development of large cities has compelled electric lines to extend
largely. The demands of the people for more frequent and more rapid
service, and more modern and larger equipment, have greatly shortened
the term of life of power-plant equipment and cars. The rapid
development in the art of electricity, the congestion of traffic in
streets of cities, the enormous increase of train movements, and the use
elsewhere of newer types of cars, have compelled the abandonment of
millions of dollars' worth of property and the investment of other
millions in new and improved facilities to provide for the increased
movements of traffic and increased safety to the public. These changes
are not due to the fact that the original installation was defective,
but to the demands of the public for frequent, safe, and speedy service,
demands which are perfectly reasonable. The query is: should a
corporation which complies with public demands be compelled to lose
capital invested in facilities which have not yet paid for themselves;
and which, under a continuance of conditions which existed when they
were installed, or any that might then have been anticipated, would
normally have a useful life of several more years, and which were
abandoned, not by reason of being worn out or unfit for service, but
purely because facilities of a more modern type were called for?
To answer this affirmatively increases the hazard of investment greatly
in the large centers of population. To answer it affirmatively in some
cases might amount to confiscation of property. The writer inclines to
the view that, as far as appraisal is concerned, the value due to the
remaining life of the abandoned facility, where such abandonment was in
response to legal requirement, and where no element of corporate
necessity due to increased efficiency or economy of the new facility
enters into the computation, should be added to the value of the
facility replacing it. Any consideration that is given such claims by an
appraiser must be most careful, as the inference to be drawn from the
decision of the Court in the Knoxville Water Case (212 U. S., 1) is that
such elements of value will receive scant consideration unless most
fully supported.
If the policy of the management of any public service company is to keep
up with the demands of modern civilization, it would appear that such
policy should not be discouraged, and, in computing the value of the
property, some provision ought to be devised for covering such values as
remain in serviceable property at the time of its abandonment in
response to public demand; or else the rates for service should be
increased sufficiently to compensate the corporation for losses of this
nature on the ground that it constitutes an element of extra hazard.
These and like subjects in connection with the appraisal must be taken
up during the period of computation and settled. The computing office
organization and methods call for no special comment, except to
emphasize the need of experienced men, the use of every possible check
on the accuracy of the work, and the prime necessity of keeping all
notes in such manner that they can be identified and used to
re-establish every step taken in the course of the appraisal.
IV.—The Preparation of the Final Figure.
The final form of the work is, of course, so much a matter of personal
judgment that even a suggestion may appear to be useless. The use of
such a classification as will conform approximately, if not exactly,
with that adopted by the Interstate Commerce Commission is more
desirable now than it was 10 years ago, as all the roads in the country
are using this classification in their accounts, and the more nearly
uniform the work of various State appraisals, the better the results
will be.
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Footnote 18:
Unchangeable only for the period under consideration and as regards
the purpose of the appraisal. This value varies from year to year,
depending on business conditions and on earnings of the company.
NON-PHYSICAL VALUES AND METHODS FOR THEIR DETERMINATION.
In the published articles treating on the subject of valuation, much
stress is laid on the intangible or non-physical elements of value. They
have been termed "going concern values," "business values," "good will
values," "franchise values," as well as "non-physical" and "intangible"
values.
So much of the argument of many writers has been taken up with this
phase of the question that it is impracticable to recapitulate the
various arguments in support of giving these elements a place in the
appraisal.
The writer cannot agree with those who would place any of these elements
of value in the physical appraisal.
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 actual investment of capital in a new plant is
made with the expectation of earnings. It is not reasonable to attach as
physical value, to such a plant, any value in excess of the actual
investment. Nor does it appear to be any more reasonable, in the case of
an old plant, to assign arbitrary and fictitious values over and above
the actual investment remaining in the plant, unless such values are
justified and supported by actual earnings in excess of such a rate of
interest on the money invested, as it would earn if invested in some
non-hazardous security, and—carrying out the clearly-expressed idea of
the Courts—such intangible value can only accrue when the rates charged
for the service are fair and proper.
The capitalist seeking investment bases his ideas of value on:
(_a_) The market price of stocks and bonds, an estimate of worth
based primarily on actual earnings of the property, but
affected to some extent by outside conditions; or
(_b_) On the capitalized net income, or actual earnings, of the
property; or,
(_c_) In the case of a new property, on an estimate of what the
probable earning capacity of the property will be, where the
business is more fully developed.
