be the most complete and comprehensive discussion of the general
question of valuation of property invested in public service industries
that has come under his notice. It is especially important in that it is
a summary of the discussion on this most difficult subject during the
past ten years, and the writer thoroughly agrees with the general
conclusions reached by Mr. Riggs.
There is one point, however, which might possibly have been developed
more completely, and that is the treatment of discounts, which presents
itself from time to time in the general discussion. Mr. Riggs quotes
with approval the following:
"If a company can market its 50-year, 4 per cent, bonds at 90 per cent.
of par, it means that the company's credit is on a 4½ per cent. basis;
that it could market a like security paying 4½ per cent. at par."
This is, of course, correct as far as the mathematics of the proposition
is concerned, but it seems to overlook that peculiar psychology of the
market which enables a corporation to secure a larger amount of actual
cash for a given interest annuity when bonds are sold at a discount than
when they are sold at par.
Aside, however, from the accuracy of the above quotation and of Mr.
Riggs' apparent acceptance of it as the final word on discounts, one may
ask if it recognizes all the elements necessarily involved in a
discussion of the problems raised by discount financiering. From the
literature of the subject one may read the following claims: Discount is
a measure of the risk involved in a new enterprise; discount is a market
adjustment that reflects the current value of money; discount is a
sacrifice of principal for a slightly reduced interest annuity; discount
is a dividend declared before the dividend is earned; and many cases are
cited in which a discount is merely a promoter's fee for services
rendered.
The writer does not care to discuss at this time these various points of
view from which discounts may be regarded. They are mentioned merely to
suggest that the subject is not as simple as some writers seem to think.
Any valuation of public service industries, from whatever point of view
it may be regarded, must, from the nature of the case, touch the problem
of fundamental equities; and one of the elements of this problem which
has not as yet been fully analyzed is this element of discounts. From
the point of view of taxation, such an analysis is not perhaps
essential; but if the valuation is to be used as a basis of determining
reasonable rates, or as a measure of reasonable capitalization, it seems
to be essential.
The writer is sure this discussion will not be construed as in any sense
a criticism on Mr. Riggs' paper; it is rather a suggestion of an
unwritten chapter in the literature of valuation. The American Society
of Civil Engineers is to be congratulated in securing from one of its
members so complete and satisfactory a discussion of the principles and
methods for the valuation of public service corporation property.
CARL C. WITT, M. AM. SOC. C. E. (by letter).—The appraisal of the
railway property in Michigan was a wonderful performance in a great many
ways, not the least of which was the thoroughness of the work,
considering the short time available, and the writer desires to express
his appreciation of this paper, as it is a valuable addition to the
meager literature on this subject.
More recent appraisals, made by States traversed by the same railway
systems as those involved in the Michigan appraisal, have been made with
a freedom from opposition by railway companies due to the educational
effect of this pioneer work. Particularly is this true of the recently
completed appraisal, by the Board of Railroad Commissioners of South
Dakota, of the physical property of the railways in that State, of which
work the writer was the Engineer in charge. No opposition was met; in
fact, some of the railway companies had established regular departments
for furnishing inventories and appraisals, had completed the necessary
field work in South Dakota before the inventory had been requested by
the State, and were able to furnish a very complete appraisal in a short
time after the request for it was made.
This appraisal was made in compliance with an act of the Legislature of
1907, which required the Board of Railroad Commissioners to ascertain
the true cash value of all the property of every railroad company in
South Dakota used in the operation and maintenance of their respective
roads. No attention was paid to the purpose of the appraisal, but one of
the first uses made of the information thus secured was in the
litigation following the passage of an act by the Legislature of 1909,
prescribing a maximum passenger fare of 2 cents per mile on all
railroads operating within the State. In connection with a rate case of
this kind, some questions have been raised regarding proper bases for
land values, the use of an item for adaptation and solidification as an
element of physical value, the value of the intangible assets, etc.
The lands of all railway companies were appraised at a cost to reproduce
or re-purchase at the time of appraisal, regardless of the original cost
of the property. The sales method was used for determining the market
value of adjoining property. There has been a very large land movement
in South Dakota in the last five years, and as most of the country is
prairie, with similar soil over large areas, it was not difficult to
determine the average market value of the land for farm purposes, at the
date of the appraisal, and the gradual trend of values for five years
previous to that date. An average multiple of 250% was used to arrive at
the cost of reproducing or purchasing the right of way. This multiple
was based on investigations made of recent right-of-way purchases, and
inasmuch as there are no large terminals in South Dakota, the same
average multiple was used throughout the State for both town and farm
property, investigation showing that town property could be secured for
slightly less and farm property for slightly more than the average
multiple used.
In each supplemental appraisal the land values will be corrected to
correspond to the changes in surrounding values, as the railway company
is entitled to any increase, due to natural causes, based on the cost to
reproduce at the time of appraisal. This is a well-established theory,
as shown by Mr. Riggs.
No allowance was made for the item commonly known as "adaptation and
solidification," except in the item of contingencies and in the
consideration of the present value of the ballast. In some recent
appraisals, large sums, based on a percentage of the cost of grading,
have been allowed for this item. While there is no question that large
sums of money are expended in maintaining a safe track on a new bank,
and that this expense gradually diminishes as the roadbed becomes solid,
due to the pounding of the trains and the action of the elements, this
expense is, and properly so, charged to maintenance, and is paid for out
of the operating revenues. Now, in the trial of a rate case, exhibits
showing the operating expenses, including maintenance charges, are
introduced, and to include this same item in the appraisal of the
physical property leads to a duplication, for if the passenger or
shipper pays for this maintenance charge, it should not be counted as an
item of physical value as a basis for determining what is a reasonable
rate.
The case is similar to that of a locomotive: When new, it is kept in the
vicinity of the shops, because trouble from lack of proper adjustment
and weak parts is likely to develop, and the maintenance charges may be
much higher than a few months later when the machine has "found itself"
and, as an operating machine, is more efficient than when new. However,
no one will insist that it has an added physical value in dollars and
cents, or that the excess cost of repairs and maintenance during its
early life should be added to its cost of reproduction now; in fact, it
is a second-hand machine, and the maintenance charges must be paid for
out of its use.
Generally, when a roadbed is turned over to the operating department by
the construction department, it is in good line and surface, and if an
appraisal were made at that time its condition would be 100%; but as
soon as it is placed under traffic, it begins to depreciate, as shown by
the fact that it requires constant attention to keep it up. If the
roadbed is cross-sectioned at each station and actual quantities
calculated from cross-section notes, there would be no depreciation, but
if the grading quantities are calculated from profiles of the line, as
constructed some time previously, and for a standard width of sub-grade,
with a percentage added for shrinkage, and allowance made where banks
have been widened, etc., it will probably be found to exceed the actual
measured quantities, because the action of the elements in washing the
slopes, the wearing of the shoulders of the embankment due to foot
traffic, etc., will show some depreciation in quantities. It is common
practice to carry the item for grading over to the present-value column
at 100%, or, with no depreciation. This practice, together with the
present condition of the ballast due to maintenance, and that part of
contingencies which covers washing of slopes, filling of ditches, sink
holes, etc., certainly takes care of all adaptation and solidification
which should enter into a valuation of physical property.
No appraisal was made of the intangible assets. A great many arguments
have been advanced for and against such an appraisal, and in South
Dakota it was held that the earning ability of any corporation due to
its franchise, strategic location, efficient organization, going-concern
value, etc., while perhaps an element of value to be considered in a
transfer of the property or if assessed on an income basis, should not
enter into a valuation which would be used for determining a just and
reasonable return on the investment, because the greater the earning
power the greater would be the return, and that this condition would
produce a never-ending increase in returns; whereas, when the returns
reach a point at which they will not only pay a fair dividend on the
investment, but take care of any depreciation in the physical condition
of the property and make all needed improvements in roadbed, buildings,
and equipment, demanded by the traveling public, shippers, increased
traffic, or natural causes, they should be kept to that point. There are
several hundred miles of railway in South Dakota which have been built
out of the surplus earnings of the parent corporation—in other words,
with money supplied by the traveling and shipping public—but which are
owned by the railways and on which they may earn another surplus for
constructing more extensions, etc., etc.
The original South Dakota appraisal, as of June 30th, 1908, on forms
similar to those used in Minnesota, has been supplemented by yearly
appraisals corrected for all additions and deductions made during the
fiscal year. For this purpose a new set of forms[29] was prepared, with
the various items classed in accordance with the "Classification of
Expenditures for Road and Equipment," as prescribed by the Interstate
Commerce Commission, and arranged so as to facilitate showing the yearly
changes.
R. A. THOMPSON, ASSOC. M. AM. SOC. C. E.[30] (by letter).—This paper is
considered by the writer to be the most complete treatise ever written
on the valuation of public service corporation property, and the author
deserves the sincere thanks of the entire Engineering Profession and all
others interested in this most important question. Its presentation is
most timely, in view of the agitation, particularly on the subject of
railroad valuation, which is now engaging the attention of Congress and
the law-making bodies of the several States, as it contains much
valuable information relative to decisions of Courts, in addition to
clear and concise expositions of the methods in vogue for the
appraisement of corporate property, etc.
It is a fact—rapidly coming to be recognized by legislative and judicial
bodies—that the prescription and regulation of tolls, charges, and
assessments against public corporations cannot be made systematic and
intelligent unless there is provided some estimate of the value of the
property involved, based on the cost of its replacement or reproduction.
Particularly is this true of railroads; and such regulation of the
affairs of these corporations as has heretofore been essayed by State
and National commissions, has generally been on illogical bases,
unsatisfactory alike to the proponents and the companies. Results have
been had, it is true, after a fashion, but there have been endless
disputes and litigation, with the prime questions involved no nearer
solution than before. One has but to contemplate the varied and often
antagonistic legislation promulgated by the several States, relating to
corporation management, and the many rulings and decisions of the
different courts and commissions on the subject of regulation,
assessment, and adjudication of corporate rates, revenues, taxes, and
tolls, to become convinced of the complicated and tangled condition of
the situation, and to realize the necessity for the early establishment
of some logical basis on which to establish the fabric of corporate
control.
While it is not maintained that an appraisement of the physical property
of public service corporations will be the panacea for all such ills,
the writer firmly believes with the author that such appraisal, as a
beginning, is absolutely necessary, and when effected on some fair and
reasonable basis, will contribute largely to the successful solution of
many of these intricate problems.
With the estimate of the physical value of a property before it—which
represents money actually invested, together with such accruals to costs
as it may be determined that the owner is reasonably entitled to have
considered—any Court, tribunal, or commission is in a better position to
mete out impartial justice, whether it be the regulation of a rate, the
assessment of a tax, or the imposition of a fine.
Although the author's experience in valuing corporate property has been
principally in connection with the Michigan appraisal of railroads, and
to him is largely due the credit for devising methods for, and carrying
forward to successful completion, this thorough and most excellent work,
it is refreshing to note his inclination to give credit to the work of
others along the same line in other States, which, it is to be
regretted, has not always been the case with writers on this subject.
There is no doubt that the work of the Michigan and Wisconsin Boards of
Appraisal—conducted under the advice and direction of some of the most
eminent and talented engineers and economists in the United States, and
practically without regard to expense—is the most complete and perfect
of its kind heretofore attempted; yet there are many features in regard
to the organization and execution of its details about which there may
be an honest difference of opinion, as viewed by those who have been
similarly employed.
It is but natural—as suggested by the author—to find the "individual"
character of the appraiser (which has been moulded by his environment,
training, and former service) reflected in his opinion, and this would
be most probable in the organization for, and carrying on the work of,
appraising a railroad property, which involves consideration of
practically every phase of engineering and economics. The judgment of
any man is essentially warped along the lines of his experience, and he
is necessarily biased and prejudiced in favor of or against certain
practice. As a consequence, therefore, it is not reasonable to suppose
that any one man, or set of men, can formulate a system for valuing
corporate property which will be perfect in all its details, and be free
from objection and criticism.
The writer was employed for a number of years as Engineer for the
Railroad Commission of Texas, and had charge of the valuation of
railroad property under the Railroad Stock and Bond Law of that State. A
paper on the methods used by this Commission was prepared by him and
published by the Society.[31] This Stock and Bond Law was enacted in
1893, and the railroads then existing were valued in 1894 and 1895. The
average value of 8,860 miles was $15,844 per mile. This valuation was
made by Charles Corner, M. Am. Soc. C. E., now Resident Engineer of the
Rhodesia Railways, South Africa, and Mr. H. J. Simmons, now General
Manager of the El Paso and Southwestern Railway System. The actual cost
of this work is not available, but is estimated at about $2 per mile.
The engineers making the appraisal secured maps, profiles, and all
available information from the offices of the railroad companies,
including all the construction records and estimates of quantities which
were preserved. Appraisal was made only after one of the engineers had
made a personal examination on the ground, accompanied by assistants to
aid in measuring structures and estimating quantities.
All valuations made since 1895 have been of new railroads making
application for issuance of securities, and in all cases the deeds for
right of way and depot grounds, the contracts for construction, the
actual quantities of construction of all kinds, the plans and
specifications for all structures and construction, and all other
information which the engineer desired, were submitted by the railroad
companies to enable an accurate appraisal of the value of the property
to be made. It is not possible for valuations of this character to be
made under more favorable circumstances. Up to October, 1909, more than
3,500 additional miles had been valued, and in all cases the estimates
limited the securities which the companies might issue.
Writers on railroad valuation have generally been inclined to discredit
the work of the Texas Railroad Commission and the system of appraisal
used by it. One writer, of more or less prominence, has referred to it
as the "cheap" method. While it may be true that other appraisals have
been more expensive, it is a fact that those of the Texas Commission
have served their purpose well, and the railroads, as a rule, have made
little complaint. As a matter of fact, it is highly probable that the
valuations of railroad property made by the Texas Commission have been
of greater utility, as far as the public is concerned, than those of all
other States combined, and, at the same time, no injustice has been done
the railroads.
It appears that those who have interested themselves in investigating
the Texas method of railroad valuation—including the author—have failed
to construe the real meaning and intention of the Stock and Bond Law.
Apparently, it was passed for the purpose of limiting railroad
indebtedness—and is referred to by Mr. Riggs as serving only this
purpose—but while its effect has been to accomplish this most
successfully, its enactment carried with it a deeper significance.
This law was passed at the same time as the General Railroad Commission
Act of the State, which gave to this Board absolute control over all
freight rates and tariffs, and also other powers not possessed at that
time by any other State commission. The decisions of the highest Courts
at that time laid stress on the right of carriers to maintain rates
which would afford a reasonable return on stocks and bonds outstanding.
Hence, to delegate the regulation of rates to any tribunal by any law
which did not carry with it also the right to supervise and restrict
mortgage indebtedness to some reasonable extent, appealed to the
legislators as being essentially ineffective. The effect of the law has
been to reduce steadily the average outstanding stocks and bonds of the
railroad companies of the State from an average of $40,802 per mile in
1894 to $31,910 in 1909—and this, too, in the face of a recognized
increase in the physical value of the properties—thus depriving the
railroads of one of their most potent weapons of offense when contending
against the Commission's orders. It is a matter of common knowledge that
the indebtedness per mile of railroads of other States has increased
greatly during this period. It is also a fact that the railroads of
Texas have, except in rare instances, contended that injustice has been
done them in the enforcement of this law, and the market value of their
stocks and bonds has steadily risen. Also their physical condition is on
a par with that of railroads in other Southern and Western States, and
their incomes from operation are as substantial. The practice of
"watering" their securities has been effectually stopped, as regards
local issuance, and any interest which might have accrued on such
securities has been saved to the public.
It has been contended that the Texas valuations of 1894-95 were too low,
and did not, even at that time, represent the fair value of the
properties. This is perhaps true to a certain extent, but it must be
remembered that the costs of materials and construction then were less
than at any time before or since; and, viewed from the present-day
standpoint, they seem to have been inadequate. It must also be
considered that real estate values throughout the entire State were very
low, compared with present values and with those of lands in other
States. Although the writer admits that the margin was very narrow,
still he is of the opinion that the valuations as made represented
closely the cost of reproduction of the physical properties at the time.
The valuations of 1894-95 stand to-day on the Commission's records as
"the value of the property," except in cases where there has been
application and necessity for re-valuation. The machinery of the law did
not provide that these appraisals should be kept "up to date." The
mortgages on these railroads are still outstanding, and there has been
no call for another appraisal, except in a few instances. The Commission
has decided that in its opinion the "present value" of any of the
railroads already appraised is represented by the original valuation
plus the value of all permanent improvements and betterments added. This
principle has been carried out with those railroads which have applied
for re-valuation for any purpose, and the Commission has admitted the
same in testimony which it has given before the Courts.
Since the appraisals which the Texas Commission makes are primarily for
the purpose of limiting indebtedness, and the carriers are entitled to
have these at least equal the cost of their property—the investment with
certain additions to cover promoters' profits—no consideration can be
given to depreciation of structures and equipment, although the
application for valuation and process of issuing of securities may be
had several years after completion. The writer holds that there is
strong argument in favor of not taking into account "depreciation," and
of estimating the value of the property as being entirely "new,"
whatever purpose the valuation is proposed to serve. This is apparent,
as already stated, when the valuation is to serve as a basis for
limiting the issue of stock and bonds. Is there any logical reason why a
valuation for this purpose should not also serve—as far as it
pertains—as a basis for taxation or for regulating freight rates? As far
as the State is concerned—and to be consistent—should not "one"
valuation serve all purposes?