 percent.37 Contemporary estimates of costs were based upon published statements and significantly understated what the producers incurred. Newsprint manufacture had high expenses (mills and equipment, electricity generation, and wood reserves), which were sensitive to capacity use. In 1930, the five leading companies had an investment of $212 per ton of capacity, of which $206 was in the form of fixed assets.38 Working capital requirements were seasonal and normally were not crucial, since each firm sold to a small group of large consumers and made carload deliveries on regular schedules. Inventory took the form of unprocessed pulpwood cut during the autumn and winter and then transported to the mills. Based upon operations at full capacity, an average of six years was required for turning over an investment dollar, and (at prevailing prices) an operating profit of $13.50 per ton was necessary for an annual return of 6 percent.39 Because most firms could not sustain capacity operations, higher figures were necessary to achieve those goals. Their vulnerability, to either lower demand or a price decline, hence was acute.
Observers later suggested a greater reliance should have been placed upon common stock, but the sales of securities were conditioned by the needs of investment bankers or their institutional clients. The Canadian market (because of its size) was incapable of absorbing huge equity issues. Although directors and underwriters recognized that leverage (in an upward financial market) could enhance price-earnings ratios, there is no evidence that the potential for the reverse was appreciated.40 In Canada, to a greater degree than in the United States, bonds and preferred equity were viewed as sine qua non for prudent investors because they were secured by mortgage deeds or other covenants. Common stocks were perceived as risky investments, caveat emptor. Nor were investors well served by reports in business publications, which typically comprised verbatim summaries of annual or quarterly statements. Press analyses rarely went beyond simple measures like the current ratio, earnings per common share, or whether a nominal profit had (or had not) been earned. Given the levels of debt and the newsprint prices that had prevailed until 1924, many observers believed the producers could meet their obligations based upon ratios like return on assets or times-interest earned. Moreover, they also assumed that the financial statements of the producers accurately portrayed earnings or the value of assets. In fact, all the firms engaged in reporting policies that were dubious, even if judged by the loose standards of the times. Record-keeping represented a key variable that obscured their actual status and delayed the dissemination of information about the potential for collapse.
This issue can be partially traced to regulatory deficiencies regarding the disclosure or independent review of company records. Canadian corporate law was a patchwork of federal and provincial statutes, and judicial appraisals of specific questions were often guided by precedents from cases adjudicated in British courts. Many laws were based upon Victorian statutes oriented toward the partnership arrangements of a preindustrial era or the close relations among business interests characteristic of a schema of personal capitalism. A federal incorporation act was not passed until 1910, and it had numerous gaps until 1917. Several provinces used a "letters patent" system, while others employed a registration format. This legislation was highly confusing, except to specialists, because the rules, procedures, and terminology varied significantly.41
Following British practice, a firm's directors nominally served as guardians of the interests of the shareholders, but they were legally defined as servants of a company, not as trustees for the equity investors. Canadian statutes mandated them to maintain true accounts, establish policies for the inspection of records, and release annually a balance sheet and a statement of profit and loss. The directors were obligated to render an account of their administration at reasonable times without suppression or concealment. Shareholders had no rights in common law to inspect books or records. The privilege of inspection was confined to cases where an individual had a definite object in view and the documents could be expected to substantiate the concern. Neither Canadian law nor the courts took account of the numerous conflicts of interest that might arise between principals and agents when, as in the newsprint sector, company directors were de facto managers and promoters. Whereas investors were inclined to emphasize the stability or growth of earnings from their holdings, the manager-directors often were more concerned with opportunistic objectives like empire building or short-term gains from sales of securities.
