TABLE 12.—Classification of Freight EquipmentAccording to the Capacity.
TABLE 12.—Classification of Freight EquipmentAccording to the Capacity.
TABLE 12.—Classification of Freight Equipment
According to the Capacity.
TABLE 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.
TABLE 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.
TABLE 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.
TABLE 13. (Continued.)
TABLE 13. (Continued.)
TABLE 13. (Continued.)
If there were not abundant evidence that the railway industry is not excessively profitable, there would be more reason on the side of those who continually put forward new schemes of restriction; but, not only is such evidence ample, but there is no evidence of any sort tending to establish the contrary. Limiting the inquiry to the region east of the Mississippi and north of the Ohio and Potomac Rivers, commonly known as Official Classification Territory, the statement in Table 13, based on the book cost of railways, with their equipment, supplies, and materials on hand, is instructive. The data are from the reports of the Interstate Commerce Commission.
The amounts shown in Table 13 as "operating income" are, as should be remembered, those earned, and not those distributed as interest on bonds and dividends on shares, which were necessarily much smaller. Bearing this in mind, it is significant that the percentage of such operating income to cost of property has not but once in the last twelve years, the most prosperous duo-decade in the Nation's history, exceeded 6%, and then only by a very small fraction; and that the average for the whole period is less than 5½ per cent. Every one knows that the real value and the actual cost of the railway property in this region greatly exceeds its book cost, so that these percentages are undoubtedly much in excess of the real rates of net earnings to value or cost of property.
P. E. Green, Assoc. M. AM. Soc. C. E.(by letter).—It is not often that there is presented to the Society a paper which shows such thoroughness of understanding of a difficult problem, and as much real experience in its solution, as is manifested therein; and the author is certainly to be congratulated on such a logical and forcible presentation of the subject. There may be some points on which engineers who have been engaged in such work cannot agree with him; but certainly it cannot be said that he has not argued very clearly and logically on nearly all the debatable questions.
Those who have not had actual experience in making a valuation of a railway company's property cannot have any idea of the enormous amount of detail and labor necessary to make such a compilation of any real value. It simply means that every detail of every structure of whatever kind must be investigated, together with the various considerations covering "intangible values," which the author has so ably discussed.
The writer was fortunate enough to be employed on the valuation of the Chicago and Northwestern Railway property in Minnesota in 1906, and possibly some details of the manner in which the actual field work of the survey was done may be of interest.
The work consisted of making a compilation from records, or from actual surveys when necessary, of about 625 miles of railway property, including several important terminals. The property had been built between 1860 and 1901, mostly in the early part of this period. The portions which had been constructed during the latterpart of the period, say from 1890 to 1906, presented no difficulties, as the records were very clear and complete, but the portions constructed in the Sixties had practically no records. Some had been built by small independent companies, which were acquired later by the Northwestern System. On these old lines the records were practically nil, and those in existence were soon found to be of absolutely no use. Even on the newer lines it was found that many changes had been made within a few years after their construction, and that it was sometimes more economical, as regards time at least, to make a new survey of the property than to use the records.
After examining all the old records very thoroughly, and endeavoring to get some order and information out of them, it was decided that the only way to do the work properly was to make a complete survey and valuation of all the physical property. Several field parties were organized and also an office force, about twenty men being put on the work. The parties ran levels for profile purposes, cross-sectioned cuts where necessary, noted evidences of clearing and grubbing, of the character of the cuts, and the disposal of the material, examined the ballast for depth and character, examined the rails for age, weight, and condition, and noted the kind and condition of the fences, gates, farm crossings, planking, whistle and highway-crossing posts, culverts, bridges, and in fact every detail of construction. Advantage was also taken of the survey to re-station the lines, to paint such stations on the rails, and to set permanent posts, so that afterward the stationing could be picked up at any time with little trouble.
In this way there was accomplished much work of value to the railway company, for which there had been a demand by the division officials for years, but which had not been done because of lack of men and money.
No attempt was made to assign depreciation, as regards the rails; this was determined afterward, from the age of the steel in the track. It was necessary, however, to make quite a thorough inspection of the ties, and to note their condition, as they were replaced year by year singly as they wore out. Almost every conceivable kind of timber had been used for ties at one time or another. Treated and untreated ties lay side by side; and thus there was great difficulty in classifying them with regard to the kind of timber. With bridge ties and timbers of frame and pile bridges, there was not so much difficulty, as they were open to inspection, and had been inspected twice yearly by the Division Engineer and the Superintendent of Bridges and Buildings, and accurate records of their condition and renewals had been kept. The depth and condition of the ballast also varied very widely.
In a very short time all the men on the survey became well acquainted with the character of the work they had to do, and, as the work went on, the progress of the party day by day was very muchmore rapid. At the beginning of the survey, a progress of 6 or 7 miles of single track was considered a very good day's work; at the end of the survey, the parties were making from 12 to 15 miles per day.
