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THE CHICAGO & ALTON CASE 
 
 A MISUNDERSTOOD TRANSACTION 
 
Digitized by the Internet Archive 
 
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 http://www.archive.org/details/chicagoaltoncaseOOkennrich 
 
The 
 
 Chicago & Alton 
 
 Case 
 
 A Misunderstood Transaction 
 By George Kennan 
 
 The Country Life Press 
 
 Garden City, New York 
 

 •55* 
 
 ^VCfAr 
 
 Copyright, 1916, by 
 
 jj GEORGE KENNAN 
 
 - . 
 
THE CHICAGO & ALTON CASE 
 
 A MISUNDERSTOOD TRANSACTION 
 
 323588 
 
The Chicago and Alton Case: 
 A Misunderstood Transaction 
 
 No episode, perhaps, in the career of the late 
 E. H. Harriman has been more severely criti- 
 cised by the Interstate Commerce Commission, 
 by certain members of Congress, and by an 
 ill-informed part of the public than the re- 
 organization of the Chicago & Alton Railroad 
 in 1899 and 1900, It excited little comment at 
 the time, but when, long afterward, the Gov- 
 ernment began its campaign against Mr. Har- 
 riman, through the Interstate Commerce Com- 
 mission, the transaction was characterized as 
 "indefensible financing," and was described 
 as the "crippling," "looting," and "scuttling" 
 of a well-managed and prosperous railroad by a 
 syndicate of unscrupulous financiers in which 
 Mr. Harriman was the "main conspirator." 1 
 
 The Chicago & Alton Railroad, when Mr. 
 Harriman became connected with it, was an 
 
 x Reports of the Interstate Commerce Commission, Vol. XII, 
 pp. 301-303; statement of Senator Cullom, New York Inde- 
 pendent, Vol. LXII, p. 692; "Railroads: Finance and Organi- 
 zation," by Prof. W. Z. Ripley, pp. 262-267. N. Y., 1915. 
 
THE CHICAGO AND ALTON CASE 
 
 apparently prosperous and well-managed road. 
 It had paid dividends of 8 per cent, on its in- 
 vested capital for thirty years or more; its 
 credit was good, and its shares of common and 
 preferred stock were selling at from 75 to 100 
 points above their par value. From a financial 
 point of view, it seemed to be as strong as any 
 railroad of its class in the Middle West. Un- 
 fortunately, however, its managers had pursued 
 an ultra-conservative policy in the matter of 
 expenditures, and had neglected, for a long 
 time, to make necessary appropriations to 
 cover depreciation, and to provide for exten- 
 sions, betterments, replacements, and addi- 
 tional equipment. The road had grown old 
 without improving in physical condition; and 
 had become more or less incapable of rendering 
 the service demanded by a rapidly growing and 
 developing territory. Speaking of this state of 
 affairs, the well-known economist, Prof. E. S. 
 Mead, says: 
 
 "The condition of the Alton was far below 
 that of its competitors. The standards of 
 construction were those of fifteen years before. 
 The track was laid with steel rails, but these 
 were only seventy pounds to the yard. The 
 bridges were in good condition, but were too 
 light for heavy engines. The capacity of the 
 
A MISUNDERSTOOD TRANSACTION 
 
 sidings and second track was inadequate to 
 handle large increase of traffic. In short, the 
 company had not maintained a sufficient de- 
 preciation account, and its property had not 
 been kept up to standard." 1 
 
 According to J. H. McClement, expert ac- 
 countant, who had occasion to investigate the 
 affairs of the company: 
 
 "It had not added one mile of road in seven- 
 teen years. It had little or no reserve capacity 
 to conduct a larger business. Its cost of opera- 
 tion, per unit of traffic, was very high in com- 
 parison with similar roads. Its grades were 
 uneconomical. Its shops and equipment were 
 uneconomical and old. Its settled policy against 
 the expansion of its facilities, because of de- 
 clining rates, was an absolute bar to the de- 
 velopment of the tributary country. While 
 for twenty-five years it had paid an average 
 dividend of 8.3 per cent, on its capital stock, the 
 gross earnings for the year 1898" — (the year 
 before Mr. Harriman became interested in it) 
 — "amounting to $6,286,000, were the lowest 
 since 1880, and had been gradually falling since 
 1887, when they amounted to $8,941,000. In 
 many respects the company was being con- 
 ducted like a commercial enterprise having in 
 
 ^'Corporation Finance," by Edward Sherwood Mead, Ph. D., 
 Wharton School of Finance and Commerce, University of Penn- 
 sylvania, pp. 252-253. N. Y., 1914. 
 
THE CHICAGO AND ALTON CASE 
 
 view ultimate liquidation, instead of like a 
 public carrier." 1 
 
 The ultra-conservative — not to say parsi- 
 monious — policy of the management, the pro- 
 gressive deterioration in the physical condition 
 of the road, and the decline of $2,655,000 in 
 annual earnings in a period of eleven years, nat- 
 urally created dissatisfaction and excited a 
 feeling of uneasiness among the owners of the 
 company's securities; and in the fall of 1898 a 
 number of the large stockholders, actuated by a 
 feeling of apprehension as to the future of the 
 road, requested John J. Mitchell, President of 
 the Illinois Trust Company, to open negotia- 
 tions with Mr. Harriman, with a view to the 
 sale of the property and a financial reorganiza- 
 tion of the company. 2 
 
 Mr. Mitchell had an interview with Mr. 
 Harriman in New York, and represented to 
 
 '"Statement of the Recapitalization of the Chicago & Alton 
 Railroad Company," by J. H. McClement, Expert Accountant. 
 N. Y., 1907. 
 
 2 Among the prominent stockholders of the Chicago & Alton at 
 this time were Morris K. Jessup of New York, Marshall Field of 
 Chicago, John A. Stewart of New York (President of the U. S. 
 Trust Company and formerly Assistant Treasurer of the United 
 States), Albert A. Sprague (of Sprague Warner & Co., Chicago), 
 A. C. Bartlett (Vice-President of Hibbard, Spencer, Bartlett 
 & Co., Chicago), and John J. Mitchell (President of the Illinois 
 Trust Company). These were not men likely to be hoodwinked 
 or deceived by "unscrupulous financiers" bent on wrecking the 
 Alton road. 
 
A MISUNDERSTOOD TRANSACTION 
 
 him that "many of the Alton stockholders 
 were dissatisfied with the existing management; 
 that the stock might be bought for less than the 
 real value of the property; that if betterments 
 and improvements were made and modern 
 methods introduced the earnings might be 
 largely increased, and that if control of the 
 road were purchased, if funds for such better- 
 ments were provided, and if the road were 
 developed, there would be an opportunity for a 
 substantial profit." 
 
 Mr. Harriman, who had never before thought 
 of purchasing the Chicago & Alton, told Mr. 
 Mitchell that he would take the matter into 
 consideration, and ascertain as soon as possible 
 the condition of the road. Shortly after this 
 interview Mr. Harriman requested Mr. S. M. 
 Felton, a well-known expert and railroad 
 manager, 1 to make a thorough examination of 
 the property and submit a detailed report on its 
 condition, requirements, and earning capacity. 
 Mr. Felton's report was favorable. He esti- 
 mated that better management, and the ex- 
 
 *Mr. Felton had had long and varied railroad experience as 
 Chief Engineer of the Chester & Delaware River Railroad; 
 General Superintendent of the P. C. & St. L.; General Manager 
 of the N. Y. & N. E.; Vice-President of the Erie, of the East Tenn., 
 Va. & Ga. system, of the Memphis & Charleston, and of the Mobile 
 & Birmingham; and President of the Alabama Great Southern, 
 and of the N. 0. & Texas Pacific. 
 
THE CHICAGO AND ALTON CASE 
 
 penditure of $5,200,000 for improvements and 
 additional equipment would enable the road to 
 increase its earnings by at least $1,000,000 a 
 year on the traffic then existing, to say nothing 
 of the increased traffic that might be expected 
 when the road should be able to afford adequate 
 f acilities to the then rapidly developing territory 
 that it served. 
 
 Becoming satisfied that the road could be 
 bought for less than its potential value, Mr. 
 Harriman invited Jacob H. Schiff (of Kuhn 
 Loeb & Co.), James Stillman (President of the 
 National City Bank), and George Gould to 
 join him in making the purchase on the terms 
 suggested, and in providing the necessary funds 
 for betterments and additional equipment, as 
 well as for the refunding or retirement of the 
 company's maturing bonds. Upon the repre- 
 sentations made by Mr. Harriman, Messrs. 
 Schiff, Stillman, and Gould agreed to co6perate 
 with him, and the four men formed a syndicate 
 for the purchase, reorganization, and recapitali- 
 zation of the Chicago & Alton road. 
 
 This syndicate was ultimately made to include 
 Morris K. Jessup, John A. Stewart (ex- Assistant 
 Treasurer of the United States), John J. Mitchell 
 (President of the Illinois Trust Company), and 
 other individuals of like character, as well as 
 
 8 
 
A MISUNDERSTOOD TRANSACTION 
 
 some of the leading financial houses and insti- 
 tutions of the country. The supposition that 
 men and firms of such standing would join a 
 band of "pirates" and "looters" for the purpose 
 of "wrecking" and "gutting" the Alton is, to 
 say the least, highly improbable. The public 
 assumed, or was led to believe, that Messrs. 
 Harriman, Stillman, Schiff , and Gould were the 
 sole managers and beneficiaries of the reorgani- 
 zation; but this was not the case. The four 
 gentlemen named organized the syndicate, but 
 it included about one hundred members. 
 