Government regulators emphasized the maintenance of records about the stakes of investors, not the accuracy of statements or the protection of investors per se. Prior to 1917, the Dominion Companies Act did not even order a firm to hold an annual meeting, although a general session of the shareholders was required every two years to elect directors. Ontario's company law provided the most detailed direction and stipulated an annual meeting, as well as the submission of an abstract of a firm's financial status. The balance sheet merely had to disclose several broad categories: cash, debts owing to a firm, stock in trade, capital expenditures, short-term and long-term debt, amounts owing on equity issues, and indirect or contingent liabilities. Neither the federal nor Quebec statutes stipulated regular audits, whereas Ontario's bill mandated the appointment of auditors either at an annual meeting or upon a shareholder's application to the provincial secretary. The legislation thus facilitated lax reporting standards, and the prosecution of auditors for malfeasance was unknown. Rather, as a manual for the Bank of Nova Scotia observed, "character, capacity and capital and it would appear precisely in that order" were expected to guide financial affairs.42
An auditor symbolically acted as the shareholders' representative and was responsible for the supply of "independent and reliable information respecting the true financial position of the company at the time of the audit."43 But even if knowledge of potential misconduct was garnered, the officer was not obliged to notify the shareholders. 44 As the judge in a widely cited case remarked,
An auditor is not bound to be a detective, or ... to approach his work with suspicion or with a foregone conclusion that there is something wrong. He is a watch-dog but not a bloodhound. He is justified in believing tried servants in whom confidence is placed by the company. He is entitled to assume that they are honest and to rely upon their representations, provided he takes reasonable care. It is not the duty of an auditor to take stock; he is not a stock expert; there are many matters in respect of which he must rely on the honesty and accuracy of others. He does not guarantee the honesty of all fraud.45
In another well-cited case, it was claimed the auditor "has nothing to do with the prudence or imprudence of making loans with or without security. It is nothing to him whether the business of the company is conducted prudently or imprudently, profitably or unprofitably. It is nothing to him whether dividends are properly or improperly declared."46
Neither federal nor provincial legislation required the officer to appraise the value of properties, securities, or book debts. The financial statements were supplied by the directors, and an auditor's responsibility was defined as an arithmetic verification of whether they appeared to reflect a true state of affairs. It was not enough to report that the documents might not exhibit a correct view; the examiner had to show where entries were manifestly wrong. An auditor was not responsible for matters of judgment, which were properly in the province of the directors. If entries clearly were absurd, then the figures could be questioned and reported, but the courts circumscribed the officer from speculating to equity holders about problematic managerial issues. In one prominent case, the judge noted that "an auditor who gives the shareholders means of information instead of information respecting a company's financial position does so at his peril and runs a very serious risk of being held judicially to have failed to discharge his duty."47
During the interwar period, lower courts in Canada began to shift away from this narrow perspective, but legal experts considered the enforcement of auditing protocols anemic at best.48 Audits were not subject to regulatory oversight but rested upon a presumption that the examiners would be guided by the norms of their self-governing profession or a concern for their personal reputations. Prosecutions of malfeasance were rare, in part because directors were responsible under statutory law when patently false information was circulated to investors. If arguable values were attached, an auditor was not expected to protest too much. This, of course, left considerable room for parboiling the books.
The institutional barriers to information disclosure were compounded by the widespread acceptance of the proprietary theory of accounting. Within the accounting profession, supporters of this perspective drew upon classical economic theory and argued that the function of a firm was to maximize shareholder wealth. They accordingly minimized the importance of retained earnings and stressed the supply of data that enabled investors to calculate the dividends potentially available for distribution. Proprietary theory thus emphasized balance-sheet presentations (with the measurement of assets, liabilities, and equities) as overviews of liquidity and solvency. Although the entity theory of accounting (which stressed income statements and data about ongoing flows of revenues and costs) emerged as a competing school among American accountants after the First World War, it was rarely employed in Canada prior to the 1940s. Standard references like Annual Financial Review or the Financial Post Survey of Industrials replicated corporate balance sheets, and their coverage of operating results was selective and inconsistent. Many Canadian firms refused even to report summary data about sales (let alone detailed breakouts of costs) on grounds of confidentiality.49
Following the amalgamations, most of the big manufacturers published consolidated balance sheets and income statements. In accord with contemporary standards, the documents normally comprised four pages, without notes or explanations, and were followed by a terse narrative about a firm's ability to meet its current liabilities or dividends. The concept of consolidated accounting had gained acceptance in North America during the early twentieth century, but it was devoid of accepted criteria. Neither the American Institute of Accountants nor its Canadian counterpart had drawn up principles to guide company actions.so In Britain during the 1920s, consolidated statements were not viewed as the primary reports of a company, nor were they considered to reflect a single economic unit. If viewed critically from a legal perspective, the records supplied data about a fictitious structure, a corporate group comprising a parent firm and subsidiaries or controlled affiliates.51 In Canada, as in the United States, there was a tendency to assume that the "property" of a large enterprise did not exist in a traditional sense but, rather, took the form of an integrated unit of facilities, equipment, and personnel. Although judges in both countries recognized that wholly owned subsidiaries could be separate entities, they often were treated as mere components of larger concerns. A merger or amalgamation was considered the formation of a new and legally distinct company.52 Concurrently, executives claimed the consolidated statements were more representative portraits of the true scope of modern business.
Regardless, consolidated accounting enhanced the potential for illusory presentations or outright chicanery by obscuring debt-to-asset coverage or the performance of particular operations. The technique mattered because it camouflaged discrepancies between the probable value of assets and the prices paid during the merger wave. The issues of bonds and preferred stock supposedly were secured by tangible assets, which either covered interest and dividend requirements or could be liquidated to cover the principal in the event of a default. Inflated prices, of course, would not merely generate excessive leverage but could also mean that a firm had insufficient earnings capacity relative to its obligations. In addition, each big enterprise retained newsprint mills with different productivity rates or operating ratios, pulp mills (which had lower and notoriously erratic profits), fine-paper or kraft-- paper facilities, hydroelectric systems, railways, and a variety of property improvement enterprises or retail outlets. Indeed, when the biggest companies were rendered bankrupt after 1930, some receivers released detailed statements about subsidiaries in order to highlight problem areas.
