physical valuation; that no attempt was made to secure a "fair value"
(the language of the Courts), and that the value as a going concern was
not attempted to be given. In no case is the statement made that
Professor Cooley had charge of the physical valuation in Michigan, and
that Professor Adams took this physical valuation, and, under his
method, treated it as one element, and with it and other data derived
from a study of the reports and earnings of the company, undertook to
determine a "non-physical," "intangible," "franchise," or "going
concern" value, which included all tangible elements, and which, added
to the physical value, was assumed by Professor Adams to give the true
value. Had such a statement been fairly made, no possible objection
could be raised to the making of any number of points against the
correctness of the methods used by Professor Adams.
"Certainly it cannot be denied that a road between New York and Chicago,
950 miles in length, passing through a manufacturing district, is of
greater value than a road 1,200 miles in length, between the same
cities, but passing through a hilly and undeveloped territory a portion
of the distance, and through a farming section for a greater portion of
the remaining distance; yet the advocates of a physical valuation would
have us believe that there is no difference in the value of the two if
they can be reproduced to-day at the same cost."
This statement is entirely unfair to every man who has been in
responsible charge of valuation work in recent years in the United
States. No theory has ever been favored by any honest-thinking advocate
of a valuation. In the first place, no interstate valuations have ever
been made, and no parallel case to the one assumed is to be found,
except for very short sections of roads, a very marked instance having
been referred to elsewhere in this paper. Such a condition as assumed
would be reflected in the earnings of the companies to such an extent as
to cause the non-physical element of Professor Adams as used in Michigan
to correct largely or wholly the inequality and inaccuracy of the
physical valuation; such at least was the theory, and, if carried to its
logical end by the use of negative non-physical values, such would be
the result.
The final arguments of Mr. Williams' address are devoted to an attack on
the plan outlined by the Interstate Commerce Commission for valuation,
and on some of the accounting methods of the Commission—points not
proper to be discussed in this paper—but it is difficult indeed to read
them without noting the apparently studied misrepresentation of the real
attitude of Professor Adams and the Commission, and the evident object
of the entire address to create a wrong impression regarding what has
been done, and a prejudice against the men who have been engaged on
State appraisal work and those who advocate the appraisal of properties
as a proper step in the way of securing such information as will enable
an intelligent consideration of the great corporation problems that must
be solved.
-----
Footnote 12:
_Proceedings_, Am. Water-Works Assoc., 1902.
Footnote 13:
Commencing with the issue of January 22d, 1909.
Footnote 14:
The _Railroad Gazette_, April 19th, 1901, Vol. XXXIII. No. 16. p. 271.
Footnote 15:
_Railroad Age Gazette_, April 2d, 1909, p. 761.
Footnote 16:
_Railroad Age Gazette_, January 29th, 1909, p. 219.
THE DETERMINATION OF ELEMENTS OF VALUE AND METHODS OF
VALUATION BY THE COURTS.
The preceding narrative of methods of appraisal work logically leads up
to the question: Will these methods that have been adopted in various
appraisal undertakings stand the test of the Courts? After all, the
final seal of approval must be stamped on a method by the highest Courts
before it can be said to be a definitely fixed and determined principle
for general use in valuation.
In a careful perusal of many papers on this subject, quotations from
judicial decisions will be noted which are literally correct as far as
they go, but which are incomplete and often very misleading; and often
such incomplete quotations are presented as to convey an entirely wrong
impression of the full decision. In order that no such charge may lie
against this paper, the quotations given are full enough to indicate
clearly the intent of the Court, even at the expense of undue length.
An examination of all Federal and Supreme Court cases which bear on the
subject of property valuation has been made, and quotations at length
from some of the older cases, establishing precedent, together with
citations to more recent decisions, are submitted. It is believed that
the points of principle and method, in so far as they have been
determined by the highest Courts, are quite fully set forth.
A study of the complete methods of the railroad valuation in Michigan,
in connection with these decisions, discloses the fact that they comply
with the requirements of the earlier cases, that all matters affecting
value be taken into consideration, and that in the more recent decisions
the detailed methods adopted in the Cooley physical appraisal have been
sustained as to very many points. In no case have any of such methods
been unfavorably criticized, and, while at this date the Supreme Court
has not squarely passed on the propriety of any method for securing
non-physical or intangible values, it has fully sustained the general
position of Professor Adams in several important points. In addition to
the complete examination of Federal cases, certain very interesting and
valuable State cases have been examined, and some of them are quoted.
These cases involve both matters of taxation and rate-making. They cover
railroads, water-works, gas-works, and other classes of public service
corporations, and clearly demonstrate the fact that any analysis of the
subject of property valuations must include all classes of corporations.
