DISCUSSION (continued 2)

Charles H. Ledlie, M. Am. Soc. C. E. (by letter).—The following is suggested as a method of procedure for determining the fair and equitable value of a property:

1st.—Examine carefully the statutes governing corporations of the class under examination.

2d.—Form an opinion as to whether or not the locality can support such a property, by inquiry regarding the different businesses carried on, bank clearings, railroad facilities, what the surrounding country produces, etc.

3d.—Find from the archives of the company a general description of the property, from its conception to the date of appraisement.

4th.—By close examination of the minute books, directors and executive committees, there can be ascertained all the details of organization, issuing of stock, bonds, and other forms of indebtedness, contracts for equipment, supplies used in the construction, etc.

5th.—Obtain from the general manager or the superintendents an explanation of the details of operating and maintaining the property, including the different classes of service, rates, etc.

6th.—Go over the property, examine it carefully, and talk to any and all employees from whom it is thought that any information can be gained.

The foregoing will give a general knowledge of the property under examination, and will enable one to begin the real work. The examiner's assistants must be competent and experienced men.

7th.—Examine all the vouchers, from the beginning of the company down to the date it began operation; classify their contents under the respective heads for the different classes of material used in the construction, for example, pipe, engines, cable, etc.; then prepare blank tables for each heading, having columns for size, quantity, prices, and total; and abstract each voucher. Do the same with the vouchers for labor, general office salaries, general expenses, interest, taxes, legal, etc. This, when completed, will give the detailed cost, as shown by the vouchers.

Next check the vouchers back through the books, and draw up a statement, which will show the total book cost and, no doubt, will 207differ from the voucher total. It is likely that many items will be found for which no vouchers exist, a list of these is made and if the officers cannot give a satisfactory explanation of any of them they are omitted. The total of what remains is added to the voucher total and represents the cash expended for the benefit of the original property, as shown by the books and vouchers.

8th.—Take all the remaining vouchers of the company (it is supposed that the examiner has already been informed by the officers, and by his inspection of the records, of the extensions and betterments which have been made), separate the vouchers for materials, labor, etc., from those on operating, etc. Next classify them by years, and then proceed as set forth in 7th, and add the different yearly amounts to the total of the original plant. This will show the amount of cash expended (according to the vouchers and books) on the property, for its physical plant, organization, etc., from its beginning to the date of appraisement.

Every examining engineer should know (or can obtain) the prices for materials, labor, etc., during these periods of original construction, extension, etc. If the prices are the same, or about the same, as at the time of purchase, the above total stands as the cash expended; if there should be much difference—and sometimes there is—take the detail of the materials as found in the vouchers, affix the proper prices, and do the same with labor, etc., and this total will be what, in the judgment of the examining engineer, the plant should have cost. A mean between this latter total and that in 8th is taken, in order to be fair and equitable. This amount, in place of that given by 8th, is then used as the cash expended on the physical property. If no difference is found in prices, then the total cash as shown by 8th is considered as the total to be hereafter used.

9th.—A careful detailed inventory is now made of the physical property as it exists at the date of examination. This often requires some excavation in order to determine sizes, quantities, and conditions. The prices used to ascertain the total of the inventory are made by taking the average of all those paid for materials, labor, etc., of the same class, during each year of the property's existence. (The writer considers it manifestly unfair to use the current prices in this calculation, for they may be very much below or above those actually paid, and in either event an injustice would be done, whereas, if the average prices are used, the examiner cannot be accused of unfairness.) To this total cost, as shown by the inventory, 5% is added for engineering and superintendence; 3% for general office salaries, 2% for general expenses, 1½% for legal and organization expenses, and from 5 to 10% for contingencies. (This latter percentage depends on the judgment of the examiner, who, after studying the local conditions carefully, can determine from his own experience what difficulties 208have been met in the construction. It is not believed that a hard-and-fast rule can, in equity, be laid down for this latter percentage.) This total represents the value of the tangible property, based on the inventory. The inventory cost and that set forth in 8th (or possibly as modified by prices current when the plant was built) are averaged, and this result, plus the supplies on hand, is the fair and equitable amount of cash which has been expended on the property. This is used in finding the "Fair and Equitable Value."

10th.—Next take the inventory of the plant set forth in 9th, affix the current prices at the date of appraisal, and to this total add the same percentages for engineering, etc., as set forth in 9th. This gives the cost of reproducing the property, with the same classes of materials, size and make of engines, etc., as is now in it, to which total add the cost of materials on hand for the total of cash required to be expended at current prices to reproduce the plant as it exists.

It is often found that this latter total is greater than that set forth in 8th, for the reason that the engines, etc., may be of types which are now abandoned or obsolete, and the manufacturing company, having to make patterns, etc., would charge more for them than the original price at the date of purchase.

This reproduction cost at current prices is only to give the examiner information he may or may not require later in the investigation to determine some point that might arise in ascertaining the "Fair and Equitable Value."

The writer considers it unfair to call the reproduction value the cost of a modern plant which will give the same service and output, because one is not dealing with the value of a modern plant, but with that of an existing property.

11th.—From this cost (using the detailed inventory to find the extent of property still in existence), calculate the amount of depreciation for each section of the plant, this being based on the present condition of the different parts and what their future life may be. The total depreciation is then deducted from the result found in 9th, and this remainder is used as the "Fair and Equitable Value" of the tangible property at the date of appraisal.

The intangible value (called by many names) must now be determined. It consists of rights, from the State, county, city, or any one or more combined, which the company must have in order to carry on its business. These rights in nearly all States are taxable, and taxes are collected on them. The Supreme Court of the United States has in the past held that they are property, notwithstanding what State "Courts and Commissions" have set forth on this subject, and in the writer's examinations they will be treated as property until the Supreme Court of the United States decides otherwise.

209There are in general three classes of franchises, namely:

I.—Those granted by the State to conduct a business, where no county or city franchise is necessary, only requiring the company to obey the ordinances for excavation, etc. The charter of the Laclede Gas Company, of St. Louis, Mo., is an example of this class.

II.—Those granted by the State to carry on a business subject to a county or city franchise.

III.—Those granted by a city to an individual, singular or plural, or a company, to do business within its limits or a section thereof.

In each case the right may be a contract, for it may require a payment for the franchise granted, either in a lump sum or in yearly installments, or in the form of services rendered, such as for light, etc., free service of some kind, or a combination of any two or all of them.

The manner of determining the value of "Intangible Property" is as follows:

(a) The gross collected earnings are audited for each year during the period the company has carried on its business. The same is done for all vouchers, i. e., operating, maintenance, salaries, legal, general expenses, interest, insurance, and taxes, and includes every item disbursed. Whatever this latter amounts to, is deducted from each year's gross earnings as already found, and the result is the true net earnings or deficit for each year.

(b) The true net earnings are added together and the mean taken; if, in the period from the beginning to the date of appraisement, any deficits are found, these are deducted from the total of the plus-earnings, the result is divided by the total number of years, and this gives the true average net earnings. This is then capitalized at the legal rate of interest of the State in which the property is located. The result is used as the value of the "Intangible Property."

12th.—The amount given by 11th is added to the result obtained by 9th, and this total is the "Tangible and Intangible Value" of the property, and the "Fair and Equitable Value" of the property at date of appraisement.

If it is found that grave mistakes in design or judgment have been made by not employing competent people, and money has been wasted in construction, the plant is re-designed, for the original plant, and its cost estimated. The same is done for each extension, using the prices paid at the different periods, and this result is used in place of 9th, as the cash cost at the date of appraisement.

In determining the intangible value, if it is found that the management has been careless in order to make large net earnings, at the expense of the physical property, estimates are made of what the 210property can be operated and cared for (here the practical knowledge of operation, etc., is necessary), and these results, plus taxes, etc., are subtracted from each year's collected earnings. The mean or average of these results is considered as the true net earnings, which are capitalized and added as set forth in 12th.

The writer holds that consumers or purchasers should not pay for avoidable error or ignorance, and the amount of the securities issued on the property is not considered as entering into the matter of "Fair and Equitable Value"; when they do, the method is somewhat different.

The mean true net earnings are used in determining the intangible value, because franchises have average values, as earnings and expenses fluctuate in corporations, and, when intangible values are to be considered, they must not be based on the last year's net earnings, for if they are, they may give a very large result in one year and a small one in the next; therefore, to be fair, the mean true net earnings should be the basis of the intangible value. If the company has been over-capitalized, and no sinking fund or depreciation has been set aside, it is the present owner's misfortune. If the company calls something a betterment, and it is found that the betterment has only replaced something, it is not allowed, but is classed as maintenance; on the other hand, if the replacement is larger, and capable of rendering greater results, such as a larger engine, pipe, cable, etc., the cost, less the cost of what it replaces, is allowed as a betterment, and if the old part is sold the proceeds are deducted from the betterment charge, for if it is credited to maintenance, it increases the true net earnings. This is often done, but is not the correct way to treat the matter, for it increases the intangible value.

13th.—When new rates are to be established for a period of future years, the manner of determining the "Fair and Equitable Value" is the same as has been heretofore set forth. The new rates are based on averages, and the first step necessary is to ascertain what gross revenue the company must have in order to pay all classes of operating expenses, maintenance, depreciation, taxes, interest on the "Fair and Equitable Value" of the property, and a reasonable profit.