In a strict sense, the purchase price represents the "cost" of an asset, but there was considerable disagreement about how this should be done. A majority of the Canadian accounting profession appears to have preferred using the book value of an acquired subsidiary.53 Another common procedure was to assign the par value of the securities used for a takeover.54 The American Institute of Accountants made a distinction between a "pooling of interests" (amalgamation) and a "purchase" (acquisition). For the former, no new basis of accountability was necessary, and the declared value of assets could be carried forward "when stated in conformity with generally accepted accounting principles." For the latter, assets were to be recorded at cost on the parent's books, with "cost" defined as money or other fair value received for an acquired property.55 Still, these technical matters presumed independent appraisals before the consummation of acquisitions or mergers, policies often employed in other industries.
Newsprint executives subsequently claimed to have thoughtfully reviewed the value of acquired firms, but the surviving evidence indicates that such conduct was exceptional, not the norm. Under crossexamination, some executives later conceded that careful reviews had not been made. Instead, two issues shaped actual custom: the nominal worth of assets outlined in financial statements or the demands (frequently nonnegotiable) set by those who held key blocks of securities. Sale prices tended to be outcomes of what could be extracted, and company records were later rationalized to correspond with the expenses. Indeed, systemic overvaluation became a trait of all statements. The buildup of assets ranged from modest recalculations of specific entries to grotesque fantasies about entire companies, practices best highlighted by three cases.
Mattagami Pulp and Paper Ltd.
Although it did not garner external scrutiny, in retrospect, the development of Mattagami Pulp and Paper was quite revealing about the cross-links between finance, strategy, and creative record-keeping. Toronto and American interests during 1916 announced the construction of an unbleached sulphite pulp mill at Smooth Rock Falls in northern Ontario. Despite advertisements about splendid timber limits, excellent power facilities, and capable management, business observers wondered whether this "particular bit of financing may be allright [sic]," since Royal Securities, the underwriter, seemed to be "taking altogether too keen an interest in the stock market end."56 Under its founder, Max Aitken (later Lord Beaverbrook), the securities firm had emerged as a force in domestic markets prior to the First World War by expediting mergers of regional companies into big concerns like Canada Cement and the Steel Company of Canada. His successor, the secretive Izaak Walton Killam, who would become one of the most commanding financiers in Canada, was anxious to replicate Aitken's success with a new industry. Based on claims that the properties were worth $9 million, Mattagami was financed by a $2 million bond issue, $1.5 million in preferred stock, and $2 million in common stock.
Given the volatility of the pulp market, the company struggled, and in 1919 Royal Securities floated another $2.5 million issue of second-- mortgage debenture stock. Killam retained half of the issue in exchange for a seat on the board of directors. Two years later, after defaults on timber rights and the bond interest, Mattagami was declared bankrupt. The receiver inherited a mess: the firm had no clear accounting practices and was unable to estimate production costs. In a vain attempt to avoid bankruptcy, the officers had hypothecated the trading assets to Molson's Bank, and it was doubtful that a judicial sale could raise more than $2.25 million. Rather than close the mill, the operation was continued at the risk of Molson's Bank and the bondholders. In 1925, as Mattagami edged toward profitability, Royal Securities offered to buy out the senior securities, but at a price that would result in the general creditors' and common shareholders' receiving nothing. Despite appeals to the courts against this "wash-out," a judicial sale was ordered because the receiver claimed the proceeds would not exceed the movies owing to the debt holders.57
Killam submitted the sole bid of $7.25 million, just above the reserve bid price set by the receiver. Collusion cannot be proven, but it was probable given the small number of participants. Killam then announced plans for an expansion of capacity, a maneuver that would cut into Abitibi's sales. Given this blackmail, the larger firm purchased Mattagami. So quickly did the transactions unfold that Abitibi, rather than Killam, made the cash payment to the court. Abitibi immediately floated a $4 million bond issue to the public, while retaining the common stock and a new $4 million preferred stock issue. How much Killam got cannot be absolutely ascertained, but he fully recouped his stake in debenture stock, received a commission from the bond sale, and probably garnered a bonus for the firm's purchase. Killam flipped his holdings of debenture stock into bonds for the new subsidiary, Abitibi Fibre (and later those of its parent), an arrangement that lowered the net cost of the deal to $5.25 million. Royal Securities also became the Canadian agent for Abitibi's forays into financial markets and (as a major bondholder in its own right) effectively was able to make or break any deal affecting the firm's future for nearly two decades.58
Within a year, the nominal worth of Abitibi Fibre had appreciated to $11.4 million, despite a mere $234,000 in actual improvements. So extreme was the overvaluation that, during the consolidation of records associated with the 1928 merger, the estimate was surreptitiously rejuggled to $8.5 million. This figure was technically derived from the cash outlay for the judicial sale, legal expenses, a "promotional service" payment to Abitibi, and a discount associated with the bond sale. In fact, an appraisal at the time of the judicial sale set the replacement value of the Smooth Rock Falls mill at $5.4 million. A fictional balancing figure of $3 million for the timber limits was then arbitrarily inserted.59
Spanish River Pulp and Paper Ltd.