 In January, 1899, the syndicate purchased 
 97 per cent, of the capital stock of the Chicago 
 & Alton Company (about 218,000 shares) and 
 paid therefor the sum of $38,815,000 in cash. 
 They then proceeded to readjust the accounts 
 of the company by crediting to surplus the 
 sum of $12,444,000, which the old managers of 
 the road, in previous years, had taken out of 
 current income and invested in permanent 
 betterments. In the opinion of the new owners 
 and their legal counsel, permanent improve- 
 ments and additions to the property ought to 
 have been charged to capital account, and not 
 taken out of surplus earnings, which belonged 
 to the stockholders and might properly have 
 been distributed in dividends. The newly 
 
THE CHICAGO AND ALTON CASE 
 
 elected directors, therefore, charged to capital 
 the sum of $12,444,000 previously spent in 
 betterments, and credited it to surplus, with a 
 view to distributing a part of it ($6,669,000) 
 in the shape of a 30 per cent, dividend on the 
 old stock, and so lessening the cost of the road 
 to its purchasers. ] 
 
 Having thus acquired the property, and 
 transferred the cost of previous betterments to 
 capital account, the syndicate, which included 
 97 per cent, of the stockholders, reorganized 
 the corporation and elected as President Mr. 
 S. M. Felton, upon whose report the road had 
 been bought. They then recapitalized the 
 company by issuing securities in the following 
 amounts: 
 
 50-year 3 per cent, bonds .... $31,988,000* 
 
 50-year 2>2 P er cent - bonds 
 4 per cent, preferred stock 
 Common stock 
 
 Total 
 
 22,000,000 
 19,544,000 
 19,542,000 
 
 $93,074,000 
 
 The $31,988,000 of 3 per cent, bonds actually 
 issued were offered to all the stockholders and 
 
 ^orty millions in 3 per cent, bonds were authorized, but 
 $8,012,000 were held in reserve for future requirements. These 
 eight millions were subsequently sold at market rates, and the 
 proceeds were spent on the property. 
 
 IO 
 
A MISUNDERSTOOD TRANSACTION 
 
 taken by them pro rata, at 65, which was be- 
 lieved at the time and in the circumstances to 
 be a fair rate. The purchase of these securities 
 at a cost of $20,792,200, and the acquirement of 
 97 per cent, of the stock of the old company at a 
 cost of $38,815,000, made the investment of the 
 syndicate in the reorganized road $59,607,200. 
 This sum was soon afterward increased by the 
 purchase of the Peoria Northern Line at 
 $3,000,000, and the payment of $500,000 for 
 commissions, charges, legal expenses, etc., in 
 connection with the reorganization. This made 
 the total investment of the new owners of the 
 road $63,107,200, as shown below: 
 
 Purchase of 97 per cent, of the old com- 
 pany's stock $38,815,000 
 
 Purchase of $31,988,000 3 per cent, bonds 
 at 65 20,792,200 
 
 Purchase of Peoria Northern Line . 3,000,000 
 
 Commissions, legal expenses, etc. . . 500,000 
 
 Total $63,io7,2oo 1 
 
 As soon as the sale of the bonds put sufficient 
 money into the treasury and made available 
 
 l It is quite possible that the syndicate did not have this whole 
 amount invested at any one time, because some of the securities 
 may have been sold before the transaction was completed. The 
 figures are given in this way only for the purpose of showing how 
 much money the stockholders put into the venture from first 
 to last. 
 
 II 
 
THE CHICAGO AND ALTON CASE 
 
 the $12,444,000 of surplus created by capitaliz- 
 ing the sums previously spent in betterments, 
 the new directors declared a cash dividend 
 of 30 per cent, on the old company's stock, for 
 the purpose of lessening the cost of the road to 
 its buyers. This reduced the sum of their 
 investment as follows: 
 
 Total cost of the road to its purchasers 
 
 (as shown above) ...... $63,107,200 
 
 Less dividend of 30 per cent, on the old 
 stock 6,669,180 
 
 Reduced cost $56,438,020 
 
 To represent this investment, the new stock- 
 holders had in hand, for sale at the best prices 
 they could get: 
 
 3 per cent, bonds, par value . . . $31,988,000 
 3 J per cent, bonds, par value . . . 22,000,000 
 
 4 per cent, preferred stock, par value. 19,544,000 
 Common stock par value . . . 19,542,000 
 
 Total $93,o74,ooo 1 
 
 In order to get back the amount that they 
 had actually put into the property ($56,438,020 
 as above shown) the stockholders would have to 
 
 ^his capitalization was increased to $101,086,000 when the 
 reserved bonds ($8,012,000) were issued. The total of 3 per cent, 
 bonds was then $40,000,000 instead of $31,988,000, as here 
 stated. 
 
 12 
 
A MISUNDERSTOOD TRANSACTION 
 
 sell the bonds and preferred stock at approxi- 
 mately the following figures : 
 
 $31,988,000 3 per cent, bonds at 80 . $25,590,400 
 22,000,000 3! per cent, bonds at 74 . 16,280,000 
 19,544,000 preferred stock at 75 . 14,658,000 
 
 Total $56,528,400 
 
 Money invested 56,438,020 
 
 They would then have the common stock as 
 clear profit, and if they sold it at, say, 25, they 
 would make about $5,000,000 on the purchase 
 and recapitalization of the road. This would 
 be equivalent to about 9 per cent, on their 
 total investment. They perhaps made more 
 than this, but how much more it is impossible 
 to determine. After the securities were dis- 
 tributed among the members of the syndicate 
 they were sold by the individual owners at 
 various prices, and at various times between 
 1900 and 1907. The profit realized depended, 
 in every case, upon market conditions at the 
 date of sale. Professor Ripley states, as a 
 fact, that the profits of the syndicate — that is, 
 of the one hundred or more stockholders — 
 were $23,600,000; but as he does not give his 
 method of computation there is no possibility 
 of testing his results. The Attorney-General 
 
 13 
 
THE CHICAGO AND ALTON CASE 
 
 of Illinois figured that the syndicate made a 
 profit of $24,648,600; but his calculations were 
 soon discredited. Expert Accountant J. H. 
 McClement showed that even accepting the 
 inordinately high prices at which the Attorney- 
 General assumed the stockholders sold, their 
 profit was only $11,124,300. In other words, 
 the figuring did not work out. 1 
 
 As a matter of fact, the computations of both 
 Ripley and the Attorney-General were mere 
 guesses, made under the influence of a strong 
 anti-Harriman bias. If the stockholders sold 
 their securities at the average prices that pre- 
 vailed between 1901 and 1907, they made 
 $7,624,000. If they sold in the summer of 
 1903, when the control of the road was acquired 
 by the Rock Island, they made $2,800,000. 
 If they held on until 1907, and sold then, they 
 lost $i,40o,ooo. 2 The probability is that 
 most of the stockholders sold at the most 
 favorable time — i. e., in the first year, or the 
 first two years, after the securities were dis- 
 tributed. By an Act of the New York Legis- 
 lature, approved February 26, 1900, the 3 per 
 cent, bonds of the Alton road were made a 
 
 ^'Statement of the Recapitalization of the Chicago & Alton 
 Railroad Company," pp. 13-14- N. Y., 1907. 
 2 McClement : pp. 13-14 et seq. . 
 
 14 
 
A MISUNDERSTOOD TRANSACTION 
 
 legal investment for the savings banks of that 
 state, and this immediately created a good 
 demand for them at prices which ranged from 
 82^ to 94. As there is no means, however, of 
 ascertaining when the hundred or more stock- 
 holders disposed of their holdings, nor what 
 prices they obtained for them, it is impossible 
 to know what their profits were; and for that 
 reason all estimates are more or less conjectural. 
 The most that can be said with certainty is that 
 owing to favorable market conditions, those who 
 happened to sell at top prices realized more than 
 they had anticipated. 
 
 A prominent New York banking house which 
 had no connection with the Chicago & Alton 
 transaction, except that it participated to the 
 extent of $250,000 in the investment, was asked 
 recently to look up its records and find out what 
 its profits were. The value of its participation, 
 and of the securities represented thereby, varied 
 from time to time according to the market value 
 of the securities. There were times when the 
 transaction showed little or no profit. The 
 maximum profit that it showed at any one time 
 was about 8.2 per cent. The impression of these 
 bankers is that if a participant got out at the 
 most favorable time, he made a profit of about 
 9 per cent. The result of the reorganization, 
 
 15 
 
THE CHICAGO AND ALTON CASE 
 
 so far as the stockholders are concerned, may 
 be summarized in the statement that they in- 
 vested $56,000,000 or $57,000,000 in the prop- 
 erty (including the purchase of the 3 per cent, 
 bonds), expanded the capitalization by issuing 
 new securities to the par value of $93,074,000 
 (excluding the $8,012,000 held in reserve for 
 betterments), and finally sold these securities 
 at prices which gave them a net profit of prob- 
 ably 8 per cent., and possibly 12 or 15 per cent., 
 upon their total cash investment. 
 
