Railroad Reorganization

by Stuart Daggett

The method chosen for raising cash was the sale of bonds. In September, 1887, J. P. Morgan & Co. announced that a preliminary contract had been entered into between the Baltimore & Ohio Railroad Company and J. S. Morgan & Co., Baring Bros. & Co., and Brown, Shipley & Co., of London, and their allied houses in America, for the negotiation of $5,000,000 Baltimore & Ohio Consolidated 5s and of $5,000,000 preferred stock, for the purpose of paying off the entire floating debt, and of placing the company upon a sound financial basis.[37] The consolidated bonds were to be part of an authorized issue of $29,600,000, of which $21,423,000 were to be reserved to retire the main stem mortgage indebtedness when it should fall due, and $8,177,112 were to be exchanged for securities in the company’s sinking fund, the freed securities to be used to pay the floating debt in part. In case this exchange should not be made, $7,500,000 of the issue might be sold direct, and the syndicate before mentioned agreed to take $5,000,000 of this amount and to place $5,000,000 in preferred stock on condition:

(a) That the statements of the company should be verified;

(b) That the management of the company should be placed in competent hands, satisfactory to the syndicate;

(c) That satisfactory contracts should be made between the Baltimore & Ohio and other roads for New York business, which should remove all antagonism between them on the subject, and should ensure the permanent working of the first-named in entire harmony with the other trunk lines, besides avoiding the construction, or the threat of construction, of expensive lines north and east of Philadelphia.

Annual payments to the Baltimore & Ohio sinking funds were to be made in the future in consols instead of in cash.[38]

The essence of this arrangement was a funding of the floating debt, plus agreements with other roads in order to maintain earnings. The funding involved, however, a certain increase of charges through the issue of bonds, while the agreements offered but a doubtful chance of increased earnings. Only by an effective community of interest or of ownership among the trunk lines could a saving have been secured on which the new bond issues could safely have relied. That this was to take place through the syndicate, that body was emphatic in denying. “The statement,” said Vice-President Spencer, “that the Baltimore & Ohio Railroad has passed into the hands of a syndicate, of which J. P. Morgan is the head, is absolutely without foundation.... The syndicate has the greatest interest now in the growth of the Baltimore & Ohio, and to secure this growth and progress absolute independence of other corporate predominance is essential, and the road must be worked in the interest of the states and territories it reaches.”[39] This declaration left only informal agreements as a resort; for pooling had been forbidden in 1887. It did more, it implied the necessity of a maintenance of competition, for to work the Baltimore & Ohio in the interest of Baltimore meant to work it against the interest of New York. In principle the plan was nevertheless adopted. Bondholders saw no necessity for a radical reorganization, and were willing to consent only to a new issue of bonds. Certain modifications were, however, imposed. The exchange of new bonds for securities in the sinking fund was abandoned, and the alternative of direct sale was embraced. It was found impossible to secure the consent of stockholders to an increase in the preferred stock, three attempts to obtain the required authorization failing in the week ending January 20, 1888.[40] Furthermore, the failure of the stock issue led President Spencer[41] to request that the city of Baltimore extend for five years at 4 per cent a $5,000,000 loan to the company, which was to mature in two years, and that it return the sinking fund of $2,400,000 which had accumulated in its hands for the eventual cancellation of the debt.[42] It may be added that this suggestion was not accepted.

While awaiting final settlement of the syndicate scheme the Baltimore & Ohio obtained some cash from the disposal of all its free resources; that is, from the telegraph, express, and sleeping-car businesses which it had conducted since early in the administration of John Garrett. In August, 1887, it sold its express business to the United States Express Company for a period of thirty years, in return for $1,500,000 of the capital stock of the express company plus a certain percentage of the annual earnings of the express lines handed over.[43] In October of the same year its telegraph business was turned over to the Western Union Telegraph Company in return for $5,000,000 of the Western Union stock, and an annual payment of $60,000 in cash.[44] Finally, in June, 1888, its sleeping-car equipment and franchises were transferred to the Pullman Company for a period of twenty-five years at a reported price of $1,250,000.[45] The company agreed to furnish all the sleeping and parlor cars required. This brought the incidental advantage of ending long-continued suits over patents. The terms of sale to the telegraph and express companies brought in no ready money, but the securities obtained were readily salable, and being independent for their value of the commercial success of the Baltimore & Ohio were available for times of difficulty. It was this policy which offset the refusal of the city of Baltimore to return the sinking fund to the company, and which by March, 1888, rendered the road even to some extent independent of the syndicate. At that date a modification of the syndicate agreement took place. The bankers gave up all claim to the $5,000,000 of stock so long under discussion, and took instead the balance ($2,500,000) of the $7,500,000 consolidated mortgage bonds which the company was authorized to sell. “The syndicate acted,” said the Baltimore Sun, “in an entirely friendly spirit, and, with a desire to continue its financial relations with the company, took the remaining $2,500,000 ... at a better price than was paid for the $5,000,000.”[46]