During the wave of consolidations, the 1927 acquisition of Spanish River by Abitibi appears to have been the single largest case of asset inflation. The role of George H. Mead, the president of Spanish River, unfolded with little press commentary, although he pursued the merger as aggressively as Abitibi's executives. By the middle of the 1920s, the spruce in the Spanish River concessions near Lake Huron had been logged out, leaving more expensive wood. The equipment in several of its mills operated at significantly higher costs than those of rival companies, and its earnings deteriorated after 1924. Instead of improving the newsprint properties, Mead concentrated upon a reconfiguration of his large American firm, Mead Inc., toward higher-value paper goods and milked large dividends from Spanish River to facilitate the conversion. The declared value of the Canadian enterprise was used to determine the settlement terms with Abitibi. Only minor outlays occurred between the end of the 1926 fiscal year and the merger, but the worth of Spanish River assets magically increased from $45.3 million to $63.6 million, while the shareholders' equity precipitously jumped from $33.2 to $52.2 million. The official entries in Abitibi's internal records later placed the value of the assets at $50.4 million at the end of 1927.60
Mead's cooperation was crucial because he had a joint interest in Manitoba Paper, Ste. Anne Paper, and Fort William Paper, which Abitibi needed if its status within the industry was to be entrenched. The firm's bargaining power was further constrained by a dependence upon Mead's sales agency for the management of its newsprint contracts in the United States. Under the terms of the amalgamation, Mead received Abitibi common stock in exchange for his holdings and became the chair of the giant firm. He subsequently claimed to have estimated the worth of the consolidated assets at $94 million versus the declared valuation of $177.9 million, but Mead never criticized the company's management prior to the 1932 bankruptcy. By then, the common stock was worthless and, the largest holder, he gave it away.61 Out of the three newsprint mills controlled by Spanish River, only the Sault Ste. Marie facility ever operated on a regular basis. As the highest-- cost facilities in Abitibi's portfolio, the antiquated Espanola and Sturgeon Falls factories were closed in 1930 and never produced newsprint again. The remaining properties with value, massive piles of pulpwood accumulated before the merger to boost the current assets, were shipped to other locations for processing.
Anticosti Corporation
During the 1930s, for Canadian politicians who believed unreasonable speculation was a cause of the Great Depression, Anticosti Corporation became a synonym for the concept of a fictitious write-up. Purchased from the province of Quebec by a French senator, during 1925 the island of Anticosti in the Gulf of St. Lawrence was offered as a supply source to Charles Whitehead, the president of Wayagamack, a kraft-paper manufacturer that later became part of Canada Power and Paper. Compensation, which was nonnegotiable, was set at $6 million for the senator and $1 million for his factotum. Whitehead found the proposal attractive because it seemed to break the quasi-monopoly of timber resources in the region held by International Paper, and the lumber could be exported without restriction since the property was a freehold, not a Crown lease. However, shortly after the sale was concluded, it became apparent that the company could not handle the deal. "We returned with the option and we knew it was too big," Whitehead later told an incredulous parliamentary investigation. For a "finder's fee" of $500,000, he brought in St. Maurice and Port Alfred as equal owners of a new enterprise, Anticosti Corporation, which issued $6 million in bonds and $3 million in preferred stock. The concession was glowingly advertised as "the largest and most valuable freehold reserve of pulpwood in Eastern Canada," one worth $15 million based upon a price of $1.00 per cord.62 The property could have been appraised at twice that level, Anticosti's directors later asserted, but under cross-examination they admitted that a systematic appraisal had not been made and that most of the wood could not be harvested for twenty to thirty years. Nonetheless, the Anticosti securities were secured by a liability for each firm of $540,000 per annum, an obligation to be met through yearly purchases of 420,000 cords at a minimum stumpage fee. In fact, only 400,000 cords were harvested across the subsequent four years, and the logs were used by just two of the partners. The delivered cost per cord was nearly double the rate from alternative sites. Although Wayagamack maintained the arrangement following the 1929 amalgamation with Canada Power and Paper, it was summarily canceled when the parent company fell into receivership two years later.
