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Mr. Smith. No, Mr. Chairman. What I'm saying is not that. I'm saying that where there are abuses of corporate power they should be addressed under the existing statutes because presumably they are violations of the law. Is that not correct?

Senator HARTKE. I don't know.
Mr. Smith. Bribery is a violation of the law.

Senator HARTKE. What violation of the law is there by an American corporation bribing a foreign official?

Mr. Smith. I would assume that it depends entirely on how that bribery is reported, both to the SEC and

Senator HARTKE. I'm asking you, what's the violation in the United States under the corporate structure?

Mr. Smith. Well, if you won't allow me to answer under the SEC rules or the methods of reporting these as legitimate expenses, I don't know how I can answer it.

Senator HARTKE. Go ahead.

Mr. Smith. If they are legitimate business expenses of doing business in a particular country where that corporation exists and they conform to the mores of that society and corporate disclosure has been followed, then I would suggest that they ought to continue.

Now let's take the myriad of cases inbetween that you continually hear about. Let's take the cases where corporate bribery is not reported and where it's not shown in the corporation's reports to the SEC and where the auditors have not uncovered it. Those are violations of the law and the corporate firms responsible for those acts should be dealt with strongly, as strongly as possible under the laws.

Senator HARTKE. How can you deal with them strongly? Let me ask you another case. The J. P. Stephens case. In the past 11 years they have been cited 15 times for violating the National Labor Relations Act and they have reported that the cost of these violations is not material to the operation of the company. I mean, you'll have to admit, there is no procedure in the corporation law to take care of that situation.

Mr. Smith. There are no procedures under the National Labor Relations Act for

Senator HARTKE. Not for continued violation. In other words, you have the directors in the corporate structure, in which they are continually found guilty of violating the law. You feel that the profit motive as far as they are concerned is sufficient to go ahead and justify that continued type of antisocial action.

Mr. Smith. I'm sorry, Mr. Chairman, I can't answer that question because I don't know what's going on in the minds of the board of directors of the J. P. Stephens Co. and I'm not familiar enough with the background to make the judgments with which you are so familiar. I simply can't answer.

Senator HARTKE. Well, evidently, there are economic incentives for them to continue to violate the law.

Mr. Smith. If there are provisions in the law that provide for recovery of damages, then those ought to be pressed very fully and actively.

Senator HARTKE. All right. Go ahead. Proceed with your testimony. Mr. SMITH. Well, perhaps it would be well to depart from the Nader proposals and skip to the end of the 21 different citations of what these proposals attempt to accomplish and proceed on the general terms of corporate responsibilities. What this study which Mr. Nader and his group have conducted hopes to accomplish is a massive overhaul of the free enterprise capitalistic system. This, in my opinion is a curious proposal which is incapable of accomplishment first, and one which is actively to be fought. That's not to say that there's no room for improvement in business practices in Western civilization. There is. There is room for gradual and progressive change, particularly where significant deviations from wesl-accepted moral standards can be established and specific answers to these kinds of problems can be developed.

Senator HARTKE. What are those ?
Mr. Smith. But you don't overhaul the whole system.

Senator HARTKE. Mr. Smith, you say there's room for improvement in business practices in Western civilization. What type of improvements would you suggest?

Mr. SMITH. I would think that there would be several things that might be done. For instance, encouragement of corporations to engender a feeling of openness in the operations of their boards of directors, perhaps a greater reliance on the outside directors.

Senator HARTKE. What if the corporation says I don't like openness, period ? How do you engender that?

Mr. SMITH. I don't think that you should legislate it. I think it can be encouraged by the market forces themselves. For instance, in the Gulf Oil case, Gulf has really taken a shellacking in the public view. The front cover of this month's Fortune magazine has a large foldout of the sign Gulf having some of the mud wiped off of the sign. The Fortune magazine, Mr. Chairman, not Forbes.

In any event, what is happening within Gulf Oil Co. is an overhaul of the board of directors, the firing of the chief executive officer, and some of his cadre of senior management officials, and a change in the operation and policies and practices of the company,

These are the kinds of market forces which are infiltrating today's boards of trustees and which are vital to the process. But I don't think that for legislative morality to be forced on them is the appropriate approach. Increasing use of outside directors is another very good method of strengthening the corporate structure.

A third possibility might be the creation of audit committees composed of outside directors; internal auditors reporting directly to the outside directors of the corporation. These are the kinds of things that would be a helpful addition to the corporate process.

Another observation of the Nader report which it would be well to address I think is the contention of the corporate accountability research group that the Constitution of the United States does not deal with the corporate form since it was not a primary form of business organization at the time the Constitution was formed. This assumption is entirely incorrect.

The commerce power of the Congress has given it an unpresented scope of regulation of all aspects of business enterprises today. There is virtually no segment of business enterprise which is free from actual or prospective congressional inquiry, investigation, and legislative



domination if it so chooses. This is the prerogative of Congress under the commerce powers of the Constitution.

One needs only to look at recent legislation, including such items as the Occupational Safety and Health Act, recent pension legislation, the Civil Rights Act and their expanded focuses since 1964, the clean water and air bills, significant changes in accounting practices and securities regulations and a myriad of other issues upon which the Congress has acted that give one an understanding of the scope of congressional control over corporate form and practice. To ascribe all of the societal deficiencies cataloged in the first chapter to the corporate impact is to deny that the commerce power of Congress exists. Mr. Nader and group are wrong in this assumption.

A second major consideration of his research is that bigness is bad. Economics of scale are glossed over and it's assumed that because a corporation somehow or other manages to become one of the 700 largest corporations in the country, it must, therefore, be guilty of all sorts of evils and sins against the public good. Nothing could be further from the truth. The fact is, of course, that capital intensive industries, such as steel, transportation, automobiles, and others virtually require a huge size in order to operate efficiently. The fallacy that bigness is somehow or other bad is a fundamental defect of the study, and I might add a pervasive attitude in some sectors of economy today, but it's one of the premises on which Mr. Nader bases his entire work.

Senator HARTKE. Is bigness per se good?
Mr. Smith. I think that it very definitely can be. It's a sign of
Senator HARTKE. Can't bigness be bad!
Mr. SMITH. Yes; it can.
Senator HARTKE. All right.

Mr. SMITH. Perhaps the most aggravating aspect of this study is the failure to recognize what the corporate form of business enterprise has been able to accomplish and what the problems which society has encountered are because of these attacks on that corporate form. The system of free enterprise guided capitalism which is currently the primary pattern in Western civilization allows this country to create over 1 million new jobs every year. Now there isn't any other complex form of society in an atmosphere of freedom of choice where that claim can be made. If one takes the period since the end of World War II, several conclusions are readily apparent just from looking at the employment figures for that period.

Employment in the Federal Government has been flat. Employment in the military services has been declining. Employment in State and local governments has been increasing. But most of all, the private sector has been responsible for creating untold numbers of new jobs to meet the growth in population which has been the pattern in this country.

Senator HARTKE. Is that true in the manufacturing establishment ?

Mr. Smith. I think that there is a general shift away from manufacturing enterprises in this country into the services industries.

Senator HARTKE. Isn't it true that the curve in employment in the manufacturing industry is on a steady, downward curve and has been since 1946?

Mr. Smith. I'd have to go back and check that. I think at least it's been flat. It may have been declining.

Senator HARTKE. Yes. In other words, the manufacturing sector is not supplying the new jobs. It's in the service industries where the new jobs are coming

Mr. SMITH. That's entirely possible.

Senator HARTKE. Isn't it true, also, in the service industries, as far as they're concerned, that primarily their wage scale is substantially lower than the manufacturing sector?

Mr. Smith. I'm sorry. I'm not familiar with any studies that have drawn that conclusion. I would also say that the service industries include a large number of very small service establishments. You don't find enterprises such as the manufacturing industries themselves that have been successful in conglomerating large numbers of services except, of course, in the finance industry, in insurance, and banking, these kinds of service establishments obviously do provide increasing numbers of jobs and at good wage scales.

This means that businesses and companies have grown sufficiently to provide the extra jobs that are needed to keep a growing population supplied with sources of income.

Now these jobs didn't just happen. These jobs were created because forward thinking managers, directors, and stockholders were willing to risk considerable amounts of capital in order to create the jobs that would be necessary to build new goods and services. The key here is on risk. If corporate managers and stockholders were not willing to assume the risk required, jobs could not be created. It's just that simple. Now the reward for risk taking is salaries paid to management and dividends paid to the stockholders.

Let's speak about this issue of risk briefly. Many people of Mr. Nader's philosophical persuasion tend to think of the stock market as a continually growing institution. Nothing, of course, could be further from the truth. There have been long periods of growth in the stock market but there have also been sharp and precipitious declines in the values of stock which effectively wipe out fortunes and destroy many corporations in the market process. One need only look at recent history to see the impact of the very steep decline in the value of corporation stocks in the last few years. When the stock market drops by a matter of 30 to 40 percent over a relatively short period of time, this means that the stockholders of all kinds, including large financial institutions such as mutual funds and pension plans, experience a very severe loss. The fact that these funds may be managed by professional investors does not allow them the option of controlling the market forces which dictate reductions in stock values.

Senator HARTKE. Is that good or bad?

Mr. SMITH. I think essentially it's great. The market forces are operating on the basis of efficiency and they assign risk values to corporations and they assign risk values to individual stocks.

Senator HARTKE. Mr. Smith, are you telling me that the value of the stocks is directly proportionate to their earnings ?

Mr. SMITH. No; I did not say that, but it certainly is a key consideration.

Senator HARTKE. Is it directly responsible to the risk? Isn't it true that you have some of the most fundamentally sound corporations today that are selling way below earnings?

Mr. Smith. That's very—well, the earnings ratios in various industries vary widely.

Senator HARTKE. That's right, and it does not relate itself in any definitive way to either risk or return.

Mr. SMITI. Yes; it does. It relates itself to stockholder expectations and stockholder expectations are a function of earnings and a function of risks.

Senator HARTKE. All right. I hear you. I don't think many people in the economic field would agree with you.

Mr. SMITH. I am in the economic field and I would agree.
Senator HARTKE. I understand that.

Mr. SMITH. I would agree that—someone characterized a comment yesterday that

Senator HARTKE. I would say, Mr. Smith

Mr. SMITH. I've forgotten the source, but yesterday at the American Enterprise Institute seminars on federally chartering corporations, someone used the citation, "if all economists were laid end to end, they would fail to reach a conclusion.” I'm sorry I can't cite the source. Al Sommer.

When the risk becomes too high and investors are not willing to purchase securities, the ability of a corporation to raise the capital necessary to expand production facilities becomes severely limited. This can have very severe long-term repercussions for the economy as a whole.

Senator HARTKE. Wait a minute. Let's come back. Hasn't there been a fundamental change within the last 20 years as to how corporate structures are financed and going from what you call an equity financing to what you call an absolutely debt financing ?

Mr. SMITH. I'm glad you mentioned that. As Rod Hills said yesterday, there is an absolute necessity that dividends be treated the same way that interest is if there is to be a movement back away

from this heavy debt structure in industry. The fact is, the corporate profits are already taxed at the rate of 48 percent. They are then taxed as income to the stockholders who receive that profit in the form of dividends. It's a double taxation and the tax laws of this country could solve that very simply if they would allow this double taxation not to take place so that dividends and equity capital could be used instead of debt.

Senator HARTKE. Let me ask you a question. In percentage to the gross revenues in the last 20 years, what's happened to corporate profits vis-a-vis personal taxation-corporate profit taxation vis-a-vis personal income tax?

Mr. Smith. For as long as I can remember, corporate profits have been taxed either at 52 or 48 percent.

Senator HARTKE. I'm not talking about percentages. I'm talking about revenue. That's what the big argument on the floor is all about right now, the question of whether or not the revenue figures in the tax bill are going to come within the budget. That's the whole essence of what's involved.

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