There was considerable difficulty in setting proper values on the hundreds of buildings, large and small, owned by the railroad. Most of these buildings had never been constructed from plans, and it was difficult to calculate what they had cost originally, and what it would have cost to build them at the time of the survey. However, time books were searched, and the contents of the buildings in board feet were calculated, and, while in many cases their age was not known from any records, it was nearly always possible to find out from somebody just when they were erected.
As intimated before, the railway company derived much actual benefit from the work, outside of the accurate knowledge obtained as to the value of the property itself. Steel charts, bridge records, etc., were established, and profiles, stationing, continuous bench-levels, etc., were all re-run or re-established; thus making the engineering work of the future more consistent and uniform, and enabling more work to be done with a smaller force. New maps of all the station grounds and terminals were obtained, and all the records were put in better shape than they had ever been before.
Examination of some of the old terminals brought to light many strange and out-of-date conditions. Old wrought-iron rails of antiquated pattern, old cast-iron frogs, etc., of a pattern which had not been in general use for fifty years, were found in the track. On some of the little-used sidings, the old wrought-iron rails were so worn that the tread of the rail was entirely gone, only the web remaining to carry the traffic, and such rails were still in use.
In such a valuation, also, many items, some of considerable magnitude, were found which were extremely difficult to classify and assign to their proper place. Such a one, for instance, as a soft, sand rock deposit beside the track, which for many years had furnished engine sand. Many thousand cubic yards of this material had been excavated, but it had not gone into the roadbed as ballast, or to make fills, or to widen embankments. It would hardly have been proper to classify such excavation as grading, for it was an item of engine maintenance and train operation. This is only one of numerous problems which had to be solved.
After all the survey had been made, most of the work of compilation had to be done. Some of it had already been done in the office by the small office force, but the great mass had to be done by the men who did the work in the field. This task was of almost incomprehensible magnitude. There were thousands and thousands of items, and such a great mass of figures that the ordinary man would become lostin the maze. The data had to be checked and re-checked by men who were not accountants, and sometimes most ludicrous mistakes were discovered. However, it was at last accomplished, and the writer's recollection of the "Present Value" of the Chicago and Northwestern property in Minnesota is that it was somewhat more than $23,000,000 for the entire mileage (about 625 miles), or an average of about $37,000 per mile of track. Hardly any of the mileage would be called high-class or trunk-line track, but most of it might be classed as second-class or important branch-line railway.
E. Kuichling, M. AM. Soc. C. E.(by letter).—This paper is a very valuable addition to the literature of a comparatively new subject that is rapidly attaining great political importance, and it gives abundant evidence of deep research and thought by the author. The reasons for determining the true value of such properties, as well as the general principles of making the valuation or appraisal, have been set forth so clearly and convincingly that little can be added in this respect; hence, there is room for comment only about details.
One of the perplexing questions is the determination of the proper value of the right of way and real estate of a railroad. The land was originally acquired at a certain cost, essentially for public use, and in the course of time its value, as determined by reproduction cost, usually becomes greatly increased by the development of the adjacent land by its various owners. Without the railroad, such development and appreciation of land values would probably not have occurred, and, therefore, it has been argued by many persons that, for taxation purposes, the railroad lands should be appraised at only their original cost, while, for capitalization purposes, they should be appraised at a value measured by that of the adjacent land at the present time. This claim is based on the theory that the railroad is like any other piece of public work, such as a canal, highway, or pavement, which is built for the use of the public, and on which no tax is levied by State or municipality. On the other hand, it has been held by some of our Courts that a proper valuation must take into account the appreciation or depreciation of land values; but, as the opinion of a Court is not unalterable, the soundness of this doctrine cannot be regarded as permanently established.
The author states[41]that there can be no serious objection to this doctrine in relation to rights of way in the country and small towns, although he admits that it is subject to exceptions in the case of cities and terminal and dock properties. It will be of great interest to learn his reasons for making such exceptions in the case of the most costly lands, and whether the valuation of such lands should be more or less than that of similar adjacent lands used for other purposes. From the context the inference may be drawn that the valuation should be somewhathigher than that of adjacent similar land in the case of a steam or interurban railroad, because its holdings form a continuous strip; but to the writer this reasoning does not appear satisfactory. The statement of the Court, that "the value of land depends largely upon the use to which it is put and the character of the improvements upon it," does not necessarily involve a higher valuation of the property than its cost, and it is quite conceivable that the actual value of the property after being taken by a railroad may be much less than it was before. The only reason in such a case for maintaining the purchase price is to conserve the general valuation of the adjacent similar real estate.
