Percentage to Gross Income
| Operating Expenses | 1893 Fixed Charges | Surplus | Operating Expenses | 1892 Fixed Charges | Surplus | ||
|---|---|---|---|---|---|---|---|
| C., B. & Q. | 64.46 | 23.12 | 12.41 | 65.17 | 20.86 | 13.96 | |
| C., M. & St. P. | 65.95 | 20.78 | 13.26 | 64.00 | 22.36 | 13.63 | |
| C., R. I. & P. | 71.72 | 13.31 | 14.96 | 69.88 | 19.83 | 10.28 | |
| Great No. | 50.44 | 34.54 | 15.01 | 52.66 | 32.98 | 14.34 | |
| Ill. Cen. | 61.92 | 25.84 | 12.23 | 64.58 | 23.99 | 11.12 | |
| N. Y., N. H. & H. | 72.31 | 16.07 | 16.36 | 73.36 | 8.77 | 17.86 | |
| N. Y. C. | 68.79 | 20.84 | 10.36 | 68.46 | 21.53 | 9.96 |
The causes which lead to railroad failure have now been mentioned. When bankruptcy has at last occurred, three groups of interests take part in the reorganization which must ensue. These are the creditors, who find interest and perhaps principal of their bonds in default; the stockholders; and the bankers and financiers who advance ready money and subscribe to necessary guarantees. Of these the creditors and the stockholders are widely scattered, and are quite unable to protect themselves by individual action. Their first impulse is, therefore, either to elect committees to represent them, or to authorize self-appointed committees of well-known men to look after their interests. Stockholders in a reorganization have little voice. They are the owners, and all that the corporation has is subject first to the bondholders from whom it has borrowed money. Occasionally they seem to make their influence felt. In 1880 the Reading actually attempted to pay off its floating debt by bonds with a lien inferior to the common stock; and in 1892 the Olcott plan for the reorganization of the Richmond Terminal Company strongly favored the junior securities. But as a rule stockholders must accept, and rightly, about what the creditors desire.
The creditors, then, are the most important factors, and they, like the stockholders, act through committees. There may be a committee for every class of bonds, or one or more classes may join together. The Union Pacific, in 1893, had committees for the consolidated first mortgage, the collateral trust 5s, the Oregon Railway & Navigation consols, the Dutch bondholders, and certain branch lines; and in 1894 for the collateral trust 4½s and the Kansas Pacific consols. As the financial situation grew worse the interest on senior mortgages became imperilled, and even the Union Pacific first mortgage bondholders deemed it wise to elect a committee; while a second committee arose for the Kansas Pacific consols, and a new committee for the Denver Extension mortgage. By April, 1895, at least fifteen committees were in active operation, of which fourteen represented not more than two classes of bonds each. The Reading reorganization of 1884 to 1886 was largely shaped by two committees representing the general mortgage bondholders; seven reorganization trustees representing the foreign creditors, the general, income, junior securities, and stockholders; and an opposition committee known as the Lockwood Committee. Within four months after the failure of the Erie in 1875 the English bondholders and stockholders each had elected a committee, and had urged all securityholders to join; a meeting of bondholders had elected Mr. John Hooper chairman of a committee in New York; and another meeting had elected Mr. N. B. Lord chairman of another committee in that city.[691] The more general a committee the greater the influence which it seems able to exert on reorganization, and the greater the likelihood that the plan which it approves may be accepted. The fact that a scheme has to meet the criticism of opposing interests during its formation renders it less likely to contain any injustice which conditions make it possible to avoid; and the endorsement of their representatives makes all classes of bondholders more ready to accord it temperate consideration. Among the numerous Union Pacific committees it was the joint committee, representing the foreign holders, the Denver & Rio Grande, the Oregon Railway & Navigation, and other interests that took the leading part. In the case of the Reading from 1884 to 1886 the seven reorganization trustees outweighed any other representatives of the creditors; in that of the Northern Pacific the Adams Committee succeeded in becoming a general reorganization committee, and took the leading part; and the Atchison reorganization was accomplished only by the union into a joint executive reorganization committee of three of the previously existing bodies.[692]
The situation which bankers and financiers occupy in relation to a bankrupt road is almost equally important. Their aid is essential to a reorganization while that of the officers and receivers of the company is not. And they are not subject to the pressure of imminent financial loss which forces creditors and stockholders to accept plans of which they do not altogether approve. It is true that these bankers may have money invested in the securities of the road. It may even happen that they have been formerly in control. In this case a certain pressure does exist. But as bankers their function is to do one or both of two things; namely, to advance cash to keep the railroad system together pending reorganization, and to underwrite assessments or the sale of securities. Either one of these involves them in new risks, and in undertaking either they will be only indirectly affected by investments which they may previously have made. Their influence on reorganization is strong because they are necessary, and because they are free to participate or not to participate according to their opinion of the precise reorganization plan proposed. For much the same reason their influence is a wholesome one. We shall see that the primary conflict which takes place in any reorganization is between the interests of the corporation which needs a lessening of its burdens, and the interests of the securityholders which is opposed to any reduction in their claims.[693] The degree to which the former interest prevails determines the strength of the reorganized company. In this conflict the bankers naturally take the side of the company. As bankers, who advance cash, and who usually receive their pay in securities, they wish to make the corporation prosperous, and to raise the quotations of its securities to a high figure. An important factor also is that as reputable banking firms they wish the future career of corporations which they have handled to reflect credit upon themselves.
An example of the influence of bankers and financiers appears in the case of the Union Pacific. A committee comprising General Louis Fitzgerald, Jacob Schiff, T. J. Coolidge, Oliver Ames, and two railway presidents took the road out of receivers’ hands, cut charges per mile by over one-half, and paid the Government’s claim in full. The Reading reorganization of 1886 to 1887 was the work of a syndicate which took hold after interests closely connected with the properties had failed to produce a satisfactory plan. The result was the best plan ever applied to the Reading Railroad. The Richmond Terminal Company was reorganized by a single banking firm. In this case the operation cut charges less than could have been desired, though the other parts of the plan were well-advised. The intervention of a syndicate has fortunately been usual of late years. And it is doubtful if the compensation accorded has been exorbitant, even for the direct services rendered. In 1886 the Reading agreed to pay a syndicate 5 per cent upon $15,000,000 of subscribed capital, plus 6 per cent on all money advanced. The Richmond Terminal paid Drexel, Morgan & Co. $100,000 in cash to cover their office expenses and $750,000 in common stock at $15 per share[694] for their work of coöperation and supervision. The Union Pacific paid the syndicate which financed its reorganization $5,000,000 in preferred stock quoted at 59, or 19 per cent at current prices on a subscribed capital of $15,000,000. All three syndicates, however, ran the risk of depreciation in the value of the stock given them, and all three rendered great service in providing large sums of cash at a time when capital was not readily to be obtained.
Payments to bankers or trust companies receiving deposits of bonds and stocks and undertaking the clerical work of a reorganization, should be sharply distinguished from those made to underwriting syndicates above described. Depositaries assume no risk, and are paid a definite sum for definite services performed. In 1895 the Erie set the compensation of Messrs. J. P. Morgan & Co. and J. S. Morgan & Co., for their services as depositaries and in carrying out the plan of reorganization, at $500,000 in addition to all expenses incurred; and the same year the Union Pacific allowed $1,000,000 in preferred stock to the bankers who managed its underwriting syndicate, as against $5,000,000 to the syndicate itself. It should be said that the compensation to depositaries is in part payment for the use of the name of the firms employed as well as in part payment for clerical work performed. Bondholders are more ready to deposit their securities with a well-known house than with an obscure one; and are to some extent influenced by the implied approval of the reorganization plan which acceptance of deposits by such houses involves.
At the beginning of the ordinary reorganization, then, creditors, stockholders, syndicate, and corporation find themselves face to face. The interests of the syndicate and of the corporation most nearly coincide except in so far as the syndicate is an owner of stocks or bonds. The syndicate desires a radical reorganization,—the corporation requires it. But as between stock- and bondholders and the corporation; between the stockholders and the bondholders; or between the junior and the senior bondholders; there is well-nigh complete antagonism. The corporation, to repeat, needs a reduction in the fixed charges which it has to pay. The securityholders wish to lose as little as possible. The stockholders hope to force sacrifices from the bondholders, and the bondholders to levy a heavy assessment upon the stock. The junior bondholders call upon their seniors to bear their part; and the seniors reply that they are well secured and that the juniors and the stock must take care of themselves.
The first question which arises is that of the cash requirements. How much cash must be raised to pay off the floating debt, and how much working cash capital will the new corporation require? It is almost always true that a large floating debt has accumulated prior to reorganization. The Northern Pacific in 1893 had a gross debt of no less than $15,000,000; the Reading in 1895 one of $13,800,000; the Baltimore & Ohio in 1896 one of $13,000,000; the Atchison in 1893 one of $16,000,000. In part this means simply the accumulation of unpaid bills. In part, however, it represents promissory notes or other short time paper which the corporation has issued, generally to pay current indebtedness, but occasionally for financing somewhat extensive operations. Thus Mr. McLeod carried his purchases of New England railroad stock by means of advances from brokers, and the Government Directors of the Union Pacific reported that $15,000,000 out of $21,400,000 of floating debt of that road in 1891 were the result of expenditure and advances in the construction of branch or tributary lines. The cost of carrying such indebtedness is naturally high. Mr. McLeod is reported to have paid an average of 9 per cent for his loans. The reorganization committee of the Atchison stated in 1895 that during the five years preceding, the road had paid over $1,100,000 in discounts and commissions to secure the renewal of $9,000,000 of guarantee fund notes. And floating indebtedness is by far the most dangerous as well as the easiest sort of obligation to incur. It represents a possible demand for large sums of cash on short notice which even a solvent company may find it impossible to meet;—a demand, moreover, which is likely to be made at a moment of stringency in the money market. For this reason, and on account of the high interest demanded, corporations endeavor to fund their floating debts when these reach unwieldy proportions. In 1891 the Union Pacific authorized three-year 6 per cent notes to the amount of $24,000,000 to be used in taking up its floating debt. In 1893 the Northern Pacific authorized $15,000,000 collateral five-year 6 per cent notes for the same purpose. In each case it was hoped to refund these short time issues with bonds of longer term when the date of their maturity should arrive. After a company has been in receivers’ hands, issues of receivers’ certificates are pretty sure to swell the current liabilities. These, again, may be issued to pay current bills, or to maintain or to improve the railroad when other resources prove insufficient. For whatever reason incurred, it is plain that the problem of the floating debt is a serious one for the creditors and owners of a bankrupt road to meet. If the provision which they make is insufficient their company will not regain a safe financial footing. And if, in addition to cancelling the debt outstanding, they do not provide a margin for working capital, the company will be forced to incur new floating debt and their work will have to be done over again.
In general there are two ways by which cash for floating debt and working capital can be raised: