John R. Brooks, Fordham University School of Law, has posted Stock Dividends, the Supreme Court, and the Great Crash of 1929:
"Stock dividends"—the distribution of a corporation's own stock to its shareholders—are a relatively minor and harmless feature of corporate finance today used almost exclusively to accomplish stock splits. But for a brief period in the 1920s, they were an important part of the corporate and investing world—and, as this Article shows, were also one of major tools used to create phantom income, inflate earnings, and maintain corporate pyramid schemes leading to the 1929 stock market bubble and subsequent Great Crash. This Article also argues that this abuse of stock dividends was a direct result of a notorious Supreme Court tax case in 1920, Eisner v. Macomber. By allowing stock dividends to be issued tax-free, the Supreme Court supercharged the use of stock dividends over the next decade, helping to drive up stock valuations and fuel the 1929 bubble. Macomber has faced substantial criticism for its destabilizing effects on the tax system, but its destabilizing effects on the larger financial system have not been noted before now. Using original archival research, this Article describes the example of Samuel Insull and his public utility holding company empire—one of the nation's largest in the 1920s, but which collapsed in scandal and bankruptcy in 1932, in large part due to its manufacture of phantom income using stock dividends.
--Dan ErnstIn addition to providing a new account of one of the causes of the Great Crash, a new part of the story of Samuel Insull, and a new critique of Macomber, this Article also illustrates three larger themes. First, that seemingly technical matters—in this case, the tax and accounting treatments of a relatively obscure element of corporate finance—have the potential for massive real-world impact. Second, that because of that potential impact, legal conclusions about such technical matters ought to take account of social and economic realities, not merely legal formalisms. In Macomber, the Court departed from the social understanding and past tax treatment of stock dividends based on the narrow application of a particular phrasing for a definition of “income,” and that error led in part to the 1929 bubble. Finally, this Article also describes a period of confusion, contradiction, and flux around the tax and accounting treatment of stock dividends, and to a degree both Macomber and the Great Crash also flow out of that chaos. This episode is thus an illustration of the risk and unpredictability that exists in periods of legal and economic change, such as the coinciding emergence of large corporate capitalism and a new regime of income taxation in the early 20th century.
Samuel Insull (William L. Koehne Studio)
