Railroads: Rates and Regulations

by William Zebina Ripley

In place of regulation of the issues of stocks and bonds by Federal authority, as pledged in the political platforms, the almost unanimous opposition in the Senate to such a plan, brought about the substitution of a Railroad Securities Commission to investigate the subject. This, after all, was probably wise; inasmuch as many details as to conflicting state and Federal powers in such matters, were yet to be determined judicially. Moreover, the plans proposed, as it appeared, were so complicated that their adoption might result in the validation of all capitalization then outstanding without reference to its real value. The question certainly merited further investigation at the hands of experts.

Under the authority above mentioned, the President appointed an able although distinctly conservative commission, headed by President Hadley of Yale University. This body rendered its report in November, 1911.[704] The document was concise, cogent in reasoning (with the exceptions noted below), wise in its general conclusions and eminently conciliatory in spirit. It was obviously intended to promote good relations between the government and the carriers. The dominant note was complete publicity as a corrective for all financial abuses of the time. The adequacy of this remedy was probably exaggerated. The wise accounting provisions of the Acts of 1906-1910[705] were certainly already far-reaching in effect. The Securities Commission proposed, however, that they be elaborated to cover fully all phases both of promotion and of subsequent finance.

Not less important and wise than the insistence upon financial publicity, was the recommendation that, until the Supreme Court had clearly defined the relations between Federal and state authority, the Federal government should refrain from attempting to regulate the issue of securities. Too many difficult legal complications remained to be cleared up.

There certainly should have been a more enthusiastic commendation of the efforts of states like Massachusetts, Wisconsin, Texas and New York to cope with their local problems of financial control.[706] The apparent absence of a due appreciation of the importance of the work of the various public service commissions all over the country may perhaps be accounted for on the ground that it lay outside the scope of the work of a purely Federal commission. Yet a word of encouragement to these state administrations would have done something to offset the rather negative character of its conclusions. Someone must exercise financial control. If inadvisable for the Federal government to undertake it at this time, as might well be, then it was important to emphasize the fact that the states must do it as best they could. On the other hand, the recommendations concerning physical valuation as an element in rate regulation were sufficiently progressive to impart an aspect of judicial balance and general fairness to the report as a whole.

Two specific conclusions of the securities commission, however, were surely open to debate. One was the contention that little relation obtains between capitalization and rates. The statement is, of course, largely true; but like most generalizations of the sort fails to state the whole truth. It is probably absolutely true as to particular rates. No one would claim for a moment that the heavily capitalized Wabash, operating in trunk line territory alongside the Pennsylvania system, could charge any higher rates because of its financial disabilities.

Rather the reverse. But while true of particular rates, capitalization does exert an indirect but nevertheless a very appreciable influence upon the general level of rates. For this point I have argued elsewhere at some length.[707] Was it surprising that the pressure for advanced rates in 1910-1911 in trunk line territory should come from the heavily capitalized New York Central, with substantial aid and comfort from the Erie? Was it a mere coincidence that the Lackawanna road, with its stock quoted above $500, was a less prominent factor in the agitation than some of its neighbors? True enough, no direct relation between rates and capitalization exists; but that a positive incentive to higher charges in general may be found in the need of supporting a large capitalization seems reasonably clear in the light of experience. This point was certainly neglected or glossed over in the report.

A most debatable and, as I hold it, dangerous proposition in this report was the proposed abolition of the "dollar mark" upon capital stock. However desirable it might be for mining companies and the lesser industrials, as in Germany, to do away with any stated par value for share capital in order to disabuse the public mind of its purely artificial character, the proposition is quite different when applied to an industry like a railroad. There is all the difference in fact between purely private and competitive conditions of a more or less speculative character, and those under which monopoly privileges are conferred by gift of the public. Space does not permit a criticism of this proposition in detail. I have elsewhere discussed it more at length.[708] Many objections occur at once, none of them mentioned in this report which, almost jauntily, as it seems, proposed to revolutionize all of our customary habits of financial thought. Among these objections there is the fact that abolition of par value removes the restraint upon the promoter or management, for liability to creditors in case of part-paid shares. The experience of the Asphalt Company of America is illuminating in this regard. May we trust mere publicity to provide corresponding safeguards for honest promotion with this liability removed? Then again, how about the issue of stock in exchange for property acquired, as had frequently occurred in the course of railway consolidation? Was it immaterial whether the absorbing company put out 500,000 "participating shares," with a market value of $100 each, or twice that number of "certificates of participation" commanding half that figure per unit in exchange for the property acquired? And still further, there is the inevitable effect upon speculation. One of the primary needs of the time was to effect a separation of our common carriers from Wall Street influence. Did it make no difference whether the Southern Railway "participating shares" were traded in around $25; or those of the Louisville & Nashville commanded a price of $150? Low quotations always offer a great stimulus to speculative manipulation—as any student of Rock Island affairs must concede. To do away with par, which means permission to emit, without reproach, at any figure "below par"—how hard it is, indeed, to get rid of that conception of some standard of normality—could not but exert a malign influence. And then, finally, over and above all other considerations there was the need of some general standard of comparison for all sorts of purposes—some base from which to judge of normality. The proposal to wipe out all such standards, with the mere warning to public and investors alike to beware, seemed like a step backward.

This brings us to the insistence of the commission upon the need of the railroads for more capital for development; and the difficulty of financing new enterprises under regulative provisions of law, such as the prohibition of the issue of shares at a discount. Massachusetts had recently passed through an experience of probably excessive regulation. But simple modifications of its anti-stock-watering laws seemed to have solved the difficulty. Of course the developmental problems of the West and South are quite different from those of New England. Yet there was the experience of Texas to fall back upon. Complaint had been made, of course, especially by the Gould roads, of the insufficiency of capital for new work. But the growth of mileage seemed, nevertheless, to compare not unfavorably with progress in other states. Were the Gould roads, for example, any better off in other states where greater liberality of laws prevails? The fact was that much new construction and improvement remained to be done all over the country, as this report duly emphasized; but much of it would probably have to be done by companies already in the field. Not many new steam railroad companies are now needed even in the West. It must be confessed that the recently authorized extension of the Grand Trunk Railway into the heart of New England shows how persistent is the demand for new roads even in the East. But whoever may build, let them learn the lesson, so often forgotten, that honest management and conservative financing, to the end that solid credit be first established, has far more to do with facilitating development than non-interference by law. This was probably a time when encouragement to the railroads in a period of stress should properly be given. But let it not be forgotten that good faith to the public and to stockholders, together with prudent financing, must be the primary source of credit.