It is to be expected, therefore, that the financial position of the company should not be secure. Operating expenses, fixed charges, and taxes absorbed 87 per cent of gross income in 1907 and 89 per cent the year before. We must not be blinded by the magnitude of the reported figures. Although $9,476,397 were carried to surplus in the year ending June 30, 1907, and $5,568,092 were paid out in dividends, these two items together comprise only about 13 per cent of gross income, and a bad year might readily see a decrease sufficient to sweep this margin away. Unlike the Union Pacific and the Northern Pacific, moreover, the Rock Island has not made consistently heavy improvement expenditures from income. Less than $40,000 was deducted by either the Frisco or the Rock Island & Pacific Railway in 1905 or in 1907; less than half a million in 1904; a little over two millions in 1903 and in 1906. And this in spite of the fact that the mileage of the Rock Island system is greater than that of any other road which this study has taken up. The fate of the company’s refunding mortgage of 1904 probably testified as much to the distrust of the Moore group of financiers and of the soundness of the property which they control as it did to the general financial uneasiness of the time. This proposition for a refunding mortgage was first framed in July, 1903. It then comprised an issue of $250,000,000 4 per cent bonds, to be used for the refunding of outstanding obligations, future enlargements and construction, purchase of bonds and stocks of other companies, and for the reimbursing of the company for advances already made. Subscriptions were sought in New York in vain. Whereas the project was to have come up at a meeting of the stockholders on October 8, the managers obtained an adjournment of this meeting until January without action, and before that month arrived announced an indefinite postponement of operations. On March 21 the stockholders voted on and approved a modified version of the original scheme, whereby $163,000,000 instead of $250,000,000 were authorized, of which $15,000,000 were to be issued at once, and $82,025,000 were to be reserved for retiring certain outstanding obligations. It proved no easier to secure subscriptions to this than to the previous plan, and in April $5,000,000 4½ per cent notes were issued instead and taken by the First National Bank of New York, which was already closely identified with the company. Not until November, 1904, after fourteen and one-half months of persistent effort, was a firm of bankers found to take the refunding issue. $25,108,000 were then sold to Speyer & Co. Mr. Speyer became a director of the Rock Island and entered the finance committee, while the proceeds of the sale went to reimburse the treasury for capital expended, and to provide for the payment of obligations maturing in 1905. Since this time other blocks of the bonds have been sold.
It is thus evident that the Rock Island has not regained the position which it held prior to the operations of Mr. Moore and of his friends. The recent developments have done two things: they have piled upon the company a mass of excessive capitalization; and they have transformed it from a moderate sized railroad with a clearly defined flow of traffic into a great system sprawled over the Central West and handling at least three different currents of business. Neither one of these changes alone can account for the present condition of the road. Together they have made it what it is. It is only fair to say that large sums from capital account are being spent upon the property and that the managers announce an intention of bringing it up to the highest standard of physical condition. Over $4,000,000 were appropriated for additions and improvements in 1907, and nearly $3,500,000 in 1906, besides still greater sums for construction and equipment. Heavier rails have been laid down, bridges have been strengthened, equipment increased and improved. Meanwhile maintenance charges have not been unduly low, though not so high as on some other Western roads. It is true, nevertheless, that the Rock Island has lost its former stability and must await a period of lessened earnings with serious apprehension.
CHAPTER X
CONCLUSION
Definition of railroad reorganization—Causes of the financial difficulties of railroads—Unrestricted capitalization and unrestricted competition—Problem of cash requirements—Problem of fixed charges—Distribution of losses—Capitalization before and after—Value of securities before and after—Provision for future capital requirements—Voting trusts—Summary.
A general survey of railroad reorganizations may now be attempted. Eighteen different ones and no less than forty-two reorganization plans have been examined in detail. In their seemingly infinite variety may not some guiding principles be found which will assist both in interpreting the past and in directing the future?[680]
It is apparent that a readjustment of a railroad’s affairs is more difficult than the readjustment of those of an individual. A railroad is a complex financial, as well as a complex operating machine. Especially when it has been built up by the union of numerous small properties, each of which has been allowed to retain a certain individuality of its own, are the relations between the different parts intricate and involved. The obligations which have been incurred in the course of its career, and the kinds of paper which represent these obligations, disclose a variety which the debts of an individual seldom or never present. This complexity in railroad capitalization inevitably leads to clashes in interest between different classes of securityholders. Divergencies in interest seem to appear even while a road is solvent. If classes of securities exist upon which payment of interest is optional, it is to the advantage of the junior issues to prevent payment of interest or dividends upon others until earnings are such that payment may be made upon all. If common stockholders can reinvest in the property sums which normally would be paid in dividends on the preferred stock, they advance the day upon which they can secure dividends for themselves at the expense of their seniors. The same situation may also arise as between the preferred stock and the income bonds. Or, again, it may be to the advantage of speculative stockholders to pay dividends to themselves by means of the accumulation of a floating debt, and to sell out at top quotations, leaving the floating debt to take precedence even of mortgage bonds.[681] Both this and the preceding operation are facilitated by the control which the least valuable portion of the capital, the common stock, usually has over the policy of the entire company. But it is when a reorganization becomes necessary that these conflicts in interest become most apparent, and it is as a compromise between contending forces that a reorganization plan must take its shape.
The term “reorganization” is used in this study to denote the exchange of new securities for the principal of outstanding, unmatured, general mortgage bonds, or for at least 50 per cent of the unmatured junior mortgages of any company, or for the whole of the capital stock. These exchanges have been the essential features of the operations which have been described. This exchange of securities must take place upon a considerable scale. Small readjustments may involve valuations of specific bits of property, but they do not require that comprehensive survey of the relations of all parts of the system to each other which distinguishes the general reorganization. In fact, the small adjustments are at once more simple and more difficult than the larger kind. More simple because they involve less change; more difficult because the same pressure cannot often be brought to bear. It is useful to mark a dividing-line between the small and the large. No such line can be defended as exact; but the one chosen seems to include a tolerably homogeneous group, and will lend a convenient definiteness to the discussion.
As thus defined, a reorganization may be, and generally is, accompanied by other operations essential to its success. If a large floating debt has been accumulated, provision for the cancellation of this debt must be made;[682] if unprofitable leases have been entered into, these must be abolished;[683] or if the system has been unduly hampered by inability to issue new capital, appropriate relief must be afforded. But none of these are determining features. They are means to an end, as is the exchange of new securities for old, and they may have their effect just as the economical management of the Union Pacific under Charles Francis Adams had its effect in the years prior to 1890; but they are not essential parts of that group of operations which have been characterized as reorganizations.