To obtain this amount, the procedure is as follows:

(a) Find the percentage of increase of the operating expenses for each year over the prior one, for a period of generally five years preceding the date of examination (a longer time may be taken if, in the opinion of the examiner, it is necessary), and then ascertain the average annual increase of the percentages. The result thus obtained is taken as the increase percentage for the operating expenses for the new period of time.

(b) In order to determine what the operating expenses will average during the time the new contract is to run, take the amount of the 211last year's operating expenses as a basis and add to it the percentage found by (a). This total is the operating cost for the first year of the new contract. The amount for the second year is found by adding to the cost of the first year the percentage found by (a), and so on for each year of the new period. These results are added together and their average is then used as the mean cost of operation for each year during the full period.

(c) The same method is followed for maintenance and taxes, in order to find the average maintenance and taxes for the new contract's life.

(d) Depreciation on the plant begins from the date of appraisement, and is estimated on the physical property by using for each section the percentages used in determining the "Fair and Equitable Value."

(e) Interest at the rate of 6% is allowed on the "Fair and Equitable Value," and 6% profit.

The question of extensions and betterments to the original plant must now be taken into consideration.

(f) The amount of the betterments and extensions have already been found for each year of the property's existence, and an average of them is taken as the amount the company will spend on extensions, etc., during each year of the new contract. On this sum 6% interest and 6% profit is allowed, and, for depreciation, the same percentage as used in the original plant.

It will be seen that all the expenses of operation, etc., of these extensions have been allowed in (b), where the increase has been added for each year for these extensions and betterments, as they are assumed to increase the cost of operation, etc.

(g) The amounts found by (b), (c), (d), (e), and (f) are now added together, and to the sum 5% is added for interest, taxes, operation, etc., which may be caused by the necessary increase in capital expenditures, for a greater growth than could be foreseen at the time the new rates were established, for losses, etc. This total is used as the basis for establishing the new schedule of rates.

14th.—The next step is to determine what part of the amount found by (g) must be paid by the different classes of consumers.

(I) First ascertain the yearly percentage of increase in the output of the plant for the five years before the new contract is to go into effect (or longer if, in the opinion of the examiner, it is necessary); then find the average increase of percentage during the before-mentioned five years. Add to the last year's output the percentage found above, this result representing the output for the first year of the new contract. Continue this operation for each year in the same way as the operating expenses were found in 13th (b). The 212average of these results will be the average estimated output during the life of the new contract.

(II) Next find the amount of the total output each class of consumers used during each of the five years, and then find the average yearly use during this period. Put these into percentages of the amount of the average output for the five years, and then use the percentages as the amount each class of consumer will use of the average output found in (I) during the period of the new contract.

This gives the average amount of the output each class of consumers will use during the average life of the new contract.

(III) Next find the average percentage of the total revenue each class of customers paid during the five years. Take these percentages as the average percentage each class will pay of the average revenue necessary during the time the new contract is to run.

(IV) Having found the average amount of the required revenue that each class must pay, and the average amount of the total output each class will use, dividing the former by the latter for each case will give the rate each class is to pay during the new period.

It is often found in plants that large extensions have been made to supply a special contract for a long period of time, and these extensions are set aside for the exclusive use of this contract. In such cases exclude the cost, etc., of this part of the plant from the "Fair and Equitable Value" in the matter of adjustment of rates.

In determining the operating expenses, etc., in such a case, find the percentage of the total output this special output amounts to; then, using this percentage, find what part of the total power-house expenses of all kinds are caused by this special contract. This result is deducted from the total power-house expense, and the remainder is the power-house cost of furnishing the consumers with their share of the total output. If it is found that special employees are required to deliver this special output, their cost is deducted, and the same for the maintenance material used. Taxes and interest on the cost of this special equipment are found by ascertaining the percentage this cost of the special equipment bears to the whole plant.

The above results are deducted from the total operating, maintenance, taxes, and interest disbursements, and "Fair and Equitable Value," and the remainders are used as the cost of the last year's expenses for furnishing the consumers with their share of the product and the "Fair and Equitable Value."

The same method is used in determining the revenue paid by the consumer.

The above result, i. e., cost of operating, etc., is then used as the basis for estimating the expenses for the period of the new contract, as heretofore set forth.

If the charter comes under Class II or III, the city no doubt 213has incorporated a clause for the adjustment of rates, and the method used above is followed.

15th.—Where the franchise has expired and is going to be renewed, the same method holds.

16th.—Where the franchise has expired and the city has paid a certain amount for service, and is to buy the property, the same method is used, except in determining the intangible value. For determining the latter, the amount the city pays for service is deducted from the gross collected revenue. From expenses is deducted the same percentage as the amount of the city's payment is of the gross revenue; a net revenue is found from this, the taxes paid are deducted, the remainder is capitalized as heretofore set forth, and is the intangible value. Whatever the latter amounts to is added to (or deducted from, in case of deficit) the "Fair and Equitable Physical Value," and the result is the price the city should pay.

Cities generally claim, and so do their "experts," that they should only pay junk value, or the cost of a modern plant to give the same results. This is eminently unfair, because the city buys a property which is in full operation and it receives the full revenue, in addition to obtaining service for itself at a less cost than it heretofore paid. The difference between the cost to the city of furnishing the service itself, and what it paid the company, is profit, but there is a charge against this of loss in taxes. These two latter items, namely, profit and taxes, generally balance each other, although the writer has known of cases where the city was the gainer.

There are many points which can be advanced to establish the fairness of the methods outlined herein, but they would take some time to explain, and therefore the writer has only set out the plan he follows in his examinations, hoping that it may be of some aid in establishing a uniform method which will be upheld by the Courts.

It may be stated that recently this method was used in an examination, going back thirty-five years, and the results were accepted by both sides without question.

The writer has refused a number of examinations when told in advance what result must be found, as well as in "expert" work, where the examiner is expected to help make a case, regardless of his honest judgment, for, by accepting such work, the engineer hurts his reputation and lays the Profession open to such remarks as Judge Lacombe recently made in the case of the Peoria Water-Works Company vs. Central Railway Company.

The writer is fast coming to the conclusion that a great deal of legal trouble is caused by the decisions of commissions, the members of which have not had experience in these matters. If a commission consisted of an able lawyer, a financial man, and an engineer who has had a broad operating experience, its decisions would carry weight, and the Courts would not be burdened with so many appeals.

214William G. Raymond, M. Am. Soc. C. E. (by letter).—This is, perhaps, the best paper on the valuation of public service property that has yet appeared. The author's analysis is very clear, and his arguments are convincing. Three points the writer would like to consider; two of them briefly.

The item, "going value," even if it is determined on logical reasoning, as suggested by Professor Mead, would seem to be a dangerous item, and one which might result in absurdities when estimated by an unscrupulous, ignorant person. Moreover, the term has been differently defined, and there is no certainty as to just what it means. The writer sees no reason for the existence of such a term, or of such a separate quantity as this term is supposed to represent.

The term, "franchise value," or, "value of the franchise," is used to represent the difference between the capitalized net earnings and the value of the physical property. Of course, there is such a difference, either positive or negative, but there seems to be some objection by the Courts to calling this "franchise value." The writer, therefore, would suggest that, since franchise value is a very elusive item, depending on the life of the franchise, the attitude of the community toward the corporation, the activity of competing corporations, and numerous indeterminate items, the term, "business value," or, "going concern value," be used instead of "franchise value." "Going concern value" is not as good a term as "business value" or "value of the business," because it may be assumed to include both the value of the business and the value of the property. "Value of the business" would presumably include the value of the franchise, and perhaps would not always be represented exactly by the difference between the capitalized net earnings and the value of the physical property, but would be this difference affected by some judgment percentage resulting from a consideration of the probable continuance of the franchise.

Mr. Riggs has truly said that the value of the physical property must not be made to depend on the purpose for which the valuation is made; that, for the business for which it is used, the value of the physical property is the same, regardless of the purpose for which a valuation is desired; but valuations are made for different purposes, and, while there is room for argument as to the proper valuation to be used for capitalization, taxation, or sale, there are perfectly definite methods suggested for valuing property for these purposes. The writer has never seen a statement—that appealed to him as at all rational—of a proper method of valuing property for rate-making. Indeed, the writer has said^[32] that "proper traffic rates have no relation to valuation except that the minimum net income should be at least sufficient to pay interest on the physical valuation." The writer is not absolutely certain of the correctness of this position, for a study 215of the public right to regulate a corporation which is performing a semi-public function seems to indicate that the public has a right to say, not only that rates shall be non-discriminatory, but also that they shall be reasonable.

Now, the writer is familiar with three bases for the determination of what constitutes reasonableness of rates. One, which applies to rates as a whole, is this: That the net income should produce not more than a reasonable interest rate on the actually invested capital. Another is the rate that the traffic will bear, and the third is a rate that represents what the service is worth to the purchaser. Of course, a difficulty arises in determining reasonable rates on any one of these three bases.

The only difficulty with the first one is in determining what is a reasonable interest rate on invested capital, and, as far as the writer has read, no Court has yet determined what this is, although some Courts have held that 5% is a not unreasonable return, that 8% is a not unreasonable return, and, if the writer's memory serves him right, that even 15% is a not unreasonable return.