Rate-making and taxation in themselves are entirely separate and
distinct from valuation, which is a necessary preliminary step in either
undertaking. For this reason all references which are not of special
interest in the valuation part of the problem are omitted.
The case of Smyth _vs._ Ames (169 U. S., 466) was an action to question
the constitutionality of a statute of Nebraska establishing rates. It is
of great interest, and, based on the ruling of the Court in this case,
the appraiser in Washington and the appraisers in Nebraska have
undertaken to secure first cost as an element of value. The decision
holds that:
(1) A railroad corporation is a person within the meaning of the
fourteenth amendment.
(2) A State enactment establishing rates that will not admit the
carrier to earn such compensation as would be just to it and
to the public, would deprive such carrier of its property
and would be repugnant to the fourteenth amendment.
(3) Rates established by a State cannot be so conclusively
determined by the legislature that they cannot become the
subject of judicial inquiry.
The reasonableness of rates prescribed by a State for intra-state
business must be determined without reference to the interstate business
done by the carrier or the profits derived from that business.
This paper is not concerned with the question of rates, which is
discussed at length in this decision. It is, however, of special
interest to note what the Court says in regard to the relation of the
corporations to the people, and to elements of value.
"A railroad is a public highway, and none the less so because
constructed and maintained through the agency of a corporation
deriving its existence and powers from the State. Such a corporation
was created for public purposes. It performs a function of the
State. Its authority to exercise the right of eminent domain and to
charge tolls was given primarily for the benefit of the public. It
is under governmental control, though such control must be exercised
with due regard to the constitutional guaranties for the protection
of its property.... It cannot therefore be admitted that a railroad
corporation maintaining a highway under the authority of the State
may fix its rates with a view solely to its own interests and ignore
the rights of the public. But the rights of the public would be
ignored if rates for the transportation of persons or property on a
railroad are exacted without reference to the fair value of the
property used for the public, or the fair value of the services
rendered, but in order simply that the corporation may meet
operating expenses, pay the interest on its obligations, and declare
a dividend to stockholders.
"If a railroad corporation has bonded its property for an amount
that exceeds its fair value, or if its capitalization is largely
fictitious, it may not impose upon the public the burden of such
increased rates as may be required for the purpose of realizing
profits upon such excessive valuation or fictitious capitalization,
and the apparent value of the property and franchises used by a
corporation, as represented by its stocks, bonds, and obligations,
is not alone to be considered when determining the rates that may
reasonably be charged."
(The Court here quotes 164 U. S., 578, Covington and Lexington Turnpike
_vs._ Sanford.)
"A corporation maintaining a public highway, although it owns the
property it employs for accomplishing public objects, must be held
to have accepted its rights, privileges, and franchises subject to
the condition that the government creating it, or the government
within whose limits it conducts its business, may by legislation
protect the people against unreasonable charges for the services
rendered by it. It cannot be assumed that any railroad corporation,
accepting franchises, rights, and privileges at the hands of the
public, ever supposed that it acquired, or that it was intended to
grant to it, the power to construct and maintain a public highway
simply for its benefit, without regard to the rights of the public.
But it is equally true that the corporation performing such public
services, and the people interested in its financial affairs have
rights that may not be invaded by legislative enactment in disregard
of the fundamental guaranty for the protection of property. The
corporation may not be required to use its property for the benefit
of the public without receiving just compensation for the services
rendered by it. How such compensation may be ascertained, and what
are the necessary elements in such inquiry, will always be an
embarrassing question.
"We hold, however, that the basis of all calculations as to the
reasonableness of rates to be charged by a corporation maintaining a
highway under legislative sanction must be the fair value of the
property being used by it for the convenience of the public. And in
order to ascertain that value the original cost of construction, the
amount expended in permanent improvements, the amount and market
value of its bonds and stocks, the present as compared with the
original cost of construction, the probable earning capacity of the
property under particular rates established by the statute, the sum
required to meet operating expenses, are all matters for
consideration, and are to be given such weight as may be just and
right in each case. We do not say that there may not be other
matters to be regarded in estimating the value of the property. What
the company is entitled to ask is a fair return upon the value of
that which it employs for the public convenience. On the other hand,
what the public is entitled to demand is that no more be exacted
from it for the use of a public highway than the services rendered
by it are reasonably worth."
The body of this decision is quoted at length to show:
First. That the Court reiterates the relation of the people to
the corporation, as defined by Covington and Lexington
Turnpike Road _vs._ Sanford (164 U. S., 578) and by Stone
_vs._ Farmers' Loan and Trust Company (116 U. S., 307).
Second. That the basis for computing a fair rate is the fair
value of the property, which must be arrived at by a
computation or series of computations taking into account
many different factors.
Third. That while the Court mentions certain things that may
serve as indices of value, which are to be taken into
account and given due weight, the Court does not outline or
define any method of arriving at a value, but does recognize
it as an embarrassing question.
Fourth. That no such stress has been laid by the Court on
original cost as has been construed by some appraisers.
The principles enunciated in Smyth _vs._ Ames are reiterated by the
Court in San Diego Land Company _vs._ National City (174 U. S., 739),
with the further ruling:
"The contention of the appellant in the present case is that, in
ascertaining what are just rates, the Court should take into
consideration the cost of its plant; the cost per annum of operating
the plant, including interest paid on money borrowed and reasonably
necessary to be used in constructing the same; the annual
depreciation of the plant from natural causes resulting from its
use; and a fair profit to the Company over and above such charges
for its services in supplying the water to consumers, either by way
of interest on the money it has expended for the public use, or upon
some other fair and equitable basis. Undoubtedly, all these matters
ought to be taken into consideration and such weight given them,
when rates are being fixed, as under all the circumstances will be
just to the company and to the public. The basis of calculation
suggested by the appellant is, however, defective in not requiring
the real value of the property and the fair value in themselves of
the services rendered to be taken into consideration. What the
company is entitled to demand, in order that it may have just
compensation, is a fair return upon the reasonable value of the
property at the time it is being used for the public. The property
may have cost more than it ought to have cost, and its outstanding
bonds for money borrowed, and which went into the plant, may be in
excess of the real value of the property. So that it cannot be said
that the amount of such bonds should in every case control the
question of rates, although it may be an element in the inquiry as
to what is, all the circumstances considered, just to both the
company and the public."
In the case of Columbus Southern Railway _vs._ Wright (151 U. S., 479),
the Court quotes approvingly from Franklin Company _vs._ Railroad (12
Lea (Tenn.), 521-537-538-539), and shows that the doctrine quoted had
already been enunciated by the Supreme Court in the State Railroad Tax
Cases (92 U. S., 575-607). The Court quotes as follows:
"The property of a railroad company for purposes of taxation
consists of its realty, its local personalty, its rolling stock, its
choses in action, and its franchises. The franchise is a privilege
conferred by the charter of incorporation, namely the right to
exercise all the powers granted in the mode prescribed for the
purpose of profit. It is a unit not confined to any one county in
which it may be exercised.
* * * * *
"Obviously, after ascertaining the value of the entire franchise in
the State as a unit, no more approximate or just division of this
value can be made for purposes of taxation than to allot it among
the counties through which the track runs in proportion of the
entire length of track in the county to the entire length of track
in the State....
"The roadway itself of a railroad depends for its value upon the
traffic of the company and not merely upon the narrow strip of land
appropriated for the use of the road, and the bars and cross-ties
thereon. The value of a roadway at any given time is not the
original cost, nor, _a fortiori_, its ultimate cost after years of
expenditure in repairs and improvements. On the other hand, its
value cannot be determined by ascertaining the value of the land
included in the roadway assessed at the market price of adjacent
lands, and adding the value of the cross-ties, rails, and spikes.
The value of land depends largely upon the use to which it is put
and the character of the improvements upon it."
The mileage basis of apportionment is sustained in the following and
other cases:
State Railroad Tax Cases 92 U. S., 608
Delaware Railroad Tax Case 18 Wall., 206
Erie Railway _vs._ Pennsylvania 21 Wall., 492
Western Union Telegraph Company _vs._ Mass 125 U. S., 530
Pullman Palace Car Company _vs._ Pennsylvania 141 U. S., 18
Maine _vs._ Grand Trunk Railway 142 U. S., 217
Pittsburg, Cincinnati, Chicago, and St. Louis Railway 154 U. S., 430
_vs._ Backus
Therefore this basis of division of values between territorial units
appears to be well established by precedent. This is in a measure
unfortunate, as certain classes of property cannot be apportioned
equitably in this way, unless the value of a railroad be determined, and
then that value allocated between different territorial units in
proportion to mileage, without any regard to the location of any
structure or series of structures in any State or county, the
track-mileage basis must be looked upon as a method of apportionment
which is subject to modification or which will lead to error.
In an Indiana tax case, Cleveland, Cincinnati, Chicago, and St. Louis
Railway _vs._ Backus (154 U. S., 444), the late Justice Brewer, of the
Supreme Court, in handing down the judgment, said:
"The true value of a line of railroad is something more than an
aggregation of the values of the separate parts of it, operated
separately. It is the aggregate of those values plus that arising
from a connected operation of the whole, and each part of the road
contributes not merely the value arising from its independent
operation, but its mileage proportion of that flowing from a
continuous and connected operation of the whole.... The value of
property results from the use to which it is put, and varies with
the profitableness of that use, past, present and prospective,
actual and anticipated. There is no pecuniary value outside that
which results from such use....
"In the nature of things it is practically impossible, at least in
respect to railroad property, to divide its value and determine how
much is caused by one use to which it is put and how much by
another. Take the case before us, it is impossible to disintegrate
the value of that portion of the road within the State of Indiana
and determine how much of that value springs from its use in doing
interstate business and how much from its use in doing business
wholly within the State. An attempt to do so would be entering upon
a mere field of uncertainty and speculation."
In the Michigan cases, the principal one being Michigan Central Railroad
_vs._ Powers (201 U. S., 245), the question of method of valuation was
not passed on by the Courts for the reason that, after the evidence was
in, and during the argument, counsel for the railroad admitted that the
Cooley valuation was as correct a figure as it was possible to secure
under then existing conditions, methods and rates of taxation being the
issue.
It is thus seen that the Supreme Court of the United States was not, in
any of the earlier cases, required to pass squarely on the propriety of
any method of arriving at a "fair value," and consequently had not,
prior to 1909, defined any hard-and-fast rules of procedure in
determining such value. The Circuit Courts have passed on kindred
questions in a few cases, among which San Diego Land and Town Company
_vs._ National City (74 Fed., 83), and San Diego Land and Town Company
_vs._ Jasper (110 Fed., 714) hold as above, and cite most of the cases
referred to. In the latter case the Court says:
"The actual value of such property obviously depends upon a variety
of considerations—among them the actual and prospective number of
consumers—and is no more unchangeable than the value of any other
kind of property."
As an illustration, there is cited the effect of a year's drouth on an
irrigation plant as temporarily affecting the value of property.
In the case of Cotting _vs._ Kansas City Stock Yards (82 Fed., 839) the
Circuit Court touches on one very interesting argument, in the light of
some of the methods of valuation advocated by railway managers and some
of the criticisms of recent valuation work.
"Different methods of estimating the value of property may properly
be employed when it is valued for different purposes. When a
valuation is placed on property which has become affected by a
public use, for the purpose of ascertaining whether the maximum rate
of compensation fixed by law for its use is reasonable or otherwise,
it is obvious that the income derived therefrom by the owner before
it was subjected to legislative control cannot always be accepted as
a proper test of value because the compensation which the owner
charged for its use may have been excessive and unreasonable. Again,
when property has been capitalized by issuing stock, neither the
market value nor the par value of the stock can be accepted in all
cases as a proper criterion of value, because the stock may not
represent the money actually invested, and furthermore because the
property may have been capitalized mainly with reference to its
income producing capacity, on the assumption that it is ordinary
private property which the owner may use as he thinks proper without
being subject to legislative control. On the other hand, however,
when property is valued for the purpose last stated, it is clear
that the owner thereof is entitled to the benefit of any
appreciation in value above the original cost and the cost of
improvements, which is due to what may be termed natural causes. If
improvements made in the vicinity of the property, the growth of
city or town where it is located, the building of railroads, the
development of the surrounding country and other like causes, give
property an increased value, the owner cannot be deprived of such
income by legislative action which prevents him from realizing an
income commensurate with the enhanced value of his property."
The language of the late Judge Brewer, sitting as one of the circuit
judges in the case of National Water-Works Company _vs._ Kansas City (62
Fed., 853), is definite as to the necessity of taking into account some
elements of intangible value, and is here quoted as giving the views of
this eminent jurist:
"The difficult question, however, still remains; and that is, what
is the 'fair and equitable value,' which by the statute and
ordinance the city is to pay for the water-works? * * * We are not
satisfied that either method, by itself, will show that which under
all the circumstances can be adjudged the 'fair and equitable
value.'
"Capitalization of earnings will not, because that implies
continuance of earnings, and a continuance of earnings rests upon a
franchise to operate the water-works. The original cost of
construction cannot control, for original cost and present value are
not equivalent terms. Nor would the mere cost of reproducing the
water-works plant be a fair test, because that does not take into
account the value which flows from the established connections
between the pipes and buildings of the city. * * * A complete system
of water-works, such as the company has, without a single connection
between the pipes in the streets and the buildings of the city would
be a property of much less value than the system connected as it is
with so many buildings and earning, in consequence thereof, the
money which it does earn. The fact that it is a system in operation,
not only with a capacity to supply the city but actually supplying
many buildings, in the city—not only with a capacity to earn but
actually earning—make it true that the 'fair and equitable value' is
something in excess of the cost of reproduction."