In dealing with the subject of depreciation, the author has been very brief, as he did not consider it essential for the purposes of the paper. This is to be regretted, as depreciation is an important feature in every valuation, and so few trustworthy data concerning it are available. The value of the paper would be greatly enhanced if the author would give the assumed average life of the principal components of a railroad, based on some definite traffic, and normal grades and curves. Much diversity of practice in this respect prevails, and the final judgment of the numerous experts who were engaged in the Michigan valuations cannot fail to be of great interest. The same remarks are also applicable to the unit prices adopted for construction and equipment.
The subjects of expenses for organization, engineering, administration, contingencies, and non-physical values are treated very thoroughly by the author, and particularly interesting is his discussion of the complex question of franchise value. After quoting from numerous judicial opinions, he reaches the conclusion that the franchise simply protects the owners of the property in their enjoyment of the earnings, and that its value merges into the "fair value" of the property and becomes inseparable from the other non-physical elements of value; also, that the aggregate non-physical value of the property depends only on the net income for a period of years. This method of estimation certainly has the merit of being simple, rational, and free from all hypothetical considerations. It is, however, obviously governed by the rates charged for the services rendered, and if these are likely to be altered at any time by governmental action, a corresponding alteration in the "fair value" of the property will take place.
This consideration brings us at once to the intricate question of reasonable rates, which involves the matter of reasonable design and construction of the property. In most cases the working capacity of the plant must be much greater than the average annual demand for the service performed, as so-called "peak loads" of relatively short duration must be provided for. The magnitude of these peak loads, however, varies with the subsequent development of the territory, which is necessarily conjectural; hence it follows that a comparatively largeamount of capital is often invested in an enterprise for the purpose of taking care of such anticipated temporary demands, and on this investment a "fair return" should be granted. This condition is particularly noticeable in municipal water-works plants, where provision must be made for supplying water for fire service to an extent which may be several times greater than the normal hourly rate of consumption. In the case of railroads, such demands can usually be met by adding to the rolling stock at moderate expense, while in a water-works the outlay is relatively greater because the entire plant must be adapted in the outset to the anticipated maximum delivery in the course of a comparatively long period of time.
The problem of rate-making has been excluded by the author from his present paper on valuation; but, inasmuch as he is so well qualified for the task, and also because the non-physical value of the property depends mainly on the rates obtained for the service rendered, it is hoped that he will deal with this feature in a subsequent paper, thereby bringing out a discussion on the obscure subject of "fair return." It is noticeable that these phrases occur frequently in judicial opinions, but the fundamental principles on which a definite conclusion should be reached are seldom set forth clearly.
Richard T. Dana, M. AM. Soc. C. E.(by letter).—The solution of this problem includes practically all the factors in the general subject of economics, in which engineering occupies a large but by no means preponderant part. Mr. Riggs has done some very valuable and pioneer work in contributing this paper at this time; and the writer, in calling attention to what appears to be a radical error in it, does not wish to be taken as attempting to detract in any way from its great value as a whole. It is most important, in the inception of such an investigation, on the part of the members of this Society, to remove from the subject the stumbling blocks as they appear.
The author makes the following statement:
"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, but the 'value' of any given property on any given date is, or should be, from an engineering standpoint, a definite sum which may not be varied or changed to suit the whim or will of the people for whom the work is done."
The fundamental conception of a value is so important in an investigation of this kind that it is worthy of careful and thorough discussion.
The appraisals which the writer has had occasion to make have generally been for one or other of the following purposes, namely:
Now, in general, a proper value for any property for any one of these purposes is different from its proper value for any of the others. This proposition is of immense significance, for the reason that, if the value for the property arrived at, on one basis, be accepted and applied for one of the other purposes, it will inevitably result in gross injury and financial loss to some one.
In attacking this problem, one must be careful to take the correct standpoint, which is not necessarily that of engineering. Engineering science is indispensable for a large part of the work, but there are other indispensables, which would not ordinarily be recognized as engineering. The writer takes the view that engineering is a part of economics, rather than economics being a part of engineering.
To illustrate this point, consider two objects, one of which is concrete and simple and the other more complex.
(1) A steam shovel belonging to a railroad, costing $10,000, new;
(2) The entire railroad as an operating entity.
Assume for (1) that the shovel has been purchased recently, is in perfect condition, and that the railroad has some work for it to commence on as soon as it can be properly installed. What is its:
(I) The tax assessor cannot properly appraise it at $10,000, because it certainly would not sell for that sum, and if the community should have to sell it for taxes the actual return minus the charges would be so much less than the $10,000 that the community's books would show a heavy loss; and this practice, if largely indulged in, would bring the community into financial straits. The community must be exceedingly conservative in its estimate, for this very reason; and, therefore, it has been customary, almost universally, to tax such articles practically on their sale value at what might be called panic prices. The company which sold the shovel to the railroad would not buy it back two days after the sale for more than the original price minus what that company considers its selling charges, say 20%; so that, in this case, even if a customer were at the door, the shovel would not be worth more than $8,000, and a fair tax appraisal could not consistently be more than $8,000 minus charges of, say, $250, or $7,750.