 At the time when the road changed owner- 
 ship, the series of transactions above outlined 
 excited little if any adverse criticism. Every 
 detail of the reorganization, including the 30 per 
 cent, dividend and the sale of the 3 per cent, 
 bonds to the new stockholders at 65, had the 
 widest possible publicity; but nobody com- 
 plained of injury or injustice. The former 
 owners of the road were satisfied with the price 
 that they received; the 3 per cent, of the old 
 stockholders who declined to sell their shares 
 enjoyed precisely the same rights and privileges 
 that were given to the new stockholders; the 
 purchasers of the new securities bought with 
 full knowledge of the syndicate's operations, 
 and did not complain that they had been either 
 misinformed or misled; the governors of the New 
 
 16 
 
A MISUNDERSTOOD TRANSACTION 
 
 York Stock Exchange considered all the details 
 of the recapitalization and then listed the new 
 securities without objection or question; and, 
 finally, the patrons of the road — the farmers, 
 manufacturers, and shippers — were more than 
 satisfied with the lower rates and greatly in- 
 creased facilities that they enjoyed under the 
 new management. 
 
 Serious and hostile criticism of the Chicago 
 & Alton reorganization did not begin until 1906 
 — seven years after the Harriman syndicate 
 bought the road. In the fall of that year the 
 friendly relations that had previously existed 
 between President Roosevelt and Mr. Harriman 
 were broken off, as the result of a disagreement, 
 or misunderstanding, with regard to a contri- 
 bution made by Mr. Harriman to the Republi- 
 can campaign fund just prior to the Presidential 
 election of 1904. Mr. Harriman thought that 
 the President had failed to observe the terms of 
 a mutual understanding with reference to the 
 best means of promoting the interests of the 
 party in New York; and when, in the fall of 
 1906, he was asked by James S. Sherman, 
 Chairman of the Republican Congressional 
 Committee, to contribute again, he declined 
 to do so, for the alleged reason that the Pres- 
 ident had not kept faith with him. His refusal 
 
 17 
 
THE CHICAGO AND ALTON CASE 
 
 was made known, of course, to Mr. Roosevelt — 
 perhaps with an unfair or inaccurate statement 
 of the reasons for it — and the President, resent- 
 ing the imputation of unfaithfulness, assumed 
 toward Mr. Harriman an attitude of hostility, 
 and finally characterized him, in a letter to 
 Representative Sherman, as an "undesirable 
 citizen." 1 
 
 Five or six months later — in April, 1907 — 
 a discharged stenographer, who had formerly 
 been employed by Mr. Harriman, dishonorably 
 sold to the New York World an imperfect copy 
 of a private letter written by Mr. Harriman to 
 one Sidney Webster of New York. In this 
 letter Mr. Harriman set forth his understanding 
 of the campaign-contribution episode, together 
 with his reasons for believing that the President 
 had treated him unfairly. The publication of 
 this letter led to a somewhat acrimonious 
 newspaper controversy, in which the President 
 denied and Mr. Harriman reaffirmed the ac- 
 curacy of the statements made therein. 2 
 
 It may be only a chronological coincidence, 
 but it was in November, 1906, immediately 
 after the rupture of friendly relations between 
 
 x Letter of President Roosevelt to James S. Sherman, dated 
 October 8, 1906. 
 
 2 New York World of April, 2, 1907, and subsequent dates. 
 
 18 
 
A MISUNDERSTOOD TRANSACTION 
 
 the President and Mr. Harriman, that the Inter- 
 state Commerce Commission, acting either on 
 its own initiative or upon suggestion, began its 
 investigation of the "undesirable citizen's" past 
 activities; and it was on the 5th of April, 1907, 
 three days after the publication of the Webster 
 letter, that the completed case was submitted 
 to the Commission for decision. 1 The investi- 
 gation covered of course the Chicago & Alton 
 case, and the report thereon described the re- 
 organization as "indefensible financing." The 
 features of the transaction most severely criti- 
 cised were the dividend of 30 per cent, on the 
 stock of the old company, the selling of the 
 3 per cent, bonds to the new stockholders at 
 65, and the alleged "watering" of the original 
 stock by increasing the number of shares with- 
 out adding to the physical assets of the road a 
 sum equal to the increase of capitalization. 
 It will be most convenient, perhaps, to take up 
 these transactions in the order in which they 
 have been mentioned. 
 
 1. The 30 per cent, dividend. 
 
 That the new stockholders had a legal right 
 to charge to capital the cost of permanent 
 
 x " Combinations and Consolidations of Carriers." Investi- 
 gation begun November 15, 1906; case submitted Aprils, 1007; 
 case decided July n, 1907. Reports of the Commission, Vol. 
 XII, p. 277. Washington, 1908. 
 
 19 
 
THE CHICAGO AND ALTON CASE 
 
 betterments which had previously been charged 
 to income is unquestionable. The practice 
 had not only the approval of expert account- 
 ants, but the sanction of the courts. In a pre- 
 cisely similar case in England the High Court of 
 Appeal said: 
 
 "The circumstance that they had been paying 
 what ought to be charged to capital out of 
 revenue does not prevent their right, or their 
 duty to the persons who are looking for their 
 payment out of revenue, to credit back to 
 revenue those things which have been carried, 
 for the time being, to capital account." 1 
 
 The new stockholders also had a legal right 
 to transform the book surplus thus obtained 
 into an actual cash surplus, by selling bonds 
 to the necessary amount, and then to declare a 
 cash dividend from the surplus so obtained. 
 W. W. Cook, the standard authority on cor- 
 poration law, says: 
 
 "When the company has used profits for im- 
 provements, it may lawfully borrow an equiva- 
 lent sum of money for the purpose of a 
 dividend. And it may properly borrow money 
 for a dividend, if upon a fair estimate of its 
 assets and liabilities it has assets in excess of 
 
 Mils vs. Northern Railway & Co. 5 Chancery Appeals 621. 
 20 
 
A MISUNDERSTOOD TRANSACTION 
 
 its liabilities, and capital stock equal to the 
 amount of the proposed dividend." 1 
 
 In paying a dividend of 30 per cent, out of 
 a surplus created by capitalizing the cost of 
 previous betterments, the new management was 
 only doing what the old management had 
 intended to do. In a circular letter to the old 
 stockholders, written in February, 1899, T. B. 
 Blackstone, then President of the Chicago & 
 Alton Railroad, said: 
 
 "In case a majority of the shares of the com- 
 pany are not sold to the syndicate, I shall advise 
 that you authorize the refunding of the out- 
 standing bonds of the company, and the issue 
 of a stock dividend to represent earnings hereto- 
 fore invested in permanent improvements." 
 
 His reasons for making this recommendation 
 were not only that large sums had previously 
 been expended in permanent improvements, 
 which ought to have been charged to capital, 
 but that, as a result of this policy, the exist- 
 ing capitalization (bonds and stock together) 
 represented less than 60 per cent, of the actual 
 cost of the property. 2 
 
 ^ook on " Corporations," 5th edition, section 546. 
 2 Report of President Blackstone for 1894. 
 
 21 
 
THE CHICAGO AND ALTON CASE 
 
 Inasmuch as this undistributed surplus from 
 past earnings was mainly responsible for the 
 high price that the purchasers had to pay for 
 the old stock ($175 and $200 per share) they 
 naturally thought that they were justified 
 in taking out of such surplus a part of the pur- 
 chase money. That it belonged to them there 
 can be no question. W. M. Ackworth, the 
 leading European authority on railway ad- 
 ministration, says, in a recent review of Wil- 
 liam E. Hooper's "Railway Accounting": 
 
 "Here in England no one has yet doubted 
 that undivided profits, put back into the busi- 
 ness, belong to the shareholders just as much as 
 the property purchased with the capital origi- 
 nally subscribed." 1 
 
 Halford Erickson, a member of the Railroad 
 Commission of Wisconsin, an authority not 
 likely to have a pro-railroad bias, seems to 
 think that it might be expedient even to capi- 
 talize past losses and discounts. 2 Under recent 
 rulings, moreover, of the Interstate Commerce 
 Commission, permanent betterments must be 
 charged to capital account, or at least kept 
 
 iRailway Age Gazette, August 23, 1915. 
 
 2 " Government Regulation of Security Issues of Public Utility 
 Corporations," p. 54. Madison, Wis., January, 1909. t 
 
 22 
 
A MISUNDERSTOOD TRANSACTION 
 
 separate from maintenance expenses in the 
 books. 1 
 
 In view of these considerations, it is hard to 
 see why it was not proper, as it unquestionably 
 was legal, to charge past betterments to capital 
 account and declare a dividend of 30 per cent, 
 on the old stock for the purpose of lessening 
 the cost of the road to its buyers. The only 
 reasonable objections to such a course are 
 stated, very fairly, by Professor Mead and 
 President Fink. The former is of opinion that 
 capitalization of sums previously spent for 
 betterments is justifiable only when the better- 
 ments have actually increased earnings, which 
 in the Chicago & Alton case they had not done. 
 "Its earnings for many years," Professor Mead 
 says, "had been stationary/' and "its property 
 had not been kept up to standard." If the 
 company had maintained a proper depreciation 
 account, there would have been no such surplus. 
 For these reasons he disapproves of the capital- 
 ization of past betterments and the issue of 
 bonds to pay a dividend thereon; but he admits 
 that, in the absence of state legislation ex- 
 pressly forbidding it, "the legality of the pro- 
 
 *W. M. Ack worth, in Railway Age Gazette, July 23, 191 5. The 
 subject is also discussed byBeale and Wyman in their "Railroad 
 Rate Regulation," Sec. 355-362. 
 
 23 
 
THE CHICAGO AND ALTON CASE 
 
 ceeding is not to be questioned." 1 This judg- 
 ment, however, does not change the facts that 
 the money was expended, the betterments were 
 made, and the cost might properly have been 
 charged, at the time, to capital account. The 
 proceeding involves a question of financial ex- 
 pediency, but not, in any sense, of illegality. 
 
 President Fink objects to the capitalization 
 of the cost of past betterments for the reason 
 that it may afford an opportunity for manip- 
 ulation of accounts. 2 In the Chicago & Alton 
 case, however, no one ever asserted that the 
 accounts had been tampered with, or that the 
 sum of $12,444,000 had not actually been spent 
 for permanent betterments. Both the old 
 management and the new recognized the past 
 expenditures for improvement as real and 
 legitimate. 
 
 2. The issue of $31,988,000 of 3 per cent, 
 bonds to the new stockholders at 65. 
 
 It was perfectly proper, and in accordance 
 with general practice, to offer the new bonds 
 to the stockholders before offering them to 
 the public. The stockholders had taken the 
 risk of putting $38,815,000 into the property, 
 and it was only just that they should have the 
 
 1U Corporation Finance," pp. 246-253. 
 
 2" Federal Regulation of Railroad Securities," pp. 4-5. 
 
 24 
 
A MISUNDERSTOOD TRANSACTION 
 
 first chance to buy the securities issued by the 
 company upon reorganization. "But," it may 
 be said, "the price at which the bonds were 
 offered was too low; it enabled the buyers to 
 resell them at a great advance, and thus to 
 realize a profit which ought to have gone into 
 the treasury of the company." That the stock- 
 holders did make a large profit when they 
 resold the bonds is unquestionable; but that 
 the price at which they acquired them was too 
 low, measured by the standards and conditions 
 of the time, is not so certain. A 3 per cent. 
 bond was then an untried experiment. The 
 bonds of the old company, which were about to 
 mature, bore interest at 6 and 7 per cent, and 
 nobody could tell in advance what the market 
 value of a low-rate security would prove to be. 
 That the price at which the 3 per cent, bonds 
 were offered to the stockholders was low enough 
 to give them a chance of profit is true; but 
 there was no intention of giving them an exor- 
 bitant profit. A market for bonds bearing as low 
 an interest rate as 3 per cent, had to be created. 
 Such securities would naturally be taken by sav- 
 ings banks; but the bill making the 3 per cent, 
 bonds of the Chicago & Alton company a legal 
 investment for the savings banks of New York 
 had not then passed the legislature, and it was 
 
 25 
 
THE CHICAGO AND ALTON CASE 
 
 uncertain whether it would pass. If it did not, 
 the demand for such bonds would be compara- 
 tively limited and they might not bring more 
 than 70, at which price they would yield 4.28 
 per cent. The bill which authorized savings 
 banks to invest in them did not become law 
 until February 26, 1900, more than a year after 
 the syndicate bought the road. It was then 
 signed by Theodore Roosevelt, governor of the 
 state, who apparently thought that the bonds 
 of the "looted," "wrecked," and "gutted" cor- 
 poration were a safe investment for savings 
 banks. 
 
 In 1907, when the Interstate Commerce 
 Commission investigated the subject, these 
 very bonds were selling for only a little more 
 than the price at which they were issued, al- 
 though they were just as good then as they ever 
 had been. The exceptionally high prices from 
 which the stockholders profited, or may have 
 profited, in 1901-1902, were purely fortuitous, 
 and were due mainly to the state of the money 
 market, the low rates of interest which then 
 prevailed, and the unprecedented demand for 
 investment securities. 
 
 It must not be forgotten, moreover, that in 
 investing cash to the amount of $20,792,200 
 in 3 per cent, bonds, the stockholders took all 
 
 26 
 
A MISUNDERSTOOD TRANSACTION 
 
 the chances of interest rates, state legislation, 
 and savings bank demand, and that such chances 
 might have gone against them. In that case, 
 their bonds might have been unsalable and they 
 might not have been able to get their money 
 back. They took risks and reaped profits, 
 and there was little if any criticism of their 
 action until seven years later, when the Govern- 
 ment, through the Interstate Commerce Com- 
 mission, began its campaign against that "un- 
 desirable citizen," E. H. Harriman. 
 
 So far as this particular transaction is con- 
 cerned, the federal authorities might, with equal 
 reason, have begun proceedings against other 
 railroad companies. In April, 1899, the Chicago, 
 Burlington & Quincy sold to its stockholders 
 at 75 three-and-one-half-per cent, bonds which 
 went soon afterward above par, and some years 
 earlier the St. Paul, Minneapolis & Manitoba 
 sold to its shareholders at 10 an issue of mort- 
 gage bonds which later went above 100. It 
 was at that time a frequently employed and 
 never contested practice to give "rights" to 
 stockholders by offering to them stocks or 
 bonds at prices below their actual or possible 
 market value, and it is still a common practice 
 in other fields of business enterprise. 
 
 3. The alleged over-capitalization. 
 27 
 
THE CHICAGO AND ALTON CASE 
 
 The question whether the Chicago & Alton 
 Railroad was over-capitalized or not — that is, 
 whether its capital stock exceeded its value — 
 depends upon the definition given to the word 
 "value." What is the "value" of a railroad? 
 To this question three different answers have 
 been given, namely: 
 
 (a) The value of a railroad is to be measured 
 by the amount of money actually invested in 
 it, from first to last. 
 
 (6) The value of a railroad is the present 
 cost of building and equipping it, as new. 
 
 (c) The value of a railroad is the sum on 
 which, as a "going concern," it can earn at 
 least the current rate of interest. 
 
 The Interstate Commerce Commission seems 
 to prefer the first of these definitions; some 
 economists favor the second; while most rail- 
 road men adopt the third. 
 
 There seems to be no good reason for assum- 
 ing that the value of a railroad differs in any 
 essential way from the value of a farm or a 
 factory. The value of a farm is to be ascer- 
 tained by capitalizing its annual net return 
 at the current rate of interest. Two farms 
 may contain exactly the same number of acres, 
 and may represent precisely the same original 
 investment, and yet one may have twice the 
 28 
 
A MISUNDERSTOOD TRANSACTION 
 
 value of the other. If a farm, during a series 
 of years, shows its ability to earn, say, 6 per 
 cent, upon a capital of $10,000, then the value 
 of that farm is $10,000 no matter what its 
 original cost was. The owner may have bought 
 it for $5,000, but it would be manifestly absurd 
 to say that its value is only $5,000 when it 
 yields crops large enough to pay the current 
 rate of interest on $10,000. Its value is to be 
 measured not by the amount of money originally 
 invested in it, but by its earning capacity as a 
 "going concern. ,, The same is true of a factory. 
 
 There was once a horseshoe nail manufactory 
 in northern New York which was started with a 
 capital of $100,000. By managing skilfully, 
 and by gradually putting $400,000 of earnings 
 into new plant, improved machinery, money- 
 saving inventions, etc., the owners finally made 
 it earn $300,000 a year, or 6 per cent, on 
 $5,000,000. Was the value of that concern 
 the $500,000 actually invested in it, or the 
 $5,000,000 on which it could earn 6 per cent, 
 a year? 
 
 In June, 1915, the directors of the Ford 
 Motor Car Company of Detroit increased the 
 capital stock of that corporation from $2,000,000 
 to $100,000,000. Forty-eight millions were 
 distributed in the shape of a stock dividend, 
 
 29 
 
THE CHICAGO AND ALTON CASE 
 
 and the remaining stock was held in reserve 
 "for future dividends and the development 
 of the company." 1 At the time of the increase 
 of capitalization the actual assets of the com- 
 pany were $61,000,000 of which only $24,191,000 
 represented physical plant. Suppose that in 
 future the company is able to earn 6 per cent. 
 on its inflated capitalization of $100,000,000. 
 What, then, will be the value of the manufac- 
 tory? Will it be worth $2,000,000 (the amount 
 of its original capital stock), or $24,191,000 
 (the amount actually invested in plant), or 
 $61,000,000 (the amount of its total assets), or 
 $100,000,000 (the amount on which it can earn 
 6 per cent.)? In explaining the transaction, 
 James Couzens, Vice-President of the company, 
 said: "The purpose of the increase in our 
 capital stock is to have the outstanding stock 
 more nearly represent the value of the company" 
 — meaning, of course, its value as a "going 
 concern." If it could earn, with regularity 
 and safety, 6 per cent, on its expanded capitali- 
 zation of $100,000,000 then its value would be 
 $100,000,000 regardless of the fact that its 
 original capital was only $2,000,000 and re- 
 gardless also of the fact that its total assets fell 
 nearly $40,000,000 short of its expanded capital. 
 
 x New York Times and New York Sun, June 5 and 20, 1915. 
 
