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 UNIVERSITY OF ILLINOIS-URBANA 
 
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 ederal regulation of rail- 
 Iroad securities and valuation 
 
 bp RAILROAD PROPERTIES 
 
 • • 
 
 ,etter to the Railroad Securities Commis- 
 sion in Reply to their Request for 
 Information and Opinions 
 
 By Henry Fink
 
 385 
 
 TMC 
 
 s T ON e 
 
 PRWTINO-AW) 
 nWUBkCTURDW 
 COMPANY 
 
 ROANOKe 
 VIRGINIA'
 
 New York, December 31, 1910 
 
 Mr. W. E. S. GRISWOLD, Secretary, 
 
 Railroad Securities Commission, 
 
 Washington, D. C. 
 Dear Sir:- 
 
 j In answer to your communication of the 10th instant, I 
 
 ^ submit the following: 
 
 <i 1. The advocates of the supervision and control by the 
 
 -^ Federal Government over the issuance of stocks and bonds 
 by interstate railroads appear to have two objects in view; 
 — . the protection of the investors in such securities against over- 
 capitalization and the protection of shippers against unreason- 
 ^^2^^ able railroad rates by restricting the income of such roads to 
 — what may be considered a "reasonable return on the fair value 
 CH of the property used in the public service." I do not believe 
 that either of these objects can be attained by the proposed 
 regulation. Moreover, I think that such regulation is not 
 needed and that it woiild create conditions that must prove 
 harmful to the public welfare. It would certainly have a 
 tendency to impair the credit of the corporations and render 
 it difficult to borrow the money they need in giving the public 
 adequate and efficient services. For these and other reasons, 
 I deem such regulation to any extent or by any methods 
 C undesirable. 
 
 2. I am not competent to express an opinion as to whether 
 the commerce clause of the constitution, when stretched to 
 
 I its utmost limits, would enable the Federal Government to 
 
 legally exercise control over the securities of corporations which 
 
 ' were created by the states and w^hich are subject to state laws. 
 
 ;; If such control is not exclusive and the corporations are made 
 
 I subject to both Federal and state regulation in this matter, 
 
 it is obvious that we will have a multiplication of the evils 
 resulting from the existing dual control of railways. The 
 supervision and control of the issuance of stocks and bonds 
 by the Federal Government seems to me unwise. 
 
 -a o5oo4
 
 3. I am of the opinion that it is not one of the functions 
 of our government to pass special laws for the protection of any 
 one class of investors and that such laws are not needed because 
 existing laws provide for the punishment of parties who are 
 guilty of fraudulent practices in connection with the issuance 
 of stocks and bonds. Moreover, attempts to protect people 
 against the consequences of their bad judgment in the selection 
 of securities for investments must always prove futile. 
 
 4. It has been proved repeatedly that with the exception 
 of some few cases, American railroads are not over-capitalized 
 in the sense that the par value of the bonds and stocks issued 
 exceeds the fair value of the property represented by such 
 securities. I believe that the true measure of the value of a 
 railroad is its earning capacity and the degree of efficiency 
 with which it serves the public and that a railroad is over- 
 capitalized when for any reason it is unable to earn its fixed 
 charges and a reasonable dividend on its capital shares. When 
 a railroad is unable to earn the interest on its bonded debt, 
 the evil of over-capitalization corrects itself, either through 
 a growth of its traffic or through bankruptcy and reorgani- 
 zation. 
 
 5. I do not think it advisable to limit the issuance of 
 capital stock at par for money or property of the actual value 
 of the par of the stock issued, nor to require that all bonds 
 must be sold at not less than par. We need more railroad 
 mileage in this country and the limitation would prevent or 
 at least retard its construction except by old established roads 
 whose credit is very high. Moreover, the limitation would 
 render consolidations and reorganizations so difficult as to be 
 well-nigh impossible. 
 
 6. I can see no objection to the sale to stockholders of 
 new stock at par, when the old stock is selling above par in 
 the market. The distribution of the premium among stock- 
 holders is in the nature of an extra di\'idend and an induce- 
 ment to purchase the new stock. 
 
 7. I am of the opinion that capitalization of betterments, 
 additions, and extensions, charged in the past, to "Income"
 
 but which might have been charged to "Capital" is improper. 
 The charge to "Income" should close the account, otherwise 
 there will be room for manipulation of accounts. 
 
 8. I am of the opinion that the physical valuation scheme 
 does not deserve serious consideration. It rests upon the 
 assumption that the cost of a railroad is identical with its value 
 and that such value can be obtained by ascertaining the original 
 cost of the road or the cost of replacing the property, that the 
 results can be used as a criterion of the reasonableness of rates 
 and that such rates can be established so as to give each road a 
 reasonable return on the property used in the public service. 
 Every one of these assumptions is fallacious. The value of a 
 road can be measured only by its earning capacity. The 
 original cost and the cost of reproduction have no relation what- 
 ever to railroad rates, nor can such rates be established for each 
 road so as to give it a reasonable return. Railroads have been 
 located, constructed and are being operated under conditions 
 that vary within wide limits. Hence, rates cannot be made that 
 will give each road a reasonable retiim on the property. Ob- 
 viously, all roads that compete, either directly or through com- 
 petition between markets, must have the same rates. Any one 
 who is familiar with railroad transportation, knows that the 
 idea of basing rates on valuation of the property of railroads, or 
 on capitalization is repugnant to common sense. It is not only 
 impossible to arrive at any just valuation by the proposed 
 methods, but the results obtained at great expense of time and 
 money cannot serve any useful purpose. The valuation scheme 
 probably originated in an erroneous interpretation of the de- 
 cision of the United States Supreme Court in the case of Smyth 
 vs. Ames, it being assumed that "a reasonable return upon the 
 fair value of the property used in the public service, is the only 
 element to be considered in determining the reasonableness of 
 rates, although the court in that case distinctly says that it is 
 only one of the nimierous elements, some of which it specifies." 
 The erroneous interpretation has proved a fruitful source of 
 error in the investigation and decisions of rate cases. This is 
 particularly true of cases involving the reasonableness of rates 
 made by state legislatures and State Railway Commissions,
 
 where railroads have practically no other defense than to en- 
 deavor to show that such rates are confiscatory, they have to 
 submit evidence, showing that certain specific rates do not 
 cover the cost of transportation, and a reasonable return on that 
 part of the property which is used and that, therefore, such 
 specific rates are confiscatory and in violation of the constitu- 
 tion. While such evidence can be obtained as to the entire 
 traffic of a railroad, it is impossible to ascertain the cost of any 
 specific shipment or of conducting any branch of the transpor- 
 tation service, nor the value of the property used in such service. 
 This is so, because no rational method has as yet been devised 
 for apportioning the operating expenses and the value of the 
 property used among the several services rendered by the rail- 
 road. The reasonableness of specific rates cannot be deter- 
 mined by ascertaining whether the revenue derived from the 
 entire traffic yields the company a fair return. Such return 
 may be fair in the aggregate, and yet many of the individual 
 rates or rates on whole classes may be unreasonably high or 
 unreasonably low. In fact, they may be so low, as to be con- 
 fiscatory. 
 
 In the Virginia Maximum Passenger Rate case, the Cor- 
 poration Commission went so far as to express the opinion that 
 it was not the question of reasonableness of rates, but the 
 reasonableness of revenue that is involved in rate cases, and that 
 the Commission is at liberty to make any reduction it may see 
 fit in the rates on any articles or any branch of service it may 
 select, provided the revenue from the entire traffic is sufficient 
 to give the road what the Commission may deem a reasonable 
 return on the property used. 
 
 The Maximum Passenger Rate case, decided April, 1907, 
 b}- the State Corporation Commission of Virginia and the order 
 of the Railroad Commission of Kentucky governing rates on 
 general merchandise in the case of the Commonwealth of Ken- 
 tucky vs. the Louisville & Nashville Railroad Company, et al. 
 affords striking illustrations of the fallac}'^ of the theory that the 
 valuation of railroad property can be used as a basis for deter- 
 mining the reasonableness of rates and of capitalization. These 
 decisions show that any result that may be desired in the matter 
 of value of property used, and the return on such value can be 
 
 6
 
 obtained by the adoption of suitable methods of valuation, and 
 of the apportionment of operating expenses and the value of 
 property among the several services rendered by a railroad. It 
 is in my opinion difficult to escape the conclusion that the theory 
 of reasonable retiun on the fair value of the property used is 
 fallacious and impracticable of application. As a matter of 
 fact, railroad companies are not entitled to a reasonable return 
 on the fair value of the property used. They are entitled only 
 to what they can earn, be it much or little, by charging rates 
 that are just, reasonable, and undiscriminatory, the reasonable- 
 ness of rates being determined by commercial and competitive 
 conditions and the value of the service to the shipper and to the 
 railroad. 
 
 9. Some of the proposed methods of valuation, while 
 having the appearance of scientific analysis, necessarily resolve 
 themselves into guess work. Of course, such so-called valuation 
 can be made by any Federal agency. 
 
 10. The Interstate Commerce Commission is overwhelmed 
 with work, Congress having already imposed duties upon it 
 without regard to its physical ability to properly perform them. 
 To give the Commission supervision and control over the issu- 
 ance of stocks and bonds would enormously increase its work. 
 Heretofore, the Commission has decided cases by careful in- 
 vestigation of all the facts and circumstances that bear upon the 
 question of reasonableness of rates. The question arises, will 
 it be able to continue this, the only fair method, if it were given 
 supervision practically to a large extent over the finances of the 
 railroad? Is it not to be feared that the Commission would 
 avail itself of an official valuation as a short-cut to the deter- 
 mination of rate questions? This seems to me to be the only 
 use that could be made of the valuation scheme, but such use 
 cannot be considered as legitimate, because the Act to Regulate 
 Commerce requires that decisions must be based upon proper 
 investigation. 
 
 I have endeavored to answer the questions in the order in 
 which they are propounded, expressing my opinions without 
 supporting them at length by facts and arguments.
 
