Business review; Conglomerate firms

From the national educational radio network here is a Business Review ASSOCIATE PROFESSOR ROSS Wilhelm of the University of Michigan Graduate School of Business Administration presents his views and comments of business and economic activity in recent months the federal government the Congress and been expressing increasing concern over the growing number of conglomerate firms in the economy and conglomerate firms one which is engaged in a number of different lines of business which are unrelated to one another either in the market served the products sold or the methods of production employed. A conglomerate may have one division which is in the food industry another division in the steel industry another in aircraft production and so on none of the divisions doing any substantial volume of business with any of the others. One of the principle business reasons why we've seen the rise of conglomerates in recent years is because such a firm can if properly organized achieve a stability of earnings and sales over the business cycle which is greater than that attainable by any of its component divisions. The firm can have some divisions which earn very large profits and boom periods but which do not do very well in business recessions along

with other divisions whose sales hold up during recessions but which do not earn very large profits during boom times. Such stability of earnings in the US dividends appeals to a segment of the investing market which wants to own common stocks to protect themselves against inflation and yet which also wants a continuing flow of dividends regardless of the business cycle. Windows administrators of ests and others who want to stability of income with a high degree of assurance are receiving the income or the groups for whom such firms are appealing. A second and almost equally important reason why we have seen many conglomerates formed it is to be found in our income tax laws. Under our income tax laws a company may claim as a deduction any interest it pays on money it borrows on bonds or. It sells or any other type of security such as that. However the company may not claim as a deduction for income tax purposes the dividends it pays to the stockholders for the money they have put into the company. As a consequence business firms are forced by our income tax laws to seek to

raise money by borrowing rather than by selling common shares. It's simply cheaper to obtain money by borrowing in most cases than by selling stock because the payments for the borrowed money can be deducted for income tax purposes but payments for money raised by the by selling common shares the dividends paid cannot be deducted unless this is a more expensive way. Further on the income tax laws it's possible for a firm given certain conditions to buy another firm and to pay for that firm by issuing bonds. Thus if one buys another firm that's earning an income the interest paid on the bonds which may be equal to a major part of the acquired firm's earnings can be deducted for income tax purposes on this basis the conglomerate is able to add to its own earnings the amount that would otherwise have been paid out in taxes on the earnings of the acquired firm. That's the stockholders of the purchased company still receive their incomes in the form of interest payments on the bonds they receive for their stock. The stockholders of the conglomerates also receive higher earnings due to the reduction of the total tax

burden. That's the second reason for the formation of conglomerates is that the tax laws make it profitable to form such companies in other words our tax laws make it profitable to make big companies bigger. From an economic viewpoint the obvious action which we should be taken to permit is to permit all or part of the dividends which are paid by firms to their stockholders to be deducted as necessary expenses from the federal income tax. This would eliminate the incentive for forming conglomerates from a profit viewpoint. And it also would be a better accounting practice from a social viewpoint most Indeed most of the money paid out in the form of dividends is a necessary payment for the firm. If it's a to obtain and to hold the capital it requires to do business. This for the most part is necessary a payment as AI's the payment on interest or on wages or on the cost of raw materials. All of which are allowed as deductions. It's true that in some cases and indeed in many cases firms may pay out in dividends more than is just required to secure the necessary capital. Such excess payment should

not be deductible but the necessary payment should be. Thus if the federal government wishes to discourage the formation of conglomerates and the extensive use of debt financing rather than stock financing the place to begin to reform is with the income tax laws so that part or all of the dividends paid out by firms can be claimed as income tax deductions. That was Associate Professor Ross Wilhelm of the University of Michigan Graduate School of Business Administration. With his views and comments on business and economic activity Business Review is recorded by the University of Michigan broadcasting services. This is the national educational radio network.