(II) Assuming that the railroad is a very small one, that it wants to borrow money, and desires to put up the shovel as collateral for the loan. What would be its loan value to the lender? In considering this point, it is necessary to assume that no aid is rendered by the credit of the railroad itself, but that the protection for the loan is to befurnished by the shovel only. Now, the banker will reason that, in the event of the note remaining unpaid, he will have to sell the shovel to reimburse the bank for its loan, and he will be required to consider the matter on a conservative basis. He cannot lend on the shovel up to its full value, for in the first place it is not a "negotiable security." If it were a security, with a free market on some stock exchange, he would probably lend to the amount of 80% of its value, but a steam shovel in a sand bank on a railroad is by no means as convenient of exchange, nor as easy to foreclose on as a stock certificate in a banker's box; therefore he will lend, or he ought to lend, less than 80% of its sale value, minus the selling charges. If he lends more than this, he is lending on the credit of the owner of the shovel rather than on the shovel itself. Granted that the maker of the shovel is willing to buy it back at its full selling price less the selling cost, the maximum loan value of the shovel would be a little less than 64% of its purchase price, or $6,400. To lend more than this on the shovel would not be conservative banking.
There is another bonding or loan value to this shovel, when it is considered as part of the assets of the railroad, the bonds of which are to be held by the banker, under which circumstances a higher value than $6,400 would be admissible.
(III) If the value is to be determined with a view of ascertaining what is a reasonable figure that the owner of the shovel ought to be allowed to earn as a public utility organization, the problem is entirely distinct from the foregoing two cases. Assume that the railroad is entitled to earn at least 6% on its investment in the shovel. Now, its investment is $10,000, because that is the money that it cost; and nothing had been credited to its account, since the shovel had just been purchased and had not yet done any work. The shovel cannot be considered as being worth more than its cost, and it can easily be shown it is not worth less for rate-making purposes.
These three illustrations, which are very briefly outlined, should demonstrate the fact that there is almost no relationship between any two of the different kinds of value which are being considered.
Now, from the standpoint of the railroad as a whole:
(I) Should railroad property be taxed on the basis of what the entire railroad would bring on a foreclosure procedure? Obviously not, because the railroad is taxed in sections. The Town of Squedunk will tax the portion of the railroad that lies within that town, and will have considerable difficulty in putting down as security for its own bonds the locomotives and cars which go through once a week or twice a day at 40 miles per hour. To cover partly the flitting assets, it taxes the railroad on a franchise value. It may tax a railroad's land on the same basis that it taxes land owned by private individuals, notwithstanding the fact that when the railroad buys the right of way itgenerally has to pay more money per acre than the householder or the farmer. This unit cost to the railroad may be two or three times that to the farmer, yet the writer has never heard of a community attempting to tax railroad property two or three times as heavily as adjoining property used for private or commercial purposes.
(II) On the other hand, this same property is an absolutely sound asset for the railroad, and the railroad probably bought the property from the proceeds of the sale of bonds. If the public service commissions were to rule that the railroad may be allowed to issue bonds only to the amount of the taxable value of the property which is to be held as security for the bonds, the result would be an absolute paralysis of railroad construction. A bond is an obligation to pay so much interest for so many years, and to pay back the principal at the end of its term. The bondholder is interested in the absolute regularity of his interest, and in the security that lies behind the principal, and it is to-day the custom of banking houses to consider a bond well secured when, in a territory of reasonably rapid growth, the principal is earning say twice the interest on its bonds, and when the cost of reproduction is in excess of the amount of the bonds, provided that the property is in good physical condition. If it should be necessary to foreclose on the bonds, it is then reasonable to suppose that some one else will buy it in for at least the amount of its bonded indebtedness. What can this possibly have to do with the taxable value of the track in the Town of Squedunk? One may be 1.5 times the other, or three times the other, depending on a multitude of circumstances.
(III) The value of the property for rate-making is a complex one to determine, and, of course, there is no opportunity for a full discussion of it here. One point, however, will serve to establish thoroughly the difference between this and taxable or bonding value. If the community is prosperous and the business is a good one and honestly managed, the railroad ought to be allowed to earn a reasonable percentage, say, at least 6%, on what has been put into it. If the community should decree otherwise, then people will not build railroads for investment purposes, and all will lose money. Now, it is a well-known fact that a new railroad's earnings have to grow for several years before they are on a normal basis, and part of what the owners of the property have put into it is, for example, the interest on its cost before its earnings are on a normal basis. This may amount to a considerable percentage of the original construction cost of the property, if the business is several years in developing. Granted that the community ought to allow the property to earn a reasonable interest on what has been put into it, then the rate-making value will be very much larger than the sum of the taxable valuation of all its different parts. It will also be much greater than its bonding value, because, as a bond proposition, it can borrow money up to a limited percentage of what it is actually worth.
George T. Hammond, M. Am. Soc. C. E.(by letter).—The engineer called on to fix the valuation of public service corporation property has so little engineering literature on this special subject to guide him that he must feel grateful to the author of this excellent paper for adding so much of a kind that is very desirable.
Estimating the cost of an engineering structure in advance of its construction is one of the most ordinary professional duties, but how difficult it actually is, and how much engineers differ with one another in their estimates on the same structure! Perhaps there is no professional duty which calls for so much study and so much experience, or which tests so closely the ability and capacity of the engineer. How seldom professional estimators agree with each other; or designing engineers with contracting engineers; as witness the bids received at the public lettings of contracts when compared with the engineers' estimates of cost; and, if this is true, which no one will attempt to deny, how much more so is it probable that estimators will disagree when they attempt to place a value on works already completed, and in service, perhaps, for many years, in which various changes in value have occurred, and in which questions of fact are mixed with legal questions involving legal rights, as well as financial questions.
The tendency in all such valuations appears to be a mixing up of things in general—like the witches' stew. Everything goes into the pot and is boiled together until all becomes soup, at least until the official commission, like the witches, considers it done and ready to be served up in the form of a report. It is then observed that the substance served out is of a complex nature; that the valuation of engineering structures has become mixed with other and uncertain values; that the whole value, as stated, is, after all, little better than the commission's opinion of the value; and that another commission would reach a different conclusion.
The author states that the valuation of corporation property:
"Should be the honest judgment of the men composing the commission, as to the actual cost of reproduction, present physical value, or 'fair value,' and should be ascertained by a systematic and scientific method which takes into account all the facts concerning the property, its physical value, its strategic location, its operating revenues and expenses, and its franchises, rights, competition, opposition, and all other tangible or intangible elements, which would affect values. The method of valuation should be such as to minimize or entirely eliminate all differences due to errors of personal judgment."
This, it seems, complicates actual present values with conditions which might, or might not, continue. Outside of the physical valuation of the plant, which offers the easiest problem presented, how can one fairly put a value on operating expenses and revenues, which might be affected favorably or advisedly by good or bad management,and by numerous other complex and almost incomprehensible circumstances.
The tendency of all such commissions seems to be to confuse together and mix up some things which are logically separate. Thus, the value of the plant and franchise, good will, and present investment or income value, etc., are too often taken together. The value of the plant is dependent on the cost of reproduction, and also the depreciation of the structures, as engineering structures, and should be based on present prices for which the work could be replaced, minus the depreciation, which is a question of engineering judgment and experience. The other items of value are largely dependent on the situation of the plant and its prospects as an income-producing property, and this again is a matter of opinion, in which the opinions of financiers and investors are sometimes of more moment than those of engineers. The opinion of lawyers as to the value of the franchises and the cost of the legal complications possible or probable must also enter into any seriously worthy opinion as to value.
The few salient lights in the picture of valuation, presented by the author, serve especially to reveal the darkness which involves the whole subject of valuation, estimating, and the use of cost data for such purposes, and to suggest that, with all the wonderful progress on the theoretical side of the profession, engineers have as yet advanced but little in this division of the practical side—cost data, valuation, and estimating. Engineers cannot compare the results of different estimators and appraisers without sorrow and even shame for their ignorance, or their incapacity to agree in the application of scientific principles and the results of practical experience to this branch of their work.
At present we would seem to be a long way from a method of valuation, "such as to minimize or entirely eliminate all differences due to errors of personal judgment."
The method described as having been used by Professor Adams seems to be at least an advance toward a logical and rational method of getting at the value of corporation property, but it must be acknowledged that we are as yet a long way from a perfect method of appraisal, even of the physical values, to say nothing of the non-physical. He held that as nothing visible or tangible gave support to the latter value, it must be determined on the basis of information secured from the income accounts of the company. This method of measure, it would seem, is not unlike the celebrated dictum on the length of the Chancellor's foot, "some Chancellors have a long foot, and some an indifferent foot, and some a short foot"; therefore, a great English Chancellor says, "the length of a Chancellor's foot should not be taken as a measure of rights in equity." Thus, if the income of the company is to be taken by the appraising engineers, or the gross income, it may have to be given a different interpretation from the net income, andif the surplus earnings depend on transient causes or on excessive rates for service it will lead to a totally erroneous conclusion. The same may be said if the rates for service are too low, or if the company is badly managed, or is carrying a great deal of "dead wood," either in the form of property or of servants. Therefore, it seems evident that he who attempts to follow this method of appraisal must possess almost superhuman judgment of present conditions, and prescience to forecast the future, as well as a grade of wisdom and knowledge of existing conditions of trade and industry which may be also characterized as superhuman. In order to apply Professor Adams' method justly, we must know whether the company is wisely managed, whether its income is a fair income, whether its physical property is all useful and needful, whether its service is what it ought to be as to efficiency and economy, etc. We must assume an ideal condition of commerce and industry, and of property value and management, and then appraise the company's property by comparing it, consciously or unconsciously, with this ideal. Possibly this is the best method devised so far, but surely it leaves a great deal to be desired; and it is difficult to see how different engineers, on different sides of the question, representing different interests, can find any common ground of agreement in Professor Adams' method. Under such circumstances, engineers are likely to differ in their results as much as the length of the different Chancellors' feet.
Leonard Metcalf, M. Am. Soc. C. E.(by letter).—Mr. Riggs has done engineers, and more particularly those interested in valuation works, a genuine service in presenting to the Society this admirable paper.
No shrewd observer can fail to recognize the increasingly insistent demand of the public for greater publicity in the accounting, and a larger measure of governmental control in the operation, of public service corporations. In its best form, such control will be welcomed by the corporations, as giving greater stability to investment in such property; in its worst, it may prove a serious limitation to prompt development of the best standards of service. In the water-works field, the anti-corporation movement has resulted in taking over by the public many such plants. It does not seem likely, however, that we are ready to go farther in the railroad field of operation than to demand reasonable regulation of such corporations.
While the writer has had no experience in railway management or valuation, he has devoted much time and thought to the valuation of, and determination of fair-rate schedules for, water-works properties; therefore, what he may have to say in comment on this paper may be assumed to have direct application to water-works valuation, and to railroad valuation only as the similarity in the public service rendered by these corporations may imply.
In the main, the writer subscribes heartily to the views expressed by the author and the temperate way in which he has expounded them. Space forbids discussion in detail of all the matters alluded to and so well covered by Mr. Riggs. On one important subject, however—the inclusion of the going value, or going concern value, of public service corporation property, in the intangible property values, rather than in physical plant value, and the consideration of it as an intangible value rather than as a real and substantial item of cost to the public service corporation—the writer differs from the author. It is clear, from what Mr. Riggs has said, that this is debatable ground, and, from the care and fairness with which he has expressed his views on this subject, one might almost be led to infer that he invites attack on it. It is in no carping spirit of criticism, however, that the following views are expressed.
As the writer has recently submitted to the Publication Committee of this Society a paper on the "Going Value of Water-Works," written by him in collaboration with John W. Alvord, M. Am. Soc C. E., in which a detailed discussion of this subject will be found, only enough will be said to outline clearly his point of view.
The author says:
"The physical property is that which enables the corporation to do business. Without physical property it could not produce the commodity which it sells. The amount of money actually invested in acquiring that physical property represents the measure of capital on which it is morally entitled to earn interest and profit; and, in the stage of promoting and financing the enterprise, all hope of earnings is based on the amount of money required to construct the property."
He also says:
"It would seem reasonable to say that this difference between the physical value and the value based on earnings represents the 'good will,' 'established business,' or 'going value,' and all other non-physical elements of value."
In referring to going value, he says:
"* * * Yet, to fix a value on it by the method described by him [Mr. Alvord] involves going into the realm of conjecture and speculation to a degree that could never be sustained. * * * It can be readily seen that the physical present value is not always—indeed, is not often—the 'fair value.' The 'fair value' may be more, or less, than the present value of the physical property."
"* * * Is it not, then, proper to conclude that the non-physical or intangible value, composed of all these various elements of value, can only be determined absolutely by a study of the earnings and operating expenses? * * *"
He also says:
"The contention that all the different elements of non-physical value merge into one intangible value, not capable of separation, willdoubtless be objected to by many engineers and corporation managers. * * *"
"The writer does not concede that 'going concern' is a proper element to consider in the physical value, as it does not represent any part of the cost chargeable to capital, and the physical valuation should be confined to the determination of capital invested."
Quotations might be multiplied. Those cited, however, will suffice to recall the author's view, and to make clear the point with which issue is taken.
Is Mr. Riggs right in his contention that going value is in fact an intangible value; that going value is not an element of real cost to the company, involving investment of capital; that going value, therefore, should not be included in physical plant value; and that the company is not morally entitled to earn interest and profit on it?
The writer contends that going value is as real an element of cost, in the property of any public service corporation, as is the cost of any portion of its physical plant. It pertains, however, to the business, rather than to the physical plant, of the corporation.
Whatever the difficulties of its computation may be, whatever the methods used—whether that adopted by the Wisconsin Public Service Commission (which is essentially one of determining the original cost of the going value and not its reproduction cost), or whether that perhaps first outlined by Mr. Benezette Williams and George H. Benzenberg, Past-President, Am. Soc. C. E., in the Middle West, and by William Wheeler, M. Am. Soc. C. E., in the East,[42]a method which seeks to determine the reproduction cost of the going value, rather than its original cost—the going concern value has come to be recognized, by water-works appraisers at least, as a substantial element in the cost of the plant, and hence as differing essentially from the franchise element or so-called unearned increments of value.
Is not going value in a "between" class—a middle ground between tangible and intangible values—tangible in that it has involved real cost and expenditure of money; intangible in that it is not as readily calculated as are other reproduction cost items, is dependent fundamentally on the earnings of the company, and that there is no tangible equivalent to show for the expenditure, except the existing income of the corporation? Surely its character is quite different from that of the franchise, as ordinarily found, the value of which, while real, from the rate-payers' point of view, seems to be made out of whole cloth; in short, seems to be of fictitious value.
Certainly, the conjectural and speculative character of the computations—as referred to by Mr. Riggs—involved in the determination of going value is no excuse for failure to recognize going value as areal element of cost, rather than as an intangible value. As a matter of fact, the variation in the views on going value, by engineers who have given this subject particular study, while greater than the variation in their estimates of the reproduction cost of the physical plant, is still far less than the variation in their views on franchise value.
As bearing on the proper basis for rate-making, the author's statement, that the "* * * physical property represents the measure of capital on which it [the public service corporation] is morally entitled to earn interest and profit * * *" cannot be admitted, equitably or legally; and it is not to be assumed that Mr. Riggs desired to imply that this sentence summed up his final views.
Are we not, however, approaching a basis of rate-making, predicated on the earning, by public service corporations, of operation and maintenance expenses, depreciation allowance, and return (i. e., interest and profit) on reproduction cost of the property, less accrued depreciation, plus going value, plus a nominal allowance for the franchise and other intangible values of the corporation? Is it not possible that the recent depression in the business world has been due, in considerable measure, to the shrinkage in the values ascribed to franchise and other intangible value in public service corporation property?
If we are approaching such a limitation, it is the more important that the public should be educated to the fact—not theory, for it is a fact—that going value, or going concern value, is a real element of cost, covering an outlay in effort and money on the part of the corporation, and as such is as much entitled to earn a return (interest and profit) as is the other capital invested in plant. It is not on any items of real and necessary cost to the corporation that the public objects to paying tribute, but on the "unearned increments" and the virtual monopoly "privileges" enjoyed by the corporation and created, in large measure at least, by the public itself and by normal conditions of growth and development for which the public, rather than the corporation, was perhaps responsible—though in many cases it may be urged truly that the corporation itself, rather than the public, has been responsible for the development.
Such a basis of rating, while still dependent on sound judgment and judicial treatment, is nevertheless not beset with the speculative element involved in the capitalization theory, which, Mr. Riggs himself admits, fails as a basis of rate-making except when predicated on fair rates.
If the writer's contention, that going value is a real element of cost in the property of any public service corporation, is sound, Mr. Riggs' statement that, "It appears to be doubtful whether the Court can be construed as approving such an element of value in rate cases," and his interpretation of Judge Tayler's ruling in the Cleveland Street Railway matter,[43]must be challenged.
Certainly, as applied to water-works valuation, Mr. Riggs' statement is not justified. The Maine cases clearly include going value as an element of value on which rates should be predicated; by inference, so does the Kansas City case. In the Knoxville case it was in fact allowed by the Master.
In equity it cannot be doubted that going value should be included in the base on which the returns are predicated, if, as contended, it involves real cost to the company; for the company must be permitted to earn a fair return on this cost, or to liquidate it in some way, as otherwise the corporation would suffer substantial property loss—from 10 to 20%, more or less, of the reproduction cost of its property. This would be contrary to public policy, for, with such an outlook, capital would not enter this field of enterprise, except at increased rates of return, commensurate with this added hazard. To assume such increased rates of return is to provide another means of liquidating such a loss.
As to "good will," it has seemed to the writer more proper to use this term in private competitive corporation enterprises, as applied to the element of value corresponding to the going value of the quasi-municipal or public service corporation enterprises, which latter are in effect controlled monopolies. If the term is used in its more colloquial sense, such as the effect on earnings of having, in the office of the corporation, men who meet the public pleasantly, who are good "mixers," and who are active in getting business, the value is substantially included in the consideration of the income, in the manner involved by going value determination and franchise valuation.
