The American Railway: Its Construction, Development, Management, and Appliances

by Thomas Curtis Clarke

Let us take a specific case. An inside ring issues stock certificates to the value of a million dollars, on which perhaps a hundred thousand is paid in. They then publish their prospectus and place on the market two million of bonds with which the road is to be built. They sell the bonds at 80, reimburse themselves for the $100,000 advanced by charging the moderate commission of 5 per cent. for services in placing the loan, and have at their disposal $1,500,000 cash. These same directors now appear as a construction company, and award themselves a contract to pay $1,500,000 for work which is worth $1,200,000 only. The road is finished, and probably does not pay interest on its bonds. It passes into the hands of a receiver. Possibly the old management may have an influence in his appointment. At the worst, they have got back all the money they put in, plus the profits of the construction company; in the case supposed, 300 per cent. The bondholders, on the other hand, have paid $1,600,000 for a $1,200,000 road.

John W. Garrett.

But the troubles of the bondholders and the advantages of the old directors by no means end here. When the receiver takes possession he discovers that valuable terminals, necessary for the successful working of the road, are not the property of the company, but of the old directors. He finds that the road owns a very inadequate supply of rolling-stock, and that the deficiency has been made up by a car-trust—also under the control of the old directors. Each of these things, and perhaps others, must be made the subject of a fight or of a compromise. The latter is often the only practicable alternative, and almost always the cheaper one; by its terms the ring perhaps secures hundreds of thousands more, at the expense of the actual investors.

These are but a few of the many ways in which a few years' control of property may be made profitable to the officials at the expense of legitimate interests. In a case like this, all depends upon the possibility of selling bonds. It is usually impossible to place the whole loan before construction; and if the market-price falls below the cost of the work undertaken, as was the case with the West Shore, the loss falls upon the construction company. Such accidents were for a long time rare. It took the public nearly twenty years to learn the true character of imperfectly secured railroad bonds. Within the past five years it seems to have become a trifle wiser. The crisis of 1873 was insufficient to teach the lesson; but that of 1885 has been at least partially successful in this respect.

In cases like the one just described the bondholders are largely to blame for their own folly. But sometimes the loss falls on those who are in no way responsible for it. A railroad may be built as a blackmailing job. If a company is sound and prosperous, speculators may be tempted to build a parallel road, not with the idea of making it pay, but because they can so damage the business of the old road as to force it to buy them out. They build the road to sell.

It is but fair to say that operations as bad as those just described are the exception rather than the rule. But the fact that they can exist at all is by no means creditable to our financial methods. The whole system by which directors can use their positions of trust to make contracts in which they are personally interested puts a premium on dishonesty. Such contracts are forbidden in England. It may be true, as is urged by many railroad officials of undoubted honesty, that it would be inconvenient to apply the same law here; but on the whole, the gain would far outweigh the loss.

At the very best, a railroad president is subject to temptations to misuse his financial powers, all the more dangerous because it is impossible to draw the line between right and wrong. He knows the probable value of his railroad and of the property affected by its action a great deal better than any outsider possibly can. The published figures of earnings of the road are the result of estimates by himself and his subordinates. Out of the current earnings he pays current expenses, and probably charges permanent expenditures to capital account. But what expenditures are current and what are permanent? This division is itself the result of an estimate, and a very doubtful one at that. There are some well-established general principles, but none which will apply themselves automatically. With the best will in the world he cannot make his annual reports give a thoroughly clear idea of what has been done. Is he to be forbidden to buy stock when it seems too low, or sell it when it is high? Shall we refuse him the right to invest in other property which he sees will advance in value? Apparently not; and yet, if we allow this, we open the door for some of the worst abuses of power which have occurred in railroad history. The line between good faith and bad faith in these matters is a narrow one, and the average conscience cannot be trusted to locate it with accuracy.

But the relations to the investors cover but a small part either of the work or of the responsibility of the railroad authorities. They are managing not merely a piece of property, but a vast and complicated organization of men, and an instrument of public service. In all these capacities their cares are equally great. The operating and the traffic departments are not less important than the financial department. The relations of the railroad to its employees, and to the business community at large, are even more perplexing than its relations to the investors.