 30 
 
A MISUNDERSTOOD TRANSACTION 
 
 If the same reasoning is not applicable to the 
 value of a railroad — why not? So far as the 
 definition of "value" is concerned, no distinc- 
 tion can reasonably be made between a rail- 
 road and a manufactory. Both are to be valued 
 according to their earning capacity. Upon 
 this point political economists generally are 
 agreed. Prof. H. R. Seager says: 
 
 "As an investment, land is valued, as is any 
 other form of income-producing property, by 
 capitalizing its annual return at the current 
 rate of interest. For example, if a given piece 
 of land is found by experience to bring in, on an 
 average, a net rent of $1,200, and the current 
 rate of interest is 6 per cent, its price will 
 normally be $20,000 or the sum which invested 
 at 6 per cent, will yield the same return." 1 
 
 In considering the value of a railroad as it 
 affects the security of its bondholders, Thomas 
 L. Greene, Vice-President of the Audit Com- 
 pany of New York, says: 
 
 "The whole property of a railroad company, 
 considered simply as real estate and old material, 
 is worth but a small fraction of the amount for 
 which it is mortgaged. The creditors of the 
 company depend for their money not upon 
 
 J " Principles of Economics," by H. R. Seager, Professor of 
 Political Economy in Columbia University; p. 239. 
 
 31 
 
THE CHICAGO AND ALTON CASE 
 
 the property considered as such, but upon the 
 business for which the company was organized; 
 that is, upon the transportation of passengers 
 and goods. If the earning capacity of that 
 company becomes for any reason impaired, the 
 strong legal language of the mortgage will not 
 save the holder of the company's bonds from 
 loss. In the end he must accept, as a basis for 
 the revaluation of his securities, the earning 
 power of the company as a carrier of traffic." 1 
 
 This whole question of value, as it affects 
 railroads, was discussed by Henry Fink, Presi- 
 dent of the Norfolk & Western Railroad Com- 
 pany, in a letter that he wrote to the Railroad 
 Securities Commission in 1 910, in reply to their 
 request for information and opinions. His 
 conclusion was that "the value of a railroad 
 can be measured only by its earning capacity." 
 His judgments, he added, were based on his own 
 experience during sixty years of continuous 
 railroad service. 2 
 
 This view of railroad "value" has not only 
 been accepted by the best economists and the 
 most experienced railway administrators, but 
 has repeatedly been sanctioned by the courts. 
 
 *" Corporation Finance," by Thomas L. Greene, Vice-President 
 of the Audit Company of New York; pp. 35-6 and $S. N. Y., 1913. 
 
 2 " Federal Regulation of Railroad Securities and Valuation of 
 Railroad Properties," by Henry Fink. Roanoke, Va., 1910. 
 
 32 
 
A MISUNDERSTOOD TRANSACTION 
 
 In the Oklahoma case, Judge Hook said: "An 
 established railroad system may be worth more 
 than its original cost, and more than the mere 
 cost of its physical reproduction." It has no 
 value except as a going concern. 1 
 
 This also was the view taken by the U. S. 
 Supreme Court in the tax case of the C. C. C. 
 & St. L. R. R. Co. vs. Backus. In its opinion 
 in that case the court said: 
 
 "The value of property results from the use 
 to which it is put, and varies with the profit- 
 ableness of that use, present and prospective, 
 actual and anticipated. There is no pecuniary 
 value outside of that which results from such use. 
 . . . Never was it held that the cost of a thing 
 is the test of its value. Suppose there be two 
 bridges over the Ohio, the cost of construction 
 of each being the same, one between Cincinnati 
 and Newport, and the other twenty miles below 
 where there is nothing but a village on either 
 shore. The value of the one will, manifestly, 
 be greater than that of the other, and that excess 
 of value will spring solely from the larger use 
 of the one than of the other." 2 
 
 Assuming then — or, rather, adopting the 
 view of competent authorities — that the value 
 
 111 Railway Statistics of the U. S.," by Slason Thompson, p. 
 740. Chicago, 1 9 14. 
 
 2154 U. S. 445. 
 
 33 
 
THE CHICAGO AND ALTON CASE 
 
 of a railroad, and consequently its proper 
 capitalization, should be based on earning 
 capacity, "present and prospective, actual and 
 anticipated," was Mr. Harriman justified in 
 believing that he could make the Chicago & 
 Alton pay interest and dividends on a capitaliza- 
 tion Of SlOIjOOOjOOO? 1 
 
 The annual net income needed would be 
 $3,533,44°, as follows: 
 
 Interest on $40,000,000 3 per cent, bonds . $1,200,000 
 Interest on 22,000,000 3! per cent, bonds. 770,000 
 Dividend on 19,544,000 preferred stock at 
 
 4 per cent. . 781,760 
 Dividend on 19,542,000 common stock at 
 
 4 per cent. . 781,680 
 
 $101,086,000 $3,533,440 
 
 Was it prudent and reasonable to anticipate 
 that when the proposed betterments should be 
 made, and the necessary equipment procured, 
 the greatly improved road would be able to 
 
 1 Owing to the necessity of spending for betterments four times 
 as much as President Felton estimated, the capital stock was 
 later increased (upon the figuring of the Interstate Commerce 
 Commission) to about $114,000,000, but I am dealing here only 
 with the original capitalization of $101,000,000 upon which Mr. 
 Harriman's calculations were based. 
 
 34 
 
A MISUNDERSTOOD TRANSACTION 
 
 earn the annual net income of $3,533,440, 
 which would be required? 1 
 
 In the year when the syndicate bought the 
 Chicago & Alton, the road, even in its run- 
 down and half-equipped condition, earned 
 $2,684,694 net, and it had earned, on an average, 
 $2,734,534 net, for the six preceding years 
 (1893 to 1898, both inclusive). It was only 
 necessary, therefore, that annual net earnings 
 should be increased by $798,906 in order to 
 pay interest and dividends on all outstanding 
 securities. Mr. Felton, a thoroughly competent 
 judge, estimated that by an expenditure of 
 $5,200,000 in betterments the annual net earn- 
 ings of the road might be increased at least 
 $1,000,000. Mr. Harriman, an even better 
 judge, believed that physical improvements and 
 good management would bring the annual net 
 
 x So far as fixed charges are concerned, the capitalization of the 
 Chicago & Alton would seem to have been prudent and conserva- 
 tive. According to Prof. Stuart Daggett^ the average percentage 
 of fixed charges to net income, in seven railroad reorganizations 
 between the years 1893 and 1898 (the Atchison, B. &. O., Erie, 
 Nor. Pac, Reading, Southern, and Un-Pac.) was 73.9. ("Rail- 
 road Reorganization," p. 358.) In the Chicago & Alton, after 
 reorganization, this percentage was only 72, and before 1907 it 
 had fallen below 60. 
 
 Prof. E. S. Mead says: "In most cases, no more than 20 per 
 cent, of the gross earnings of a railroad company should be rep- 
 resented by interest charges." ("Corporation Finance," p. 
 65.) After the recapitalization of the Chicago & Alton, in 1900, 
 the ratio of interest charges to gross earnings was 27.5; but in 
 1907, on the whole indebtedness then outstanding, it had fallen 
 below 20. 
 
 35 
 
THE CHICAGO AND ALTON CASE 
 
 earnings up to $4,000,000. How prudent and 
 conservative these estimates were the result 
 showed. In the year when the Interstate Com- 
 merce Commission investigated the recapitali- 
 zation, the net earnings of the road were 
 $4,415,974, a sum which was $415,974 above Mr. 
 Harriman's estimate, and $681,440 above the 
 estimate of Mr. Felton. If rates had not been 
 reduced during the period of Mr. Harriman's 
 administration, the increase in net earnings 
 would have been even greater than this. 1 
 
 x The reduction of ton-mile freight rates between 1899 and 1907 
 is given by the Director of the Bureau of Railway Statistics as 
 follows: 
 
 Receipts per ton-mile 
 Year (in cents) 
 
 1899 800 
 
 1900 796 
 
 1901 723 
 
 1902 679 
 
 1903 599 
 
 1904 • • 677 
 
 1905 689 
 
 1906 639 
 
 1907 604 
 
 A part of this reduction, but according to Mr. Thompson only 
 a small part, was due to the development of a large coal traffic, 
 on which the rates were low; but in commenting on the figures 
 the Director says: 
 
 "Whatever may be the popular impression as to the over- 
 capitalization of the Alton, the above table furnishes proof that 
 it had no effect whatever in causing exorbitant rates, for these 
 are nearly 25 per cent, lower than in 1899." ("Cost, Capitali- 
 zation and Estimated Value of American Railways," by Slason 
 Thompson, Director of Bureau of Railway Statistics, pp. 186-187. 
 Chicago, 1907.) 
 
 36 
 
A MISUNDERSTOOD TRANSACTION 
 
 A case parallel in some respects to that of the 
 Chicago & Alton is furnished by the reorgani- 
 zation of the Norfolk & Western Railroad in 
 1896. In 1895, before the reorganization and 
 recapitalization, the road and equipment were 
 valued at $115,098,721 and the capitalization 
 was $117,364,909 as follows: 
 
 Bonds $ 57,864,909 
 
 Preferred stock 50,000,000 
 
 Common stock 9,500,000 
 
 Total capitalization .... $117,364,909 
 
 In the reorganization, the bonds were in- 
 creased by $4,635,000 and the common and 
 preferred stock by $30,000,000, making an ex- 
 panded capitalization of $151, 999,909.* In 
 commenting upon this inflation, which amounted 
 as above shown to nearly $35,000,000, President 
 Fink said: "Stocks issued in such cases are in 
 no sense fictitious. They represent actual values, 
 and are drafts, for value received, on more pros- 
 perous times." 
 
 He then shows that although the Norfolk & 
 Western was over-capitalized in 1896, in the 
 sense that it was not then earning dividends and 
 fixed charges, it did begin paying dividends on 
 its preferred stock in 1897, and on its common 
 
 ^Commercial and Financial Chronicle, Vol. LXII, 1896. 
 
 37 
 
THE CHICAGO AND ALTON CASE 
 
 in 1901. 1 Its stock is now quoted at 119, which 
 shows that its earning power has much more 
 than overtaken its expanded capitalization. 
 
 Mr. Harriman expected to do with the Chi- 
 cago & Alton just what Mr. Fink did with the 
 Norfolk & Western, viz., increase by means of 
 extensive betterments its capacity for doing 
 business and its earning power, and thus bring 
 its net operating revenue up to the requirements 
 of its enlarged capitalization. That he measur- 
 ably succeeded in doing this is shown by the 
 fact that when, after losing control of the road 
 in 1903, he completely severed his connection 
 with it in 1907, it was paying 4 per cent, on its 
 preferred stock and earning 5 per cent, on its 
 common. In other words, it was taking care 
 of its entire capitalization, and was doing this 
 with no increase of rates and with an enormous 
 extension of its facilities for doing business and 
 serving the public. 
 
 All these facts, however, were suppressed or 
 ignored in the Interstate Commerce Commis- 
 sion's report. The Commissioners, from their 
 point of view, might have been justified in ex- 
 pressing disapproval of Mr. Harriman's financial 
 methods; but they were not justified in con- 
 
 v< Over-capitalization," by Henry Fink; Railway Age Gazette, 
 July, 1908. 
 
 38 
 
A MISUNDERSTOOD TRANSACTION 
 
 cealing the fact that these methods had more 
 than doubled the capacity of the road to serve 
 the people. "Suppressio veri suggestio falsi," 
 and the concealment in this case gave the im- 
 pression that Mr. Harriman — in the words of 
 Senator Cullom — had "looted the road," re- 
 gardless of the interests of the people and the 
 territory that it served. The rebuilding of 
 the Chicago & Alton was one of the great rail- 
 road achievements of the time; but in the report 
 of the Commission it is made to appear a pirati- 
 cal raid of unscrupulous financiers, who, for 
 their own selfish purposes, wrecked and looted 
 a well-conducted and prosperous corporation. 
 If the members of the Commission could be 
 put on the witness stand, as Mr. Harriman was, 
 and could be required, under oath, to tell "the 
 whole truth," they might find it difficult to 
 explain why, in a report that was supposed to 
 cover all the facts essential to an understanding 
 of the case, they said nothing with regard to 
 the physical condition of the Alton road when 
 the syndicate bought it; nothing about the 
 intention of the old managers to declare just 
 such a dividend as that declared later by the 
 new managers; nothing about the sanction 
 given by courts and legal authorities to the 
 capitalization of past betterments; nothing 
 
 39 
 
THE CHICAGO AND ALTON CASE 
 
 about the practice of the time in the matter of 
 reorganizations; nothing about Mr. Harriman's 
 virtual reconstruction and reequipment of the 
 road; nothing about the increase of 90 per 
 cent, in gross earnings and 80 per cent, in net 
 earnings which resulted therefrom; nothing 
 about the benefit that the public derived from 
 the lowering of rates and the improvement of 
 facilities; nothing about the relation between 
 the earning capacity of the reorganized road 
 and its expanded capitalization; and nothing 
 about the resumption of dividends on the pre- 
 ferred stock in 1906. A report which conceals 
 or ignores these pertinent facts is not a judicial 
 review of the case, but merely a prosecuting 
 attorney's brief. 
 
 The responsibility for the present condition 
 of the Chicago & Alton cannot justly be thrown 
 upon Mr. Harriman. The control of the road 
 was wrested from him by the Rock Island, 
 while he was in Europe in 1903, and he severed 
 his relation with it altogether when the Rock 
 Island transferred its holdings to the Toledo, 
 St. Louis & Western in 1907. The financial 
 measures adopted by the later management 
 were ill-advised and unfortunate, and never 
 would have met Mr. Harriman's approval. 
 Partly to these measures, and partly to regula- 
 40 
 
A MISUNDERSTOOD TRANSACTION 
 
 tion, low rates, and depressed business condi- 
 tions, the present difficulties of the road are due. 
 When Mr. Harriman resigned, it was not only- 
 paying its fixed charges, but was earning more 
 than 4 per cent, on both classes of its stock. 
 
 Before concluding this review of the Chicago 
 & Alton reorganization, it seems necessary to 
 answer specifically certain charges made against 
 Mr. Harriman by two men who occupy posi- 
 tions of responsibility or authority, namely: 
 Interstate Commerce Commissioner Prouty and 
 Prof. William Z. Ripley of Harvard University. 
 
 In an address delivered before the National 
 Association of Manufacturers, in May, 1907, 
 Commissioner Prouty said: 
 
 "When Mr. Harriman, by dealings like those 
 in the Chicago & Alton, enriches himself to the 
 extent of many millions, he has not created that 
 money. He has merely transferred it from the 
 possession of some one else to himself." 1 
 
 In the first place, there is no evidence to show 
 that Mr. Harriman, as an individual participant 
 in a syndicate of one hundred members, en- 
 riched himself to the extent of "many millions.' ' 
 In the second place, it may controversially be 
 said that when the Interstate Commerce Com- 
 
 *New York Independent, May 30, 1907, p. 11 29. 
 41 
 
THE CHICAGO AND ALTON CASE 
 
 missioners, by drawing money in the shape of 
 salaries from the people of the United States, 
 enrich themselves to the extent of many hun- 
 dreds of thousands of dollars, they have not 
 created that money. They have merely trans- 
 ferred it from the possession of some one else 
 to themselves. They may reply that for the 
 money they have thus transferred from the 
 people of the United States to themselves, 
 through the United States Treasury, they have 
 rendered valuable services — in other words, 
 they have earned it. Mr. Harriman might 
 have said the same, and with much more reason. 
 By his "dealings" in the Chicago & Alton he al- 
 most entirely rebuilt the road; doubled its pas- 
 senger accommodations; improved immensely 
 its train service; increased by 134 per cent, 
 the hauling power of its locomotives; added 
 269 per cent, to its capacity for moving freight; 
 fostered old industries and created new ones 
 all along its line, and enabled the people of 
 Illinois to "create" tens of millions of dollars 
 which they never could have created without 
 the traffic facilities given them by Mr. Harri- 
 man's betterments. If the Interstate Com- 
 merce Commissioners could show anything like 
 this equivalent for the money they have "trans- 
 ferred" from the United States Treasury to 
 
 42 
 
A MISUNDERSTOOD TRANSACTION 
 
 themselves, their claim to have earned their 
 salaries would be unquestioned and unques- 
 tionable. Unfortunately, in the judgment of 
 many thinking people, they have injured the 
 business of the country instead of promoting 
 it, and by their cramping over-regulation of 
 railroads have frightened away capital, and 
 have thus prevented the construction of thou- 
 sands of miles of new road, which the country 
 already needs, and will need still more urgently 
 in the near future. In the judgment of many 
 competent observers they have also forced into 
 bankruptcy dozens of railroads which were not 
 mismanaged, and which might have met all 
 their obligations if they had been allowed to 
 make their rates high enough to cover increased 
 taxes, increased wages, and the largely increased 
 cost of materials and equipment. Eighty-two 
 railway corporations are now in the hands of 
 receivers, and even Mr. Prouty will hardly 
 contend that they have all been "wrecked," 
 "looted," or financially mismanaged by un- 
 scrupulous speculators. Most of them have 
 failed simply because the policy of the Inter- 
 state Commerce Commission has impaired the 
 credit of railway corporations generally, and 
 made it impossible for weak roads to sell their 
 securities on advantageous terms. Investors 
 
 43 
 
THE CHICAGO AND ALTON CASE 
 
 will not buy such securities until they have a 
 reasonable assurance that the Commission will 
 permit the companies to earn fixed charges and 
 dividends. It seems, therefore, to be at least a 
 debatable question whether the Commission 
 has not wrecked more railroads than the un- 
 scrupulous financiers have. 
 
 One of the most unfair, as well as one of the 
 most recent, of Mr. Harriman's assailants is 
 Prof. William Z. Ripley, Ropes Professor 
 of Economics in Harvard University. In a 
 volume entitled "Railroads: Finance and Or- 
 ganization," published by Longmans Green 
 & Co. of N. Y., in 191 5, Professor Ripley devotes 
 a large part of his eighth chapter to the Chicago 
 & Alton reorganization, and begins his account 
 of it in the following words: 
 
 "Practically all of the possible abuses and 
 frauds described in the preceding pages under 
 the caption of stock-watering are found com- 
 bined in a single instance in recent years — the 
 reorganization of the Chicago & Alton road by 
 the late E. H. Harriman and his associates 
 during the eight years following 1898." 1 
 
 Most of the hostile critics of the Chicago & 
 Alton transaction try to make their points by 
 
 Chapter VIII, p. 262. 
 
 44 
 
A MISUNDERSTOOD TRANSACTION 
 
 concealing or ignoring facts favorable to the 
 defence. Professor Ripley not only conceals or 
 ignores, but misstates. He says, for example, 
 that the Chicago & Alton road, prior to the 
 reorganization, was doing "a constantly ex- 
 panding business." This, simply, is not true. 
 The gross earnings of the road had decreased 
 more than $2,500,000 in the eleven years that 
 preceded the change of ownership. In 1887 
 they were nearly $9,000,000, while in 1898, the 
 year before the Harriman syndicate acquired 
 the property, they had fallen to $6,286,568. 
 A business which declines to the extent of 
 $2,655,000 in a little more than a decade may 
 still continue to be a profitable business, but 
 it certainly is not "a constantly expanding busi- 
 ness." 1 
 
 J Prof. E. S. Mead, who is a much more careful and trustworthy 
 student of railroad affairs than Professor Ripley seems to be, 
 states the fact accurately when he says ("Corporation Finance," 
 p. 251): "The earnings of the Chicago & Alton, prior to the reor- 
 ganization, had been stationary for many years." They had 
 been stationary for about five years, but had decreased 30 per 
 cent, in eleven years. The precise figures are given by Director 
 Thompson of the Bureau of Railway Statistics as follows: 
 
 Year Gross earnings 
 
 1887 $8,941,386 
 
 1888 7,511,465 
 
 1889 7,516,616 
 
 1890 7,065,753 
 
 1891 7,590,881 
 
 1892 7,73o,6io 
 
 1893 7,566,640 
 
 1894 6,292,236 
 
 45 
 
THE CHICAGO AND ALTON CASE 
 
 Professor Ripley states repeatedly (pp. 264- 
 265) that the operations of Mr. Harriman and 
 the syndicate were "covered up," "remained 
 undisclosed," "were never disclosed," "were 
 obscured in the published accounts," and "were 
 thoroughly concealed." This, again, is simply 
 not true. All the operations of Mr. Harriman 
 and the syndicate, including the capitalization 
 of past betterments, the declaration of a 30 per 
 cent, dividend, and the sale of the 3 per cent, 
 bonds to the stockholders at 65, were fully and 
 accurately set forth in the listing application 
 to the New York Stock Exchange, as well as 
 in the leading railroad and financial publications 
 of New York, including Poor's Manual, Moody's 
 Manual, the Manual of Statistics, the Com- 
 mercial and Financial Chronicle, the Wall 
 Street Journal, and the New York Evening 
 Post} 
 
 1895 $6,292,486 
 
 1896 6,840,283 
 
 1897 6,673,605 
 
 1898 6,286,568 
 
 ("Cost, Capitalization, and Estimated Value of American Rail- 
 ways," by Slason Thompson, Director of the Bureau of Railway 
 Statistics; p. 183. Chicago, 1907.) 
 
 x Poor's Manual for 1900, pp. 654 and 657, and for 1901, pp. 
 661-2. Moody's Manual for 1901, p. 1195. Manual of Statistics 
 for 1900, p. 61, and for 1901, p. 59. Commercial and Financial 
 Chronicle in the five numbers for April 7 and 14; May 5 and 19; 
 and November 17, 1900. 
 
 46 
 
A MISUNDERSTOOD TRANSACTION 
 
 In commenting upon this feature of the case, 
 in a statement written in 1907 but never pub- 
 blished, Mr. Harriman said: 
 
 "Every essential fact connected with the 
 recapitalization of the Chicago & Alton system, 
 including the objects for which the new securi- 
 ties were issued, was fully disclosed and widely 
 published, at the time, in circulars, financial 
 papers, annuals, and reference books for invest- 
 ors, etc., etc. These publications, as well as 
 the printed applications to the New York 
 Stock Exchange, showed exactly for what con- 
 sideration each class of securities had been 
 issued, including the fact that the refunding 3 
 per cent, bonds of the railroad company had 
 been subscribed for by the stockholders at 
 65, and that a dividend of 30 per cent, had been 
 declared in May, 1900. The listing committee 
 of the Exchange investigated fully, and unani- 
 mously recommended the granting of official 
 quotations to all the securities and their ad- 
 mission to dealings on the Exchange. This 
 recommendation was approved, without any 
 dissenting voice, by the Board of Governors of 
 the Exchange, consisting of forty members of 
 high standing. So far as I know, there has 
 never been the slightest pretence that any of the 
 original stockholders were deceived in any 
 manner or form, or that any subsequent invest- 
 or was in any way misled. All parties in 
 interest have acquiesced, for seven years, with 
 
 47 
 
THE CHICAGO AND ALTON CASE 
 
 full knowledge. The transaction is now criti- 
 cised, for the first time, and in a manner cal- 
 culated to misrepresent and distort the facts 
 as they existed in 1900 when the securities were 
 created and issued." 
 
 Mr. Harriman's statement, supported though 
 it be by all the railroad manuals and financial 
 journals of New York, may fail to carry con- 
 viction to as biassed a mind as that of Professor 
 Ripley; but it will be generally accepted by 
 people who are more desirous of knowing the 
 truth than of making out a case against the 
 Chicago & Alton syndicate. 
 
 Professor Ripley accuses Mr. Harriman of 
 "prejudicing the interest of shippers by creat- 
 ing the need of high rates for service in order to 
 support the fraudulent capitalization." (p. 
 262.) This charge is doubly misleading. In 
 the first place, it erroneously assumes that 
 rates are dependent upon capitalization, and 
 in the second, it suggests that, as a matter of 
 fact, Mr. Harriman did raise rates on the Alton 
 in order to bolster up fictitious securities. 
 Neither the assumption nor the suggestion is 
 supported by the facts. 
 
 High capitalization, as a rule, does not result 
 in high rates. On the contrary, the lowest 
 average freight rates are in the parts of the 
 
 48 
 
A MISUNDERSTOOD TRANSACTION 
 
 United States that have the highest railroad 
 capitalization. 1 That there is no interdepend- 
 ence of capitalization and rates has been re- 
 peatedly admitted even by the Interstate Com- 
 merce Commission. As long ago as 1899 
 Chairman Martin A. Knapp testified before the 
 Industrial Commission that he had never seen 
 a case in which rates seemed to depend upon 
 capitalization, or to be influenced by it. "The 
 capitalization of a railroad," he said, "cuts no 
 figure in this rate question." 
 
 In an article entitled "Railroad Capitali- 
 zation and Federal Regulation," Franklin K. 
 Lane, while he was yet Commissioner, said: 
 "Fundamentally there is no interdependence of 
 capitalization and rate. The latter is not in law, 
 nor in railroad policy, the child of the former.' ' 
 
 Mr. Harriman, who had a much clearer 
 understanding of the principles of rate-making 
 than the Harvard Professor of Economics seems 
 to have, said in the unpublished statement 
 previously quoted: 
 
 "It is just as impossible to raise rates to any 
 level that may be necessary to pay charges on 
 increased capitalization as it would be for a 
 
 x "The Railroad Situation of To-day," by Frank Trumbull: 
 An Address to the Western Society of Engineers, January 5, 
 1909, p. 7. 
 
 49 
 
THE CHICAGO AND ALTON CASE 
 
 manufacturer of steel, or of woolens, or of any 
 other commodity, to raise his prices because he 
 had a large debt upon which it was necessary 
 to pay interest, or a large capital employed in 
 the business. It would be suicidal for a railroad 
 company to throttle or paralyze the industries 
 along its lines by charging exorbitant rates. 
 Even if there be no direct competition by parallel 
 roads, every industrial plant located along a 
 line of railroad is competing with plants located 
 on other lines, and every railroad is forced to 
 make such low and reasonable rates as will 
 permit the industries in the territory tributary 
 to it to make sales in competitive markets, and 
 thus furnish the traffic from which the railroad 
 company derives its earnings. It is impossible 
 for a railroad company to sever its interests 
 from those of its patrons. Its life blood is 
 drawn from their prosperity, and it must furnish 
 them with adequate and ever-increasing facili- 
 ties at reasonable rates, wholly irrespective of 
 its capitalization. If the calculations of the 
 organizers of a railroad company turn out to be 
 erroneous, and the capitalization is fixed at too 
 high a figure, it is a misfortune for them and the 
 other security holders; but the wide-spread 
 popular impression that a railroad company can 
 extort money from the public at will, and in 
 defiance of the laws of trade, simply for the 
 purpose of paying interest or dividends upon 
 increased issues of securities, is not justified by 
 the facts." 
 