 In compliance with the request that I furnish the Com- 
 mission with any of my views that have been printed, I herewith 
 enclose copies of two chapters of a monograph I wrote in 1907 
 (about the time the question of valuation of railroads was first 
 agitated), on the "Valuation of Railroad Properties as a Basis 
 for Regulation of Rates." One of these chapters treats of 
 "Over-capitalization", the other of "Valuation of Raih-oad 
 Properties." They were published by the Railway Age Gazette 
 in July, 1908. 
 
 The following are some of the conclusions I reacted, upon 
 nvestigation of the subject: 
 
 I. 
 
 The value of the property used has no direct relation to 
 rates; hence, rates caimot be based upon such value, nor can 
 the reasonableness be ascertained upon the basis of such valua- 
 tion. 
 
 II. 
 
 The value of railroad property cannot be determined by a 
 physical valuation. The only measure of value that can be 
 properly applied is the earning capacity. 
 
 III. 
 
 The earning capacity depends on the rates that can be 
 charged and on the volume and character of the trafl&c. The 
 rates depend upon commercial and competitive conditions. 
 The volimie and character of traffic depends upon the location 
 of the road and the degree of success which has attended the 
 efforts of the company to develop the resources of the cotmtry 
 tributary to its railroad. 
 
 IV. 
 
 There is no recognized basis for apportioning the value of 
 the property used between the several branches of the service. 
 
 V. 
 
 The value of the property used in any branch of the service 
 (even if it could be ascertained upon a recognized basis), multi-
 
 plied by the reasonable percentage of profit, is no criterion of the 
 reasonableness of rates on such branch. 
 
 VI. 
 
 Railroad companies are not entitled to a reasonable return 
 on the value of the property used. They are entitled only to 
 what they can earn, be it much or little, by charging rates that 
 are just, reasonable, and undiscriminatory, the reasonableness 
 of such rates being determined by commercial and competitive 
 conditions and the value of the service to the shipper and to the 
 railroad. 
 
 VII. 
 
 Rates adjusted on the value of the service principle, intelli- 
 gently and fairly applied, are just alike to the railroad and to 
 the shipper. 
 
 VIII. 
 
 The reasonableness of rates can only be determined by the 
 facts bearing upon each particular case. Reasonableness of 
 revenue is a legal fiction. 
 
 IX. 
 
 The profits of railroad companies, resulting from the volume 
 of business they have helped to create and such reasonable 
 rates as commercial and competitive conditions enable it to 
 charge cannot be restricted to the usual rate of interest without 
 doing injustice to the owners of such properties. 
 
 X. 
 
 Unreasonable rates can be readily corrected under existing 
 laws. The Courts, State Commissions, and Interstate Com- 
 merce Commission have ample power to make such corrections. 
 
 XL 
 
 Railroad companies have not the power to charge extor- 
 tionate rates, nor is it to their interest to do so. Such rates 
 would kill their business. 
 
 9
 
 XII. 
 
 The underlying error of the demand for valuation of rail- 
 road property is the assumption that railroads have the power 
 to fix their rates and that they exercise it so as to produce an 
 unreasonable return on the capital invested. 
 
 XIII. 
 
 The statistics pubhshed by the Interstate Commerce Com- 
 mission and by Poor's Manual for 1905, show that American 
 railroads, with few exceptions, have not earned a reasonable 
 return on the capital invested. 
 
 XIV. 
 
 These statistics also show that the increase of capitalization 
 has been invariably accompanied by a reduction in passenger 
 and freight rates. 
 
 XV. 
 
 Justice to the railroads and to their customers requires 
 that the reasonableness of rates on intrastate traffic be deter- 
 mined by the same method that the Interstate Commerce Com- 
 mission and the Federal Courts employ in ascertaining the 
 reasonableness of rates on interstate traffic ; that is to say, upon 
 the facts surrounding each particular case. 
 
 The above conclusions are based mainly on my own exper- 
 ience. It may not be amiss to state that I have been contin- 
 uously in the service of American railroads for sixty years. 
 
 Yours very respectfully, 
 
 (Signed) HENRY FINK. 
 
 10
 
 APPENDIX 
 
 Extracts from Monograph Written by Henry 
 
 Fink, in 1907, on the "Valuation of 
 
 Railroad Properties as a Basis 
 
 for Regulation of Rates." 
 
 " OVLR-CAPITALIZATION/' 
 VALUATION OF RAILROAD PROPERTY.
 
 OVER-CAPITALIZATION. 
 BY HENRY PINK. 
 Chairman of the Board: Norfolk & Western. 
 
 The term capitalization is generally applied to the capital shares, and 
 bonded debt combined, although the latter constitutes a debt, and is in no 
 sense part of the capital of a railroad company. The reason for this 
 misapplication of terms probably is that very^few American railroads were 
 built from the proceeds of the sale of their capital shares. Nearly all of 
 the companies were obUged to use their credit and borrow sufficient money 
 for the completion of their roads, and to issue bonds of various kinds as 
 security for their debts. It is presumed that the money so borrowed has 
 been honestly invested in the railroads, and is represented by adequate 
 property, and that therefore the bonded debt may be considered a part 
 of capitalization. The term over-capitalization may be definied in several 
 ways. For example: 
 
 1. When a railroad corporation has not received an equivalent in 
 cash or in property, for the par value of its stocks and bonds, the corpora- 
 tion may be said to be over-capitalized to the extent of the difference 
 between such par value and the money realized. 
 
 2. When the par value of the stock and bonds issued exceeds the 
 fair value of the property represented by such issues. 
 
 3. If the earning capacity is the true measure of the value of a rail- 
 road (as I beheve it is), then a railroad is over-capitaUzed when for any 
 reason it is unable to earn its fixed charges, and a reasonable dividend on 
 its capital shares. 
 
 According to the last definition, the capitaUzation of a road may be 
 very low, and still it may be over-capitalized, because of insufficient 
 
 earnings. 
 
 When a railroad is unable to earn the interest on its bonded debt, the 
 evil of over-capitalization corrects itself, through bankruptcy and reor- 
 ganization. 
 
 Whatever definition may be adopted, it is necessary to discriminate 
 between over-capitalization that is legitimate because unavoidable and 
 harmless, and over-capitalization that is due to fraud and trickery of 
 dishonest promoters, and which carries in its train many material and 
 
 moral evils. 
 
 Over-capitalization in the sense that the par value of the stock and 
 bonds has not been realized is obviously unavoidable, because railroad 
 
 12
 
 companies which have to borrow money must necessarily pay what the 
 money is worth at the time they borrow it; and they must offer induce- 
 ments to investors by agreeing to pay a high rate of interest, or by seUing 
 their securities below their par value. The amount of such discounts 
 must vary with the varying credits of the borrowing companies. It follows 
 that except in cases where the credit of a railroad is exceptionally high, 
 there must always be some "water" in stocks and bonds. The only way 
 to prevent this would be to prohibit railroads from selling their securities 
 below par. This, of course, is impracticable. 
 
 The history of the early days of American railroads furnishes a strik- 
 ing illustration of the fact that capitalization has no direct relation to 
 railroad rates. In the early days railroad companies generally received 
 par value for their stocks, and they issued no bonds until a basis of credit 
 had been created by the construction of a part of their roads from the 
 proceeds of the sale of the stock. In many cases these roads were built 
 in anticipation of the future needs of the people. The traffic which was 
 to support them had to be created. The charges for transportation were 
 very high, but the people were glad to avail themselves of the improved 
 facilities, and did demur so long as the charges did not equal or exceed 
 those by wagon or river and canal transportation. The charters in many 
 cases prescribed maximum rates, which, however, were much greater thtin 
 the traffic could bear.* 
 
 Section 1242 of the Virginia Code of 1887 provides: 
 
 "When the net profits of any company heretofore or hereafter incorporated, which may 
 be governed by this chapter, shall be such that, but for this section, dividends might be 
 declared out of the said profits exceeding the rate of fifteen per centum per annum on the 
 capital stock invested, laws may be passed for reducing the toll of the company. But no 
 law shall reduce the tolls so as to prevent dividends of 15 per centum per annum, within 30 
 years from the time the first dividend of profits of the said company was declared, or so as 
 to prevent dividends of 12 per centum per annum after the said 30 years and before .SO 
 years from the same time, or so as to prevent dividends of 10 per centum per annum after 
 the said SO years.' ' 
 
 As state and federal railroad commissions were unknown in those 
 days, one might suppose that the railroads would have charged such 
 rates as might have given them a reasonable return on a fair value of the 
 property used. But experience proved otherwise. Advances in rates 
 resulted in diminished traffic and earnings; and many of the roads were 
 forced into bankruptcy. In these cases the capitalization was low, but 
 nevertheless the roads were over-capitalized; and as a result, the capital 
 invested in them was sunk in whole or in part, except in cases where the 
 owners were able to invest additional capital for the extension of their 
 road to regions which aflforded more traffic. In such cases over-capi- 
 talization was corrected by an increase of the capital. 
 
 •A Kentucky charter of 1829 fixes a maximum rate of 3i mills per 100 pounds for a 
 distance of 20 miles or less; 3 mills for over 20 miles and under 60 miles, and 2i mills for 60 
 »nd over 60 miles. 
 
 A Maryland charter of 1831 fixes a maximum rate of 3 cents per ton per mile. 
 
 A Georgia charter of 1827 fixes a maximum of 25 cents per 100 pounds for heavy 
 articles and 10 cents per cubic foot for light articles. 
 
 13
 
 At another period we find that over-capitalization by the issue of 
 stock on which par value was not realized became the recognized method 
 of raising capital for the construction of railroads through the undeveloped 
 country of the West and Middle West. In some cases stock was given 
 as a bonus to the purchasers of the company's bonds. This was neces- 
 sary in order to assure capitalists who had seen one railroad after another 
 go into bankruptcy, an ample reward for their risks. 
 
 At one time it was a common practice to issue stock to contractors 
 in part payment for constructing railroads. Of course in such cases the 
 par value of the stock was not realized. 
 
 It is often asserted that the payment of stock dividends contributes 
 to over-capitalization or stock-watering. This is true only when such 
 payments are based upon false accounting, or other deceptive methods. 
 In such cases the practice must be classed with fraudulent over-capitali- 
 zation. When based upon an honest accounting, the stock dividend 
 shares represent earnings which were expended on the property, instead 
 of being divided in cash among the shareholders. 
 