The depreciation question has been discussed so fully elsewhere that the writer only calls attention to the fact that, while physical and functional depreciation only are to be considered in a review of the present physical condition of any plant, in considering a fair-rate schedule, provision should also be made for contingent depreciation, covering such items as cost incident to change in street grades or construction of subways; placing structures under ground, which were previously above ground; serious loss due to injury by electrolysis, the distribution of which over a period of years rather than inclusion in the operating cost for one year, is to be preferred, alike from the public and from the corporate point of view, from the fact that it spreads the burden to be borne by the rates, and prevents violent fluctuation in prices or valuation of the public service corporation's property. The public pays dearly for all hazards. It is wise, therefore, to pursue the conservative course in providing adequate funds to meet extraordinary conditions, and to give stability to the investment of the corporation. Moreover, such funds can be carried in a separate account which can readily be watched; any excess can be credited to future reduction in depreciation account requirements, while a prolonged deficit cannotperhaps be recovered by the corporation, in the light of the Knoxville decision.
The comment that no hard-and-fast rule can cover determination of proper depreciation allowances, is amply justified. In its final analysis, it is a matter of good judgment, experience, and judicial temper.
The author's statement that the organization, legal, engineering, administration, and general expense accounts, "should not be considered as affected by depreciation, as long as the property is a going concern," is not quite clear. Obviously, this is true with regard to all the early organization expenses, as these expenses are incurred once for all, and constitute a continuing asset similar to other elements of plant cost. If, however, the author refers therein also to the engineering and contingent item added to many of the reproduction cost items making up the physical property, exception must be made; for when an old structure, the life of which is gone, is replaced with a new structure, new engineering costs are incurred, and the engineering element of cost incident to the installation of the original structure no longer inheres in the plant. It, too, has passed away with the life of the structure, and, therefore, its cost should be liquidated, or provided for in the depreciation account, as well as the cost of the structure to which it was incident.
In the same way the "interest-during-construction" item is not a continuing asset, but should be liquidated with the complete depreciation of the portion of the structure to which it relates. The replacement of the structure will involve new "interest-during-construction" charges, commensurate with the time required for construction. The value of the initial "interest-during-construction" costs will have disappeared with the original structure and, therefore, should be taken care of by the depreciation account.
The method of making allowances for interest during construction, suggested by the author,[44]accords closely with that used by Mr. Alvord and the writer in a recent valuation of a large water-works property, in which the "interest-during-construction" charges were limited, and the contributions to depreciation account were begun, at the date on which any workable unit of the property was assumed to be available for service and to begin to earn a return on its investment cost, even though the structure, as a whole, was not assumed to be completed for a considerable period of years thereafter. Thus, for instance, it might be assumed that as soon as the supplying works in a water-works project were in operation, the investment in them and in the distribution pipe system laid up to that time, would cease to be credited further with "interest-during-construction" allowances, and would be compelled to earn interest through the water rates or income fromwater supplied to consumers—the fact that the interest charge could not be wholly met, immediately at this time, being taken care of in the resulting increment in going value.
Such a theory, of course, does involve a determination of the probable order and rapidity of construction of the component parts of the property, and this is usually made, in water-works valuation, in the estimate of the reproduction cost of the property.
For the sake of completeness, in reference to the legal decisions of importance in valuation proceedings, attention is called to the Pennsylvania case, Brymervs.Butler Water Company (179 Pa., 231), referred to in the closing discussion on the writer's paper on "Water-Works Valuation."[45]
In this case Justice Williams, speaking for the Supreme Court of Pennsylvania, says:
"By what rule is the Court to determine what is reasonable and what is oppressive? Ordinarily, that is a reasonable charge or system of charges which yields a fair return upon the investment. Fixed charges and costs of maintenance and operation must first be provided for. Then the interests of the owners of the property are to be considered. They are entitled to a rate of return, if their property will earn it, not less than the legal rate of interest; and a system of charges that yields no more income than is fairly required to maintain the plant, pay fixed charges and operating expenses, provide a suitable sinking fund for the payment of debts, and pay a fair profit to the owners of the property cannot be said to be unreasonable."
The Pennsylvania Court, therefore, in the words of William S. Wallace, Esq., recognizes the single standard:
"The Single Standard, according to the Brymer case, while acknowledging the full right of the public to regulate such public corporations, also recognizes as a prime factor its private character and the rights which accrue to it in that capacity, ... and holds to what seems to me the only rational and practicable basis, that a fair return, after deducting the charges above enumerated,isa reasonable rate"; whereas, "the Double Standard basis of fixing a reasonable rate seems to accentuate the public side of the corporation and rather ignores the private element."
As to the propriety of the inclusion of a substantial recognition of franchise value as a basis for rating, the layman may well confess to perplexity, in the light of the conflicting nature of the two important recent United States Supreme Court opinions referred to—the Knoxville case, and the Consolidated Gas Company case—for, while substantial allowance was made for franchise value, in the Consolidated Gas Company case decision, in large measure apparently on account of its earlier recognition by the legislature, in the Knoxville case, in spite of legislative recognition of such value, and similar approval ofthe issue of securities predicated on such recognition, the United States Supreme Court failed to make similar allowance for franchise value.