“Stock dividends”—the distribution of a corporation’s own stock to its shareholders—are a minor and harmless feature of corporate finance today used almost exclusively to accomplish stock splits. But for a brief and forgotten period in the 1920s, they were a major part of the corporate and investing world—and, as this Article shows, were also used to create phantom income, inflate stock prices, and maintain corporate pyramid schemes leading into the 1929 stock market bubble and subsequent Great Crash. This misuse of stock dividends can be traced to the Supreme Court’s 1920 decision in Eisner v. Macomber, in addition to a larger set of contradictions between corporate law, tax law, and accounting standards. The key question was whether, how, and for what purposes stock dividends could be considered “income,” and this Article details the halting and contingent legal history of that question. Tax law and accounting standards both get the answer wrong, but in different directions, thus providing an opening for corporations to abuse stock dividends, a practice that surged after the Macomber decision. This Article thus adds a previously unknown chapter to the Great Crash story, tying the bubble and Crash back to errors in legal and accounting doctrine, including by the Supreme Court.
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. But less extreme versions of Insull’s practices were common in the 1920s, and were encouraged by the combination of generous, but erroneous, tax and accounting treatment.
In 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 has important implications today. First, the larger question of what constitutes “income” continues to be relevant, especially for the constitutionality of tax laws. Second, the harm this Article describes flows from errors in seemingly obscure and technical questions of legal and accounting doctrine—getting the details right matters. Third, this Article 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 thus illustrates 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.