 It is frequently pointed out that the issue of stocks and bonds in pay- 
 ment for railroads which have passed through bankruptcy, and are reor- 
 ganized, results in over-capitalization. This may be and often is the case; 
 but it does not follow that such over-capitaHzation is illegitimate or harm- 
 ful. One of the main objects in reorganizing a railroad company is to 
 cut down its fixed charges so as to bring them within the earning capacity 
 of the road during periods of lowest business depression. In order to 
 attain this object owners of certain mortgage bonds of the old company 
 agree to accept bonds of the new company, but to a less amount as to 
 principal, and frequently at a reduced rate of interest. In consideration 
 of this sacrifice of capital and interest, they receive certain stocks upon 
 which dividends are payable only when a revival of business and the 
 growth of the traffic enable the new company to earn such dividends. 
 And stocks so issued are in no sense fictitious. They represent actual 
 values, and are drafts, for value received, on more prosperous times. In 
 many cases such drafts have been honored. A good illustration of this is 
 afforded by the result of the second reorganization of the Norfolk & 
 Western Railroad Company in 1896. 
 
 After the first reorganization in 1881, millions of dollars were expended 
 in improving and extending the road, and in furnishing increased trans- 
 portation faciHties to the public. Private persons and corporations also 
 invested millions in manufacturing and mining enterprises along the line 
 of the road. But, unfortunately, the development of the country did 
 not keep pace with these investments. Many of the enterprises came to 
 grief; and the railroad company, being unable to earn its fixed charges, 
 was put into the hands of receivers for the second time, in 1895. 
 
 At the reorganization in 1896 the new company issued $62,500,000 
 of first mortgage 4 per cent, bonds, to be used as follows: 
 
 14
 
 A. $23,322,675 to be used to provide for the disturbed bonds of the 
 old company and to carry out the plan. 
 
 B. $25,986,889 to be reserved for the purpose of taking up or paying 
 the undisturbed bonds at their maturity. 
 
 C. $3,500,000 to be reserved or deposited in trust, subject to suitable 
 restrictions, for the purpose of taking up or paying any existing obligations 
 which shall not be taken up or paid out of funds received by the committee, 
 and for other necessary purposes of the new company. 
 
 D. $9,690,436 to be reserved for the construction or acquisition of 
 side-tracks, second-tracks, branches, and equipment, and for other improve- 
 ments and additions to the property covered by the first consolidated 
 mortgage, and for other requirements of the new company; but such 
 bonds are to be issued only subject to suitable restrictions to be prescribed 
 in the mortgage securing the same, and at a rate not exceeding $1,000,000 
 for each fiscal year after June 30, 1896 (the first fiscal year being that 
 ending June 30, 1897); it being understood that any portion of such 
 $1,000,000 of bonds remaining unissued in any one fiscal year may be 
 added to the amount which may be issued in subsequent years. 
 
 It also issued $23,000,000 of 4 per cent, non-cumulative adjustment 
 preferred stock — shares of $100 each — and $66,000,000 of common stock — 
 shares of $100 each. The shareholders of the common stock of the old 
 company were required to pay an assessment of $12.50 per share for 
 participating in the reorganization and retaining their interest in the road. 
 
 The following table will show the scaling down of the disturbed 
 securities and the issues and percentage of stock to such security holders 
 as compensation: 
 
 Per cent, received in. 
 
 . oi 
 
 C C 
 
 O o M 
 
 DISTURBED SECURITIES. -S 1^5 " 
 
 Adjustment mortgage 7 per cent, bonds 7 130 20 
 
 100-year mortgage bonds 62i 75 
 
 Maryland & Washington dividend bonds 70 67} 
 
 Clinch Valley dividend bonds 50 70 
 
 Equipment mortgage bonds of 1888 100 48 
 
 5 per cent, debentures of 1892 . . , 100 
 
 Roanoke & Southern Railway Co. bonds 55 65 
 
 Lynchburg & Durham Railroad Co 35 65 
 
 N. & W. Railroad common stock *75 
 
 N. & W. R. R. pf. stock, on payment of $12.50 per share deposited 112J 
 
 Roanoke & Southern Ry. stock, on payment of $12.50 per share 
 
 deposited 75 
 
 Lynchburg & Durham R. R. Co. stock, on payment of $12.50 per 
 
 share deposited 75 
 
 *Common stock above 75. 
 
 15
 
 There can be no doubt that in 1896 the road was largely over-capi- 
 talized, in the sense that the earnings were insufficient to pay fixed charges 
 and dividends on the capital shares. No one dreamed that any dividends 
 could be paid on the common stock for many years; hence it sold in the 
 market at very little above, and at times below, the $12.50 per share of cash 
 assessments. But owing to the revival of business and the ensuing un- 
 exampled prosperity of the country and the great development of the 
 resources of the region traversed by the road, the company earned and 
 was able to pay a dividend of 1 per cent, on its adjustments preferred 
 stock in November, 1897, a like dividend in February, 1898, and a 2 per 
 cent, dividend in August, 1898, since which time semi-annual dividends 
 have been paid regularly on this stock. In June and December, 1901, 
 and June, 1902, dividends of 1 per cent, were paid on the common stock. 
 From and including December, 1905, 2 per cent, dividends were paid on 
 it semi-annually until after the June payment of 1906, and since December, 
 1906, dividend payments have been at the rate of 5 per cent, per annum, 
 the market value of the common stock at times approaching closely to par. 
 
 Fraudulent over-capitalization through stock issues which represent 
 no property or values, and made for the purpose of affording greater 
 opportunities for speculation or gambling, and for obtaining or retaining 
 by trickers a controlling interest in the road, or for other illegitimate 
 purposes, cannot be too severely condemned. It is a crime differing only 
 in degree from forgery of stock certificates, and it is frequently accompanied 
 by false reports, dishonest accounting and other misrepresentations and 
 methods of deception. There was a time when these practices obtained 
 to a considerable extent, to the disgrace of the railway management of 
 this country. 
 
 Happily, over-capitalization of this sort has become rare. The evil 
 effects resulting from it, though serious, aflfect share-holders of the rail- 
 roads concerned more than they do the public. Generally these effects 
 are but temporary, because the operation of economic laws soon results 
 in the correction of the evil. Wall Street can always be relied upon to 
 promptly squeeze out the "water" from such stocks. 
 
 While there are many railroads in this country which do not earn an 
 adequate return, even in times of great prosperity, there are few which 
 can be said to be over-capitalized in the bad sense of the term. Certainly 
 the aggregate capitalization of American railroads is below their real value. 
 This has been shown by the history of these railroads and by comparison 
 with the capitalization of railroads in England and on the continent of 
 Europe. 
 
 16
 
 Prof. H. C. Adams, the statistician of the Interstate Com- 
 merce Commission, states on Page 34 of Eighteenth 
 Annual Report on the Statistics of Railways in the 
 United States for the year ending June 30, 1905, 
 
 _ that the aggregate amount of capitalization of all the 
 
 railroads in the United States was $13,805,258,121 
 
 But on Page 55 he says that this amount overstates the 
 capital, as it does not allow for an admittedly proper de- 
 duction of amounts of stocks and bonds in other rail- 
 roads which are owned by the railroads themselves, 
 and on Page 58 he says such amounts were: 
 
 Stocks $2,070,052,108 
 
 Bonds 568,100,021 
 
 2,638,152,129 
 
 Leaving the real aggregate capitalization $11,167,105,992 
 
 On Page 99 of the report he gives the 
 cost of all the roads in the United 
 States as $11,170,458,581 
 
 And of their equipment 780,890,368 
 
 11,951.348,949 
 
 Excess of cost over capitalization $784,242,957 
 
 It will thus be seen that the capitalization of the railroads of this 
 country is less than their cost by nearly eight hundred million dollars. 
 
 And as will be seen from the following figures taken from the Report 
 on Transportation Routes and Systems of the World, issued by the Depart- 
 ment of Commerce and Labor at Washington, the capitalization of the 
 European railroads is much in excess of that of the railroads of this country : 
 
 CAPITAL OR COST, PER MILE OF RAILROADS. 
 
 1904 United States $55,261 
 
 1904 Canada 60.504 
 
 1899 Uruguay 52.756 
 
 1904 Venezuela 70.972 
 
 1903 Germany 98.443 
 
 1903 Austria 128.334 
 
 1903 Hungary 74.045 
 
 1903 Belgium (state roads only) 160.893 
 
 1902 France 137.601 
 
 1903 Switzerland 104.969 
 
 1904 United Kingdom 272,737 
 
 1902 Russia 78,553 
 
 1902 Finland 32.189 
 
 1904 Norway 38,371 
 
 1904 Sweden (state railroads) 44,669 
 
 1902 Sweden (private railroads) 22.006 
 
 1902 Italy 108,212 
 
 The issue of railroad stocks is subject to the regulation of the states 
 which created the corporations through the original charters or by-laws en- 
 acted subsequently. For instance, in Virginia the Corporation Commission, 
 
 17
 
 and in New York the Public Utilities Commission, have power to regulate 
 such issues. The constitution of Illinois, adopted in 1870, provided: 
 
 "No railroad corporation shall issue any stock or bonds except for money, labor or 
 property actually received and applied for the purposes for which such corporation was 
 created, and all stock dividends and other fictitious increase of capital stock or indebtedness 
 of any corporation shall be null and void." 
 
 It is now proposed that the federal government assume the regulation 
 of such matters; and as the commerce clause of the federal constitution, 
 when stretched to its utmost limits, may not prove adequate for the purpose, 
 and in view of the fact that an amendment to the federal constitution 
 involves great difficulties and delays, it has been suggested that the seventh 
 clause of Section 7 of Article 1 of the constitution, in regard to post roads, 
 be utilized, and that by means of a new construction of the constitution the 
 federal government usurp the power reserved by the states. This regu- 
 lation is not to be confined to railroads, but is to be applied to all "big 
 corporations," whether affected by the pubhc interest or not. 
 