There is great difficulty in the determination of what the traffic will bear. It is a matter of the exercise of judgment and of experiment, and must be applied to a considerable extent to particular rates, for particular commodities, for particular places.

The third basis would seem to be the most difficult to use, although it is one which has recently been established in important Court decisions, and is mentioned by Mr. Riggs. What is a monopoly-provided service worth to the user or purchaser? Suppose that a gas company charges $1.60 per 1,000 cu. ft. for gas, and a very considerable part of the populace living in the city served purchases gas at this price. Presumably the purchasers pay what the service is worth to them, and what they are willing to pay rather than suffer the inconvenience of tallow candles, oil lamps, or to pay a high price for electric lights. Suppose that through a period of five years, by a series of reductions voluntarily made, the price of gas finally reaches $1.15 per 1,000 cu. ft. Is this gas worth any less to the consumer at the end of the five-year period than it was at the beginning? So far as the writer can see, it is, for only one reason, namely, that it can be had for less; but this has been a voluntary reduction on the part of the supply corporation, and who shall say that the service is not worth less than $1.15 to the consumer, or who shall say that it was not worth less than $1.60 at the beginning of the period suggested? The figures here given represent an actual case which has occurred during the last five years, within the writer's knowledge. There seems to be a growing feeling among the people that rates as a whole must be fixed so as to yield only a reasonable return to the corporation, and, apparently only for want of the suggestion of a better method, a reasonable 216return has been held to mean a reasonable return on the capital invested. Believing that there may be some ground for the claim that rates as a whole should be thus fixed, and that the return should not be unreasonable, let us consider how what is reasonable may be determined.

In the first place, it appeals to the writer that the invested capital is not the proper basis for estimating reasonable rates. If it shall be finally established that a corporation is entitled to realize only a reasonable interest rate on the capital invested, there will be no more public service corporations organized; but, if the reasonableness of the return may be based on the capital invested and the business done, there will still be good inducement to capable men to engage in public service business.

It would seem that the rate of return that is reasonable differs for the capital invested and for the business done—that is to say, if the capital invested is $1,000,000, an ordinary investment return of from 4 to 5% may be sufficient; and if the business done with this million-dollar plant amounts to $10,000,000 a year, a reasonable return may be 10% or even 15% of the whole.

Now, as has been suggested by Mr. Riggs, it is manifestly impossible to capitalize the net earnings as a basis for determining reasonable rates, because these net earnings are the result of certain rates already established, the reasonableness of which may be in question; and if, instead of speaking separately of interest rate on capital actually invested and profit rate on business done, it is desired to obtain a value on which to base reasonable rates, the following is suggested as a method: Determine the physical value and the annual interest on this physical value at an assumed reasonable rate, say 5%; determine the annual expense of conducting the business, and assume a business man's profit rate, say 15%, and find the profit that should be earned on the business done. This, added to the total interest charge, should give the net income, over and above operating expenses, that may be considered reasonable, and this sum, capitalized at any given assumed reasonable interest rate, would give a value which might with reason be used as a basis for rate-making, rates being deemed to be reasonable as a whole which furnish from year to year a simple reasonable interest rate on this established value. Of course, there is no necessity for establishing such a value, as the reasonableness of the rates will be determined when it is learned that they produce not more than a fair interest rate on the actual physical value of the property plus a fair profit rate on the business done.

This method is not free from the objection that what is a reasonable interest rate and what is a reasonable profit rate have never yet been fixed, but it is much easier to fix these separately than to fix what is a reasonable return on the capital actually invested or the physical valuation of the property.

217W. H. Williams, Esq. (by letter).—Before entering upon the discussion of the more essential elements of the problem presented by this paper, it seems worth while to correct one or two misapprehensions under which Mr. Riggs seems to labor, and to call attention to the rather extraordinary temper in which he approaches the grave questions with which he deals.

Mr. Riggs' first serious misapprehension is that railway officers, as a class, are, with substantial unanimity, opposed to any official valuation of railway properties, and that this opposition was voiced through the writer's discussion of Professor Henry C. Adams' paper in favor of valuation, at the last annual (December, 1909) meeting of the American Economic Association. Of course, on that occasion, the writer spoke, as he now speaks, only for himself, but, more than that, he then expressly disclaimed any such opposition, undertook to make suggestions as to the manner in which a proper valuation could be obtained, and directed his criticisms plainly at a proposal which contemplated, as he then observed:

"An incomplete and misleading valuation bearing the stamp and carrying the weight of governmental sanction, which can be of no practical advantage to the Government, the public, or the railways; but may easily injure the public and the railways by disturbing the confidence of the former and hampering the activities of the latter."

The writer then added:

"It seems very clear that such a valuation as is proposed would be wholly useless to the Government for any practical purpose, because it would omit so many factors essential to any fair appraisement of the worth of the enterprises as going concerns."

Bearing in mind that the foregoing was addressed to the particular proposal made by Professor Adams, that being the topic on which the writer was invited to speak, a proposal expressly limited to the ascertainment of cost of reproduction less depreciation (the equivalent of cost of replacement with second-hand materials in a condition equivalent to that of the materials in use and hereinafter referred to as "cost of replacement") under the pseudonym of "physical value" (or sometimes "inventory value"), it would seem as though Mr. Riggs should sympathize with the writer's view, rather than with that of Professor Adams. Certainly, Mr. Riggs is fully aware of the inadequacy of mere cost of replacement to serve any useful purpose, for, after saying that:

"No account may be taken of the purpose for which the resultant figure of value is to be used; and the result should not vary, no matter what the purpose may be."

He says, in another place:

"* * * it is clear that the worth of the physical property, being the cost of reproduction less depreciation, is not necessarily the value of the property. * * *"

218And, defining what he calls the "non-physical or intangible elements of value," says:

"These are those things which, added to or taken from the worth of the physical property, make up the value, and include whatever accrues to the property by reason of its operation, or by reason of grants, contract rights, competition, or location, which at the time of appraisal affect favorably or unfavorably the worth of the property."

The second misapprehension that is worthy of notice seems to have grown out of a curious sensitiveness, on the part of Mr. Riggs, as to any suggestion, other than his own, of criticism of any work undertaken or theories advanced by Professor Adams. As to every reader, other than Mr. Riggs, it is surely quite unnecessary to say that no attack has been made upon Professor Adams by the writer at the New York meeting of the American Economic Association or anywhere else. Certainly, it will be conceded that some difficulty would attend an effort to respond to an invitation to discuss before a scientific body a paper written by one of its members without making any allusion to the author of the paper or to his views or work, and those who have any knowledge of the history of official railway valuations in the United States, and especially of the proposal to undertake a Federal investigation of cost of replacement, are fully aware that Professor Adams has been from the beginning, and now is, the Hamlet of the drama, without whom it would become dull and lifeless. Strangely enough, Mr. Riggs seems to wish to deny to Professor Adams this prominence, for he says:

"Professor Adams was associated with the Michigan appraisal, but had no connection whatever with the 'physical valuation,' to which such objection is taken, and his appointment was made after the work of physical valuation had been fully outlined and was well under way."

It is true that the scheme devised by Professor Adams, and adopted at his suggestion by Governor Pingree, required the employment of civil engineers for the preliminary work which necessarily had to precede the final "valuation" by Professor Adams, but the bare statement of this fact is utterly misleading. Professor Adams' own testimony in one of the Michigan tax cases happily places his responsibility for the whole plan entirely beyond controversy. He said:

"In 1900 I was called upon by the Michigan State Tax Commission to determine whether railroads were paying a tax rate on their value equal to the rate on other property. With that problem in view, I formulated this inventory plan. * * *"^[33]

Any discussion of the proposal for a National inquiry concerning cost of replacement which omits to show that its most persistent advocate, Professor Adams, has advocated and actually conducted or 219controlled several successive "valuations," in Michigan, as Statistician to the Interstate Commerce Commission, and as special employee of the Bureau of the Census, made in accordance with other methods than those which he now proposes to apply, is seriously inadequate; as seriously inadequate as it would be to omit to state that, using what purported to be the same method, Professor Adams, by changing the details of its application and decreasing the rates of interest used in his computations, raised his "valuation" of Michigan railways from $152,958,202 to $177,689,292 or 16.17%, each of the two calculations being presented to the public, with assurances that it disclosed the actual taxable value, and there being barely eighteen months between them. The writer is by no means alone as an object of Mr. Riggs' dissatisfaction because of public criticisms of Professor Adams' plan for estimating cost of replacement. Thus, of a statement in which Professor Taylor, who conducted the Wisconsin inquiry, questioned the validity of some of Professor Adams' methods, he writes:

"Undoubtedly this statement was made in good faith, and has gained currency by not having been corrected, but it is not the fact."

In another place, referring to a statement of comparative costs to the respective States for valuation work, made by the Railroad Commission of the State of Washington, he says:

"It does not appear to be good taste either to criticize costs of work in other States, or compare the costs in Wisconsin and Michigan with the cost in Washington."

Referring to a paper by Charles Hansel, M. Am. Soc. C. E., who took part in the Michigan valuation, Mr. Riggs says:

"The one point to which special attention is drawn is Mr. Hansel's astonishing misconception of Professor Adams' plan of work. This misleading statement appears in the first paper and is reiterated in the second."