Revealing Profits
The overvaluation of assets was complicated by the dubious treatment of depreciation. Not only were corporate policies highly inconsistent, but until the 1930s many Canadian executives retained a preindustrial notion of a depreciation reserve as an appropriation of earnings rather than a value of fixed assets legitimately charged against operational departments. Even well-established producers, like Laurentide Paper or Price Brothers, did not account for depreciation prior to 1915. During the 1920s, smaller or new firms rarely dealt with the subject unless their economic status became secure. Most of the producers did not develop coherent policies for the depletion of forest resources, and the firms that did made calculations based upon income-tax regulations. This policy reflected contemporary norms about conservation, which assumed timber concessions would replenish themselves at a rate equal to the annual cut.64
This treatment of depreciation was one component of an issue that colored reporting practices. Above all, published statements of the newsprint producers were aimed at revealing "a profit"-not only because of the need to attract investors but also to satisfy the minimum earnings criteria for institutional holders. Annual statements stressed several themes to demonstrate the reliability of the companies. The times-earning ratio was cited to show an ability to meet debt or preferred equity obligations, and attention was given to any increase in the corporate surplus, no matter how small. After 1926, as sectoral conditions deteriorated, executives drew attention to the ratio of current assets to current liabilities, even though the former sometimes comprised large inventories of unsold wood.
Still, the authorization of generous dividends represented the key means for demonstrating stable performance. Even by the standards of the times, the distributions reached extraordinary levels. Most of the manufacturers annually paid out at least half of their net profits. Companies like Spanish River and Abitibi tried to maintain a 4 percent common dividend rate. This policy satisfied the life-insurance companies and other investors and seemed to validate notions about the reliability of common stock and newsprint firms as akin to utilities. Conflicts of interest were rife, however, since newsprint executives and directors, who were among the largest shareholders, also benefited from the largesse. Among the major producers, only Wayagamack showed apparent restraint, owing to the uncertain state of the kraft-paper market. However, when the merger with Canada Power and Paper was consummated in 1929, the Wayagamack directors authorized special dividends, which drew down the firm's reserves. This incident replicated a practice that cannot be fully recaptured via the surviving data. Well into the 1920s, Canadian executives considered an accumulated surplus as a capital pool available for distribution to the shareholders, not as a resource to be kept for difficult times. As the newsprint firms were reorganized, an accumulated surplus was disbursed through either dividends or new securities. Retained earnings were not built up, even by the biggest producers, and the smaller often had none at all.
After the companies fell into bankruptcy during the 1930s, some investors alleged these policies amounted to malfeasance by corporate officers. Following Anglo-American precedents, Canadian statutes forbade dividends to be paid out from capital and made directors liable if the payments rendered a company insolvent or impaired the shareholders' stakes. Older legal cases had declared the payment of dividends ultra wires if the directors did not provide for wastage or depreciation. Although the protection of preferred shares and debt capital was considered sacrosanct by judges, the growing use of common stock without par value created major legal headaches. Based upon British rulings, Canadian courts tried to resolve the issue by making a distinction between "fixed" and "circulating" capital. The former referred to subscribed capital expended upon permanent and reusable incomeearning assets; the latter constituted capital temporarily utilized in business operations with an expectation of an eventual return to investors. In theory, a company would keep separate accounts for the two forms of capital. In practice, most corporations were reluctant even to estimate the real value of assets. The artificial distinction was complicated by inconsistent technical rulings about how losses and depreciation should be allocated, how "net profit" should be defined, and when firms could be deemed to have sufficient resources for dividends. In the end, judges essentially left the issue to the discretion of directors, and their reviews merely gauged dividend payouts vis-a-vis the net assets officially reported in financial statements.65
Paying for the Show
The objectives of the merger movement moved beyond attainment even before the consolidations were completed. Although promoters and many investors had believed the pulp and paper sector was invulnerable to major shifts in economic conditions, it slipped into recession during the summer of 1928 as capacity exceeded demand. American consumption of newsprint flattened out after 1926, attained a high of 3.8 million tons in 1929, and then ruinously declined to 2.7 million tons by 1933. Canadian annual exports to the United States dropped from 2.2 million in 1929 to 1.5 million tons in 1933. The number of pages printed daily by American newspapers decreased by nearly a quarter across that period, while advertising linage dropped by more than a third.66 To a significant degree, this trend was derived from structural problems within the American economy. From 1920 to 1930, productivity in the United States grew at a much faster rate than wages. As manufacturing costs fell rapidly, prices remained relatively stable and wages rose slowly, but corporate profits soared. The consequence, as a study by the Brookings Institution noted, was an ever-widening maldistribution of income. Major gains were reaped by already prosperous citizens, but nearly 80 percent of households had no savings at all and, attempting to telescope the future into the present, many purchased goods on installment. Credit-purchase markets reached saturation by 1928, forcing manufacturers and retailers to reduce advertising expenses. Continued growth was dependent upon investment and luxury spending by affluent consumers, and, as their confidence weakened in late 1929, the economy entered a singularity of ever-decreasing production and consumption.67
Efforts to enforce price stability via a cartel (sanctioned by the Ontario and Quebec governments) proved short lived. No firm had amassed the influence necessary for enforcing price leadership, and the temptation to charge below the agreed rate proved too great. Neither International Paper (citing the possibility of antitrust prosecution in the United States) nor the smaller Quebec producers (desperate to cover interest payments for their debt) adhered to the negotiated arrangements, especially after the spring of 1930, when economic conditions imploded. Rather, they again pursued low strategies of excess production and private concessions, along with repeated attempts to steal business from other firms, which slashed newsprint prices well below the level necessary for any producer to achieve profitability. The largest companies were less able to cope with the crisis, owing to their dividend policies. Canada Power and Paper issued virtually all its net profits as dividends during 1928 and 1929. In 1930, despite net losses of $2.4 million, $1.8 million in dividends (the regular outlays) were distributed, a policy that pushed the firm into bankruptcy by 1931. As a precondition for the Abitibi amalgamation, Alexander Smith had promised an annual dividend of $4.00 per common share, a policy that drained the firm's cash resources until it was suspended in 1931. By the summer of 1932, operating at 30 percent of its capacity and with all the trading assets pledged to banks in exchange for capital infusions, the corporation was placed in receivership. The other manufacturers similarly weakened, with bankruptcy or near bankruptcy determined by how fast their reserves were exhausted.
Although newsprint demand again reached 1928 levels by 1937, low prices and excess capacity kept most of the producers in a tenuous state until the late 1940s. Economic failure precipitated a lengthy period of reorganization and, although each company had a distinctive experience, there were analogous results (see Table 3). The operating managers usually were retained, but the directors and senior executives (who had put their enterprises in harm's way) were replaced. In particular, financiers usually were removed from managerial roles in favor of engineers or production specialists, who focused upon efficiency issues and achieving break-even status. Massive write-downs of assets, divestitures, and plant closures followed. As a result of mortgage deeds and other covenants, bondholders or preferred shareholders tended to recoup their principal and the accrued obligations, but only after lengthy legal battles. The biggest losers were the common shareholders, as courts ruled their stakes worthless, mere water. General creditors, the claimants with the lowest priority, got little or nothing. The process that led to these outcomes can be revealed best by summarizing the experiences of four companies.
Canada Power and Paper Ltd.
As the first firm to be placed in receivership, Canada Power and Paper experienced the least difficulty in securing reorganization. A bondholders' committee engaged Sir Charles Dunning, a former minister of finance, to shepherd new arrangements past the claimants. The company had left most of the preferred equity or debt issues of its subsidiaries with the existing investors and then had issued other securities to complete the mergers. With the securities fragmented among different interests, no group could garner special treatment or mobilize opposition. International capital markets still had significant liquidity in 1931, thereby permitting the release of new securities. The Dunning plan reduced the capitalization from $109.4 million to $51 million, with a concomitant reduction in the annual fixed charges from $6.6 million to $2.8 million. In return for common stock in a new enterprise, Consolidated Paper, the holders of first mortgage bonds, agreed to pass up the accrued interest and to accept new bonds, which operated on an income basis for five years, and then promised fixed-interest payments. The debt issue also had a sinking-fund arrangement to ensure its prompt liquidation. A merger with Anglo-Canadian Paper, just being finalized when Canada Power and Paper failed, was never completed, and an investment in Thunder Bay Paper was allowed to pass to Abitibi by default. A massive write-off of assets completed the process as the original identity of the large firm was cast off into the netherworld of deceased companies. Ignoring a "washout" of the common shareholders and creditors, business observers characterized the reorganization as "reasonable and efficient." In fact, Consolidated Paper's weak state forced new negotiations during 1936, and the debt holders then received fifteen common shares per $1,000 of bonds to compensate for a cancellation of interest payments until 1939.68
Price Brothers Ltd.
One of the first Canadian firms to manufacture newsprint and the second largest producer in Quebec, Price Brothers defaulted during 1932. The trustee in bankruptcy and the bondholders' trustee jointly managed the firm for five years. The severity of the Great Depression delayed underwriters' plans to float new securities, but by the mid1930s, unwilling to accept further losses, institutional investors also demanded the complete repayment of debt and preferred-stock obligations. A transnational struggle for Price Brothers unfolded between Viscount Rothermere of Associated Newspapers (a major stockholder and the firm's most important customer) and the Duke-Price Power Co. on one side, and Lord Beaverbrook (head of the Daily Express group of newspapers), Bowater's Paper Mills, and a Canadian investment banking group on the other. Legal or political maneuvering among the parties repeatedly blocked different reorganization plans. In 1935, Pacona Limited, a stepchild of Lehman Brothers of New York, worked with Duke-Price Power to foreclose on the properties and auction the assets. This initiative was derailed when Royal Securities (formerly controlled by Lord Beaverbrook) cobbled together a syndicate, which enabled the British press baron to gain control and allowed members of the Price family to remain among the operating managers. The bondholders were paid off in cash. New bonds were issued to replace the existing issues, meet the demands of the unsecured creditors, and provide $6 million in working capital. Because of the demands advanced by the different claimants, the reverse of a normal process occurred. The revised capital structure increased the annual charges from $1.1 million to $1.2 million. Until wartime conditions stimulated demand, the firm barely met its obligations and was "profitable" only because minimal depreciation was charged.69
Great Lakes Paper Ltd.