 It will be seen from President Roosevelt's speeches that while he is of 
 the opinion that, with the exception of some isolated instances, American 
 railroads are not over-capitalized, he nevertheless recommends that Con- 
 gress make provision to enable the Interstate Commerce Commission to 
 undertake the physical valuation of each and any road in the country, 
 whenever, in the opinion of the Commission, such valuation of any road 
 would be of value to the Commission in its work. It is not unreasonable 
 to suppose that if the President would carefully investigate the subject, 
 he would find that in view of the obvious fact that the value of railroad 
 properties has no relation to the rates, and cannot be used as a criterion 
 of their reasonableness, such valuation cannot be of any value to the 
 Interstate Commerce Commission in its work. He will also find that the 
 injuries resulting from over-capitalization to the wage-earner and to the 
 public, which is concerned in the rates paid by the shipper, are wholly 
 imaginary. It is true, however, that the Interstate Commerce Commission 
 might favor an official valuation of the railroads, because it would furnish 
 a convenient justification of some of its orders that carriers make radical 
 reductions of individual rates, or of rates on whole classes of business, for 
 so long as the earnings derived from other sources of traffic can be shown 
 to be sufficient to yield the carrier what may be considered a reasonable 
 return on the value of the property as ascertained by the official valuation, 
 it would be impossible for the carrier to appeal to the federal courts for 
 the reversal of such order with any hope of success, no matter how un- 
 reasonable th? reduced rates ordered by the Commission might be in and 
 of themselves. 
 
 It is obvious that the owners of the railroads would have no redress 
 when an order of the Commission deprived them of a reasonable compen- 
 sation for services rendered, and that they could only appeal to the courts 
 for protection in cases of actual confiscation of their property. 
 
 18
 
 The President's suggestion that the clause of the Constitution grant- 
 ing the national government power to establish post roads, by necessary 
 implication confers upon the federal government control over railroads, 
 whether their business is intrastate or interstate, derives importance from 
 the great weight his opinions have with the people and with their repre- 
 sentatives in Congress of both political parties. 
 
 The question of effecting changes in the Constitution by construction, 
 instead of by amendment, has already been discussed by able members of 
 of the legal profession. Our concern not being with legal questions, but 
 with the probable practical effect of proposed measures for the regulation 
 of railroad rates, we will briefly consider whether any additional legislation 
 having for its purpose the enlargement of the powers of the federal govern- 
 ment, is needful, if it were found to be practicable. 
 
 It cannot be denied that a dual control of railroad rates by the states 
 that created these corporations and by the federal government, which 
 obtains control through the commerce clause of the Constitution, has its 
 serious disadvantages. In many cases the rates between points within a 
 state necessarily affect the interstate rates, and very frequently the latter 
 are based upon the former; hence it may be said that in such cases the 
 state and the federal government excercise jurisdiction over the same 
 subject matter. The fact that in the past no serious difficulties have 
 been experienced from this dual control, is due in part to the success which 
 has attended the efforts of traffic men to adjust rates in compliance with 
 the requirements both of state and federal commissions, but more particu- 
 larly to the conservatism that has marked the action of the state legislatures 
 and state railroad commissions. Unfortunately many of the states have 
 in recent times departed from that conservative policy. They have not 
 only ordered radical reductions in rates on intrastate traffic, especially in 
 the passenger rates, but in some cases are enforcing by legislation or 
 through state railroad commissions certain rules and regulations in the 
 conduct of intrastate business that must affect the interstate traffic of the 
 roads. 
 
 Much of the legislation referred to is ill-advised, and in its results 
 must prove detrimental to the material interests of the states that enacted 
 it. The writer hopes and believes that when the people begin to feel the 
 injurious effects, as they must, sooner or later, we will see such laws as 
 are fraught with the greatest mischief amended or abolished, In the 
 meantime it is, in the opinion of the writer, not needful or advisable for 
 Congress to enlarge the powers of the government so as to give it juris- 
 diction over intrastate traffic. This opinion is based upon the fact that 
 the government, under the Constitution and existing laws, has already 
 ample power to regulate rates on interstate traffic, even though intrastate 
 rates may be involved in such regulation. The commerce clause was 
 adopted by the framers of the federal Constitution for the avowed purpose 
 of preventing the states from obstructing traffic between the states and 
 with foreign countries. A law passed by Congress under that clause is 
 
 19
 
 the supreme law of the land, and a violation of such law by a state, whether 
 directly or through the exercise of its power over intrastate traffic, is 
 unconstitutional, and will be so declared by the Supreme Court of the 
 United States. 
 
 In view of recent railroad legislation by states, the management of 
 systems which traverse six or more states, it they had their choice, would 
 naturally elect to serve but one, instead of six or more masters. However, 
 at the present stage of the evolution of railroad regulation, the discussion 
 of the question of transferring the direct control of intrastate traffic to the 
 federal government appears to be purely academic. 
 
 The suggestion that the federal government assume the regulation 
 of stock and bond issues, in order to prevent over-capitalization and 
 protect individuals who may desire to invest in railroad securities, involves 
 some interesting questions as to the legitimate sphere of the government's 
 interference, what is to be the limit of such interference with the freedom 
 of the individual, and what human action should remain under the exclusive 
 jurisdiction of the individual. 
 
 So far the kind of socialism which proposes to use the power of the 
 government for the regulation, not only of production and consumption 
 but of ever)' detail of life, for the purpose of neutralizing the effects of 
 innate inequality of man. has not found favor in this country. Socialism 
 of this kind is imported. It is foreign to this country, and cannot flourish 
 among a people of practical common sense who habitually pay more attention 
 to facts than to theories based on mere assumption. It is true, however, that 
 occasionally men occupying high positions express opinions on the functions 
 of government which the most advanced socialist might indorse, but these 
 opinions do not meet with general acceptance. Freedom of the individual 
 within the law, that is, limited individualism and equality before the law, 
 are underlying principles of American governments. It may be said that 
 in the sphere of economy the government poHcyhas been one of laissez 
 faire. Under this policy the country has grown to be what it is, and it is 
 steadily gaining in power and material prosperity because of the large 
 measure of liberty and the wide scope given to individual energy and skill 
 in the development of its immense resources. It is a historical fact that 
 the opposite policy, that oi fueur de gouverner, which prevailed in France 
 in the eighteenth century, nearly strangled every branch of French industn,-. 
 and brought about starvation of the people. 
 
 The country is suffering from an excess of railroad regulation. Much 
 of it is ill-considered. In many cases the remedies are worse than the 
 evils they are designed to cure. We have seen that the best remedy for 
 over-capitalization due to insufficiency of earnings to pay fixed charges 
 and return on the capital stock Hes in the growth of the volume of the 
 traffic. In such cases a restriction of the issue of stock cannot affect its 
 intrinsic value. Its market value is determined by appraisements made 
 in Wall street, and such appraisements afford a better protection to investors 
 than any government regulations. Indeed it is difficult to understand
 
 how such regulation could give any protection at all, even if it were a 
 function of government to protect individuals against the consequences 
 of their own errors of judgment. That over-capitalization is an evil 
 cannot be denied, but it would seem irrational to shackle commerce and 
 industry and their instruments by an attempt to abolish by legislation an 
 evil which is corrected by operation of economic laws. 
 
 VALUATION OF RAILROAD PROPERTY. 
 
 BY HENRY FINK. 
 
 Chairman of the Board, Norfolk & Western. 
 
 No definite basis o' valuation having as yet been determined, we 
 will examine as briefly a ■ possible some of ".he method which have been 
 suggested for the valuation of railroad property. 
 
 By keeping in mind the use that is proposed to be made of this valua- 
 tion, the reader will be able to judge for himself whether these objects 
 can be accomplished by the proposed methods. 
 
 PHYSICAL VALUATION BASED ON THE ORIGINAL COST OF THE PROPERTIES. 
 
 All methods of determining the physical valuation of railroad prop- 
 erties have in common the underlying idea that the terms "cost" and 
 "value," when applied to railroads, are synonymous. By the method 
 we are now considering, the property is divided into its constituent parts, 
 the original cost of each part being determined separately. For example, 
 it is proposed to ascertain the original cost of the right of way, depot 
 grounds, and other real estate, embankments, cuts, tunnels, culverts, 
 bridges, ballast, cross-ties, rails, switches, station buildings, employees' 
 buildings, machine shops, office buildings, telegraph line, machinery, 
 locomotives, passenger cars, freight cars, etc. To the aggregate amount of 
 
 21
 
 this original cost there is to be added the cost of all the property which has 
 been acquired since the road was turned over to the company by the con- 
 tractors. Whether the condition of the property at the time the valua- 
 tion is made is to be taken into consideration, and a deduction is to be 
 made for depreciation, the writer does not know. In view of the difficulty, 
 and, in case of the older railroads, the impossibility of ascertaining the 
 original cost, and the cost and value of all the additions that have been 
 made to the property, it is proposed to make a 
 
 PHYSICAL VALUATION BASED ON COST OF REPRODUCTION. 
 
 By this method, the property is also divided into its constituent 
 parts; but the value of each part is ascertained by the cost of reproducing 
 it at prices ruling at the time of the valuation. 
 
 For example: Right of way, depot grounds, and other real estate 
 is valued at the prices of adjoining lands; the cost of graduation and 
 masonry is ascertained from the prices per cubic yard for which such work 
 can be done at the time of the valuation. As the quantities and classi- 
 fication of material can rarely be obtained from the original engineering 
 notes, it will be necessary to put engineering parties in the field to survey 
 the railroads, cross-section the cuts and fills, measure the bridges, tunnels, 
 etc. A careful inspection of every part has to be made to determine the 
 amount of depreciation. For it is the cost of reproducing the property 
 in its condition at the time of its valuation which is to be ascertained. 
 As the cost of materials and labor fluctuates, and the railroads have to 
 add constantly to their property in order to furnish adequate facilities 
 for the requirements of the traffic, it follows that what may be 
 a fair valuation of a railroad one year may not be so one or two years 
 later. Hence, it would be necessary to make new valuations from time 
 to time. The proposed method is the same as that adopted since 1902 
 by the Board of State Tax Commissioners of the State of Michigan for 
 the appraisal of railroad properties for the purpose of taxation. 
 
 The following table from Bulletin 21 (on the "Commercial Valuation 
 of Railways Operating Property in the United States, 1904"), issued by 
 the Department of Commerce and Labor at Washington, will give the 
 reader a good idea of this method: 
 
 SUMMARY OF ALL RAILROADS IN MICHIGAN. 
 
 MILEAGE. 
 
 Main track 7.052.35 
 
 Second track 164.83 
 
 Branches 730.92 
 
 Spurs and sidings 2 ,904 . 70 
 
 22
 
 VALUE OF PHYSICAL PROPERTIES. 
 
 Pr. ct. 
 Cost of re- Present of 
 
 production value new 
 
 1. Engineering, 4 per cent., items 2-25, inclusive, 
 
 and 33 $5,386,772 $5,386,772 100.0 
 
 2. Right of way and station grounds 27,745,313 27,745,313 100 
 
 3. Real estate 863,337 863,337 100 
 
 4. Grading 21.699,995 21,693,024 100.0 
 
 5. Tunnels 1,148,070 1,093.445 95 4 
 
 6. Bridges, trestles and culverts 8,027,119 6,337.819 78.8 
 
 7. Ties (cross and switches) 11,139.024 6,148,748 53 9 
 
 8. Rails 28,703.012 21,865.994 76.1 
 
 9. Track fastenings 3,845,030 2,987,982 77.6 
 
 10. Frogs, switches and crossings 1,469,721 1,040 120 71 
 
 11. Ballast 3.723,556 3,723',556 10o!o 
 
 12. Track laying and surfacing 6,355,638 6,400,972 97 5 
 
 13. Fencing 2,763,595 1,627,790 58.8 
 
 14. Crossing, cattle guards and signs 607,542 428.474 70.4 
 
 15. Interlocking and signal apparatus 501.683 448^686 89 3 
 
 16. Telegraph (30 telephones) 258,985 134,797 52 .0 
 
 17. Station buildings and fixtures 4.108.736 3,111,103 75.8 
 
 18. Shops, roundhouses and turntables 2.157.228 1,467,569 68.2 
 
 19. Shop machinery and tools 1.107,910 882,634 79 7 
 
 20. Water stations 725.670 522.135 72 
 
 21. Fuel stations 303.289 201,461 66.2 
 
 22. Grain elevators 1,336.794 1,009,043 75 
 
 23. Warehouses 258.646 183.910 71 3 
 
 24. Docks and wharves 5,531,919 3,831.934 69.4 
 
 25. Miscellaneous structures 1.234.345 856,253 69.4 
 
 26. Locomotives 9,021,517 5,092,053 66 4 
 
 27. Passenger equipment 3,197,473 2,277,271 712 
 
 28. Freight equipment 19,734,246 13,690.587 69.4 
 
 29. Miscellaneous equipment 702.940 423,689 60.3 
 
 31. Ferries and steamships 1,725,300 1,095.500 63 5 
 
 32. Electric plants 93,061 69,898 96 . 8 
 
 33. Terminals 
 
 34. Legal expenses. 0.5 per cent.. Items 2 to 25 
 
 inclusive, and 33 673,349 673,349 100.0 
 
 35. Interest, 3 per cent.. Items 1 to 34, inclusive 5,290,549 5,290.549 100.0 
 
 36. Miscellaneous expenses: 
 
 Organization, 1 .5 per cent 2,645,277 2,645,277 100 
 
 Contingencies, 10 per cent 18,428,759 15,127,110 62.3 
 
 Total cost of construction and equipment .. . $202,716,252 $166,398,156 81.4 
 
 *Value of non-physical properties 35.814,043 
 
 Total value of physical and non-physical 
 
 properties $202,212,199 
 
 37. Stores and supplies 1,474,829 1,474,829 82.2 
 
 ♦Figures furnished by Prof. Adams. 
 
 This inventory method is supplemented by a consideration of the 
 earning capacity of the roads, and in the same Bulletin will be found an 
 interesting letter from Prof. Henry C. Adams, addressed to the Michigan 
 Board of State Tax Commissioners, in which he recommends a rule for 
 the appraisal of non-physical elements of corporate property. 
 
 PHYSICAL VALUATION, SUPPLEMENTED BY THE PERSONAL EQUATION, 
 OR METHOD ADOPTED BY THE VIRGINIA COMMISSION. 
 
 We have seen that in fixing the maximum value, per mile, of Virginia 
 railroads, the commission was largely influenced by the property principle 
 by direct assessment — which is essentially a physical valuation principle. 
 The commission says in respect to valuation matters that it knows no better 
 
 23
 
 or more reliable method than to give due and proper consideration and 
 weight to the following matters, among others: 
 
 "1. The original cost of the property, so far as it is shown. 
 
 "2. The amount of the capital and bonded debt of the company- 
 applicable to the property in this state. 
 
 "3. The market value of such stock and bonds. 
 
 "4. The cost of reproducing the property anew so far as it is shown. 
 
 "5. The cost of reproducing the property in its present condition 
 so far as it is shown. 
 
 "6. The properly assessed value of the property for purposes of 
 taxation. 
 
 "7. The personal knowledge of the property by the commission." 
 
 It then proceeds to say that "no one of these considerations should 
 control, but due weight should be given to each." But it immediately 
 afterward observes that "the original cost of a railroad and its equipment 
 is often unascertainable, and it is wholly impracticable to ascertain the 
 cost of reproduction — either new or in its present condition," and that 
 "the most unreliable and misleading of all the foregoing considerations 
 is the amount or present market value of the stock and bonds of the road." 
 
 This would seem to reduce the seven matters to be considered to only 
 two; that is, the 6th, or the properly assessed value of the property for 
 purposes of taxation, and the 7th, the personal knowledge of the property 
 by the commission. 
 
 It should not require any argument to show that the methods above 
 described cannot result in a fair valuation of property for any purpose, 
 because the principal characteristic of a purely physical valuation is gross 
 inequality. For example: The cost of grading, masonry, bridges, tunnels, 
 etc., of a comparatively new railroad built through a mountainous countiy 
 may be five times greater than that of an older road built through a valley 
 or on a plain, while the value as a railroad, measured by its efficiency to 
 serve the public and the volume and character of its business, may not 
 be one-tenth part as great as that of the road built in the valley or on the 
 plain. 
 
 The underlying error of the method is that cost represents value. The 
 cost of preparing a roadbed for the track adds nothing to the value as a 
 railroad, no matter what its cost may have been. The advocates of a 
 physical valuation impute value to the cost of things which contribute 
 little or nothing to the real value as a railroad, and they disregard the 
 things which have real value; that is, the efficiency as an instrument of 
 commerce, and the degree of success in building up the country' and develop- 
 ing its traffic as measured by its earning capacity. 
 
 In view of these facts, and others which might be mentioned, it is 
 impossible to escape the conclusion that a physical valuation is irrational 
 in principle, and impracticable of application. 
 
 24
 
 VALUATION BASED ON MARKET VALUE OF BONDS AND STOCKS. 
 
 Unlike the physical valuation, this method has a rational basis. The 
 value of a railroad depends on its net earning capacity, and the market 
 value of its securities under normal conditions reflect such earnings, as 
 well as the physical condition of the property and the degree of efficiency 
 with which it is able to serve its purpose and afford safe, regular, expedi- 
 tious and cheap means of communication between sections of the country, 
 and especially the volume and character of the traffic it has been able to 
 develop in the course of years. 
 
 Wall Street is a good appraiser of values. The market values of 
 stock represent the best judgment of thousands of men — investors and 
 speculators — who make it a business to study railroad problems and to 
 keep themselves constantly informed of all the conditions which influence 
 or affect the earning capacity of the roads. It is true that prices of stock 
 fluctuate — at times violently — but this difficulty can be overcome in a 
 measure by using the average prices for long periods, such periods being 
 judiciously selected with reference to normal conditions of the market. 
 No doubt this method would give good results when applied to railroads 
 which have been in operation for many years, in old and well-developed 
 sections of the country, for generally the stocks of such roads are bought 
 largely for investment. Their prices do not fluctuate materially, and 
 owing to the enhanced value of real estate and terminals, the value of the 
 property is generally greater than the aggregate market value of the 
 securities representing it. But it is different with comparatively new 
 roads, which, to a great extent, have to develop the business which is to 
 support them, and also with the newly reorganized companies. In these 
 cases the method of valuation based upon the market value of the stocks 
 and bonds would not give satisfactory results. 
 
 THE TRUE MEASURE OF VALUE OF A RAILROAD IS ITS EARNING 
 
 CAPACITY. 
 
 Corporations build and operate railroads for the purpose of earning 
 dividends for their stockholders (if they can) by selling transportation 
 to the public. The value of a railroad depends upon the degree of efficiency 
 with which it can serve its customers. This efficiency is reflected in their 
 earning capacity and is affected by various conditions and circumstances — 
 some of which may be enumerated as follows: 
 
 1. Location and construction with reference to sources of traffic and 
 economy of operation. 
 
 2. Character and amount of transportation facilities, terminals, etc. 
 
 3. Degree of success of the efforts to develop the resources of the 
 country and in locating commercial, manufacturing, mining, and other 
 industries which afford traflSc. 
 
 4. Volume and character of the traffic. 
 
 25
 
 5. Conditions affecting the value of the service; that is, the rates 
 of transportation which can be charged to the customers. 
 
 6. Competition with other railroads, water lines, and between markets. 
 
 7. Good-will of the customers, and good feeling generally of tlie 
 people. 
 
 8. Skill, industry, and honesty in the financial and physical operation 
 of the road. 
 
 Some of these conditions affect the earning power more than others; 
 but all of them are reflected in the net earnings of a road. Therefore, 
 the net earnings are the true measure of the value of a railroad. The 
 tnxth of this cannot be successfully controverted.* 
 
 It is manifest that the earning capacity cannot be considered by the 
 advocates of valuation, because, as the Kentucky Commission observes 
 in respect to the apportionment of the annual charge for valuation: 
 
 "Certainly neither gross earnings nor net earnings can be a satisfactory basis of appor- 
 tionment of these charges for this purpose, particularly where the purpose of the apportion- 
 ment is to determine the propriety of the rates from which these gross earnings and net 
 earnings result. In this case the earnings result from the rates in question. This annual 
 charge for valuation is in a sense part of the carrier's cost, and to attempt to justify the 
 apportionment of costs by the earnings resulting from rates, and then to justify the rates 
 by the apportionment of costs based on the earnings resulting from the rates, would clearly 
 be reasoning in a circle.' ' 
 
 The commission's reasoning is of course correct from its standpoint, 
 but it does not prove that earning capacity is not a good measure of value 
 of railroads. It merely proves the fallacy of the method of ascertaining 
 the reasonableness of rates from a valuation of the property used. 
 
 VALUATION IS NOT NEEDED, BECAUSE RAILROADS CANNOT AND DO 
 NOT CHARGE EXORBITANT RATES. 
 
 One object of the valuation is to prevent railroads from charging 
 exorbitant rates. The remedy is not needed because the evil does not 
 exist. - Existing state and federal laws regulating railroad charges, if 
 properly enforced, afford ample protection to the shipper. But even if 
 this were not so, railroad companies cannot charge exorbitant rates, because 
 they would kill their business and put themselves into bankruptcy. 
 
 No private persons or corporations that are "affected with public 
 interests" are so much affected by pvtblic prejudices that seek, and too 
 often find expression, in ill-considered legislation, as the railroads are. For 
 every ill, real or imaginary, a special legislative nostrum is prescribed. 
 Thousands of railroad bills are introduced in Congress and in state legisla- 
 tures. The remedies proposed are more numerous than the patent medi- 
 cines which are advertised as panaceas for the ills to which the natural 
 person is subject. Before the meeting of the last Congress it was earnestly 
 demanded that, in order to cure the evil of rebating, the Interstate Com- 
 merce Commission should be clothed with the rate-making power. The 
 pointing out of the obvious fact that a commission-made rate can be 
 rebated as easily as a rate made by the railroads made no impression upon 
 the persons who demanded such legislation. Nor did the fact that the Elkins 
 
 26
 
 Act had been on the statute books for some years, which law, if it had 
 been properly enforced, would have stopped rebating long ago. At a 
 recent session of Congress, Senator LaFollette introduced a bill providing 
 for the official valuation of all the railroads in this country. This bill, 
 however, did not receive the approval of the Senate Committee on Inter- 
 state Commerce. Mr. Bryan strongly advocates the valuation of railroad 
 properties by the Interstate Commerce Commission and by the various 
 state railroad commissions. As we have seen. President Roosevelt also 
 advocates the valuation of the railroads by the Interstate Commerce 
 Commission. The wild cry of "over-capitalization"* is raised in every 
 section of the country and the physical valuation of railroad property is 
 demanded. 
 
 To make a valuation of all the railroads would require years of labor 
 and the expenditure of several millions of dollars. Owing to rapidly 
 changing conditions, a new valuation would be needed before the preced- 
 ing one could be completed. The question arises: what good would these 
 valuations do? What do their advocates expect to accomplish? 
 
 One object is said to be the correction of the evil of exorbitant rates. 
 As stated above, this remedy is not needed because the evil does not exist. 
 It has been shown repeatedly that while the passenger rates on a certain 
 class are somewhat higher in this country than in some of the more densely 
 populated countries in Europe, the American freight rates are the lowest 
 in the world. 
 
 A conclusive answer to the charge that rates have been extortionate 
 in the past can be found in the report of the Interstate Commerce Com- 
 mission to the Senate Committee on Interstate Commerce in reply to a 
 resolution of the Senate, January 16, 1906. This report shows the work 
 of the commission in respect to complaints, hearings, and decisions of the 
 courts as to exorbitant and unreasonable rates, etc. It appears by an 
 extract from this report made by Joseph Nimmo, Jr., former Chief of the 
 Bureau of Statistics in the Treasury Department, and a well-known writer 
 on economics, that only 15 cases involving exorbitant rates were decided 
 by the courts from April 5, 1887, to March 1, 1905, and that only three of 
 these cases were sustained by the courts, or on an average one case of 
 exorbitant rates during each six years of the life of the commission up to 
 March, 1905. 
 
 From a statement made by Walker D. Hines, in his testimony before 
 the Senate Committee, it appears that from January 1, 1900, to January I, 
 1905, the commission issued 13 orders in cases of unreasonably high rates, 
 of which 10 were obeyed by the carriers, two were not obeyed, and one 
 was not sustained by the court. 
 
 The Hon. Martin A. Knapp, Chairman of the Interstate Commerce 
 Commission, declared several years ago that exorbitant rates were practi- 
 cally obsolete. 
 
 An inspection of the following table will show that the freight rates 
 of American railroads have steadily and materially decreased since 1882: 
 
 27
 
 
 Tons hauled 
 
 Av. rate per 
 
 Tons hauled. 
 
 one mile. 
 
 ton per mile. 
 
 360,490.375 
 
 39,302,209,249 
 
 1 . 236 cents. 
 
 400.453,439 
 
 44,064.923,445 
 
 1 236 •• 
 
 399,074,749 
 
 44,725,207,677 
 
 I 124 •• 
 
 437,040,099 
 
 49,151,894,469 
 
 1 057 •• 
 
 452,245,254 
 
 52,802,070,529 
 
 1 042 " 
 
 552,074,752 
 
 61.561,069,996 
 
 I 034 " 
 
 590,857,353 
 
 65,423,005,985 
 
 .977 " 
 
 539,639,583 
 
 68,727,223,146 
 
 922 " 
 
 636,541,617 
 
 76,207,047,298 
 
 941 " 
 
 675,608.323 
 
 81,073,784,121 
 
 895 " 
 
 706,555,471 
 
 88.241,050,225 
 
 .898 '• 
 
 745,119,482 
 
 93,588,111,833 
 
 878 ■• 
 
 638,186,553 
 
 80,335,104,702 
 
 .860 " 
 
 696,761,171 
 
 85.227,515.891 
 
 .839 •' 
 
 765,891,385 
 
 95,328,360,278 
 
 .806 " 
 
 741,705,946 
 
 95,139,022,225 
 
 .798 " 
 
 879,006.307 
 
 114,077,576,305 
 
 .733 " 
 
 959,763,583 
 
 123,667,257,153 
 
 .724 •• 
 
 1,101,680.238 
 
 141,599.157,270 
 
 .729 •• 
 
 1,089,226,440 
 
 147,077,136,040 
 
 750 •' 
 
 1,200,315,787 
 
 157,289,370,053 
 
 .757 '• 
 
 1,304,394,323 
 
 173,221,278,993 
 
 . 763 " 
 
 1,309,899,165 
 
 174,522,089,577 
 
 .780 " 
 
 1,427,731,905 
 
 186,463,109,510 
 
 .766 •' 
 
 Mileage 
 
 Year. operated. 
 
 1882 104,971 
 
 1883 110,414 
 
 1884 115,704 
 
 1885 123,320 
 
 1886 125,185 
 
 1887 137,028 
 
 1888 145,387 
 
 1889 157,758 
 
 1890 163,597 
 
 1891 168,402 
 
 1892 171,563 
 
 1893 176,461 
 
 1894 178,708 
 
 1895 180,657 
 
 1896 182.776 
 
 1897 184,428 
 
 1898 186,396 
 
 1899 189,294 
 
 1900 193,343 
 
 1901 197,237 
 
 1902 202,471 
 
 1903 207,977 
 
 1904 212,577 
 
 1905 217,017 
 
 (The above figures, 1882 to 1888, inclusive, are from Poor's Manual for 1890. The 
 figures, 1889 to 1905, inclusive, are from the annual Statistics of Railways in the United 
 States, issued by the Interstate Commerce Commission.) 
 
 *See President Roosevelt's Indianapolis speech. 
 
 It will be seen that during the 23 years from 1882 to 1905, the average 
 rate per ton per mile decreased from 1.236 cents to .766 cents, or 470, or 
 over 38 per cent. While the average rates per ton per mile do not show 
 actual reductions in individual rates or classes, because of the varying 
 proportions of low-rate freights, such material reductions as have been 
 made are necessarily reflected in the average rates. 
 
 The Interstate Commerce Commission's "Forty Years' Review of 
 Changes in Freight Tariflfs" contain over 100 tables showing the great 
 reductions that have been made in individual rates both competitive and 
 local. 
 
 WHAT IS A REASONABLE RETURN ON THE PROPERTY USED? 
 
 That railroad companies are entitled to a reasonable return on a fair 
 value of the property used is but another way of saying that every laborer 
 is worthy of his hire. The compensation of the laborer, be he one who 
 labors with his hands, or a professional man, is determined by the value 
 of his services to his emploj^er. 
 
 The services of railroad corporations have a distinctive character, 
 because they render three separate services to the public for which they 
 make only one charge, viz. : 
 
 1. As proprietors of the railroad. 
 
 2. As transporters or common carriers. 
 
 3. As warehousemen. 
 
 The early railroad charters in England and in this country contem- 
 plated that the railroad companies furnish the roadway and throw it open 
 
 28
 
 as a highway for the use of the public, charging tolls for such use in the 
 same manner in which canals and turnpikes did. If this idea could have 
 been carried out it would have greatly simplified the matter of reasonable- 
 ness of railroad charges. No one could object to paying the proprietary 
 company such reasonable toll as might enable it to keep the road in a safe 
 condition, and to earn a fair profit on the investment; and as this kind 
 of property is exposed to dangers from the elements and deteriorates 
 rapidly, no reasonable person would limit this fair return to the ordinary 
 legal interest. 
 
 If transportation were furnished by a separate company, it would be 
 less difficult to determine the value of the services, and a reasonable return 
 on the capital invested. But in that case the extra-hazardous nature of 
 such investment should also be taken into consideration in determining 
 what is such reasonable return. 
 
 It is probable that if railroad accounts were kept more in detail with 
 the view of ascertaining, with a closer approach to accuracy, all the factors 
 which affect rates of transportation, the difficulties of ascertaining the 
 reasonableness of rates under the varying conditions of performing the 
 service would be minimized. At all events, prevailing misapprehensions 
 on the subject might be more easily corrected.* 
 
 It has been pointed out frequently that the existing confusion in the 
 minds of the people on the subject of railroad tariffs arises from the fact 
 that people do not bear in mind that railroad charges are made up of three 
 distinct services, and that a single measure cannot be applied to them. 
 
 There are hardly any two railroads in this country which were built 
 or are operated under the same, or even similar circumstances and 
 conditions. Therefore, a fixed rate of profit, or an inflexible rule, applied 
 to all railroads, would result in injustice and unjust discrimination. 
 
 There is a great diversity in the earning capacity of different rail- 
 roads — in their location, construction, gradients, alinement, density of 
 traffic, and other important factors determining the net earnings of rail- 
 roads. These factors vary within wide limits. What would be a fair 
 return to the owners of one railroad may not be to those of another railroad, 
 whose volume and character of traffic is materially different. Moreover, 
 the earning capacity of railroads varies within wide Hmits during different 
 periods. Hence, what may be a reasonable return during times of great 
 
 •The Hepburn Act provides that the Interstate Commerce Commission may prescribe 
 the formg of any and all accounts, records and memoranda to be kept by carriers, including 
 the accounts, records and memoranda of the movement of traffic, as well as the receipts and 
 expenditures of moneys. This provision of such Act prohibits under heavy penalties (of 
 not less than $1,000 nor more than $5,000, or imprisonment for a term of not less than one 
 year nor more than three years, or both such fine and imprisonment) [keeping any other 
 accounts, records or memoranda than those prescribed or approved by the Commission. 
 
 While the uniformity of railroad accounts is very desirable, the unwisdom of prohibiting 
 railroad companies from keeping ancillary accounts is apparent from the fact that the con- 
 ditions as to operation and traffic are not the same on any two roads in the country, and 
 Information which may be of value to the operating officers of one railroad may be entirely 
 valueless to those of another. It is gratifying to learn that the Interstate Commerce Com- 
 mission in issuing its orders putting the law into efiFect has tempered this provision with 
 common sense, by allowing railroad companies, at least until otherwise directed, to keep 
 inch ancillary accounts. 
 
 29
 
 prosperity might be wholly inadequate during times of business depression. 
 Therefore, a uniform maximum rate of profit cannot be fixed by law, unless 
 the government guarantees such profit for all time — and this, of course, 
 cannot be done. 
 
 May not these considerations account for the fact that the courts have 
 not established a basis for the valuation of railroads, nor fixed a percentage 
 of profit ("reasonable return")? That this percentage cannot be justly 
 restricted to the legal rate of interest is manifest from the fact that owing 
 to the hazardous nature of investments in railroads, they cannot be deemed 
 analogous to investments in commercial, industrial, and other enterprises. 
 
 We know from experience that a large portion of the capital invested 
 in railroads in this country has either been unproductive for a number of 
 years or has proved a total loss. The traffic of railroads is fluctuating. 
 There are long periods of depression of business, when rates have to be 
 reduced in order to enable shippers to send their commodities to the 
 markets, and when many railroads can barely earn their interest charges, 
 and the stockholders can receive no dividends. It would therefore be 
 unfair to confine shareholders to a fixed rate of profit when a revival of 
 business enables the company to earn more than the established maximum. 
 
 Railroads cannot suspend operations during times of business depres- 
 sion, nor transfer their plants to other points, as manufacturers can do. 
 Their operation is continuous; and as a large part of their operating 
 expenses have to be incurred anyhow, regardless of the volume of business, 
 they cannot materially reduce their operating expenses when the traffic 
 diminishes. 
 
 Their properties are exposed to great dangers from the elements. 
 Cloudbursts in the mountains and swollen streams frequently destroy 
 hundreds of thousands and even millions of dollars worth of property, and 
 necessitate a suspension of operations for days, weeks, and even months. 
 
 Railroad properties depreciate very rapidly. Some portions are from 
 time to time rendered of little or even no value by the revision of grades and 
 alinement, by the adoption of modern improvements in machinery and safety 
 appliances, etc. Railroads sustain heavy losses from excessive awards of 
 damages in cases of accidents, many of which are unavoidable so long as 
 the human equation enters into the operation of railroads. The construc- 
 tion of parallel lines may at any time materially affect the earning capacity 
 of a road. And not the least of the dangers to which railroads are exposed 
 is ill-considered legislation by states and the federal government, at times 
 when the waves of popular prejudices sweep over the land. 
 
 Capital is keenly alive to these dangers. It may be asked, who would 
 have invested in American railroad securities if the rate of interest had 
 been confined to the legal rates in the several states? And who is Hkely 
 to furnish in the future the capital necessary to build new roads and to 
 enlarge transportation facilities now so heavily overtaxed,, if the returns 
 on the capital is to be restricted? There are many other opportunities to 
 earn the legal interest, or more, where ample security can be obtained for 
 
 30
 
 the regular payment of interest, as well as of the principal. Capital 
 invested in hazardous enterprises must necessarily receive a large rate of 
 profit as a reward for the risk. Investments in railroads are in a measure 
 speculative. Investors expect to receive not only a reasonable rate of 
 interest, but also a share of the advantages which fiow from the growth 
 of the country and from the skill and industry of the management. Why 
 deny them the fruits of their skill and industry in the management of the 
 property, or deprive them of an increment in the value of the property due 
 to the development of the country? 
 
 RAILROAD CAPITALIZATION AND RETURN THEREON. 
 
 A suggestive comparison of freight and passenger rates, and the return 
 
 on stocks and bonds during the past twenty-three years is brought forth 
 
 in the following table: 
 
 Earnings Per- 
 
 Average rate per mile of road centage 
 
 Per cent. Per mile, eta. in operation of exp. to 
 
 Year. Interest. Dividends. Per ton. Per pass. Gross. Net. earninga. 
 
 1883 4.94 2.76 1.224 2.422 17.405 $2,679 63.82 
 
 1884 4.82 2.50 1.124 2.356 6,663 2,318 65.22 
 
 1885 4.97 2.00 1.057 2.199 6,209 2,163 65.17 
 
 1886 4.86 2.02 1.042 2.194 6.570 2.376 63.83 
 
 1887 4.86 2.17 1.034 2.276 6,799 2,418 64.44 
 
 1888 4.48 1.80 0.977 2.246 6,540 2,045 68.72 
 
 1889 4.53 1.79 0.970 2.169 6,446 2,066 67.95 
 
 1890 4.44 1.82 0.927 2.174 6,875 2,166 68.50 
 
 1891 4.41 1.87 0.929 2.184 6,851 2.135 68.83 
 
 1892 4.25 1.93 0.941 2.168 6,852 2.068 69.82 
 
 1893 4.31 1.88 0.893 2.072 6,963 2,069 70.29 
 
 1894 4.19 1.66 0.864 2.025 6,054 1,803 70.22 
 
 1895 4.24 1.58 0.839 2.069 6,097 1,804 70.41 
 
 1896 4.45 1.52 0.821 2.032 6,233 1,840 70.43 
 
 1897 4.24 1.51 0.797 2.029 6,228 1,884 69.74 
 
 1898 4.21 1.71 0.758 1.994 6,771 2,111 68.16 
 
 1899 4.26 1.92 0.726 2.002 7,161 2,272 68.27 
 
 1900 4.27 2.44 0.746 2.031 7,826 2.519 68.93 
 
 1901 4.24 2.65 0.756 2.028 8,270 2,668 67.73 
 
 1902 4.10 2.97 0.764 2.012 8,696 2.830 67.45 
 
 1903 4.17 3.03 0.781 2.052 9,301 2,887 68.96 
 
 1904 4.01 3.31 0.787 2.053 9,248 2,989 67.68 
 
 1905 3.79 3.27 0.789 2.030 9,643 3,135 67.49 
 
 It will be seen that the highest average rate of dividend was 3.31 per 
 cent, in 1904, and the lowest 1.51 per cent, in 1897. The two tables also 
 furnish conclusive refutation of the theory that capitalization has any 
 relation to rates and that increased capitalization must result in an increase 
 of rates. It will be seen that the capitalization, including stock and bonded 
 debt, increased from $5,402,038,257 in 1880 to $14,563,199,931 in 1905, 
 or 170 per cent., and that during the same period the average rate per ton 
 per mile decreased from 1.224 cents to 0.789 (cents, or 35 per cent., and 
 that the passenger rates decreased from 2.422 cents per passenger per mile 
 in 1880 to 2.030 cents, or 16 per cent. 
 
 It will also be seen from the accompanying tables taken from the 
 Interstate Commerce Commission "Statistics of Railways in the United 
 States" for the decade ended June 30th, 1905, that during that period of 
 exceptional prosperity, shareholders, with few exceptions, did not re- 
 ceive a reasonable return on their investment. 
 
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 RATE MAKING ON THE BASIS OF VALUATION OF PROPERTY IS IMPRACTICABLE. 
 
 The Virginia and Kentucky cases furnish a striking illustration of 
 the impracticability of government rate-making on the basis of Evaluation 
 of property. 
 
 Let us assume, for further illustration, that a railroad commission 
 has to establish freight tariffs for road A, built in a mountainous country, 
 and at a cost of $50,000 per mile; and, also, for road B, built in a valley 
 or on a plain at a cost of $25,000 per mile. 
 
 We assume further that there are important industrial establishments 
 on both roads, which produce the same articles and ship them to the same 
 markets. A tariff for road A that is 25 per cent, higher than that for 
 road B must be considered as reasonable, both on account of the greater 
 value of the property used, and the probable greater cost of operation. But 
 what would be the result of such tariff? Obviously, road A would have 
 reasonable rates; but road B would get all the competitive freights. The 
 industrial estabUshments on road A would have to be closed. As the 
 commission could not order road B to advance its rates (such advance 
 might enable that road to earn more than a reasonable return on a fair value 
 of the property used), it must say to road B: the rates we fix for you are 
 maximum rates. You can charge as much less as you please. That would 
 solve the problem; but what would become of the theory of rate-making? 
 