Again, of the report of the expert of the Washington Railroad Commission, who had the temerity to declare that it found "little value" either in Professor Adams' methods or his estimates of the cost of the work, Mr. Riggs says:

"Such sentences, and others which, by inference if not by name, reflect on work executed by men of high professional standing, are hardly in good taste, even if true, in a report to a railroad commission of another State."

Yet Mr. Riggs does not fail to criticize the method of "valuation," applied by Professor Adams in Michigan, in terms quite as definite as any used by others.

Thus, he condemns the method used to estimate the value of the non-physical elements appertaining to the Michigan railways, on the grounds (first) that it made this value a mere derivative of the rates 220existing, and (second) that it made no allowance for negative values when cost of replacement exceeded real value, saying:

"It will be seen that, in the case of a property in which the surplus earnings depend on excessive rates for service, it will fail as a method of determining a value for use as a basis of rate-making; and it fails, in the form in which it was used in 1900 and 1902, to bring out those negative or subtractive elements which may be determined from the income accounts, in the case of properties which do not earn a fair return on the investment."

Of the published statistics of American railways, compiled in the office of which Professor Adams is the responsible head, derived from annual reports made in accordance with forms prescribed by the Interstate Commerce Commission under his guidance, and containing items selected from and depending on the uniform railway accounting system devised by Professor Adams and imposed on the carriers by the Commission, Mr. Riggs writes:

"The published statistics are in such form that only the careful student of affairs can understand or analyze them, and but few of the public officials who receive them are able to read the reports of the properties and comprehend them."

Railway officers fall quite generally under Mr. Riggs' condemnation, for, of them he says:

"As a body * * * it is doubtful if any equal number of men, of equal intelligence, have as limited a knowledge of the fundamental truths of government, or knowledge so colored by bias. It is also doubtful whether any equal number of men have in their ranks so few who bear an active part in the duties and activities of citizenship, or who exercise large influence on their neighbors."

Such assertions as the foregoing need no comment; their intemperance is their most effective refutation; yet a few recent examples may be cited: Paul Morton resigned as Vice-President of the Atchison, Topeka and Santa Fe to become Secretary of the Navy in Mr. Roosevelt's cabinet; Jacob M. Dickinson, General Solicitor of the Illinois Central, became Mr. Taft's Secretary of War; his successor with the Illinois Central, William S. Kenyon, later became Special Assistant of the Attorney-General; Lloyd W. Bowers, General Solicitor of the Chicago and Northwestern, was Solicitor-General of the United States from early in Mr. Taft's administration until his death a few months ago. Thus, within but four or five years, the Federal Government took four of its highest officers from the railway officers located in only one of the country's great cities—Chicago.

Of a recent address by one of the ablest and most public-spirited of railway officers, he says:

"This address well expresses the spirit of the railway managers and employees toward all forms of investigation, and the complete lack of 221understanding, on the part of these managers, of the legal and moral relations which they bear to the communities which they serve."

Belonging to this so hateful class, and having also ventured to question whether Professor Adams has said the last and most perfect word on the subject of railway valuation, the writer is neither surprised nor disheartened to find that he, also, has caused Mr. Riggs undisguised dissatisfaction. It is a misfortune apparently inseparable from his profession and his conception of his obligations to his employers and to the public.

As has been already noted herein, the question is not whether railway property shall be officially "valued," but rather (first) as to how the "value" which is to be ascertained is properly to be defined, and (second) how the determination of "value," as properly defined, can be made most accurate.

The essential difference between the view advocated before the American Economic Association by Professor Adams and that of the writer was, and is, that the former now desires to exclude all elements of value which are not physical and tangible, while the writer holds that, if it is worth while to ascertain, on a general scale, at the cost of a necessarily large expenditure of taxpayers' money, and as to a particular date, so unstable a fact as railway value, the kind of value the ascertainment of which could be of sufficient utility to warrant the effort can be nothing less significant than the "fair value" which the Courts have said is a proper element for consideration in fixing reasonable rates of charge. The fundamental difference between these two conceptions of value is admirably indicated by the following quotations, both of which rest on the authority of the Interstate Commerce Commission.

Fair Value.

"The present value of a railroad property is necessarily very largely a matter of opinion only; it depends upon a vast number of contingencies and uncertainties, a road apparently of great value to-day may soon become worthless by the opening of a competing line having superior advantages or by the competitive struggles of other lines which operate to reduce the income of all; the value of a railroad largely results from the personal characteristics of its officials; the policy pursued by directors for the conservative and economical or progressive and daring, is a great factor in the determination of the current value of the property; a railroad property is not necessarily worth what it would cost to replace it and, on the other hand, it may be worth very much more than that."^[34]

Replacement Cost.

"The bill in question makes use of the phrase 'fair value.' Unless there is some legislative necessity, which we do not perceive, we question the advisability of using this phrase.

"It would seem to us preferable to substitute a phrase which indicates the fact that Congress desires an inventory valuation of railway property. By inventory valuation is meant that the property of the several railways shall be listed in detail, and that each kind or class of property so listed shall have assigned to it a valuation to be determined from the 222point of view of the contracting engineer, and not from the point of view of a court or board of arbitration which, from the nature of the case, cannot judge of what is 'fair value' except in the light of some specific use to be made of the valuation."^[35]

As has already been noted herein, and amply verified by quotations, Mr. Riggs is fully aware that replacement cost and real value can rarely, if ever, coincide, and therefore plainly agrees, as to that elementary and essential point, with the writer and disagrees with Professor Adams, who would ignore or destroy every non-physical element of value in the property of all public service corporations. Mr. Riggs' recognition of the inadequacy of mere replacement cost is shown also by the excellent and convincing example which he cites^[36] of competitive railway routes between two Michigan cities which were built and are maintained and operated under such conditions that the far more costly of the two, which inferentially has correspondingly higher replacement cost, has much lower earning capacity, both as to gross and net, and is therefore actually worth much less than its less costly competitor. Mr. Riggs explicitly favors full recognition of the non-physical elements in every valuation; and, therefore, may be ranked as an opponent of any such scheme of valuation as that advocated by Professor Adams before the American Economic Association, or in the letter of the Chairman of the Interstate Commerce Commission, hereinbefore quoted.

Mr. Riggs, however, believes that the determination of the cost of replacement is an essential first step toward the ascertainment of real value. He says:

"The worth of the physical property is primarily that on which the value of the whole property rests."

The thought which the writer would place in opposition to the foregoing is that: Physical property has no value which is not an expression of its adaptation to economic needs. This is only another way of expressing the inevitable economic law, from which there is no escape, either in theory or in practice, that has been stated and sanctioned by the Supreme Court of the United States, as follows:

"But the value of property results from the use to which it is put, and varies with the profitableness of that use, present and prospective, 223actual and anticipated. There is no pecuniary value outside of that which results from such use."^[37]

Mr. Riggs' own definition of value is not inconsistent with the foregoing. He says:

"The value of a property is its estimated worth at a given time, measured in money, taking into account all the elements which add to its usefulness or desirability as a business or profit-earning proposition."

The view of Mr. Riggs is that:

"While ... the worth of the physical property, being the cost of reproduction less depreciation, is not necessarily the value of the property, ... the physical worth must bear some very definite relation to value...."

And he is, further:

"Strongly of the conviction that this relation is such that 'value' cannot be ascertained without a determination of physical worth."

It is exceedingly difficult to comprehend just what Mr. Riggs means when he describes the relation between real value (which he recognizes so clearly as value in use) and cost of replacement as "very definite." Certainly, he does not mean that it is a constant relation, or one which can be ascertained until there has been independent determination of both of the aggregates whose relation it expresses. In fact, the emphasis which Mr. Riggs places on replacement cost has led him into the grotesque fallacy of arguing that a correct estimate of real value is only to be attained by ascertaining: (first) cost of replacement, (second) real value, and (third) correcting the aggregate first obtained by applying whatever "very definite" relation (ratio) is necessary to make it agree with the second aggregate, which was from the beginning the only aggregate really wanted. The accuracy of this characterization of his proposed procedure is made perfectly clear by the following quotation:

"... the true method of valuing a corporate property is first to determine the cost of reproduction of the property and its depreciation, and modify this figure by any applicable positive or negative non-physical elements of value."

It is submitted that the clear meaning of the foregoing is that both replacement cost and real value as derived from use must be separately and independently ascertained, and that, these aggregates having been compared, the former is to be corrected by whatever allowance for non-physical value may be required to make it agree precisely with the latter. The obvious suggestion flowing from this discovery of his theory is that only value in use is wanted, as that is the only real value, and as it must be separately ascertained in any 224event, no other and pseudo value need be taken. The essential character of the method is as described, even when it is applied through determination of the annual value of the use and the assignment of one portion of such annual value to return on the capital value of the physical property and another portion to return on the capital value of non-physical property. The real nature of the method is not even effectually concealed by the capitalization of the income assigned to physical property at one rate and the income assigned to non-physical property at a different and higher rate. In fact, if it is necessary to conclude that a portion of the net annual income of railway property is normally paid to, or in respect of, a portion of capital entitled to a lower rate of return, and the remainder to or in respect of a remainder of capital entitled to a higher rate, the appraisal of the physical property is an excessively costly, cumbersome, and inaccurate expedient for determining the amount or value of either portion of the capital. Yet that is exactly what was done in Michigan by Professor Adams, the "valuation" he then made being completed before he altered his view by deciding that the non-physical elements of value are entitled to no consideration whatever, and that only cost of replacement is worthy of inclusion in an official "valuation."