Methods (_a_) and (_b_) ignore cost of construction, or present
investment in physical property, and base a value on past performances.
Method (_c_) is based purely on hypothetical earnings, but the only real
measure of value in this instance is the actual amount of capital that
has been invested.
No appraiser would be justified in placing a "going concern" value, in
excess of original cost, on a new property, nor would he be justified in
placing such a value on a property 3 years old, or 10 years old, unless
the net earnings were such as to indicate that the property had a
business or commercial value in excess of the physical property value.
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 the other
non-physical elements of value.
To take a specific example: it would be impossible to separate the
different elements of intangible value of the Michigan Central Railroad,
and say that a certain sum of money represented "good will," another sum
"established business," still another sum the "franchise value," and
still another sum the "going concern."
The "going concern value" of the Michigan Central Railroad is exactly
analogous to the going concern value of the hypothetical water-works
cited by Mr. Alvord. Instead of having water pipes connected with
buildings along the mains, and considerable sums invested in appliances
for using the water, there are manufacturing plants located along the
railroad, connected with it by side-tracks built by the industry, and
depending on the transportation facilities of the road for their
connections with their customers, the very life of the manufacturing
plant dependent on its connection with the road. This is "connected good
will" of the same kind as described by Mr. Alvord. Yet, to fix a value
on it by the method described by him involves going into the realm of
conjecture and speculation to a degree that could never be sustained.
Difficulties as great would be encountered in an effort to separate and
set up any other elements which go to make up the intangible value, and
any figure thus determined would be absolutely incapable of proof.
The Courts say that the value must be the "fair value of the property
being used," all the conditions being taken into account (169 U. S.,
466).
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. It would
seem to be reasonable to interpret the Court's meaning of the term "fair
value" to be the value as a business or commercial property, taking into
account the actual investment existing in the property, together with
any favorable conditions which would enable it to earn, on rates which
were fair and reasonable to the consumer, an income in excess of a usual
rate of interest on the actual investment, or any unfavorable ones which
under the same rates would reduce its earnings to less than usual
interest. If such an interpretation be allowable, it would appear to be
correct practice to use a "fair value" made up of two elements: a
physical value, representing the investment, and a non-physical value,
representing all the elements which affect that investment to give it
favorable or unfavorable financial returns. 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? Is not this clearly what
the Court had in mind in the Nebraska Rate Case?
Much of the argument on the subject of "going" values and other kindred
elements of value consists of statements of theory and generalities, and
may be said to be merely argument to support the theory that there is an
intangible element of value. If work of valuation is to be of any real
benefit, must it not give a definite result? Must not this result be
based on absolute facts?
In securing the present value of any physical property the fixed and
certain facts are:
The inventory of property owned.—This is absolute.
The cost of reproduction of the different elements.—This is
capable of determination within very close limits.
The depreciation.—This is in a measure a matter of judgment,
based on the experience, not only of the engineers making
the appraisal, but of the entire scientific world; and, if
properly made and properly checked, there should be no very
wide divergencies in results.
The items of general expense.—These, based on available
statistics, must be estimated. The exact determination of
these items will be made comparatively easy as statistics
based on the uniform classification of accounts become
available.
It is believed that the physical values, when secured along the lines
suggested, are definite enough to be accepted as a fair estimate of the
amount of capital actually invested in the property, and that, if a
sufficiently large force of men experienced in the construction,
operation, and financial management of the kind of property under
investigation is engaged on the work, the element of uncertainty due to
errors of personal judgment can be largely eliminated.
The next question to be determined is whether there is, at the time of
the appraisal, any non-physical value, and, if so, to select a method
for computing it that will give a result that can be definitely
supported as to the particular property under investigation. A study of
the income accounts of the property being valued should be made. If the
property is not earning a sufficient sum to pay its operating expenses,
and taxes, and to set aside a fund to cover depreciation and
obsolescence, there is clearly no intangible value of any sort to be
added to the physical value. If, however, after all these charges are
taken care of, there is a net earning which is large enough to pay 4 or
5% on the physical property and still leave a surplus, is it not
perfectly reasonable and proper to hold that this surplus represents
earnings on all intangible elements of value?
The contention that all the different elements of non-physical value
merge into one intangible value, not capable of separation, will
doubtless be objected to by many engineers and corporation managers.
Among the elements adding value to property have been described:
_1.—"Going Concern" Value._—Professor Mead defines this as the value due
to the fact that a plant has consumers actually utilizing its product,
and that it is in actual and successful operation and has its business
developed. This value is the worth of the plant in excess of a similar
plant without connections, and constitutes an asset in the consideration
of its physical value. Mr. Alvord has used the term "connected good
will" as applicable to this element of value.
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.
It has already been argued that to the physical property as inventoried
should be added proper figures to cover organization, legal expense,
administration, engineering, and contingencies. All these items are in
the nature of additions on account of the fact that the property is a
"going concern." It is maintained that these costs should carry to the
present value column as values, for the reason that all these services
rendered in connection with the creation of the property remain,
unimpaired in value, as long as the property is operated. When, however,
a property ceases to be operated, and is abandoned and dismantled, not
only do all these elements absolutely disappear, but also all increments
of value by reason of the special use of the property are wiped out, and
there exist only a lot of partly worn out and partly obsolete machinery
and equipment, salable at scrap values, buildings constructed for a
purpose which renders them unfit for other use, and land partly salable
at going prices and much that will not sell at all.
As long as a gas-works, a water-works, or a railroad is in operation and
earning, it is a "going concern," and all increments which attach to its
physical property as a whole continue to exist, even if the physical
value of the property is greater than a fair value. That fair value can
be determined and reached by means of a negative non-physical value.
In view of these things, it would seem to be highly improper to add to
physical value anything more for "going concern." In the final report of
U. S. Judge R. W. Tayler, Arbitrator in the Cleveland Street Railway
matter, in December, 1909, the following language supports the above
contention:
"I allow nothing for going value, except in so far as that is the
result of the necessary expenditure of money in building the road,
acquiring its land, power-houses, and equipment, and putting them
into successful operation. The expenditures for these purposes are,
and necessarily must be, included in the valuation of the physical
property."
_2.—Developed Business._—It is perfectly clear that the "fair value" of
a property must take into account the established business of the
concern. This really is covered by the "going concern values," as
defined by Messrs. Mead and Alvord. The only manner in which this can be
determined intelligently is by an analysis of income accounts.
_3.—Cost of Handling Business._—A railroad with heavy grades, bad
curves, poor equipment, or unskilful management is not nearly as
valuable a property as one having good line and grades, and far-sighted,
economical, and skilful management, and which handles its business at a
lower cost per unit.
In such cases the differences in location and management are bound to
show in the earnings, adding to the physical value of one property and
possibly taking from the value as shown by the physical appraisal in the
case of another.
_4.—Good Will and Established Organization._—These are valuable assets.
It is difficult, indeed, to attach exact weight to these elements of
value, except as they are shown in the intangible value indicated by the
earnings. In most cases of public service companies, as is argued
elsewhere, it is doubtful if such elements are entitled to any place in
a public valuation.
_5.—Franchise Values._—These cover various specific items arising out of
the ownership of special franchises, or, out of the general rights
granted by law to corporations.
All these elements of value have been presented, and have been supported
by able arguments. No one has offered a method of separating them. While
there is universal recognition of their existence, in the case of many
properties, they are supported by nothing visible or tangible. They are
practically inseparable, one from another. They are not always present,
and the application of any such arbitrary rule as that suggested by Mr.
Alvord would make it possible to place values which were purely
fictitious. Therefore, it follows that, if they are to be considered at
all, they must be treated as parts of one intangible value, and that
value must be derived from a study of the income account of the
property.
There are other points to be noted as reasons why no such elements of
value may attach to the physical property.
Any value of an old and well-established property in excess of a fair
return on its physical property (in other words, any intangible value)
must be limited and restricted, when used for rate-making purposes, by
the value to the consumer of the services rendered. The Courts hold so
squarely that the rates charged for services must not be more than the
particular service is worth, and that the Company may exact a fair
return on property actually being used, that it is not conceivable that
any valuation which attempts to attach fictitious elements of value to
physical property can be sustained.
This argument is not intended as an attempt to show that intangible
values are improper and that where they exist rates should be lowered.
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. It is further contended
that the work of valuation should separate the tangible and intangible
elements, so that the further work of rate-making or assessment may not
be complicated by improper elements which are included among the items
of the physical properties.