 Owing to the interdependence of rates, what is true of roads A and B 
 is equally true of other roads in different sections of the country. Com- 
 munities that are served by roads of small capitalization would have lower 
 rates than those which are not so fortunate. The result would be unjust 
 discrimination against localities, and hopeless confusion and disaster to 
 commercial enterprises which depend on railroad transportation. Ulti- 
 mately the roads which have the lowest capitalization would fix the rates 
 for all the other roads in the same section, with which they compete 
 either directly or indirectly, by competition between markets. This 
 might mean bankruptcy to many railroads, unless they could make up 
 for their losses on competitive business by putting heavier burdens on the 
 local or non-competitive traffic. 
 
 The theory of rate-making on the basis of valuation of property ought 
 to commend itself to the advocates of government ownership of railroads; 
 for no more effective plan for depreciating the value of railroad securities 
 could be devised. As a basis for rate-making this theory may be charac- 
 terized as "the sublimity of absurdity," to borrow a phrase which Presi- 
 dent Roosevelt applied to another matter. 
 
 VALUE-OF-SERVICE PRINCIPLE. 
 
 About forty years ago, a friend of mine, then superintendent of a 
 Virginia railroad, was asked by the chairman of an investigating committee 
 of the Virginia Legislature, "Why does your company charge $1 per bale 
 of cotton from local station A on your road to the terminal station B?" 
 
 33
 
 He answered promptly, "Because we can get it." A shout of derisive 
 laughter followed, and the chairman added: "Oh! you charge all you can 
 get, do you?" 
 
 The newspapers, and even some railroad men, did not fail to cast 
 ridicule upon my friend, and yet he had stated in a few words, probably 
 without being aware of it, the underlying principle of all railroad tariffs, 
 and of the tariffs of tolls that applied to canals and turnpikes hundreds of 
 years before railroads were dreamed of. 
 
 It is apparent that under no circumstances can a railroad charge a 
 shipper more than such shipper is able to pay. It does not follow, how- 
 ever, that rates are made on a basis of charging all a shipper can afford to 
 pay. Such a basis would be unfair, because it would deprive the shipper 
 of his equitable share of the value created by the transportation. Hence, 
 the rate would not represent the fair value of the service to the shipper. 
 But the rate must also be fair to the railroad. Hence, it follows that the 
 fair value of the service is determined by what the shipper is able to pay 
 to yield him such profit as he is willing to accept, and what the railroad 
 can afford to render the service for. A railroad and a shipper may be said 
 to be in partnership limited to each particular shipment. The shipper 
 furnishes the article and the railroad the transportation, the profit from 
 each transaction, that is, the earned increment of value created by the 
 service, to be equitably divided between these partners. The first ques- 
 tion to be determined is, can the article be transported at all? If the 
 shipper's share of the value created by the service gives him no profit at 
 all, and the railroad's share does not reimburse it for the expense of hand- 
 ling and moving the article, then the service is practically of no value, 
 and the article cannot be transported. For example: If we assume that 
 the increased value of an article by reason of transportation from the point 
 of production (A) to the market (B) would be equivalent to 20 cents per 
 100 pounds, and the actual outlay of the railroad for handling and moving 
 the article was 22 cents per 100 pounds, then the service is of no practical 
 value, and the article cannot be carried. If, however, the shipper's share 
 yields him such minimum profit as he may be willing to accept, and the 
 railroad's share gives it something more, however little, than the expense 
 of moving and handling the article, then the service is of some value, 
 which may be designated the minimum value, and the article can be trans- 
 ported. The minimum value in such a case fixes the maximum rate that 
 particular article can bear. 
 
 For instance: If the increase of value created by the transportation 
 should be equivalent to 30 cents per 100 pounds, and the expense of hand- 
 ling and hauling is 22 cents per 100 pounds, then a rate can be fixed which 
 will give some profit to the shipper, and give to the railroad something 
 over the actual expense of handling and hauling. It follows that the rate 
 must not be higher than the article can bear — the value of the service 
 being determined by the ability to pay. This ability varies within wide 
 limits with different articles, according to their values. For instance: 
 
 34
 
 Silks and dry goods can bear higher rates than pig iron; manufactured 
 goods can generally bear higher rates than the raw materials out of which 
 they are made. Railroads classify their articles in accordance with the 
 rates each article can bear, and for the purpose of so adjusting rates that 
 every article contributes, in addition to the expense of movement, such 
 proportion of the expenses of maintenance of way, track, bridges, buildings, 
 general administration and taxes, and, if practicable, interest on the 
 capital invested, as the value of the service enables each article to con- 
 tribute. 
 
 The underlying principle of railroad classification is discrimination 
 between different classes of freight in accordance with the value of the 
 service and expense of operation. We will now see whether this theory 
 can be applied to the practical work of rate adjustment. 
 
 It may be said that a railroad favorably located in respect to the 
 sources of its traflSc, and economically built and operated, should yield to 
 its owner a fair return on the capital actually invested, and that rates 
 should be so fixed that each article of freight carried over the road should 
 pay the cost of its transportation, and in addition thereto, an equitable 
 proportion of the fixed charges, and of the dividends to be paid to the 
 stockholders. But the cost of transporting any article of freight is not 
 known and cannot be ascertained; nor can the amount and character of 
 the traffic which has to be assessed with these charges be known in advance. 
 Moreover, the principles which should govern the equitable distribution 
 of such charges remain to be discovered. But assuming that freight 
 rates can be made according to this theory, it might, and probably would 
 be found that they were in many cases higher than the rates in effect 
 on a competing railroad or water line — so that the rates made upon mathe- 
 matical principles and according to rules of equity would be of no practical 
 use. 
 
 As the value of service theory is correct, the above example merely 
 shows that this method of application is impracticable. This, however, 
 does not affect the correctness of the value of service principle. 
 
 How, then, are freight tariffs made? 
 
 It cannot be said that they are made in the sense that they are prod- 
 ucts of manufacture. It would be more correct to say that they are 
 products of evolution. One generation transmits them to the next, with 
 such additions and modifications as traffic conditions necessitated. It 
 would be interesting to trace the development of modern freight tariffs 
 from the simple rate sheets of the earliest days of railroads, to the modem, 
 highly organized tariffs, with their elaborate classifications embracing 
 thousands of articles, and to note that influence and effect of surrounding 
 circumstances that from time to time necessitated modifications and 
 additions — and, especially, the effect of increasing competition. Unfor- 
 tunately, the information which would be necessary to make such a study 
 is not obtainable. 
 
 It cannot be said that, in modern times, railroads make tariffs; they 
 
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 can only adjust them to varying conditions. This work is performed by 
 a department known as the traffic department or commercial department. 
 Rate adjusting is not a science, but a profession taught in the school of 
 experience. The proficiency of traffic men can only be acquired by many 
 years of practical work in the several branches of the service. Generally 
 traffic men grow up with their respective railroads, and are familiar with 
 the commercial and economic conditions of the country tributary to their 
 respective railroads. They are in close touch with the public, either 
 directly or through their numerous assistants — division freight agents, 
 station agents, and soliciting agents. By being in close touch with ship- 
 pers they can acquaint themselves with their needs and requirements. 
 It has been said that traffic men should know the business of shippers 
 almost as well as the shippers do themselves. These traffic men are also 
 in close touch with the transportation departments of their respective 
 roads, and keep themselves informed of the movement of traffic and the 
 factors which influence the economy of movement. They know whether 
 the road is being worked to its full capacity, or whether it is desirable to 
 increase the volume of business and thus reduce the expenses of operation. 
 Adjusting freight rates is practical work for men who have special 
 training for it and large experience. They may not all be able to explain 
 underlying principles, such as the value of service, but they have used this 
 principle for years, and apply it intuitively in every case which comes 
 before them. Indeed, it has become with them a habit to apply it — not 
 unlike the lawyer who is called upon to give opinions on questions involving 
 facts and the law, the traffic man is called upon to decide rate questions 
 with promptitude, upon the facts and the law, according to his best judg- 
 ment. He must be familiar with commercial and economic laws, as well 
 as state and interstate laws regulating rates. It is apparent that in 
 adjusting rates, or in making new rates when it is within their power to 
 do so, these traffic men decide what is an equitable division between the 
 railroad and the shipper, of the increment of value. Frequently his 
 decision results from bargaining and compromise. But generally it is 
 arbitrary. Hence, laws regulating railroad rates are imperatively neces- 
 sary, to give the shipper relief in case of errors of judgment of railroad 
 men. While decisions of railroad men are necessarily arbitrary, it should 
 be borne in mind that railroad men appreciate the importance of treating 
 their customers fairly, and of fostering and developing the business of their 
 roads. Railroad men can no more disregard the interests of the shipper 
 than those of the railroads they represent. The saying that the interests 
 of the railroads and the public are identical is trite, but true. The present 
 laws afford ample protection to the shipper and to the railroads, except, 
 as we have seen, in the case of state-made tariffs. 
 
 VALUE OF SERVICE THE CORRECT STANDARD OF REASONABLENESS OF RATES. 
 
 The standard of reasonableness of rates must fulfill the following 
 conditions : 
 
 36
 
 1. It must be based upon correct principles. The measure to be 
 applied must have direct relation to the thing to be measured. 
 
 2. It must be in harmony with the underlying principles of practical 
 rate adjustment. 
 
 3. The method of applying the standard in determining the reasona- 
 bleness of a rate must be practicable. 
 
 We have seen that neither the theory of cost of transportation, nor 
 of the fair value of the property need comply with any of these requisites. 
 I believe that the value of service is the correct standard of reasonableness 
 of rates; the principle constitutes a basis for judging rate questions that 
 is broader and sounder than that now being used. It will clear the com- 
 plex question of rate adjustment of irrelevant matter, and greatly simplify 
 it. Of course, it cannot be made the basis of a formula for general appli- 
 cation. Each case must be determined by itself on its merits according 
 to the facts and the law bearing upon it in the same manner as the Inter- 
 state Commerce Commission and the courts do in cases arising under the 
 Act to Regulate Commerce. 
 
 I believe that the value of service principle fairly and intelligently 
 applied would result in conclusions that are just to the shipper as well as 
 to the railroad. 
 
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