Kochland

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Christopher Leonard. Kochland: The Secret History of Koch Industries and Corporate Power in America. New York: Simon & Schuster, 2019.

Christopher Leonard has done us all a favor by amassing and organizing a great volume of information about Koch Industries. The company has not usually gotten the attention its wealth and power deserve, because it is the family business of a highly secretive family. But it is a massive company with many subsidiaries producing a wide range of products, and it is the second largest privately held company in the United States. It branched out from its original focus on oil refining and petrochemicals into businesses like agricultural products and building materials.

Koch traders sell everything from fertilizer, to rare metals, to fuel, to abstract derivatives contracts. Koch Industries’ annual revenue is larger than that of Facebook, Goldman Sachs, and US Steel combined.

The profits from Koch’s activities are stunning. Charles Koch and his brother David own roughly 80 percent of Koch Industries. Together the two men are worth $120 billion. Their fortune is larger than that of Amazon CEO Jeff Bezos, or Microsoft founder Bill Gates [as of 2019]. Yet David and Charles Koch did not invent a major new product or revolutionize any industry.

The book is a detailed portrait of one company, but its subtitle reveals how the author sees that company—a prime example of growing corporate power in America over the past half century. Many of the book’s themes are central to recent economic history—the ascendancy of a free-market, antigovernment philosophy, the victories of capital over labor, the reliance on corporate acquisitions and asset speculation for corporate profits, the growing political muscle of big business, and its effective resistance to environmental legislation. The book gives life to these abstractions by showing how one company has accomplished them.

Origins of a corporate powerhouse

Fred Koch founded the company in 1940 in Wichita, Kansas. He had four sons, the oldest of whom, Freddie, was more interested in art than the family business. That made the next son, Charles, the heir apparent, and he took over the management shortly before his father died in 1967. The third son, David, served on the board of directors but devoted himself more to politics, eventually running for vice president as a Libertarian. David’s twin brother William was also on the board, but feuded with his brothers over corporate policy and dividend payments. Charles and David succeeded in getting him fired by the board, and the company bought out both Freddie and William’s ownership shares.

Charles Koch took the lead in consolidating his father’s holdings under the name of Koch Industries. Although it began as mainly a refiner and transporter of oil, the company became more diversified and flexible in order to adapt to increasing economic volatility, such as wild swings in oil prices. Charles created a development group specializing in new acquisitions, which the author compares to a private equity firm, but one within an existing company. “The group would come to embody modern American capitalism in the early twenty-first century, an era when private equity and hedge funds scoured the landscape in search of acquisitions.”

Charles Koch ran his company according to a philosophy he called “Market-Based Management” (MBM) which was formalized and taught to every manager. Although he was well-read in a variety of subjects, his philosophy seemed to rely mostly on what he had learned from his domineering father and from free-market economics in the Austrian tradition of Friedrich Hayek. Fred Koch had been a founding member of the John Birch Society, which was considered the far-right fringe of the Republican Party in the 1950s and 60s. Hayek was a well-known critic of the New Deal, and Leonard says that Hayek “was almost religious when it came to describing what the market could do when left to its own devices. He believed that the market was more important, and more beneficial, than the institution of democracy itself.” Charles Koch saw his company as a kind of internal market that should also reward personal initiative motivated by economic reward. He encouraged the manager of each unit to be on the lookout for new opportunities that could benefit the bottom line. He took his philosophy beyond the company as well, working with Wichita State University to establish the MBM Center there. And on Sunday mornings when many Wichita residents were in church, Charles was in the family library, schooling his own children in “a curriculum that taught them about his systematic view of human behavior and how best to organize human society.”

Growing pains

By the mid-1990s, Koch Industries had developed what Leonard calls a “bias toward acquisitions.” Like private equity firms, the company had discovered that they could make more money by buying existing companies then by developing new products on their own. When it worked best, the acquisition strategy could unlock hidden value in underperforming companies, managing them or reselling them for high enough returns to justify the costs of acquiring them. But Koch Industries wasn’t immediately or consistently successful at this.

In the case of Purina Mills, acquired in 1998, Koch paid much more than Purina appeared to be worth, financing most of the deal with bank loans. Koch tried to characterize the loans as “non-recourse” debt, so that the banks would have no claim on Koch’s assets, only those of the Purina subsidiary. But when a collapse in hog prices threw Purina into bankruptcy, the banks successfully sued, claiming that Koch was not independent enough of Purina to justify non-recourse debt. Koch lost its own $100 million investment in Purina, plus another $60 million.

Koch had many other legal problems. In 1989, a report by the Senate Select Committee on Indian Affairs described the company as “the largest purchaser of Indian oil in the country” but also “the most dramatic example of an oil company stealing by deliberate mismeasurement and fraudulent reporting.” The federal case against Koch was eventually dropped for lack of evidence, but a federal civil suit over the same allegations was more successful.

Violations of environmental regulations were another problem. The company employed environmental engineers, but Koch’s Market-Based Management assigned them only advisory roles, while decision-making authority was reserved for the organization’s profit centers. When too much ammonia showed up in the Pine Bend refinery’s wastewater, Koch maintained production by illegally discharging it into the river anyway or letting it spill onto surrounding land. “Koch industries racked up a shocking number of criminal charges and civil complaints throughout the 1990s, branding the company as a kind of corporate outlaw.”

Leonard attributes such failures to the downsides of Market-Based Management, especially its single-minded emphasis on corporate growth and profits.

The culture inside Koch industries…borrowed some of the worst impulses from Wall Street—a hunger for high-profile deals, a desire for giant paydays, short-term thinking—and combined them with Koch Industries’ mandate for growth.

Reinvention and mastery

In 2000, Koch Industries went back to the drawing board and revised its corporate structure and growth strategy, though without abandoning the MBM philosophy. Koch Industries became basically a holding company, owning many smaller firms. The company took pains to segregate those firms from the parent company, so that the latter could avoid the kind of liability that had arisen in the Purina case. Koch Industries would profit from a strategy similar to that of private equity firms—buy a struggling company using mostly borrowed money, but structure the deal so that the debt was the responsibility of the acquired company; then use the company’s cash flow to make the debt payments. If they came out ahead, Koch got the profits. If they didn’t, they could let the acquired company take the fall. “In a matter of just a few years, Koch Industries would execute some of the largest private equity deals in America, with acquisitions worth nearly $30 billion.”

Another lucrative activity was speculation in futures options. If Koch could acquire more accurate information about future conditions than other traders had, it could profit on the difference. Since the demand for energy depends heavily on weather conditions, Koch hired the best meteorologists it could find. One Koch trader speculating on insurance policies made almost five times as much in a year as Koch’s entire pipeline company.

Surprisingly, for those who thought of Koch Industries as a corporate outlaw, Charles Koch began to insist on what he called “10,000 percent compliance,” which meant that everyone in the company would obey 100% of the laws 100% of the time. Sounds great, but what it may also have meant is that the company learned how to shape the law and use the law to its advantage, rather than risk breaking the law. The Clean Air Act had grandfathered in the pollution standards for refineries, so that old companies like Koch could operate, but newer ones found it too expensive to compete. Deregulation of energy prices opened up new opportunities for profit. Proposed regulations to combat climate change were a threat, but the company could use its considerable lobbying and media campaigns to defeat them.

In the early twenty-first century, Koch Industries was thriving. It seemed to have mastered the financial and political challenges of a complex and volatile economy. The Koch brothers were not simply producing something of obvious value and getting paid for it, like a Henry Ford. As Leonard said, they “did not invent a major new product or revolutionize any industry.” One wonders how much of their vast fortune was earned by making real economic contributions, and how much was a matter of using financial, intellectual and political capital to take advantage of those with less capital. With that in mind, I turn to Koch’s labor practices and political operations in my next posts.

Continued

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