 So 
 
A MISUNDERSTOOD TRANSACTION 
 
 In this brief statement there is more financial 
 and economic wisdom, perhaps, than in a dozen 
 volumes of Interstate Commerce Commission 
 reports, and more even than in some Supreme 
 Court decisions. 
 
 The statement that the "unscrupulous man- 
 agement " of the Chicago & Alton did, as a 
 matter of fact, "increase rates for service in 
 order to support the fraudulent capitalization" 
 is not true. The freight records of the Chicago 
 & Alton for the period in question show a slight 
 reduction in rates on grain, live-stock, merchan- 
 dise, and other classified commodities, with a 
 very substantial reduction on coal. In 1899 
 the through rate on coal from the Springfield 
 district was 80 cents. In 1907 it fell as low as 
 40 cents. The average rate per ton per mile 
 on the whole traffic (including coal) was re- 
 duced, as Slason Thompson has shown, about 
 25 per cent. The precise figures have been 
 given on a previous page. 
 
 The most surprising of all Professor Ripley's 
 misstatements is that which charges Mr. Har- 
 riman with "crippling" the Alton road "physi- 
 cally." (p. 262.) Mr. Frank H. Spearman, 
 who made the rebuilding of the Chicago & 
 Alton the subject of a special article, described 
 the "crippling" process in the following words: 
 
 5i 
 
THE CHICAGO AND ALTON CASE 
 
 "Without delay or hesitation he" — (Mr. 
 Harriman) — "set about making of the Alton 
 the best possible road of its class, and its class 
 is the first. He overhauled the system com- 
 pletely, and put it physically a little in advance 
 of every competitor. To instance: For thirty 
 years the Alton had been strong in a territory 
 possessing the richest coal deposits in Illinois, 
 and not until the Harriman forces took hold of 
 the road had it ever developed a coal business. 
 Not only has the new Alton been equipped with 
 what it never had before, cars and motive power 
 to handle this traffic, but its engineers, in re- 
 building the line, show the lowest maximum 
 grades from the Illinois coal fields into Chicago. 
 Beginning with nothing, the new owners have, 
 within five years, developed a coal traffic that 
 already ranks second in volume among the soft- 
 coal roads of its territory. . . . The Alton 
 being once acquired, it became the policy of the 
 new owners to increase the facilities of the public 
 along their line for doing business. . . . 
 The heaviest freight engines previously owned 
 had been of fifty-five tons, and were capable, 
 in condition, of hauling thirty cars, of twenty- 
 five tons each; but the engines had been allowed 
 to deteriorate until not above 80 per cent, 
 of that capacity could be obtained. The new 
 engines, of the consolidation type, for freight 
 traffic, weigh one hundred and sixty-five tons 
 and haul one hundred freight cars. The pas- 
 senger power consisted of forty- to fifty-ton 
 
 52 
 
A MISUNDERSTOOD TRANSACTION 
 
 engines, capable of hauling five to seven coaches 
 of their day at high speed. Such engines have 
 been replaced by modern engines of one hundred 
 and thirty-five tons, while for especially heavy 
 passenger service, of which the road has more 
 than any line in its territory, exceptionally large 
 engines have been provided, recent additions 
 including the two most powerful express pas- 
 senger engines in the world. ... In freight 
 car equipment, twenty- and twenty-five-ton 
 capacity wooden gondola cars were replaced by 
 fifty-five-ton capacity steel gondolas, and the 
 proportion of the weight of car to load was 
 reduced one third at a stroke. Acquiring a 
 line that had always enjoyed a heavy passenger 
 traffic, the new owners, where they had found 
 fifty-feet coaches, built coaches seventy feet 
 long, and by ingeniously installing seats of a 
 modern type, as well as more comfortable than 
 those of earlier models, they have succeeded in 
 accommodating in the new cars twice the num- 
 ber of passengers provided for in the old. . . . 
 "What it means to make over a railroad for 
 such modern traffic requirements is reflected 
 sharply in the work put upon the construction 
 department. Working out of Chicago, track 
 elevation was pushed until every railroad grade- 
 crossing, from the terminal station to the su- 
 burban yards, has been eliminated. The grades 
 receiving the heaviest of the traffic, as it centred 
 toward Chicago, were reduced until they gave 
 the rebuilt road the lowest maximum grade of 
 
 53 
 
THE CHICAGO AND ALTON CASE 
 
 any road entering Chicago from the western 
 coal fields. At the very outset the work of 
 double-tracking was begun. To provide for 
 heavy cars and engines, heavier rails have been 
 spread south and west until to-day over one 
 half the total mileage of the entire system shows 
 new steel. The work falling on the bridge 
 department was continuous and exacting. While 
 shops were being enlarged, engine-houses re- 
 built, and turn-tables lengthened, the track 
 elevation at Chicago called unceasingly for 
 viaducts, and the traffic conditions everywhere 
 on the system demanded new bridges for the 
 motive power. ... On less than a thou- 
 sand miles of trackage three hundred and 
 eighteen bridges were replaced within four years. 
 Of these, one hundred and fourteen bridges 
 were wholly done away with by the cast-iron 
 pipe and the concrete arch — the progress in 
 the use of concrete work being one of the most 
 striking features of recent bridge construction. 
 But besides the great bridge across the Missouri" 
 — (the old million-dollar steel bridge was 
 "scrapped") — "and four solid-floor creosoted 
 trestles, one hundred and twenty-two steel 
 bridges also were installed. 
 
 "The elimination of curvature, pushed till 
 the maximum had been reduced to four degrees, 
 is still in progress, and so far has bad curvature 
 been taken care of that an engineman familiar 
 with a division five years ago would hardly 
 recognize the right of way in the daylight. 
 
 54 
 
A MISUNDERSTOOD TRANSACTION 
 
 Long restful stretches of straight track have 
 been developed until there are now on the 
 system many tangents of from fifteen to twenty 
 miles; there is at least one tangent of twenty- 
 nine miles; and one extraordinary stretch of 
 forty-five miles of track, straight as an arrow's 
 flight. ... To strengthen the work of the 
 operating department, the railroad world has 
 been drawn upon for the most effective safety 
 devices in the operation of trains. Long 
 stretches of track, in one instance covering a 
 distance of sixty-five miles, are provided with 
 continuous electric signals which protect moving 
 trains, stations, grades, and curves. Previously 
 to the rebuilding there were comparatively few 
 interlocking signals on the whole line to protect 
 railroad grade-crossings." 1 
 
 According to Professor Ripley, the nefarious 
 purpose of the "main conspirator" in making all 
 these improvements was to "cripple" the road 
 "physically!" 
 
 During the period of Mr. Harriman's ad- 
 ministration he spent $11,262,763 on roadway 
 and structures, and $11,064,454 on new equip- 
 ment, making a total of $22,327,219 for per- 
 manent betterments, a sum equivalent to about 
 $22,000 per mile. The road thus "physically 
 
 x "The Rebuilding of an American Railroad," by Frank H. 
 Spearman (in "The Strategy of Great Railroads"), pp. 50^ 223, 
 225-226. N. Y., 1914. This article was originally published 
 before the work of rebuilding had been finished. 
 
 55 
 
THE CHICAGO AND ALTON CASE 
 
 crippled' ' increased its gross earnings from 
 $6,286,569 in 1898 to $12,809,426 in 1907, and 
 its net earnings from $2,684,694 to $4,415,974. 
 How it was able to do this, in its "physically 
 crippled" condition, Professor Ripley does not 
 explain. 
 
 Those who have made a serious study of Mr. 
 Harriman's activities know that he never 
 "physically crippled" a railroad in his life. On 
 the contrary, he never touched a railroad that 
 he did not physically improve. From the Sodus 
 Bay & Southern to the Union Pacific and the 
 Alton, he made every railroad that he controlled 
 serve the public better than it had ever served 
 it before. No railroad corporation, moreover, 
 ever defaulted on its bonds, or failed to earn its 
 fixed charges, under Mr. Harriman's man- 
 agement. 1 
 
 It is not easy to characterize Professor Rip- 
 ley's statements fittingly without overstepping 
 the bounds of controversial courtesy; but 
 inasmuch as he, himself, has not hesitated to call 
 Mr. Harriman a "conspirator," and to describe 
 his management of the Chicago & Alton as 
 "unscrupulous," "piratical," "fraudulent," and 
 "predatory," it may perhaps be proper to say, 
 
 hearings before the Interstate Commerce Commission in the 
 Chicago & Alton Case, p. 73. 
 
 56 
 
A MISUNDERSTOOD TRANSACTION 
 
 in the form, although not quite in the words, of 
 the professor's opening sentence: 
 
 "Practically all of the possible methods, 
 described in previous pages, of making a thing 
 seem that which it is not, are found combined 
 in a single instance in recent years — the ac- 
 count of the reorganization of the Chicago & 
 Alton Railroad by William Z. Ripley, Ropes 
 Professor of Economics in Harvard University." 
 
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