But is there any real distinction between the "physical properties" and the "immaterial elements," such as the foregoing extract seems to assume? Is not the superficial appearance of such a distinction plausible but deceptive? A locomotive is an entity; so is a railway. The separate parts of a locomotive are most of them independently valuable; so are the separate parts of a railway; but a large share of the value of the locomotive is the result of the nice adjustment of these separate parts to each other and to the work to be done.

Take a hundred different-sized locomotives, each adapted to different work under different conditions, and separate each piece of metal; it would be possible to value all these parts, but the aggregate would be far less than the value of the locomotives from which they were taken. Again, it would be possible to construct from these parts a hundred locomotives of such poor design, their respective parts so out of adjustment and balance, that they would be worth even less than the parts out of which they were assembled. The highest paid intelligence has not yet contrived the perfectly balanced locomotive, but a large part of the so-called "physical value" of every locomotive represents this sort of highly paid intelligence put forth at every stage from the opening of the mine where the ore was obtained to the delivery of the completed locomotive. Take ten railways of a thousand miles each, every one of them efficiently constructed, and equipped with proper terminals, stations, signals, rolling stock, and trained employees, and each properly adapted to the requirements of its territory and traffic; separate them into piles of ties and rails, groups of locomotives and cars, 225acres of land, unorganized bodies of men of varied capacity and training; what sort of intelligence will it require to build up out of these masses ten railways as efficient and useful as those that originally existed? Why, then, should the "physical value" of the locomotive include the assembling of its parts in proper balance and the "physical value" of the railway exclude the cost of the much more complicated adjustment of its elements of machinery and labor and location to each other?

At an early point in his discussion, Mr. Riggs makes an announcement, highly becoming on the part of one who proposes to deal with the problem solely from the point of view of a civil engineer, that he does not intend to argue the public utility of any sort of valuation, but only the method by which it may best be made, should one be determined upon. He says:

"This paper is confined to a discussion of the methods which should be used in arriving at a correct figure of cost of reproduction and depreciation—it does not take up questions involving the propriety of those figures when reached. The propriety or legality of using such figures as a basis for an assessed valuation, as a basis for rate-making (rate-making being an art in itself involving complications as great as those encountered in valuation), or any arguments as to the justice or injustice of legislation restricting issues of stocks or bonds, will be conceded no place in this paper. It is assumed that all these questions would have been taken up and a satisfactory answer reached before a valuation could have been ordered."

Two pages after the foregoing paragraph, under the sub-heading "The Relation of Public Service, or Quasi-Public Corporations, to the People," Mr. Riggs proceeds to violate the wise, though self-imposed restriction, and devotes no less than eleven pages to a defense of the project on grounds of alleged public policy. In these pages he concludes that such a valuation as he proposes—not a mere determination of replacement costs, but a real valuation, with proper allowance for all elements of value in use—would be of service in connection with (a) taxation, (b) public control of rates, and (c) public control of issues of capital securities.

In supporting valuation as an expedient in taxation of railway property, Mr. Riggs seems to rely on a table made up from Professor Adams' Bulletin No. 21, as expert employed by the Federal Bureau of the Census, which table shows that the assessment of the railways of Wyoming for taxation purposes in 1904 was but 7.5% of their commercial valuation, as estimated by Professor Adams, and that this ratio varied greatly throughout the different States, running as high as 114.4 in Connecticut. Of course, nearly every one knows, even if Mr. Riggs does not, that the relation between the real value and the assessed value of all other kinds of property varies greatly from State to State, and even in different portions of the same State. On account 226of this variation, no table such as that offered by Mr. Riggs in support of his argument can have any value unless supplemented and explained by data covering the assessment of other kinds of property. It is worth noting, en passant, that the so-called "Commercial Valuation," on which Mr. Riggs rests this part of his argument, assigns a value equivalent to $32,054 per mile to the railways of Michigan and one of $45,211 per mile to the railways of the prairie State of Nebraska. Possibly this variation in the estimate of value is partly expressed in the conclusion that Michigan railways are assessed at 70.9% of their value and Nebraska railways at but 18.5 per cent. Obviously, there is no more need of uniformity among the States in the taxation of railway property than in their methods of deriving revenue from other kinds of property.

Also, Mr. Riggs admits that, when the Michigan valuation for taxation was made, it was not diminished, as it should have been, by the use of negative, non-physical value. This is fully equivalent to an admission that the method was unjust to every railway not capable of earning the full return on its replacement cost. He says:

"The use of a negative or subtractive non-physical value was considered, and advised by Professor Adams....

"Professor Adams and his associates, therefore, applied only positive values, where any such were found, although advocating the use of negative values."

And, of the method then used, he says:

"... it fails, in the form in which it was used in 1900 and 1902, to bring out those negative or subtractive elements which may be determined from the income accounts, in the case of properties which do not earn a fair return on the investment."

And again:

"... where the earnings have been fairly uniform and stationary for a period of years, and the property does not earn a sufficient sum to care for depreciation and annuity, it is clear that the value as an earning investment is less than the determined physical value, and that the physical valuation should be reduced by some amount to arrive at the 'fair value.'"

In his argument favoring the use of a valuation in rate-making, Mr. Riggs affords no support to Professor Adams' contention that, for that purpose, only replacement cost should be considered, and that, after fixing the rates on the basis of the least favorably located and least efficient line, so as to afford it a bare return on its replacement cost, the surplus earnings at the same rates of its more favorably located or better operated competitors should be confiscated under the guise of a special tax. This extraordinary proposal, the character of which is so illuminating as to the attitude toward railway property and investments of the most prominent and persistent advocate of 227so-called "physical valuation," is best stated in Professor Adams' own words, which are as follows:

"I cannot evade the conclusion that equity, as between various classes of roads, can never be attained until all the excess of revenue over the Constitutional limit be made a contribution to the public treasury, and that this contribution be made as a substitute for all taxes of all kinds and all sorts."^[38]

On the contrary, Mr. Riggs distinctly upholds the right to earnings in excess of the bare return, at the minimum rate of interest, upon the cost of replacement, saying, inter alia:

"It is contended that the determination of rates that will be just and fair to all competing companies involves other consideration than the valuation of either physical or intangible properties, and that when all these rate-making problems are properly solved, there will remain large intangible values on the well-designed plants."

Professor Adams has himself admitted that there is no possibility of utilizing any valuation for the purpose of fixing specific rates, as such a task is far beyond the capacity of any conceivable system of cost accounting. Supplementing this admission, Mr. Riggs' opposition to the plan proposed by the former and its gross injustice, so apparent to every one but its author, destroys the last element of plausibility in the suggestion that any sort of valuation could be of utility in that connection. The writer is not overlooking the fact that the Courts, when under the necessity of repelling efforts to confiscate railway properties under the guise of rate regulation, and in view of the form in which this necessity has commonly presented itself, have accepted "fair value" as an element of importance in their inquiries; but if the railways are entitled to charge rates based on the value of the services they perform, it is clear that the question whether a rate or a schedule of rates is reasonably adjusted to the value of the service or services is very different from the question whether a fair return upon fair value has been allowed. Assuming, however, the need of an appraisement in every litigated case involving railway schedules, it is evident that each case would have to have its own appraisement, for value is ever changing and unstable. Mr. Riggs himself says:

"It is true that the 'value' of a property is an unstable figure, subject to fluctuations due to natural or artificial causes, and that a material change in value may occur suddenly...."

Professor Adams proposed to keep his replacement cost up to date by annual accretions equal to annual expenditures for extensions and betterments; but this plan is illogical and inconsistent, for it proposes to ignore that very essential difference between original cost (less a proportionate allowance for wear and tear) and present worth, which 228is the very basis of the argument in favor of any valuation at all. Equally obvious objections, growing out of the instability of the ascertained value of any particular date, apply to any plan which does not provide for a re-appraisement every time the aggregate is to be used.

The objections to the use of any valuation for rate-making which have been cited are valid, and should be convincing, but they are insignificant by the side of the fundamental objection that, as Mr. Riggs says, "as a business proposition, the value of any property depends on its earnings," while those who would thus utilize a valuation are attempting to reverse the fact and make earnings depend on the value. Such a reversal is impossible. Ascertain real value and you have a consequence of earnings, past, present, and prospective, nothing else; use this as a basis for a rate schedule and you get, as a mathematical result, the present rates. The only way to derive any other result from this method would be to use as the basis some figure other than the real value, a method which would only be resorted to through moral turpitude or intellectual incapacity. One might almost assume that Mr. Riggs knows this, for he says:

"Value is given to a property, either by reason of the fact that it is an instrument for earning profit, or that it does earn profit or gives promise of profit."

The substance of Mr. Riggs' argument on capitalization control is that American railways are not often over-capitalized, but such evils do obtain in other industries, and therefore railway issues of capital securities ought to be restricted.^[39] Unfortunately, he gives no clue to the methods he would have applied, nor as to how far he would go in interference with the normal action and interaction of commercial forces in determining what securities can and ought to be issued. Railways are not over-capitalized. Table 9, a comparison of official valuations and capitalization, originally compiled by Mr. Slason Thompson, is instructive.

TABLE 9.

State. Year. Valuation by commission or tax board. State proportion of capitalization.

Minnesota 1907 $411,735,194 $334,979,691

South Dakota 1909 106,494,503 108,911,000

Wisconsin 1909 284,066,000 249,299,060

Texas 1909 413,000,000 412,465,743

Washington 1908 186,007,490 153,493,940

Total $1,401,303,187 $1,259,049,434

Excess of total valuation over total capitalization $142,253,753

229In view of frequent suggestions, in the public press and elsewhere, which indicate that there is a widespread opinion that the securities of railways have generally been watered, Table 10 is given. It is an analysis of the consolidated balance sheet as given in the reports of the Interstate Commerce Commission for 1908 and 1890.

Table 11 shows the length, in miles, of main and other tracks in 1908 and 1890.

The Commission, in its annual report, shows the securities issued per mile of road (first main track), but does not show the results per mile of main track (i. e., 1st main track, 2d, 3d, 4th, and other main tracks), nor does it show the results per mile of all tracks (i. e., main tracks, yard tracks, passing tracks, and industrial tracks). From the consolidated balance sheet, it will be noted that the securities per mile of road have increased 29%, while per mile of main track they have increased only 24%, and per mile of all tracks they have increased but 14 per cent. However, deducting the investments in stocks and bonds of other corporations, and showing the results only for the securities issued on account of the cost of road and 12% equipment, we have an average per mile of road of $62,388, an increase of 12%; and an average per mile of all main tracks of $56,166, an increase of 8%; and an average per mile of all tracks of $42,864, or a decrease of 0.7 per cent. It will be noted that a considerable part of these increases is due to increased cost of equipment, and the advantageous results obtained from such investment have been clearly shown. Of the investment in the track itself (cost of road), it will be noted that the cost per mile of main track has increased only 5%, while the cost per mile of all tracks shows a slight decrease in 1908 as compared with 1890.

These comparisons are more significant and convincing in the light of the large expenditures since 1890 for the reduction of grades, revision of line, interlocking towers, automatic block signals, increased weight of rail, increased capacity of bridges, improved stations and terminals, elevation of tracks, and the many other items going to make up the additions and betterments, and increasing the book cost of the property. The figures plainly prove that there has been no general practice on the part of the railroads of the country, from 1890 to date, of issuing capital securities without securing full value for the vast amount referred to. Why, then, should any restriction be placed on the form or manner of their future appeal for the very large volume of capital necessary to keep abreast of American industrial development? Why should they be limited as to what form of security they may offer in return for the cash capital which they must obtain if they are to serve the public adequately and properly?

230TABLE 10.—Consolidated Balance Sheet for Railroads of the United States. Exclusive of Terminal and Switching Roads.

Assets.

Total. Per mile of road. Per Mile of main tracks. Per mile of all tracks.

1908. 1890. 1908. 1890. 1908. 1890. 1908. 1890.

Railroad:

Cost of road $12,035,195,403 $7,333,096,430 $56,268 $51,400 $50,656 $48,109 $38,659 $40,033

Cost of equipment 1,178,571,137 422,290,951 5,510 2,960 4,961 2,770 3,786 2,305

Material and supplies 226,250,462 63,785,950 1,058 447 952 419 727 348

Total $13,440,017,002 $7,819,173,331 $62,836 $54,807 $56,569 $51,298 $43,172 $42,686

Investments:

Stocks owned $2,115,313,379 $489,049,859 $9,890 $3,428 $8,903 $3,208 $6,795 $2,670

Bonds owned 1,271,311,512 241,115,665 5,944 1,690 5,351 1,582 4,083 1,316

Total $3,386,624,891 $730,165,524 $15,834 $5,118 $14,254 $4,790 $10,878 $3,986

Current Assets:

Cash and current assets $1,213,575,272 $307,871,188 $5,674 $2,158 $5,108 $2,020 $3,898 $1,681

Sinking, Insurance, and other funds 154,975,409 125,095,987 724 877 652 820 498 683

Total $1,368,550,681 $432,970,175 $6,398 $3,035 $5,760 2,840 $4,396 $2,364

Miscellaneous $1,277,458,795 $710,300,536 $5,973 $4,979 $5,377 $4,660 $4,103 $3,878

Grand total—All assets $19,472,651,369 $9,692,609,566 $91,041 $67,939 $81,960 $63,588 $62,549 $52,914

Liabilities.

Securities Issued:

Capital stock $7,289,597,964 $4,179,156,990 $34,081 $29,293 $30,682 $27,417 $23,415 $22,815

Bonds 9,441,200,261 4,462,577,079 44,141 31,280 39,738 29,277 30,327 24,362

Total $16,730,798,225 $8,641,734,069 $78,222 $60,573 $70,420 $56,694 $53,742 $47,177

Current Liabilities:

Accrued interest $25,341,994 $177 $166 $188

Other current liabilities $1,151,233,255 440,513,629 $5,382 3,088 $4,845 2,890 $3,698 2,405

Total $1,151,233,255 $465,855,623 $5,382 $3,265 $4,845 $3,056 $3,698 $2,543

Miscellaneous $845,115,552 $394,918,201 $3,952 $2,768 $3,557 2,591 $2,715 $2,156

Grand total—All liabilities $18,727,147,032 $9,502,507,893 $87,556 $66,606 $78,822 $62,341 $60,155 $51,876

Profit and loss balance 745,504,337 190,101,673 3,485 1,333 3,138 1,257 2,394 1,038

Grand total—All assets $19,472,651,369 $9,692,609,566 $91,041 $67,939 $81,960 $63,588 $62,549 $52,914

231It ought also to be borne in mind, in this connection, that, while there could be no lawful mode for the revision of existing capitalization, should it in any instance be found to be too small or too great when measured by the results of such a valuation, the future issue of securities must be controlled by the necessities of the carriers and the state of the market, and is also practically restricted by the Interstate Commerce Commission's accounting system, which declares what expenditures may and what may not be carried into the capital account. The law cannot compel any company to repudiate any existing security, and if it could it is not to be supposed that Congress would compel such an impairment of contract rights; public policy will not permit in practice restrictions that would prevent the issue of securities to meet the actual needs of the public and the carriers; the accounting system prevents issues of any other sort. Further restrictions would be cumulative and superfluous.

TABLE 11.

Track. 1908. 1890. Increase. Percentage of increase.

Single track 213,888.36 142,665.89 71,222.47 49.9

Second track 20,209.05 8,437.65 11,771.40 139.5

Third track 2,081.16 760.88 1,320.28 173.5

Fourth track 1,408.99 561.81 847.18 150.8

Total, all main tracks 237,587.56 152,426.23 85,161.33 55.9

Yard track and sidings 73,728.57 30,750.17 42,978.40 139.8

Total mileage operated (all tracks) 311,316.13 183,176.40 128,139.73 69.9

"The Interstate Commerce Commission in 1908 report that their Balance Sheet covers 'miles of road' aggregating 213,888.36 miles, whereas their statement of mileage represents all roads reporting to the Commission whether or not they furnished a Balance Sheet.

"To analyze the Consolidated Balance Sheet, we have revised the statement of mileage to cover same roads as are included in the General Balance Sheet. The 'miles of road,' i. e., miles of first main track, are actual. The Commission's report not showing separately for each line the miles of other main tracks or yard tracks and sidings, the figures shown in the statement of mileage are approximate. It includes mileage of all second, third and fourth tracks. Undoubtedly, practically all of the second tracks, third tracks and fourth tracks are owned, or operated by, roads furnishing the Commission with a Balance Sheet. Mileage of Yard Tracks and Sidings is based on the proportion which the single-track mileage of roads represented in the Balance Sheet bears to the total single-track mileage of roads reporting to the Commission."

Mr. Riggs considers seriatim nine objections to the ordinary methods of estimating cost of replacement which were mentioned specifically by the writer, as among the most important commonly omitted items, in an address before the New York Traffic Club, delivered during January, 1909. He concedes that the writer is correct in urging that allowances for "working capital with which to carry on the business" and for "impact and adaptation" ought to be included, and were omitted in Michigan and have been usually omitted. These are two of the nine objections specifically raised. As to five others, Mr. Riggs seems to be in considerable doubt. Concerning the objection that an allowance of 3% for interest during construction is too low, he contends that it was justified in Michigan by the "assumption," that the whole work of replacement would be accomplished in 232one year, and also "that on long roads partial operation would commence as various sections of the line were completed." He admits that these assumptions "clearly would not be proper" under different conditions, but appears to hold that they were warranted as to the Michigan work.

Another of the writer's objections was the absence of an allowance for "wear and tear of materials during the period of construction." As to this, Mr. Riggs says:

"This deterioration is a necessary incident to any construction work. It has not been customary or usual to take account of it. To add to the amount capitalized on account of this item would be manifestly improper. The only way in which this could be cared for would be in an adjustment of the depreciation reserve when raised to cover that which takes place during the construction period."

Of course, the depreciation account, when there is one, is a charge to operation. Therefore, Mr. Riggs' anxiety to disagree with the writer has led him into a frame of mind in which he is prepared to find that it is "manifestly improper" to charge to capital the real cost of construction, but is quite proper to charge to operation a part of the cost of construction, even though this results in carrying into the operating account items of expense incurred long before operation began or could have begun.

Mr. Riggs thinks that the writer was incorrect in objecting that "a uniform price for earthwork was used, thus ignoring the varying character of soil and length of haul," but he admits that there was "practically no classification in the Southern Peninsula of Michigan, or, in fact, on 90% of the mileage of the State," and his defense goes no further than to assert that "the price * * * was not much out of the way when considered as a fair average for the territory."

His criticism of the objection to the use of a uniform price list for materials, and ignoring the source of supply and the cost of delivery at the point of use, is equally forced, for it admits that "no effort was made to use different unit prices as between counties," and only contends that "in a number of cases" differences in prices were made.

The absence of an allowance for interference by labor troubles, weather conditions (which he admits are "a frequent source of annoyance, delay, and sometimes of expense"), Mr. Riggs defends on the ground that it is "an expense difficult to separate and set up," and therefore ought to be covered by an allowance for contingencies. On the same ground, he could easily carry every item of cost of replacement into the contingent account.

The two remaining objections specifically raised by the writer are squarely attacked by Mr. Riggs. As to one of them, the propriety of an allowance for carrying charges up to the time of attaining a revenue basis, has been admitted by the Railroad Commission of Wisconsin, 233but it is a broader question than ought here to be discussed. The writer will only suggest, at present, that in some form or other, these charges must be on the whole and in the long run met out of net operating income, and that the cheapest way, for the user of the services supplied, is to carry them into the capital account—otherwise there must be an early amortization of this item, which cannot do otherwise than to throw a heavy burden on the early schedules of charges. The language of the Wisconsin Railroad Commission on this subject merits quotation, and is as follows:^[40]

"But new plants are seldom paying at the start. Several years are usually required before they obtain a sufficient amount of business or earnings to cover operating expenses, including depreciation and a reasonable rate of interest upon the investment. The amount by which the earnings fail to meet these requirements may thus be regarded as deficits from the operation. These deficits constitute the cost of building up the business of the plant. They are as much a part of the cost of building up the business as loss of interest during the construction of the plant is a part of the cost of its construction. They are taken into account by those who enter upon such undertakings, and if they cannot be recovered in some way, the plant fails by that much to yield reasonable returns upon the amount that has been expended upon it and its business. Such deficits may be covered either by being regarded as a part of the investment and included in the capital upon which interest is allowed, or they may be carried until they can be written off when the earnings have so grown as to leave a surplus above a reasonable return on the investment that is large enough to permit it. When capitalized, they become a permanent charge on the consumers. When charged off from the surplus, they are gradually extinguished. (These facts alone, however, do not always furnish the best or most equitable basis for the disposal of such deficits.) Whether they should go into the capital account, or whether they should be written off, as indicated, are questions that largely depend on the circumstances in each particular case."

The other objection that is squarely opposed by Mr. Riggs is the refusal to allow for unavoidable discounts on the securities sold. Here he quotes with complete approval an unnamed writer, who contends that the impropriety of such an allowance is proven because, as between an issue of $10,000,000 in bonds (par value) at 4% and at 4½%, the 4% bonds bringing 90 and the 4½% selling at par, there is an annual saving, in issuing the 4% of $50,000 in interest, and that, if the issue is to be for fifty years, this saving is $2,500,000, or $1,500,000 in excess of the discount. Of course, these figures are correct, but both Mr. Riggs and his unnamed authority seem strangely to have overlooked the fact that if a railway construction requires $10,000,000, it cannot be obtained by issuing $10,000,000 in par value at 90. The comparison, 234of course, ought to be based on the issue of enough bonds at each rate to obtain equal sums of money. As $10,000,000 in par value of bonds sold at 90 would produce $9,000,000, the following comparison is based on the issue of enough bonds at each rate payable in fifty years to secure that sum.

Fifty-Year Bonds,

4½% sold at par. 4% sold at 90.

Amount of capital required $9,000,000 $9,000,000

Par value of bonds necessary 9,000,000 10,000,000

Annual interest charge 405,000 400,000

If 4% bonds are used:

Annual saving in interest $5,000

Fifty years saving in interest 250,000

Loss, original discount 1,000,000

_________

Net loss $750,000

Of course, the foregoing figures are not absolutely accurate, for the real net loss in the issue of the 4% rather than the 4½% bonds at these prices would be the difference between the $5,000 annual saving in interest and the amounts which would have to be set aside annually for fifty years to produce $1,000,000, the amount of the discount, at the end of that period. But the table is sufficiently accurate to expose the curious error into which Mr. Riggs has fallen. Perhaps it will convince him that it would be better, hereafter, not to stray so far outside the field of civil engineering.

Mr. Riggs has little sympathy with those railway men who venture to express the opinion that regulation ought not to extend so far as to render it impossible to conduct the railway business in a business-like way. His animadversions on railway men in general have already been illustrated herein. He finds nothing worse with which to characterize a previous utterance of the writer's than to say of it:

"The manifest impatience with all forms of governmental interference with corporations, which so often characterizes the utterances of prominent railway officials, appears in this paper to a marked degree."

At the risk of incurring further displeasure, the writer will not omit now to observe that, in his judgment, the whole question whether railways shall be generally and officially valued, and how and by whom the task shall be performed, is primarily conditioned by the country's need of managing its legislative control of railway methods so as not to restrict unduly the flow of capital into that industry. The steady pressure for legislation during the last five years has so extended legislative regulation that, for the first time, the sturdy, frugal, conservative, "small investor" stands in the forefront of the problem. His 235views of the stability and future prosperity of the American railway industry now dominate the situation. What they are may be read in the facts attending recent efforts to finance necessary improvements of old and prosperous railways. It developed before the Interstate Commerce Commission during the recent hearings in connection with the proposed partial adjustment of rates to the diminished purchasing power of the money in which they are paid, that one of the greatest of Eastern railway systems, paying 8% annual dividends on its stock, which is very widely distributed, had offered new shares to its stockholders at a premium of 25%, and had found them unsalable at that figure, so that it was obliged to recall the offer and put them out at par. Other testimony disclosed the failure of one great company to obtain an offer of more than 85 for its 4% bonds, while another had been forced to go to France to raise $10,000,000, and many others have been forced to the expedient of issuing short-term notes at relatively high rates of interest. It also appeared that extensive proposals for new branch lines had been abandoned or postponed, in view of the impossibility of obtaining funds on reasonable terms.

Other testimony shows that locomotive shops and car builders are putting out not more than half of their capacity; that the supply trade is receiving no new orders. Never, since the beginnings of the American railway industry, has the American and foreign investor been so reluctant to supply necessary capital, or so doubtful of the future of railway enterprises. This fact is not due to absence of confidence in the industrial future of the American people, but is directly attributable to the unanswered inquiry as to how far the policy of legislative control is to extend. Either this question must be answered in a manner satisfactory to the investor, or the credit of the Government must be made available for the extension and improvement of railway facilities, either through Governmental guaranties of adequate returns to capital, or through Government ownership; for adequate and properly constructed and equipped railways the public must and will have. Thus far, the American public is ready neither for Federal guaranties nor for Federal ownership; it is to be hoped that it will never be ready for either. In this situation, if a Federal valuation is to be undertaken, it is primarily important that it should be under such auspices and by such methods that the investor will not be alarmed as to its consequences. This is not a suitable occasion to attempt to lay down all the considerations applicable to such a valuation, but it ought to be perfectly clear that it must relate to value in use, not to some concept of value limited to replacement cost which excludes some of the most important elements of value (which are also those most worthy of a return, because they represent the highest and most difficult social and industrial services), in order to obtain a means of excluding these same elements from possibilities of adequate reward.

236One of the most important items to be considered is the "cost of progress," which is sometimes referred to as "abandoned property," or as "obsolescence." For illustration, in the revision of the grade and line of a road, whereby the capacity of existing track is doubled, the present instructions of the Interstate Commerce Commission require the charge to operating expenses of the cost of that portion of the old line no longer continued in use. If, however, the doubling of the capacity of the line be secured by the construction of a second main track, the entire cost of the new work can be charged to capital account and paid for from the proceeds of the sale of capital securities. The latter method becomes the easier to finance, but what of the comparative results? Say, for example, the original cost of material of existing property, including equipment, stations, yards, etc., was $10,000,000, that the first main track cost $1,000,000, and that to double the capacity of the main track would require a present expenditure of $1,000,000, either for (1) a reduction of the grades and curves of the first main track, or (2) for the construction of a second main track. The increase in capacity is identical, but in the first case the cost of train service to handle the tonnage is decreased 50%, and some reduction in maintenance is secured, while in the second case no economies of operation are effected, but the expenses may be increased. Undoubtedly, Road (1) would be much more favorable than Road (2), yet the Commission says a portion of the cost of perfecting Road (1) must be charged to operating expenses, and cannot be capitalized. What general manager will dare recommend such extensive improvements when the charging of a portion of the cost to operating expenses will show the dividend as unearned, and thus render the securities of the company no longer legal investments for savings banks, trustees of trust funds, etc.? As an alternative, he might permit the old line to remain, and by placing thereon a few cars occasionally, could consider it as still in use, and carry it in his capital account, thus avoiding the charge to operating expenses. Thus, again, is it the method and not the result that is controlled by these instructions. What should be done is to permit the cost to be charged against the surplus accumulated during the years in which the property to be abandoned was used. This would not affect adversely the operating income of the year, and would not impair the credit of the Company.

Plainly, the instructions of the Commission tend to compel a method that is contrary to the economic law.

Obviously, any requirement as to valuation which would impose on the carrier such a result as that shown would compel the continuance of the less efficient service and prevent the progress which such replacements express. The railway business is a continuing one, and an improvement ought to be made whenever it can earn income, not only on its own cost, but on that of the property abandoned, even 237though it cannot afford income sufficient to wipe out the whole capital charge for the latter in a single year. There is no reason for requiring each item of capital to earn its cost in addition to its interest during its individual life. Such a requirement would cry halt to progress. It is reasonable and proper that such charges to operation should be made as far as the rapid development of the art of transportation permits, and such is the practice of every well-managed railway; but, to make the practice uniform and compulsory, permitting no exceptions and allowing no scope for individual judgment, is quite another thing. When the conditions warrant such a course, the railway ought to be permitted to adjust its accounts in a manner of which the following is typical:

Replacing. Not replacing.

Capital account $19,750 $5,000

Additional net operating income attributable to this item 1,000 250

Charge to operation for abandoned property 250

______ _____

Operating gain $750 $250

A valuation adjusted in recognition of this developmental need would include, in addition to the item of $15,000 for the replacement cost of the new locomotive, an item representing "cost of progress" of $4,750 for the former locomotive. It is not to be overlooked that in actual practice it would be easy to obtain this allowance by cumbering the yards and round-houses with obsolete and superfluous equipment. The plan of Professor Adams places a premium on such a course, and there are many conditions under which it could and would be followed where it would be less obvious and more detrimental. For example, it might be that an additional track over a steep grade and a new alignment which would avoid it would cost the same. The new alignment would give greater operating efficiency, but it would require the charging off of the old line; the new track over the grade would be more costly to operate, but would leave the apparent capital unimpaired. It is such possibilities as this that are giving pause to the investors who would otherwise supply funds for the needed development of the American railway system. How far this development has so far required the abandonment of property capable of further use and having genuine capital value is indicated by available records. The aggregate capacity of all equipment has increased much faster than the increase in number of locomotives and cars. The reports of the Interstate Commerce Commission only show this information for the years 1902 to 1908, both inclusive. The average tractive power of locomotives in 1908 was 26,356 lb., as compared with 20,485 lb. in 1902, being an 238increase of 5,871 lb., or 28.7% per locomotive. The average capacity of freight cars in 1908 was 35 tons, as compared with 28 tons in 1902, an increase of 7 tons, or 25 per cent. Undoubtedly, the average capacity of locomotives and the average capacity of freight cars in 1908 was not less than 60% above the average capacity of 1890.

L. F. Loree, M. Am. Soc. C. E., President of The Delaware and Hudson Company, as Reporter (For United States) to the International Railway Congress, held in Paris in 1900, communicated with all roads in the United States then operating 500 miles of line, or more, relative to the capacity of cars actually in service. The result is shown in Table 12.

As a result of these improvements in roadway and equipment, the average number of tons of freight handled per freight train in 1908 was 351.80 tons, as compared with 296.47 tons in 1902, an increase of 55.33 tons, or 18.6 per cent. The average tons per freight train in 1908 was 351.80, as compared with 175.12 in 1890, an increase of 176.68 tons, or 100.8 per cent.

These improvements have not been solely or mainly for the benefit of the carriers, though there is no question that they have been prompted by railway self-interest. The new car of 40 tons capacity is but 20% longer than the old car of 13 tons, which means a great augmentation of the efficiency of the private sidings and tracks of the manufacturers, as well as the side tracks and terminals of the railway. Who would retrace the steps of progress of the last decade or of the last two decades? Yet the project to tie railway earnings to replacement cost, which makes no allowance for the costly steps in such progress, is in reality a project to tie them to their present state of development and to prohibit future progress. Nor can it be forgotten that it is an inviolable law of Nature that that which does not go forward must go backward—nothing can remain stationary.

The story of the crude millionaire who wanted to know the value of the "plant" of Oxford University, in order that he might duplicate it, is not inappropriate, and ought to have some significance to those who imagine that replacement cost would tell the story of railway values. Do they imagine, because they are ignorant of them, that a great railway organization carries no traditions of loyalty, of persistence in the face of overwhelming difficulty, of generous recognition of public needs and rights, of courageous adherence to the real interests of its shareholders that inspire its personnel and provide a genuine esprit du corps? Do they find no superiority in one organization over another, no systematic economies of method, no especial adaptation to economic needs that has value more genuine than any replaceable element, and is at least equally worthy of compensatory return?

239TABLE 12.—Classification of Freight Equipment

According to the Capacity.

Year. No. of Roads Reporting (see note). Five tons and under. Ten tons. Fifteen tons. Twenty tons. Twenty-five tons. Thirty tons. Thirty-five tons. Forty tons. Forty-five tons. Fifty tons and over. Total number of cars. Total capacity, in tons. Average capacity, in tons.

1880 A-7 38,399 131,988 447,270 89,420 53,733 707,077 13.2

7 38,399 131,988 447,270 89,420 53,733 707,077 13.2

1890 A-7 16,450 71,982 182,175 651,740 441,475 548,670 4,000 50 91,281 1,916,492 21.0

B-13 16,450 72,082 240,900 933,040 624,125 638,100 4,000 50 119,513 2,528,747 21.2

1893 A-7 1,145 34,088 144,795 629,780 734,350 842,640 4,000 103,315 2,390,798 23.4

C-13 1,145 34,238 255,795 993,840 947,500 1,112,070 4,000 145,440 3,848,588 23.0

1895 A-7 355 13,978 120,435 589,140 743,975 1,011,030 70,000 4,000 50 104,496 2,652,963 24.4

D-15 355 20,863 245,709 1,186,320 1,103,100 1,493,700 70,000 4,000 50 171,307 4,074,217 23.8

1897 A-7 20 6,462 92,585 555,980 761,150 1,224,030 74,865 4,400 450 150 108,118 2,720,042 25.2

E-16 20 9,407 163,189 1,029,756 1,089,300 1,822,530 183,190 4,400 450 150 174,315 4,322,432 24.8

1898 A-7 1,540 94,275 523,080 721,425 1,314,840 75,320 4,480 270 50,950 108,559 2,786,180 25.7

F-27 63,565 9,491 418,551 2,190,360 1,654,850 4,831,170 88,515 8,840 270 104,700 385,765 9,409,918 24.4

Note:—A—Figures cover only these roads:

Reporting for 1880 and all other years, viz.:

Allegheny Valley

B. & M. R.

C. of G.

G. R. & I.

Penn. Lines W.

Phila. & Reading

Wis. Cent.

B—Includes roads under "A," also:

Ches. & Ohio

C. G. W.

M. K. & T.

N. D. & C.

Phg. & Western

Vandalia

C—Includes roads under "A," also:

Ches. & Ohio

C. G. W.

Mich. Cent.

M. K. & T.

N. D. & C.

Phg. & Western

D—Includes roads under "A" and "B," also:

Mich. Cent.

Southern Ry.

E—Includes roads under "A" and "C," also:

C. R. I. & P.

Seaboard Air Line

Southern Ry.

F—Includes roads under "A" and "B," also:

Ann Arbor

B. & M.

C. R. I. & P.

C. St. P. M.& O.

Grand Trunk

Lehigh Valley

Mich. Cent.

O. R. R. & Nav.

Penn. R. R.

P. B. & L. E.

Seaboard Air Line

So. Pacific

Southern Ry.

240TABLE 13.—Statement of Return on Investment in Road, Equipment, etc., for Roads in the Official Classification Territory, for Eleven Years Ended June 30th, 1909, also for the Year 1890.

Year. Cost of road. Cost of equipment. General expenditures. Material and supplies. Total. Operating Revenues. Operating Expenses.

1909 $4,357,455,101 $686,116,206 $50,586,812 $75,550,135 $5,169,708,254 $1,032,285,890 $700,694,007

1908 4,306,902,038 669,751,320 51,324,157 86,201,748 5,114,179,263 1,049,545,984 746,575,094

1907 4,438,582,438 587,637,733 91,923,338 5,118,143,509 1,141,324,116 794,998,803

1906 4,269,066,800 513,028,004 80,479,333 4,862,574,137 1,044,552,909 714,461,452

1905 4,110,883,904 492,498,488 65,875,071 4,669,257,463 944,805,659 658,337,498

1904 3,906,766,459 461,941,677 72,240,521 4,440,948,657 899,868,519 636,217,217

1903 3,830,580,776 426,822,318 64,458,257 4,321,861,351 871,697,611 601,864,284

1902 3,744,205,552 389,909,755 50,565,290 4,184,680,597 782,975,559 528,681,892

1901 3,682,894,343 378,545,580 47,746,178 4,109,186,101 730,590,144 491,657,899

1900 3,620,630,187 377,156,700 49,940,838 4,047,727,725 698,368,829 467,462,093