In consideration of franchise value, the history of the corporation
should be investigated with a view to determine what part the public
played in the creation of the property.
The granting of aid bonds, of public lands, and of aid money to
railroads, the giving of encouragement to water-works companies by the
payment of excessive hydrant rentals, are illustrations of the fostering
and development of public service utilities by the public to such an
extent as to justify in a large measure the claim that in many cases the
allowance of an intangible value is improper as against the public.
A further consideration in the matter of intangible values is the fact
that they all partake more or less of the nature of "good will," and the
question very properly arises, in the case of a purchase by the public,
or of a rate-making valuation: "Should the public be compelled to pay
for its own good will?" In the case of such a corporation as a
street-railway company in a large city, any value arising from a surplus
of earnings is due to the franchise, established business, or going
value, or good will of the citizens of that city. This element of value
frequently sustains an excessive bond indebtedness. At the expiration of
the franchise period the citizens of that city consider a purchase, and
are asked to pay, among other things, for their own good will. In view
of the attitude of the Federal Courts in the Consolidated Gas Case, and
the language of the lower Court in disallowing the item of "good will,"
which judgment was sustained by the Supreme Court, it is very evident
that any attempt to fix arbitrarily a value on such an item in an
appraisal is not likely to be supported successfully. The grounds named
by the Court are:
Tangible property has a value apart from any franchise or good
will value.
The franchise, conferring the privilege to be a corporation, to
use public property, to be free from competition, and to
enjoy many other privileges, has some value apart from
tangible property.
Good will can have no existence as apart from or detached from
the franchise conferring the necessary privilege. Such good
will (by itself) is not capable of being capitalized and
distributed among stockholders.
Citizens are entitled to have gas (or water) because they
pay for it, exactly as they are entitled to have clean
streets (and, in the same way, police protection or fire
protection), because they pay taxes among other things
for that.
The Court, therefore, finds that there is no good will value in
connection with the gas business in the City of New York, although it is
said, elsewhere in the finding, that it is the best, most favorably
located, and most prosperous business of its kind in the country.
Judge Tayler, in the Cleveland Railway arbitration, says:
"I allow nothing for good will. A street railway company which has a
monopoly, and especially if it has a franchise value remaining, can
have no good will value."
Judge Lurton, in the Omaha Water-Works Case, says:
"That kind of good will, as suggested in Willcox _vs._ Consolidated
Gas Co., is of little or no commercial value when the business is,
as here, a natural monopoly with which he must deal, whether he will
or no."
In connection with a consideration of franchise values, the following
points are raised by the Federal Court in the Consolidated Gas Cases
(157 Fed., 872-879):
"Should a corporation have a right to demand an income return,
separable from any return upon its tangible property, from its right
to place gas mains in the public streets and maintain them for its
private profit, a right which it did not buy from city or state or
pay therefor any legal valuable consideration? The Court thinks not,
because 'Return can be expected only from investment, and he that
invests must part with something in the act of investing.' Does any
company invest its franchise in its business? It does not part with
its franchise in the same way it parted with money or money's worth
in acquiring or creating mains or plants. The investment of property
was made, not in the franchise, but under the franchise, and on the
faith thereof. The franchise is but a part of the power or
sovereignty, allotted to a private person for the benefit of all,
and only incidentally given for private emoluments.
"What is the value of a franchise to perform a certain service,
under which no money is invested and no service yet performed? What
is it worth apart from performance under it?
"Unless it can be seen to possess inherent value entirely apart from
the earning capacity of the subsequent investment or from the actual
earnings resulting from such investment, the value asserted or
claimed is but a duplication of that derived from the use of the
tangible property when so invested.
"The concepts of the nature and value of franchises are seen dimly
and confusedly because of the failure to distinguish between
productive and non-productive property. Land, money, chattels may by
industry and intelligence be made productive without a franchise;
but no excellence in these desirable qualities can ultimately render
a franchise productive without the use of money, chattels, and land
in connection therewith, and when the juncture is made the earning
capacity of the real and personal property, plus the franchise and
plus intelligence and industry, is really no greater than it would
be without the franchise, for the franchise has added no producing
power to the realty or personalty; it has but authorized their
employment in a particular way and protected the owners while so
employing them."
The Court emphasized the fact that the particular way in which they are
used is in performing a function of the State—in doing a service for the
public which the public might do equally well for itself, in the
following language: