These issues were all protected from future introduction of new bonds between them and their property. The preferred stock certificates of the Atchison in 1897 contain the following words: “No mortgage, other than its general and its adjustment mortgage, executed in December, 1895, shall be executed by the company, nor shall the amount of the preferred stock be increased unless the execution of such mortgage and such increase of preferred stock shall have received the consent of the holders of a majority of the whole amount of the preferred stock which shall at the time be outstanding, given at a meeting of the stockholders called for that purpose, and the consent of the holders of a majority of such part of the common stock as shall be represented at that meeting.” Similar restrictions were imposed by the Southern in 1893, by the Erie in 1895, by the Northern Pacific in 1896, by the Reading in 1896, and by the Baltimore & Ohio in 1898; or in other words by all the large corporations except the Union Pacific, whose failures in the nineties we have described.
As for the years before 1893, in them the use of preferred stock was known, if not so widely resorted to. The East Tennessee in 1886 offered new consols and preferred stock for old consols, divisional and debenture bonds. In 1881 securityholders of the Reading proposed, and in 1886 nearly secured, the adoption of plans which comprised extensive issues of preferred stock in exchange or in partial exchange for old mortgages. The influence of English capital, however, and the liking for the name of bond to which we have referred seems to have prevented large employment of the device. Where either preferred stock or income bonds were used protection was afforded. When, in 1875, all the outstanding bonds of the Northern Pacific were replaced by stock, provision was made for an issue of first mortgage bonds to an average of $25,000 per mile of road completed; but no other bonds were to be issued except on a vote of at least three-fourths of the preferred stock at a meeting specially held in reference thereto on thirty days’ notice. In the Reading reorganization of 1886 a clause provided that in calculating the net earnings from which dividends on income bonds should be paid there should be deducted from gross profits operating expenses, taxes and existing rentals, guarantees and interest charges, but not fixed charges of the same sort subsequently created. And in the case of the Atchison in 1889 the provision that no bonds could be inserted between the incomes and the general mortgage 4s was so absolute as to prove an almost complete bar to new issues.
It is this use of preferred stock and income bonds which makes it possible to realize the last and highly important rule which the engineers of exchanges have in mind. Only by the combined use of securities upon which payment of interest is optional with securities upon which payment is obligatory can the claims which their corporations are forced to meet be reduced, while at the same time former bondholders are given the chance to share in future prosperity. Such a result is deliberately sought. “The general theory of adjustment of disturbed bonds,” said the Richmond Terminal reorganization plan of May, 1893, “has been to substitute for them the new 5 per cent bonds to such an extent as is warranted by the earnings and situation of the properties covered by the present mortgages, and the new preferred stock for the remainder of the principal.” This purpose receives, moreover, a natural development. Justice does not demand that old bondholders be given the unlimited chance at future surpluses which old stockholders should enjoy. Their former holdings could expect but a fixed amount, and the maximum to be paid on their new bonds and preferred stock is therefore rightly restricted. But fair play dictates that they be given opportunity to receive the same income as before. If they must surrender 6 per cent bonds in exchange for 4 per cent bonds it is equitable to allow to them as well 50 per cent of their original holdings in new 4 per cent preferred stock. The corporation thus announces its intention of saving them unharmed if it can possibly do so, while it insists that its solvency be not dependent on the success of its attempt. This idea has been realized in a number of cases with approximate exactness. The old third mortgage 6 per cent bonds of the Northern Pacific in 1896 received 118½ per cent in new 3 per cents, 50 per cent in 4 per cent preferred stock, and 3 per cent in cash,—which together could yield nearly the same as the old mortgage. The holders of Chicago Division 5s of the Baltimore & Ohio in 1898 surrendered an annual income of $50 for a chance to receive $50.30; the Union Pacific first mortgage 6s in 1898 obtained precisely 100 per cent in new 4 per cent bonds and 50 per cent in new 4 per cent stock. It would be too much to expect that such exactness should generally obtain. The variations in security between issues, the well-founded desire to distinguish and not at the same time to swell unduly the amount of new stock put forth lead to fluctuations both above and below the point of equivalence of return. The important fact to remember is in short this: that the use of bonds with a fixed rate of interest, together with bonds or stock upon which payment of interest is optional, provides that compromise between the interests of the old bondholders and the interests of the corporation which alone can afford justice to both sides and can allow the reorganization to proceed.
The matter of rentals may now be considered. “The extent of the reduction in rentals from reorganization,” says one authority,[716] “is seen where the reduction of this item of fixed charges for the entire country is considered. The net reduction in lease rentals from 1892 to 1898 was $24,527,000, and of this sum $17,768,000 appears in the South and West where the failures where most numerous and extensive. The reductions of rentals are most conspicuous in the Northwest and Pacific coast railroads. It is true that a part of this decrease in rentals is to be ascribed to the steady movement in the direction of consolidation which is constantly converting lease into purchase; but coming so close together, the difference between the figures of 1892 and those of 1898 is sufficiently marked to warrant the conclusion that most of the reduction is due to the numerous reorganizations which intervened.”
This conclusion is at first sight borne out by the following tables, which show the decreases or increases in absolute rentals and interest for thirteen reorganizations, of which six fall within the period covered by the quotation:
FIXED CHARGES
| Six Reorganizations, 1893–8 | |||||||
|---|---|---|---|---|---|---|---|
| Interest | Rentals, etc. | Total Charges | |||||
| Decrease | Increase | Decrease | Increase | Decrease | Increase | ||
| Atchison | 40.6 | 13.7 | 31.1 | ||||
| B. & O. | 19.7 | 77.2 | 11.7 | ||||
| Erie | 33.3 | 62.7 | 5.9 | ||||
| N. Pac. | 14.2 | 88.9 | 51.0 | ||||
| Reading | 20.8 | ||||||
| U. Pac. | 21.8 | 78.2 | 43.7 | ||||
| Average decrease | 4.7 | 58.8 | 25.7 | ||||
| Six Reorganizations before 1893 | |||||||
| Atchison, ’89 | 39.0 | 17.3 | 34.9 | ||||
| Atchison, ’92 | 38.7 | 3.9 | 31.0 | ||||
| Erie, ’75 | 13.4 | .5 | 11.0 | ||||
| Reading, ’80 | 15.9 | 98.1 | 49.1 | ||||
| Reading, ’83 | 13.3 | .6 | 7.9 | ||||
| Rk. I., ’80 | 11.9 | 25.2 | 16.3 | ||||
| Average decrease | 1.0 | 9.9 | 5.3 | ||||
| One Reorganization, 1902 | |||||||
| Rk. I. ’02 | 139.0 | 29.0 | 119.3[717] | ||||
It appears that while the decrease in rentals was of little importance in the six reorganizations before 1893, it was of great importance in the reorganizations from 1893 to 1898. Whereas absolute interest charges were reduced by none of the later reorganizations by over 40 per cent, four of the railroads cut rentals by over 60 per cent, and two others might have shown a similar result if a satisfactory division between interest and rentals could have been made. Unfortunately, both these statistics and Meade’s statement are open to criticism for the reason which Meade recognized but to which he did not give sufficient weight. The relative amounts of interest and of rental paid by a railroad at any time represent the method by which its system is held together. If a parent company raises money by the sale of bonds, and purchases its branches outright, or buys a majority of their shares, its interest charges will be large and its rentals small; if it leases these same lines its interest payments will be small and its rentals large. A steady movement in the direction of consolidation doubtless existed before 1893, but this movement was certainly accelerated by, and made a prominent feature of many of the reorganizations of the following five years. Thus the Northern Pacific in 1893 reported a total length of line of 5431.92 miles; of which leased lines and lines operated under contract constituted 1912.92. In 1898, after reorganization and surrender of the Wisconsin Central, it reported 4524.45 miles owned and operated, of which 2430.42 consisted of main line, and 2030.82 of branch lines owned. The Erie in 1893 reported 551.12 miles leased and 598.51 operated for 32 per cent out of a total of 1970.32.[718] Four years later it either owned outright or held a majority of the stock of 1806.92 miles out of a total of 2162.81. The Baltimore & Ohio operated 26.5 per cent of its mileage in 1897 under lease or contract, but had reduced this by 1899 to .5 per cent. The Southern Railway proportion was 38.1 per cent in 1892 and 28.4 per cent in 1895. A reduction in rentals through reorganization has occurred, but a reduction due nevertheless largely to consolidation of systems, rather than to revision of rental contracts.
It was partly because of the difficulty of exact statement on the subject that a discussion of rentals was postponed till the matter of interest should have been considered. It now appears that the reduction in interest payments which was so prominent took place in spite of a reduction in rentals. If, for instance, the annual interest charges fell $10,261,369 in the course of all reorganizations, and if in later years the interest figures represented charges which at earlier date appeared as rentals, then the real reduction in interest was greater than the figures show. It is true that consolidation is not responsible for all of that decline in rentals which has occurred. It is as open to a reorganizing railroad to continue old leases at easier terms as it is to absorb the leased roads into its system; and much of this has been done. The East Tennessee, Virginia & Georgia, for instance, leased the Memphis & Charleston in 1877 for a yearly payment of $297,750; while the Southern Railway Security Company a few years before had agreed to pay $318,763.50 annually for the same property. And it is a fact that both consolidation and direct agreement have been the occasion of considerable reductions in the payments for the control of subsidiary lines. There is no reason why leased lines which have not earned their rentals should not suffer as much as portions of the main system which have not earned interest on their bonds. On the whole, then, rentals have decreased, both by means of direct negotiation and through an absorption of leased roads into the main system accomplished by exchange of new securities for old. The significance of precise figures must not be exaggerated. The losses which have occurred have been distributed according to the same principles which have already been detailed.
It is now clear that creditors, stockholders, and syndicate in practically all successful reorganizations agree that cash must be raised, fixed charges reduced, and the losses distributed according to the seniority of existing claims; and that of all methods the comprehensive exchange of new securities for old is best suited to accomplish at least the last two of these necessities. To give a comprehensive view of the operations the capitalization after reorganization of the roads which have been studied may be compared with the capitalization before. It will then be possible to see at a glance the consequences of the great variety of exchanges. The following table gives the percentages which the stock and bonds of these companies bear before and after reorganization to the total capitalization before.