Part 38
Regulation of rates by governmental authority, which means their limitation to that which is reasonable and just, will probably in the future be the purpose in the making of most valuations of the property of public service corporations, and no methods or rules for the making of appraisals can be considered as being at all complete or fairly comprehensive which do not meet the logic of such an end.
If capitalization of net earnings is to determine railroad values for rate-fixing, whatever the process, it must presuppose a fair and equitable rate, thus following the rate, instead of the rate following the property value. This is but a shifting of the difficulty; for, what constitutes a fair and just rate, irrespective of the value of the property used, is at least as difficult of determination as is the property value, irrespective of its earnings. Valuations, to be useful, must have their purposes carefully predetermined, that the right application of principles may be made.
Perhaps nowhere more than in California has thought been directed along this line, for the organic law of the State for thirty years has required the annual fixing of rates for water and light companies by public official bodies, and many important cases involving rates and valuations of large properties, chiefly in later years, have been tried. Unfortunately, the most important and best tried of these have not yet reached the United States Supreme Court. The result, thus far, is too long a story to be told now, but it may be said that capitalization of earnings in any form is not regarded as a logical basis of value under such conditions. Franchises, as they exist here, are not regarded as having value, unless from unusual circumstances. "Going concern" value is recognized, but its money measure is sought through other channels than present net earnings.
The author's emphasis on the necessity for eliminating the personal equation, as far as possible, is commendable, but a large exercise of discretionary judgment is inseparable from the process of appraisal. The fullest investigation of all pertinent facts should be made. Too much must not be expected from rules and formulas. They are education only. Governing principles must be understood, and subsequent procedure the writer cannot better express than in the words substantially as used on a former occasion:[47] Having considered the various factors likely to influence the value of any property under consideration, and having summarized the results, it will remain to determine the varying degrees of importance and weight to attach to each, and to decide, in view of all the attendant circumstances, what the amount is on which the company is entitled to receive a suitable return. This final solution can never be reduced to a mathematical formula applicable to all cases. The inquiry will have established approximate limitations, both as to maximum and minimum, but there will then usually be found remaining quite a wide intervening field for the exercise of discretionary judgment.
That the final result will depend to some extent on the personal equation, does not of necessity detract from its worth. It only shows the greatness of the problem, which requires for its solution the exercise of faculties higher than the application of mere formulas and mere routine, faculties which are rooted in laborious thought, in ripe experience, in moral worth.
A word concerning the use of experts on work of this class: Most valuations grow out of or grow into cases at law. Under the prevailing order, the litigants secure the services of the necessary expert appraisers, who, in the course of examination, are subjected to processes usually much better calculated to magnify than to harmonize differences, and to cloud rather than to clarify issues, to the detriment of the record, the confusion of the Court, and the attempted discredit of the witnesses and their profession. Self-defense is calculated to lead witnesses into undue reliance on rules and mathematical formulas, as direct means of obtaining the desired result, instead of aids for the final exercise of a right judgment as to the real value of the property for the purpose intended, simply because it is easier in dealing with attorneys to justify mere mathematical processes than to support opinion resting on considerations of a general character, not always readily measurable in figures. This tendency leads also to under-valuations. A change in the process of Court procedure relative to such expert evidence is needed, and the influence of the Profession, both individually and collectively, might be used to secure the appointment of such witnesses at the instance of the Court, instead of the litigants, to the great advantage, both of society and of those more immediately concerned.
C. D. PURDON, M. AM. SOC. C. E. (by letter).—A comparison of some of the more important items in the Minnesota valuation may be of interest. In the "Cost of Construction of Roadbed and Track," the principal items are:
Land 25.46% Clearing and grading 21.49% Rails 12.72% Bridges 7.01% Ties 6.72%
These five items amount to 73.40% of the total cost, and "Adaptation and Solidification of Roadbed" to 4.53%, the other twenty-three items amounting to 22.07 per cent.
The estimated value of "Adaptation and Solidification of Roadbed" ranges from $543 to $1,542.80 per mile, averaging $1,231.92, which includes 4½% for engineering. If engineering is omitted, the average for all roads is $1,124.95, and for "Carrying Roads"[48] $1,128.16.
The "multiplier" for cost of right of way was ascertained from the market value of land in the vicinity, as shown by late transfers, and the prices paid for right of way at about the same time; this cost ranged from 195 to 891% of the market value. Taking "all roads," the cost of land for terminals was 71.05% of the total cost of land for all purposes, but only 3.78% of the quantity.
A. MORDECAI, M. AM. SOC. C. E. (by letter).—Mr. Riggs has done a valuable service in preparing this very able and painstaking paper, as the subject of the proper value of Public Service Corporation property is one but lately demanding attention. When the country was undeveloped, and the railroad companies struggling for existence, and often ahead of the needs of the people, no criticism was made; but, during the last few years, securities have increased so largely, the increased issue often being manipulated so as to accrue to the benefit of a few individuals in place of the great mass of original security holders, rates have been made and defended on the plea that the increase was necessary to pay a fair interest on the capital invested, and increases in assessments for taxes were fought and criticized to such an extent by the companies that the public seems to think it absolutely necessary to have some investigating and regulating power. It argues that the history of the past shows that we cannot depend on the officials themselves, not from any desire to be dishonest or unfair, but merely that they cannot reach the proper point of view. After years of struggling, they cannot see the justice of being obliged to show their books or have their incomes disturbed, while they see a neighboring factory, owned by a like chartered company protected by patents and copyrights, greatly enlarged, and the company paying a very handsome return on an ever-increasing capital, without investigation of any kind.
No one supposes that any body of legislators or a committee selected from one should understand the situation better than the managers themselves, but the public, forced to look somewhere, demands that its representatives try to regulate these matters and see that no abuses occur, fully aware that the machinery is not perfect. It asks:
As to Capital: that the company can show proper value for the securities issued, and, if an increase is made, the sum obtained should be used for the betterment of the property;
As to Rates: the Courts have said that what the company is entitled to ask is a fair return on the value of that which it uses for the public convenience;
As to Taxes: what is the true value of the property of the company, treating it with absolute equality, as compared with that of other taxpayers?
It is to determine what these values are that the Engineer among others has been called on. The literature on the subject is increasing, and there are some decisions of the Courts which help, but there are yet perplexing and intricate questions to be determined; not to be answered by captious criticism and indignant retort, but by an honest effort to arrive at some common ground of fairness to both State and Corporation; for, after all, the Corporation is a part of the State, a great distributor of money, a large taxpayer, its stockholders men of worth and capacity, and there should be no desire to penalize it or interfere with its legitimate prosperity. The Corporation is surely dependent on the State and the good will of the people for its welfare. Mistakes have been made, no doubt, just because this common ground has not been reached, and the writer thinks that it is largely within the province of the Engineer to establish it.
In arriving at either of these values, the chief tangible asset is the value of the physical property. This can be determined with a great degree of accuracy, and though by no means alone representing any of the values, it seems to be indispensable as a basis and starting point. The balance sheets of the Corporation commence with a statement of the cost of road, plant, etc., and must be checked to permit correct deductions from the results of operation shown in them; and, for purposes of taxation, they would seem to be particularly reliable.
The Engineer called on to make such a valuation for whatever purpose should, under like conditions, value each item the same for all, but it does not follow that every item, including the percentages added, should appear in the total valuation for all purposes. There are legitimate charges in valuations made to determine capital which should not appear in one made for assessment for taxes. Unit prices should not change, but the purpose for which the valuation is made should properly be considered in arriving at the final figure.
To or from this valuation, especially if made to determine proper capital, there must be added or subtracted certain values for intangible property, often found by a study of the income account of the Corporation. This makes the official ask: Why make a valuation of the physical property at all if your final result depends on the income? Because it is one item which cannot be manipulated; it does not change materially from year to year; it is not dependent on rates or income; it forms a very large item in the assets of the Corporation; and it is a sound basis on which to stand.
For the purpose of determining the proper amount of securities, the cost of reproduction at present prices would seem to be the value sought; whereas, for taxation purposes, or to determine a proper selling price, the present value is what is required, allowance being made for depreciation. A railroad, for instance, might be considered as an instrument for transporting passengers and freight, and, though the ties are not new, the rails worn, and the locomotives of an old type, they do their work just as safely and expeditiously, and, if no account is to be taken of the cost of maintenance, the road might be considered to be worth as much as if new.
The officials of the Corporation are generally perfectly willing to give any facts or to furnish access to any records they may have, but are not willing to state their opinions as to prices, depreciation, etc. The Engineer is making the valuation, not they; and they reserve the right to criticize, at the proper time, both the results and the conclusions drawn from them. The Engineer should be absolutely fair and just, not using improperly the information obtained, but endeavoring to reach results which appear to be unquestionably correct. He must divest his mind of the innate desire to minimize the consequences of his decision to the Corporation, on the one hand, or to favor the State or his employer, on the other; it may be difficult, but on his ability to do this depends the success or failure of his work.
Considering the subject generally: in making the valuation of the physical property, the organization should consist of one man in charge, and under him a field organization and an office organization. The property, if large, should be divided into convenient districts, with a division engineer and necessary assistants in charge of each. Care should be taken that these assistants are competent men, though they are often hard to obtain for temporary work of this character, and there is not sufficient time in which to weed out and perfect an organization. They should be men of experience on the particular class of work to which they are assigned, and should be tactful and courteous. Stress should be laid on keeping plain, neat notes, not too crowded; on watchful care of the party working in the field, to prevent accidents, and on the necessity of absolute correctness in calculations and figures, in the multitude of which it is surprising how many mistakes will creep in unless special care is taken to check every step thoroughly. The office engineer should be equally competent, and accustomed to systematizing and analyzing, so that the results will be arranged systematically, not only as considered by themselves, but as far as possible according to the classification of the Interstate Commerce Commission, so that, no matter where made, they can be easily compared.
The work, if large, should be standardized. Everything to be reported should have a form for the purpose. These should be as concise as possible, calling attention to the essential information, but not in too much detail. Unit prices should be established after proper consideration.
_Reproduction Value._—In ascertaining the reproduction value, the aim should be to obtain prices for which the material could be purchased and the work let to responsible parties at the date of the valuation. Real estate and depreciation are probably the two items in which there will be the largest differences in opinion as to values, and both should be determined by the personal examination of experts, following some prearranged system. One founded on the Somers system might do for the land, and certain percentages of depreciation per year, varying for the three conditions of good, fair and poor, for the structures and equipment, but the results in any case should be examined and passed upon by some one person so as to eliminate the individual equation as far as possible.
It is when the figures thus reached are before him that the Engineer finds himself confronted with many perplexing problems. To what items should percentages be added, and in what amounts? A small change in such items often makes a large difference in the total. There is not much trouble about general expenses, legal expenses, engineering, etc., as these are undoubtedly proper items to be added, and the amounts of the percentages are not difficult to determine from sufficient study of the property. Opinions on such matters will not vary greatly, but there is a difference with regard to such items as leasehold interests, solidification, contingencies, interest and taxes during construction, commissions and discounts on securities, working capital, value of the good will, and considering the property as a "going concern," about which opinions will differ much more widely.
Leases from the company are like any other book asset. Leases to the company should be considered as the land is considered. What is the present value of the leasehold interest for the remainder of the term for which the rental is fixed?
_Present Value._—In ascertaining the present value, it would seem that something should be allowed for solidification, the amount depending on the manner in which the work was built, its age, the likelihood of damage by the elements, etc. Possibly a percentage of appreciation on the value of the earthwork and masonry would be the fairest manner in which to consider it. Due care must be taken, however, to give proper credit to good work and not put a premium on inferior construction.
A percentage should be allowed for contingencies in all cases, but this is not necessarily the same for every piece of property. The estimate is made on a completed piece of work, consequently, if done with proper care, this item should not be as large as if the estimate were made for work to be constructed; but there are many things, not seen by the estimating engineer or disclosed by available records, which must be covered by this item, such as buildings bought with the land and afterward destroyed, damages paid for reasons not now apparent, difficulties encountered in excavating wet or hard material, amounts spent in dredging, in artificial and difficult foundations, losses during construction on account of strikes, washouts, etc. These are perfectly legitimate charges, and are likely to have occurred, and proper allowance should be made for them.
It would seem that interest and taxes during construction is a legitimate charge, and therefore, in the cost of reproduction, sufficient amounts should be added to cover it. Care should be taken to make the time long enough, as engineers are often too sanguine as to the length of time necessary to complete a certain piece of work. It is true that a part of a railroad, for instance, may be completed and opened for operation, but the net revenue derived would be very different from that of the completed road with its terminals and connections.
A new corporation can rarely market its securities at par, not only on account of the chances taken by the investor, but also because, being human, he likes to think he is buying at a bargain, getting something a little below its value; consequently, inducements vary from a small discount on bonds to a share or two of stock thrown in. To what extent a reasonable discount is a proper charge against construction may be considered an open question. It might seem fair that a certain fixed percentage be allowed in valuations, to determine capital for commissions and necessary discounts, varying according to the amount of the securities. This need not cover the whole amount of the discount, but only that portion which experience would consider essential in marketing unquestioned securities.
Consideration of the items working capital, good will, etc., may not properly belong to the Engineer, but rather to the Statistician, except as the former hears of such items being used as an argument against the necessity for a valuation of the physical property of a corporation. It is often asked, for instance, how can a value be placed on the property of the Pennsylvania Railroad Company, with its great commercial position, its magnificent terminals, and its splendid organization, all the result of the expenditure of much time and money? It is certainly a difficult problem, but the Pennsylvania Railroad is one of the greatest properties in America, possibly in the world, and because the proper valuation of this property is surrounded with difficulties it does not follow that the valuation of the properties of all other public service corporations are equally troublesome. The very difficulty of the task shows the importance of having firm ground for the first step. Having that, it may not be as hard as imagined to take others.
Thus it is seen that there are many perplexing questions for the Engineer to consider, and many details for him to work out, in doing which Mr. Riggs' paper will materially help. Above all, the Engineer must aim to be impartial; he must arrive at such a point of view as to see both sides with equal distinctness, and judge fairly and justly, trying to determine some well-defined laws and formulas which will serve as a basis in ascertaining the values desired.
W. B. RUGGLES, M. AM. SOC. C. E. (by letter).—In his discussion Mr. Lavis quotes the case assumed by the _New York Sun_, of two bridges over the Ohio River—one between Cincinnati and Newport and one 20 miles below, between villages, etc.
In 1898 the writer was employed by the Board of Supervisors of Cincinnati to put a valuation on its Ohio River bridges for purposes of taxation, and the many points of view, as to their cost and their actual value to the owners and to the communities, were at that time, and have been frequently since, considered by him. In this particular valuation the duties of the Engineer were comparatively simple and plain, for, as there were sure to be controversies on two points at least, first, as to the right of the city to levy any tax on the bridges as such, and second, as to whether any control by the city extended to the center of the river, informally but generally recognized to be the division between the cities for police and similar purposes, or only to the northerly low-water mark, the limiting boundary to the "Territory Northwest of the River Ohio," as recognized by the ordinance of 1787, it appeared to the Board to be advisable, in the earlier stages of their efforts, to avoid, as far as reasonable, any controversies concerning details of the valuation, and the writer was instructed to give the bridge companies the benefit of any doubts.
The railroad bridge of the Cincinnati Southern Railway, the one lowest on the river and having the little village of Ludlow at its southern end, and thus most nearly filling the conditions of one of the assumed structures of the _Sun_, is, with its railroad, the property of the city, and the Supervisors believed that, under the terms of the lease to the operating company, it should not be taxed.