judgment. It seems to be assumed by many that after a valuation has
been made it will be merely an exercise in mathematics. Suppose the
value of a railway for state purposes is $50,000,000. Then, on this
theory, all that will have to be done will be to multiply this
amount by 6 per cent.—or whatever may be regarded as a fair
return—and so adjust the rates as to enable the road to earn, say,
$3,000,000 a year," but, the writer goes on to ask, "how are the
specific rates to be fixed? A great majority of those who advocate
valuation say that they should be based on the cost of the service.
The proper method, then, would be to ascertain the exact cost of
hauling each commodity and then base rates on these ascertained
costs, making them just high enough to allow the road a fair
return."
Then the article goes on to point out the difficulties of doing this,
which of course we all know, and finally concludes that: "The theory of
basing rates absolutely on the cost of service is unjust and
impracticable." In the present state of the art this is probably true,
but why is it necessary to change the present theory of rate-making
because the rates are to be lowered or raised? If, for instance, it is
shown that it is necessary to reduce the rates sufficiently so that the
net earnings will be reduced, say, approximately 10%, is it beyond the
capacity of the traffic officials of a railroad to adjust their rates
accordingly?
In an editorial in another part of this same issue the _Gazette_
advocates the raising of rates to meet higher prices of supplies and
higher wages; it is surely as feasible to lower rates as it is to raise
them, and, even though it were necessary to base rates on the cost of
service, it does not seem as if that would be entirely impractical,
inasmuch as it is the whole argument advanced for raising the
commutation rates on the railroads entering New York City. Will the
_Gazette_ say that the arguments put forward by these railroads are all
wrong? Mr. Fink, in the article[24] already referred to, states:
"It cannot be said that ... railroads make tariffs; they can only
adjust them to varying conditions."
* * * * *
"Adjusting freight rates is practical work of men who have special
training for it and large experience. They may not all be able to
explain underlying principles, such as the value of service, but
they have used this principle for years, and apply it, intuitively
in every case which comes before them."
Surely this body of men is equal to whatever adjustment may be
necessary. Rates will probably never be arranged to suit every
individual shipper; but if the people, as a whole, believe that the
railroads are fairly capitalized on a reasonable basis of value, and the
rates, in the aggregate, are adjusted so that unduly high profits are
not made, individual complaints of injustice may easily be taken care
of.
The most important considerations affecting the regulation of railroad
rates arise in attempting to fix the amount which shall be considered a
fair return on the investment. If a certain rate of interest is fixed as
the maximum which may be earned, all incentive toward improvement or
progress is removed. The effect of this would be, of course, to retard
all development. Once a railroad was earning its legal rate of interest,
there would be no necessity of cutting down grades, building larger
locomotives to handle larger trains, investigating the economics of
operation and location, in order to introduce the thousand and one
economies which are being developed day by day, or for our railroad
presidents to lie awake nights thinking how they are to save that
million dollars a day for the benefit of the always ungrateful shipper.
This objection against rate regulation, and incidentally against
physical valuation, can undoubtedly be overcome. One proposal which has
been made is somewhat along the lines on which it is proposed to finance
the New York Subways, the profits to be divided between the railroads
and the State, after a certain rate of interest had been earned. There
is nothing novel about this, as several railroad charters have been
granted with a provision that all earnings, over an amount necessary to
provide a certain rate of interest, should be paid to the State. Another
suggestion[25] is that the reasonable rate of return be fixed as a
percentage of the gross income, irrespective of the amount of capital
required to produce it. There are probably other ways in which this
might be worked out and adjusted, and this phase of the subject surely
does not present any insuperable objections.
That the railroads have little to fear, in regard to capitalization,
from a properly made valuation, is shown by the results in the State of
Washington, where the valuation was undertaken solely for the purpose of
fixing rates, the result being a determination of the market value of
the three principal railroads of the State—the Northern Pacific, Great
Northern, and Oregon Railroad and Navigation Company—at an amount
considerably in excess of their capitalization.[26] It is true that
rates were lowered in this case on some commodities, but it does not
necessarily follow that every change of rates on the basis of valuation
must be toward a lower scale. Railroad rates are low and have stayed low
while the cost of everything else has been raised, and yet, while this
fact is well known to the general public, they still believe that, in
some way or another, the railroads are getting or have been getting more
than their proper share of profits. Evidently there is something wrong
somewhere, and it is not going to be set right by calling the public
fools and ridiculing their presumption for meddling in any way with
railroad affairs. Mr. F. W. Whitridge, the Receiver of the Third Avenue
Railroad, of New York, while stating[27] that he had only just
discovered that there was such a thing as valuation, at the same time
held up the whole scheme to ridicule, though he admitted that:
"The people of this country have, I think wisely, made up their
minds, in consequence of great corporate abuses, that public service
corporations should be subject to regulation, etc."
He nevertheless ridicules the efforts of the authorities, particularly
their endeavors in the matter of valuation, with its "irreverence for
facts." They seem, he says, "to be singing the song of the Banderlog who
dreamed of
"'Something noble, grand, and good
Won by simply wishing we could.'"
Valuation, however, has gone far beyond the point where it can be
considered a visionary scheme, or can be held up to ridicule; and it has
been worked out far enough to show, at least, that there is a rational
basis, on which a determination of values can be made, which will do
justice to both sides; furthermore, the Supreme Court of the United
States has not only ruled that valuation must necessarily be precedent
to rate regulation, but has gone so far as to specify at least some of
the elements which must be taken into account, and it may be worth while
noting that, in spite of the author's criticisms of the Washington State
Valuation, it is the only one, thus far, in which an attempt has been
made to comply with the rules laid down by this Court. The results in
Washington, however, indicate clearly the need of regulation of the
railroads, as a whole, and not varied regulation by individual States of
the parts of systems within the borders of each.
Arguments on either side can be prolonged indefinitely, and many good
reasons for and against physical valuation are advanced from time to
time, just as they may be on any proposition. Some of the principal
objections have been referred to here in an endeavor to show that they
are not insuperable; the point which concerns us now is that to-day we
are confronted with a fact and not a theory, and that fact is that the
railroads are going to be regulated, and that their proper development
is held back and general business is hampered by the feeling of
uncertainty as to the outcome. Physical valuation is not a panacea for
all evils, but a properly made valuation of the physical elements, with
a due allowance for the intangible values, based possibly on some such
method as that developed by the Washington State Commission or by
Professor Adams in Michigan, is surely as good a way of breaking into
the circle of argument as any that has been proposed thus far.
The equipment of freight trains with air brakes and safety couplers was
practically forced on the railroads by the pressure of public opinion
led by laymen, yet one will hardly find a railroad man now who will not
admit that this is good practice, not only from the standpoint of safe
operation, but from that of economy as well. The early attitude of the
railroads in this matter is already being quoted by the advocates of
valuation, and inasmuch as we have to admit, as we surely do, that a
start is going to be made somewhere along the line of obtaining some
more definite information in regard to the true relation of the value,
capital, and profits, of railroad properties, than the mere statement by
the railroads themselves that they are all that is good and fair, would
it not be wise on their part to do all they can to have the start made
properly rather than oppose it? Some of the most prominent and
progressive railroad men of the country have already arrived at the
point of believing and saying that regulation properly carried out may
not be an unmixed evil, in fact, would probably be beneficial, but they
still balk at valuation, without, however, suggesting any other means
whereby the general public is to obtain the information on which to base
an intelligent opinion as to how such regulation is to be carried out.
The speaker does not for a moment underestimate the difficulties
incident to the determination of the intangible values, or forget the
difference between the problem presented by the comparatively new lines
in the State of Washington and a valuation of, say, the Pennsylvania
Railroad or the New York Central. No one who gives any real thought to
the problem pretends that the value of a railroad is the value of its
purely physical property; but, because the matter of determining the
intangible values is difficult and complicated, is it necessary that we
should sit back and fold our hands and say "it can't be done"; that in
the whole country there is no man or body of men, or engineers, if you
please, with brains and ability enough to solve the problem? As for
cost, is it not worth $10,000,000, which is more than $40 per mile for
all the railroads in the country, or about three times as much as the
cost of the most careful appraisals yet made, to have the question put
once and for all on a stable basis, satisfactory to all, if the problem
be approached in a fair, broad-minded, common-sense way, by engineers
big enough to command the respect of both sides? Aside from the question
of rate regulation, is it not worth this much to the railroads of the
country to be able actually to prove that the amounts at which they are
capitalized are reasonable, as in the great majority of cases they
probably are?
There are one or two points which, it seems to the speaker, cannot be
too strongly emphasized:
First, that valuations properly made may be the means whereby confidence
may be restored, not only in the mind of the general public, but in that
of the investor; but, in order to obtain this result, the railroads
should urge, with all the power they possess, the necessity of having
such valuations made by a body of men, some of whom, at least, should be
engineers, big enough to entitle their opinions to the respect of both
sides, and thoroughly qualified by training and experience for the work.
Second, that, as far as possible, regulation should be general or
national, so as to avoid the complication of dividing all roads at the
State lines, and of having different regulations in different States.
Third, that there need not necessarily be any relation between rate
regulation and rate-making. Rate regulation can well be confined to
rates in the aggregate, rate-making applies to the adjustment of
individual rates, and must necessarily be the work of men well versed in
all the varied elements which control it and the particular conditions
affecting the business of each particular road. The speaker believes
that valuations made in this way and with these objects in view will do
no harm to the railroads, and will do much to restore confidence and
give us the much needed peace and quietness to carry out necessary
development.
* * * * *
CHARLES H. HIGGINS, ASSOC. M. AM. SOC. C. E.—Mr. Riggs' able and timely
paper is of great interest and worth to all concerned with the matter of
values, whether of public service corporation property, or other
property; and what engineer is not concerned with values?
One cannot but wish that an index accompanied the paper, as its
usefulness would be thereby greatly increased, particularly as, by its
arrangement, such subjects as depreciation, non-physical values, etc.,
are treated of in many different portions of the paper.
_The Wisdom of Having a Physical Valuation._—It is hard to understand
how any thoughtful person can now doubt this, for we are in a period of
regulation and taxation of public service corporations, and the only
question is whether they shall be regulated and taxed with a full
understanding of the investment involved, or by arbitrary methods, such
as the 2 cents per mile passenger rate, which has been so popular in
many States, under widely different conditions and irrespective of the
cost of the service.
The time would seem to have arrived when the thoughtful public service
corporation manager would welcome a fair valuation of the company's
property, as protection against legislation conceived in ignorance of
the capital invested.
_Relation Between Railroads and Other Properties._—The relation between
appraisals of railroad and of water, gas, and traction companies is very
close, and the same general principles apply. In the former, however, it
is complicated more often by the fact that the lines of a railroad
extend through many States, with terminals in one or two, and, further,
that the railroads have many subsidiary, controlled, or dependent
companies, such as coal, lighterage, terminal, car, warehouse,
contracting, elevator, stock yard, and supply companies, often owned,
wholly or in part, by men in the railroad management. Agreements with
these companies may greatly affect the non-physical values, as
determined by the methods advocated in this paper, which may otherwise
be sound.
_Valuation of All Properties._—The author says that the valuation of all
railroad properties in the country "would be of interest." It would be
more; it would be of value infinitely greater than the cost. The mere
presence of light prevents many vices, and this is as true in
corporation practices as in the streets. It is in accord with Dr.
Woodrow Wilson's "pitiless publicity"; and, which is, perhaps, more
important, it is the basis, or should be, of all legislation concerning
the regulation of these great highways.
_One and Only One Fair Value._—Nothing in Mr. Riggs' paper is of more
value than his insistence that there is one and only one fair value of
the physical property of a railroad, no matter for what purpose it is to
be used. How futile are the misdirected efforts of those who would have
it otherwise, for, no matter what the purpose of the appraisal may be,
who can foresee the use that may be made of it when it becomes public
property?
_Cost of Reproduction._—Cost of reproduction less depreciation seems to
be the established method—that recognized by the Courts—for arriving at
the value of the physical property. Cost, as the author contends, can
only be an element in determining the present value, for the owner of a
stone bridge has as much right to any appreciation in the value of
masonry as the owner of land has in the increased value of his property;
and, though the cost early in the life of the structure is usually near
its value, it may lose that position. What relation exists between the
value of the Pyramid of Cheops and its cost? Now, as then, our unit
measure of value is changing. Cost is certainly of historic interest,
but present value is the subject for present uses.
The points in favor of inspection to determine the physical condition of
the object to be valued are convincing, where the structure may be
readily inspected. Mortality tables mean little without a history of
maintenance. With perfect maintenance there would be no physical
depreciation.
_Maintenance versus Depreciation._—Depreciation and maintenance are
interdependent, so much so that some engineers have advocated dropping
the term, "depreciation," and substituting "deferred maintenance." A
little thought will make this clear. While this term would not apply in
the case of a single rail or car, it is not illogical when applied to a
system, built and renewed piecemeal and maintained at a certain standard
of usefulness, that is, on all well-managed undertakings of magnitude,
units are constantly being replaced, thus maintaining a standard of
efficiency. This standard, on the entire system, is usually found to be
between 70 and 90% of the cost of reproduction. Some items are even
improved, and the cost is charged to the maintenance account, such as
that referred to in the paper as "consolidation and adaptation" of
roadbed; and only a few, such as steel rails, steadily and progressively
become less useful, and even these have a bottom value, that of scrap
steel. Nor are examples numerous where all the rails are laid at one
time, and they are extremely rare where all are replaced at
approximately the same time. When the rails on a street or section are
renewed, the cost cannot properly be charged to capital account, except
in so far as the new rails are of a more valuable type than the old
ones; for, if this were done, there would be no limit to the
capitalization as time goes on. Furthermore, the moment it is admitted
that, by reason of a change in the art, we may have depreciation through
obsolescence, we admit that through a change in the art we may have
appreciation through the opposite of obsolescence. This being the case,
the use of "mortality tables" to determine present value is misleading,
unless it is done with the full itemized accounts of maintenance, which
are seldom, if ever, available. The author's position in regard to the
need of inspection of each item is well taken.
_Dead versus Live Properties._—These, perhaps, are not happy
expressions, but they serve to emphasize a vital distinction which must
be made in the valuation of properties. The difference may be as great
as between a corpse and a man; here, also, the distinction is hard to
define. We say the soul has departed, or the spark of life is
extinguished, but these expressions do not contain a satisfactory
scientific definition. So, as Mr. Riggs points out, the physical
property of a going business may not be valued as so much junk, even if
the non-physical values are to be determined separately.
_The Franchise a Contract._—The Courts hold a franchise to be a
contract, something often forgotten, both by the public and by
corporations. The speaker, however, understands this only to mean, even
where the franchise is in perpetuity, that the property of the
corporation cannot be taken for public use without just compensation. In
a sense, then, there can be no such thing as a perpetual franchise.
Using the word franchise with its restricted meaning, the
unreasonableness of the rates may be measured by the value of the
franchise.
_Physical versus Non-Physical Values._—The following division has been
made by the author between physical and non-physical property, for the
purpose of valuation:
"That the Physical Value, or present value of the physical property,
should fairly represent the actual capital invested in the property
at the date of appraisal; that it should be made up of the sum of
the various elements which constitute the cost of reproducing the
property together with any appreciation which may have been added to
any of them, less all depreciation.
"That the Non-Physical Value is the difference between the 'fair
value' as defined by the Courts, or the reasonable value of the
property as a business or producing property, and the physical
value, or actual present worth; and that the only proper method for
determining such values involves a study of income accounts.
"This Non-Physical Value may be: positive, or a value in excess of
the physical property, or negative, or less than the physical value.
In the case of a property having a negative intangible value, a
deduction should be made from the physical value."
This division is convenient but arbitrary. It is the division of an
engineer rather than of an economist; for these so-called non-physical
values are like the breath of a man's life; without them, the physical
value is like the discarded body. Again, the use of negative
non-physical values, while convenient, may not be wholly logical. These
remarks are not directed at Mr. Riggs, for he is careful to say that he
is dealing only with active enterprises, and not with those which are
inert, and the speaker realizes that he is not attempting primarily to
build up a logical argument, but to formulate certain rules to overcome
practical difficulties met by all who have attempted valuation work. As
many who have not given this matter much thought are apt to be misled by
the distinction made between physical and non-physical values, they
should bear in mind that the line between them is like the equator, an
imaginary one.
_Water._—"The water is as much a part of the cost of putting that line
there as the rails," remarked a corporation official, of admirable
character and wide experience, pointing to a trolley line from the
window of a Pullman car; and, bearing in mind what he meant by "water,"
this is undoubtedly so. The cost of promoting the enterprise, the
discount on the hazard, the loss of interest during its infancy, the
labor of building up the undertaking—these are all real elements of
cost, and may remain in the property as value, but, like all other items
of cost, they have their reasonable limits, which, in each individual
case, can be determined within narrow bounds.
_Purpose of a Valuation._—As Mr. Riggs points out, there are four
reasons for a valuation: Taxation, rate-making, purchase, and control of
the issue of securities, one of which is usually the primary cause for
the valuation being made; and he argues that there can be but one "fair
value" of the physical property, whichever of these reasons may prompt
the appraisal. This is fundamental, for "fair value" is used in the
sense of true value, which, to the writer, seems to be a more apt
expression. It is rather surprising that it does not appear in the
paper. Its use, of course, is old; in the Constitution of New Jersey,
1875, we find: "Property shall be assessed for taxes under general laws,
and by uniform rules, according to the true value." Each of the three
matters, taxes, rates, and authorized capitalization, are interdependent
and, in the long run, cannot be considered separately. This can be
emphasized by a _reductio ad absurdum_: Modern civilization is so
dependent on transportation by rail that unquestionably all taxes could
be raised by assessment on the railroads, if these roads were allowed to
fix their rates and were protected in the collection of them; but how
would this method differ from that of the Romans, of farming out the
collection of taxes? Not materially, and no one advocates a return to
that method. This is absurd, but it serves to emphasize the relation
between taxes and rates. Taxes can only come from the rates.