For many of the investors associated with the two largest Ontario producers, receivership became a protracted descent. Because of a high level of leverage, the mortgage for the bonds of Great Lakes Paper had required Edward W. Backus to maintain the Canadian firm as a legally-distinct enterprise from his American parent company. Minnesota and Ontario Paper defaulted in the United States during 1931, but Backus temporarily retained a management role despite the appointment of receivers. The bondholders' trustee for Great Lakes Paper filed with the Supreme Court of Ontario for separate protection to prevent prejudicial conduct. After difficult negotiations, the company received 30 percent of a supply contract with an American newspaper when the trustee promised not to compete for other contracts held by its former parent. The status of the Canadian firm was complicated by an illegal transaction made by Backus in a vain effort to stave off the bankruptcy of the corporate group. Late during 1930, he personally withdrew $2 million in cash from Great Lakes and, as compensation, transferred shares of other Backus companies, which were supposedly worth $10 million. Backus used the cash infusion to authorize a new $8 million issue in new preferred shares by Minnesota and Ontario Paper, but he then flipped $5 million of those securities into the company's par value common stock, effectively wiping out their worth. The securities remained on the books of the American and Canadian companies at the alleged values, but legal suits ensued over malfeasance and fraud. Backus died in the midst of the confusing dispute, and his estate turned out to be worthless relative to the claims. As a result, lengthy court cases delayed a reorganization of the American company until 1940.70
Technical problems associated with the deed behind the bonds of Great Lakes Paper prevented a simple process for reorganization and left a judicial sale as the only option. Headed by Senator (and former prime minister) Arthur Meighen, the bondholders' committee insisted upon full repayment. During 1935, it received five purchase offers from Canadian or American interests.71 The accepted proposal paid off the bondholders, slashed the fixed-debt charges in half, and reduced by a third the contingent charges associated with the preferred equity. The plan entailed the formation of a consortium of twenty-five American publishers, who agreed to take a minimum amount of newsprint in exchange for a second class of preferred shares, which were then placed in a voting trust. The dividends from the shares effectively provided the holders with a rebate on their purchases. Despite approval by the courts, this arrangement undercut the Ontario government's attempts to enforce price stability. A four-year battle ensued as the province sought to bring the firm's activities into accord with its policy, while the American president of Great Lakes assiduously tried to circumvent guidelines issued by the government. The problem was finally resolved by an upsurge in demand, which eased the need for regulation, and the convenient appointment of a new president, the former leader of the opposition party in the Ontario legislature.72
Abitibi Power and Paper Ltd.
Abitibi became a cause celebre-the longest, the most complicated, and the most controversial bankruptcy in Canadian history. After the firm defaulted in June 1932, a bondholders' committee, comprising representatives from life-insurance companies and investment bankers, gained control by manipulating the appointments of the receiver and the liquidator. The bondholders insisted upon the full value of their claim and, learning from the experiences of participants in other bankruptcies, refused to accept losses. Operating below half of its rated capacity for five years, the firm could not meet fixed charges from earnings. The receiver focused upon divesting unprofitable operations, regaining control over Abitibi's contracts in the United States, clarifying accounts, and writing down liabilities. The divestment of Ontario Power Service (which had undertaken a massive hydroelectric project) triggered an extraordinarily ugly political scandal, making it impossible to reorganize until relations with provincial authorities were stabilized.
When a temporary surge in newsprint demand occurred during 1937, the bondholders' committee advanced a plan for a new capital structure. A minority group of debt holders claimed this scheme gave too much to the other security classes, while representatives of the common shareholders denounced the terms as insufficient. Despite its approval by a plurality of the debt holders, various interests launched legal challenges, and relations among the investors and their lawyers were poisoned by miscues, perceptions of unreasonable greed, or speculative games. The reorganization was rejected by the Supreme Court of Ontario on a technicality, and, in the aftermath, the bondholders' committee itself was restructured with the appointment of an officer from Royal Securities as the new chair. It then launched a "plan of procedure" for a judicial sale at depressed prices, a course of action that would have left the other claimants with nothing. This maneuver was denounced by the business media, politicians, and different stakeholders as little more than an attempt to steal the company. The Ontario government tried to block a sale by delay, a royal commission, and, finally, a moratorium as the case was converted from a matter of insolvency into a constitutional question about the rights of a province to regulate natural resources. The government's position eventually was upheld by the highest court, and a government-appointed committee began the tedious process of negotiating a solution. The final package provided a nominal settlement for the common shareholders and complete repayment of the bond principal-after fourteen years.73
Conclusions
Reflecting the widespread antibusiness sentiment during the Great Depression, one of Canada's leading historians, Arthur R. M. Lower, claimed the newsprint sector had fallen "into the clutches of the masters of high finance and then a series of amalgamations, new flotations, and grandiose projects were initiated which had the inevitable consequence of bankrupting most of the companies concerned, ruined thousands of investors, and abruptly halted the march of settlement in pioneer areas."74 His concerns about the vagaries of corporate finance were widely shared-even during the bull market of the late 1920s. In a popular polemic, Harvard professor William Z. Ripley portrayed selective reporting by American corporations as a serious impediment to the transparency of corporate affairs or the effectiveness of market governance. Although his concerns were dismissed by professional accounting associations, numerous observers had similar anxieties.75 The policies pursued by the newsprint companies were, indeed, highly representative of the age. When combined with personal ambition, showmanship and the desire for market power, they reinforced a drift toward disaster-not the elaboration of rational bureaucratic systems emphasized by the Chandlerian perspective.
In the United States after 1932, government oversight of financial markets was extended in order to rectify the deficiencies of securities regulation and enforce mandatory disclosure standards. In particular, business leaders and legal scholars steadily embraced the notion of managers as trustees for investor interests, an intellectual reorientation that became the basis for a new institutional framework mixing regulation via public agencies and norms propagated by professional associations.76 In Canada, the collapse of the newsprint producers triggered not a clarion call for reform but a muted, muddled melody. Although business publications and politicians denounced the failures, remarkably little action followed. Most of the criticism was aimed at the brokers or executives who had pushed "paper bonds." Unlike the United States, where the accounting profession was openly brought into disrepute, Canadian observers rarely focused upon the individuals associated with audits of the statements that had attracted unwary investors. They were perceived as mere minions, tools of more powerful interests.
Given the precarious state of Canadian financial institutions during the Great Depression, politicians were reluctant to interfere with the enforcement of property rights or to disturb the investment climate further. Within the pulp and paper sector itself, to a significant degree, the lessons remained unlearned. Some producers sought government controls to reestablish market-sharing arrangements and prevent price cutting. The initiatives, however, had mixed success, and (despite their jurisdiction over natural resources) provincial authorities also found it difficult to influence the dynamics of corporate reorganizations. From 1930 to 1936, with the moral support of the Ontario and Quebec governments, bankers and other interests tried to merge the producers into a giant combine. The proponents again used dubious valuation techniques and planned for a firm that would have heavily relied upon debt financing. Given the dilapidated state of the companies, none of those schemes advanced beyond the speculative stage.77 Accounting practices slowly were standardized, but during the reorganizations of the 1930s the adjustments of financial statements often were as creative as those they replaced. Chastened, the surviving firms then pursued conservative competitive strategies for thirty years.
A short-lived parliamentary investigation examined the relation between investment banking and the failure of the newsprint manufacturers based in the province of Quebec. Ill prepared and lacking knowledgeable support staff, the committee could not deal effectively with witnesses and was positively effusive toward financiers like James Gundy and Herbert Holt. The latter were selective in their testimony and essentially blamed the collapse on imprudent investors or the weather (demand-supply trends and the like). Ironically, numerous financiers and executives associated with the mergers complained they had ended up among the "losers" because they had not sold their holdings of common stock before the sector collapsed. The regulatory response was similarly anemic. Modest amendments to the federal corporations act during 1934 tried to encourage disclosure of data. However, an emphasis upon that issue did not emerge until the 1960s, when provincial authorities began to embrace the goals of reliable information and comprehensible reporting as key elements of securities policies.
This comparative case analysis has illustrated a harsh reality associated with the emergence of managerial capitalism. Many efforts to attain large size and develop economies of scale and scope ended in ignominy, not success. Since the promulgation of the 1844 British Companies Act, a major legislative theme in all countries has been the need for ensuring the true and fair disclosure of corporate affairs. But managers, quite understandably, have been reluctant to disclose data or to adhere to stronger standards than those defined by public authorities or professional associations. A complex dynamic sometimes has occurred among regulatory conditions, corporate strategy, and functional practice-a dynamic that has facilitated loose or brazen conduct. Capital markets also are hardly perfect and can be subject to manias, until a reality check occurs. Certainly, the issues discussed in this essay (unrealistic expectations, creative accounting, and fuzzy financials) remain highly relevant for a new century with megamergers, ongoing efforts to find new investment opportunities, and the emergence of industries based upon innovative technologies. In accepting its relevance, we may gain a better appreciation of the advances that have occurred with the development of professional management, as well as of the very real limits.
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