at least an advance toward a logical and rational method of getting at
the value of corporation property, but it must be acknowledged that we
are as yet a long way from a perfect method of appraisal, even of the
physical values, to say nothing of the non-physical. He held that as
nothing visible or tangible gave support to the latter value, it must be
determined on the basis of information secured from the income accounts
of the company. This method of measure, it would seem, is not unlike the
celebrated dictum on the length of the Chancellor's foot, "some
Chancellors have a long foot, and some an indifferent foot, and some a
short foot"; therefore, a great English Chancellor says, "the length of
a Chancellor's foot should not be taken as a measure of rights in
equity." Thus, if the income of the company is to be taken by the
appraising engineers, or the gross income, it may have to be given a
different interpretation from the net income, and if the surplus
earnings depend on transient causes or on excessive rates for service it
will lead to a totally erroneous conclusion. The same may be said if the
rates for service are too low, or if the company is badly managed, or is
carrying a great deal of "dead wood," either in the form of property or
of servants. Therefore, it seems evident that he who attempts to follow
this method of appraisal must possess almost superhuman judgment of
present conditions, and prescience to forecast the future, as well as a
grade of wisdom and knowledge of existing conditions of trade and
industry which may be also characterized as superhuman. In order to
apply Professor Adams' method justly, we must know whether the company
is wisely managed, whether its income is a fair income, whether its
physical property is all useful and needful, whether its service is what
it ought to be as to efficiency and economy, etc. We must assume an
ideal condition of commerce and industry, and of property value and
management, and then appraise the company's property by comparing it,
consciously or unconsciously, with this ideal. Possibly this is the best
method devised so far, but surely it leaves a great deal to be desired;
and it is difficult to see how different engineers, on different sides
of the question, representing different interests, can find any common
ground of agreement in Professor Adams' method. Under such
circumstances, engineers are likely to differ in their results as much
as the length of the different Chancellors' feet.
LEONARD METCALF, M. AM. SOC. C. E. (by letter).—Mr. Riggs has done
engineers, and more particularly those interested in valuation works, a
genuine service in presenting to the Society this admirable paper.
No shrewd observer can fail to recognize the increasingly insistent
demand of the public for greater publicity in the accounting, and a
larger measure of governmental control in the operation, of public
service corporations. In its best form, such control will be welcomed by
the corporations, as giving greater stability to investment in such
property; in its worst, it may prove a serious limitation to prompt
development of the best standards of service. In the water-works field,
the anti-corporation movement has resulted in taking over by the public
many such plants. It does not seem likely, however, that we are ready to
go farther in the railroad field of operation than to demand reasonable
regulation of such corporations.
While the writer has had no experience in railway management or
valuation, he has devoted much time and thought to the valuation of, and
determination of fair-rate schedules for, water-works properties;
therefore, what he may have to say in comment on this paper may be
assumed to have direct application to water-works valuation, and to
railroad valuation only as the similarity in the public service rendered
by these corporations may imply.
In the main, the writer subscribes heartily to the views expressed by
the author and the temperate way in which he has expounded them. Space
forbids discussion in detail of all the matters alluded to and so well
covered by Mr. Riggs. On one important subject, however—the inclusion of
the going value, or going concern value, of public service corporation
property, in the intangible property values, rather than in physical
plant value, and the consideration of it as an intangible value rather
than as a real and substantial item of cost to the public service
corporation—the writer differs from the author. It is clear, from what
Mr. Riggs has said, that this is debatable ground, and, from the care
and fairness with which he has expressed his views on this subject, one
might almost be led to infer that he invites attack on it. It is in no
carping spirit of criticism, however, that the following views are
expressed.
As the writer has recently submitted to the Publication Committee of
this Society a paper on the "Going Value of Water-Works," written by him
in collaboration with John W. Alvord, M. Am. Soc C. E., in which a
detailed discussion of this subject will be found, only enough will be
said to outline clearly his point of view.
The author says:
"The physical property is that which enables the corporation to do
business. Without physical property it could not produce the
commodity which it sells. The amount of money actually invested in
acquiring that physical property represents the measure of capital
on which it is morally entitled to earn interest and profit; and, in
the stage of promoting and financing the enterprise, all hope of
earnings is based on the amount of money required to construct the
property."
He also says:
"It would seem reasonable to say that this difference between the
physical value and the value based on earnings represents the 'good
will,' 'established business,' or 'going value,' and all other
non-physical elements of value."
In referring to going value, he says:
"* * * Yet, to fix a value on it by the method described by him [Mr.
Alvord] involves going into the realm of conjecture and speculation
to a degree that could never be sustained. * * * It can be readily
seen that the physical present value is not always—indeed, is not
often—the 'fair value.' The 'fair value' may be more, or less, than
the present value of the physical property."
"* * * Is it not, then, proper to conclude that the non-physical or
intangible value, composed of all these various elements of value,
can only be determined absolutely by a study of the earnings and
operating expenses? * * *"
He also says:
"The contention that all the different elements of non-physical
value merge into one intangible value, not capable of separation,
will doubtless be objected to by many engineers and corporation
managers. * * *"
"The writer does not concede that 'going concern' is a proper
element to consider in the physical value, as it does not represent
any part of the cost chargeable to capital, and the physical
valuation should be confined to the determination of capital
invested."
Quotations might be multiplied. Those cited, however, will suffice to
recall the author's view, and to make clear the point with which issue
is taken.
Is Mr. Riggs right in his contention that going value is in fact an
intangible value; that going value is not an element of real cost to the
company, involving investment of capital; that going value, therefore,
should not be included in physical plant value; and that the company is
not morally entitled to earn interest and profit on it?
The writer contends that going value is as real an element of cost, in
the property of any public service corporation, as is the cost of any
portion of its physical plant. It pertains, however, to the business,
rather than to the physical plant, of the corporation.
Whatever the difficulties of its computation may be, whatever the
methods used—whether that adopted by the Wisconsin Public Service
Commission (which is essentially one of determining the original cost of
the going value and not its reproduction cost), or whether that perhaps
first outlined by Mr. Benezette Williams and George H. Benzenberg,
Past-President, Am. Soc. C. E., in the Middle West, and by William
Wheeler, M. Am. Soc. C. E., in the East,[42] a method which seeks to
determine the reproduction cost of the going value, rather than its
original cost—the going concern value has come to be recognized, by
water-works appraisers at least, as a substantial element in the cost of
the plant, and hence as differing essentially from the franchise element
or so-called unearned increments of value.
Is not going value in a "between" class—a middle ground between tangible
and intangible values—tangible in that it has involved real cost and
expenditure of money; intangible in that it is not as readily calculated
as are other reproduction cost items, is dependent fundamentally on the
earnings of the company, and that there is no tangible equivalent to
show for the expenditure, except the existing income of the corporation?
Surely its character is quite different from that of the franchise, as
ordinarily found, the value of which, while real, from the rate-payers'
point of view, seems to be made out of whole cloth; in short, seems to
be of fictitious value.
Certainly, the conjectural and speculative character of the
computations—as referred to by Mr. Riggs—involved in the determination
of going value is no excuse for failure to recognize going value as a
real element of cost, rather than as an intangible value. As a matter of
fact, the variation in the views on going value, by engineers who have
given this subject particular study, while greater than the variation in
their estimates of the reproduction cost of the physical plant, is still
far less than the variation in their views on franchise value.
As bearing on the proper basis for rate-making, the author's statement,
that the "* * * physical property represents the measure of capital on
which it [the public service corporation] is morally entitled to earn
interest and profit * * *" cannot be admitted, equitably or legally; and
it is not to be assumed that Mr. Riggs desired to imply that this
sentence summed up his final views.
Are we not, however, approaching a basis of rate-making, predicated on
the earning, by public service corporations, of operation and
maintenance expenses, depreciation allowance, and return (_i. e._,
interest and profit) on reproduction cost of the property, less accrued
depreciation, plus going value, plus a nominal allowance for the
franchise and other intangible values of the corporation? Is it not
possible that the recent depression in the business world has been due,
in considerable measure, to the shrinkage in the values ascribed to
franchise and other intangible value in public service corporation
property?
If we are approaching such a limitation, it is the more important that
the public should be educated to the fact—not theory, for it is a
fact—that going value, or going concern value, is a real element of
cost, covering an outlay in effort and money on the part of the
corporation, and as such is as much entitled to earn a return (interest
and profit) as is the other capital invested in plant. It is not on any
items of real and necessary cost to the corporation that the public
objects to paying tribute, but on the "unearned increments" and the
virtual monopoly "privileges" enjoyed by the corporation and created, in
large measure at least, by the public itself and by normal conditions of
growth and development for which the public, rather than the
corporation, was perhaps responsible—though in many cases it may be
urged truly that the corporation itself, rather than the public, has
been responsible for the development.
Such a basis of rating, while still dependent on sound judgment and
judicial treatment, is nevertheless not beset with the speculative
element involved in the capitalization theory, which, Mr. Riggs himself
admits, fails as a basis of rate-making except when predicated on fair
rates.
If the writer's contention, that going value is a real element of cost
in the property of any public service corporation, is sound, Mr. Riggs'
statement that, "It appears to be doubtful whether the Court can be
construed as approving such an element of value in rate cases," and his
interpretation of Judge Tayler's ruling in the Cleveland Street Railway
matter,[43] must be challenged.
Certainly, as applied to water-works valuation, Mr. Riggs' statement is
not justified. The Maine cases clearly include going value as an element
of value on which rates should be predicated; by inference, so does the
Kansas City case. In the Knoxville case it was in fact allowed by the
Master.
In equity it cannot be doubted that going value should be included in
the base on which the returns are predicated, if, as contended, it
involves real cost to the company; for the company must be permitted to
earn a fair return on this cost, or to liquidate it in some way, as
otherwise the corporation would suffer substantial property loss—from 10
to 20%, more or less, of the reproduction cost of its property. This
would be contrary to public policy, for, with such an outlook, capital
would not enter this field of enterprise, except at increased rates of
return, commensurate with this added hazard. To assume such increased
rates of return is to provide another means of liquidating such a loss.
As to "good will," it has seemed to the writer more proper to use this
term in private competitive corporation enterprises, as applied to the
element of value corresponding to the going value of the quasi-municipal
or public service corporation enterprises, which latter are in effect
controlled monopolies. If the term is used in its more colloquial sense,
such as the effect on earnings of having, in the office of the
corporation, men who meet the public pleasantly, who are good "mixers,"
and who are active in getting business, the value is substantially
included in the consideration of the income, in the manner involved by
going value determination and franchise valuation.
The depreciation question has been discussed so fully elsewhere that the
writer only calls attention to the fact that, while physical and
functional depreciation only are to be considered in a review of the
present physical condition of any plant, in considering a fair-rate
schedule, provision should also be made for contingent depreciation,
covering such items as cost incident to change in street grades or
construction of subways; placing structures under ground, which were
previously above ground; serious loss due to injury by electrolysis, the
distribution of which over a period of years rather than inclusion in
the operating cost for one year, is to be preferred, alike from the
public and from the corporate point of view, from the fact that it
spreads the burden to be borne by the rates, and prevents violent
fluctuation in prices or valuation of the public service corporation's
property. The public pays dearly for all hazards. It is wise, therefore,
to pursue the conservative course in providing adequate funds to meet
extraordinary conditions, and to give stability to the investment of the
corporation. Moreover, such funds can be carried in a separate account
which can readily be watched; any excess can be credited to future
reduction in depreciation account requirements, while a prolonged
deficit cannot perhaps be recovered by the corporation, in the light of
the Knoxville decision.
The comment that no hard-and-fast rule can cover determination of proper
depreciation allowances, is amply justified. In its final analysis, it
is a matter of good judgment, experience, and judicial temper.
The author's statement that the organization, legal, engineering,
administration, and general expense accounts, "should not be considered
as affected by depreciation, as long as the property is a going
concern," is not quite clear. Obviously, this is true with regard to all
the early organization expenses, as these expenses are incurred once for
all, and constitute a continuing asset similar to other elements of
plant cost. If, however, the author refers therein also to the
engineering and contingent item added to many of the reproduction cost
items making up the physical property, exception must be made; for when
an old structure, the life of which is gone, is replaced with a new
structure, new engineering costs are incurred, and the engineering
element of cost incident to the installation of the original structure
no longer inheres in the plant. It, too, has passed away with the life
of the structure, and, therefore, its cost should be liquidated, or
provided for in the depreciation account, as well as the cost of the
structure to which it was incident.
In the same way the "interest-during-construction" item is not a
continuing asset, but should be liquidated with the complete
depreciation of the portion of the structure to which it
relates. The replacement of the structure will involve new
"interest-during-construction" charges, commensurate with the
time required for construction. The value of the initial
"interest-during-construction" costs will have disappeared with the
original structure and, therefore, should be taken care of by the
depreciation account.
The method of making allowances for interest during construction,
suggested by the author,[44] accords closely with that used by Mr.
Alvord and the writer in a recent valuation of a large water-works
property, in which the "interest-during-construction" charges were
limited, and the contributions to depreciation account were begun, at
the date on which any workable unit of the property was assumed to be
available for service and to begin to earn a return on its investment
cost, even though the structure, as a whole, was not assumed to be
completed for a considerable period of years thereafter. Thus, for
instance, it might be assumed that as soon as the supplying works in a
water-works project were in operation, the investment in them and in the
distribution pipe system laid up to that time, would cease to be
credited further with "interest-during-construction" allowances, and
would be compelled to earn interest through the water rates or income
from water supplied to consumers—the fact that the interest charge could
not be wholly met, immediately at this time, being taken care of in the
resulting increment in going value.
Such a theory, of course, does involve a determination of the probable
order and rapidity of construction of the component parts of the
property, and this is usually made, in water-works valuation, in the
estimate of the reproduction cost of the property.
For the sake of completeness, in reference to the legal decisions of
importance in valuation proceedings, attention is called to the
Pennsylvania case, Brymer _vs._ Butler Water Company (179 Pa., 231),
referred to in the closing discussion on the writer's paper on
"Water-Works Valuation."[45]
In this case Justice Williams, speaking for the Supreme Court of
Pennsylvania, says:
"By what rule is the Court to determine what is reasonable and what
is oppressive? Ordinarily, that is a reasonable charge or system of
charges which yields a fair return upon the investment. Fixed
charges and costs of maintenance and operation must first be
provided for. Then the interests of the owners of the property are
to be considered. They are entitled to a rate of return, if their
property will earn it, not less than the legal rate of interest; and
a system of charges that yields no more income than is fairly
required to maintain the plant, pay fixed charges and operating
expenses, provide a suitable sinking fund for the payment of debts,
and pay a fair profit to the owners of the property cannot be said
to be unreasonable."
The Pennsylvania Court, therefore, in the words of William S. Wallace,
Esq., recognizes the single standard:
"The Single Standard, according to the Brymer case, while
acknowledging the full right of the public to regulate such public
corporations, also recognizes as a prime factor its private
character and the rights which accrue to it in that capacity, ...
and holds to what seems to me the only rational and practicable
basis, that a fair return, after deducting the charges above
enumerated, _is_ a reasonable rate"; whereas, "the Double Standard
basis of fixing a reasonable rate seems to accentuate the public
side of the corporation and rather ignores the private element."
As to the propriety of the inclusion of a substantial recognition of
franchise value as a basis for rating, the layman may well confess to
perplexity, in the light of the conflicting nature of the two important
recent United States Supreme Court opinions referred to—the Knoxville
case, and the Consolidated Gas Company case—for, while substantial
allowance was made for franchise value, in the Consolidated Gas Company
case decision, in large measure apparently on account of its earlier
recognition by the legislature, in the Knoxville case, in spite of
legislative recognition of such value, and similar approval of the issue
of securities predicated on such recognition, the United States Supreme
Court failed to make similar allowance for franchise value.
The author's treatment of the unit price question and the contingency
item is intelligent and creditable. Engineers are prone to make
valuations based on "hindsight" instead of "foresight," on the
assumption that no substantial difficulties in construction were
encountered, when, in fact, substantial difficulties should perhaps have
been anticipated, and may actually have been encountered in the original
construction, record of them having been obliterated, however, with the
lapse of time.
The author's definition of the value of a property, as the "estimated
worth at a given time, measured in money, taking into account all the
elements which add to its usefulness or desirability as a business or
profit-earning proposition," suggests the advisability of recognizing
the other side of the ledger by modifying his statement so as to read:
"* * * all the elements which add to, 'limit, or detract from' its
usefulness or desirability as a business or profit-earning proposition."
While recognizing the author's view, that there is no separate and
independent method of determining franchise value, which is not based on
the determination of the value of the property as a whole, by
capitalization methods, it must be recognized that going value may be
determined independently, and may have a positive value, even though the
property as a commercial whole is worth less than the sum of the
physical value and the going value.
The Court, appraisers, and the author, alike recognize that there is no
one method of valuation of universal application. First cost,
reproduction cost, reproduction cost less depreciation, commercial value
determined by capitalization, worth of the service to the consumer, and
market price of the property, if such exists, all have their weight, in
varying degree in different cases. Whatever may be said of, for, or
against, these several methods of valuation, relates rather to their
significance, and the weight which should attach to the results obtained
by them, as evidence of value and of the effect of the modifying local
conditions, than to the soundness of the methods themselves.
In this connection it may be of interest to refer to a recent valuation
of a water-works property, in the appraisal of which the writer chanced
to participate, in which there was finally placed before the board of
appraisal a summing up of:
1. The original cost;
2. Reproduction cost less accrued depreciation, plus going value;
3. The worth of the service to the consumers, based on a stated
assumption of reasonable increment in value in excess of actual
cost, upon which a return (or interest and profit) should be
earned;