With temporary financial requirements provided for, President Spencer was enabled to achieve some much-needed reforms. At a meeting of the directors on March 14 a complete reorganization of the service was authorized, with changes and transfers affecting employees from the first vice-president down. Later a committee of mechanical experts was organized “to examine thoroughly all the shops, shop tools, etc., of the entire Baltimore & Ohio system, and to report on all the improvements needed.”[47] The form of the annual report was improved. The much-quoted surplus, which had proved such an unreliable support, was cut in two by the writing off of bad investments, the marking down of the price of securities, and the like; and, finally, a committee was appointed to make a general examination of the financial as well as the physical condition of affairs.[48] “Great anxiety,” said a resolution of the directors, “exists in the public mind as to the financial condition and the value and earning capacity of the road and property ... [and] it is due to all interests that a full, frank, and complete statement of its affairs should be made public.” So far as lay in his power President Spencer, and through him the syndicate, tried to secure a real and permanent improvement in the condition of the road, and to gain, through increased efficiency in operation, the margin which the refusal to cut down fixed charges had denied. The failure of the attempt may be ascribed to the continuance of the Garrett family in power. Any irregularities or mistakes which had taken place in the past reflected on the Garretts, so that it was to their interest to stifle investigation. Moreover, any change in policy for the future implied a criticism of their acts to which they were reluctant to accede. In 1888 the Garrett holdings amounted to from 50,000 to 60,000 shares out of a total of 150,000 shares, or, deducting 32,500 shares held by the city of Baltimore, which were not entitled to vote, to about one-half of a total of 117,500 shares. This gave undisputed control. The effect was seen in the annual election in November. Of 12 old members of the board only 5 were reëlected, and of the 7 dropped 3 formed part of the investigating committee engaged in securing “the full, frank, and complete statement of the company’s condition” promised at an earlier date.[49] The same month President Spencer was ousted and Mr. Charles F. Mayer was elected in his place.

This revolution was fatal to any radical reform, so that during the next seven years the condition of the Baltimore & Ohio improved but little. Net income grew, it is true, up to the panic year of 1893, but fell so sharply after that that the reported figures for 1895 exceeded those of 1888 by but $1,283,843, and even this gain was practically wiped out during the following year. Meanwhile fixed charges grew from $6,550,972 in 1888 to $6,934,052 in 1895, and to $7,303,781 in 1896; an increase which transformed the profits of the company the following year into a deficit. A comparison of the balance-sheets of 1888 and 1895 shows an increase of $10,207,434 in stock, of $16,261,000 in funded debt, and of $4,554,939 in floating debt. These changes were offset mainly by increases in bonds and stock owned, or in the hands of trustees, by advances to subsidiary lines, and by a reduction of $11,080,000 in bonded debt secured by collateral or by mortgage on the main line. During this time dividends were nevertheless steadily paid on the preferred stock, and, beginning in 1891, upon the common stock as well. The liberal tendencies of the management were also evinced by a 20 per cent dividend upon the common stock, declared in 1891 to compensate shareholders for expenditures in betterments and improvements of the physical condition of the property.[50] It will be seen how different this was from the policy of retrenchment and economy which had been inaugurated by President Spencer, and which might fairly have been expected from a corporation barely escaped from bankruptcy.

Traffic conditions from 1887 to 1893 were very far from satisfactory. The difficulties between the Baltimore & Ohio and the Pennsylvania were indeed patched up, and the opening of the former’s lines to New York rendered it independent of other trunk-line connections; but frequent charges of rate cutting were made in 1887, and a war in dressed-beef rates was inaugurated by the Grand Trunk in November of that year. In 1888 rates were pretty much demoralized. Published rates on grain dropped from 27½ cents in January to 20 cents in October. Emigrant rates from New York to western points became the subject of active competition; and, most important of all, the dressed-beef controversy was pushed till it developed into a war of the most active kind. The trouble here was started by cuts on dressed beef by the Grand Trunk. In May other lines retaliated by cuts in live-stock rates; by July 14 published rates on cattle from Chicago to New York were 5½ cents per 100 pounds, and on dressed beef and hogs 7 cents. In November the New York Central extended the contest by a general reduction in west-bound rates.[51] These struggles, though terminated for a time by an agreement of February, 1889,[52] seriously diminished railway revenues, and prevented the rapid growth which the general prosperity of the country might have occasioned.[53] In fact, the Erie management stated in their annual report for 1888 that their company had retired altogether from certain classes of through business for a time during the preceding twelve months, owing to the unremunerative level of rates. Conditions during the greater part of 1889 were better,[54] and during the following three years constant attempts at agreement and arbitration, joined with a considerable volume of business,[55] prevented a long continuance of any difficulties which arose.