sent most efficient and careful construction on the one hand, or careless construction and excessive costs, even carefully concealed fraud, on the other; in consequence there is failure to reward efficiency and honesty, to penalize inefficiency and graft. Yet, a half-century, even a score of years, later, it is almost impossible to determine whether costs have been abnormally low or abnormally high-and, if the latter, whether the cause was beyond the builders' control or such as to justify paring sharply the investment accounts. Finally, if historical cost serves as the sole, even the primary, basis in determining railway values, to avoid a clear injustice to the investor, the rate of return must be sharply increased during years of inflation if the property was built during a period of low or normal prices. Conversely, if built during a period of high costs, the rate of return should be cut sharply during normal times. For, after all, a "fair return" is definitely related to the purchasing power of funds.

COST-OF-REPRODUCTION

A third basis of value determination is that which has been named cost-of-reproduction. Cost-of-reproduction is essentially a theoretical basis, and may be figured as costof-reproduction-new or cost-of-reproduction-new-less-depreciation. Further, cost-of-reproduction may mean the reproduction of an identical plant in all essentials or it may mean the reproduction of a substitute plant capable of performing the same service, a quite different matter in any field in which rapid technical progress features. And again, costof-reproduction may be estimated either upon the basis of physical conditions as they existed when the plant was originally constructed or as they would be at the present time, did the plant not exist. In general, it may be said that cost-of-reproduction-new-less-depreciation of the identical plant under original conditions is the basis of the estimate made, though the inadaptability of the plant to its use or some peculiar situation may justify a modification of this

general policy. In the determination of cost-of-reproduction not only must all physical property, "used and useful" in the rendition of the service, be included in the inventory, but also, as in the case of historical cost, all immaterial or intangible items for which a cost can be established.

Certain evident advantages flow from the adoption of this policy. It gives a figure which, at a particular time, represents the present economic cost of a property necessary to the rendition of a particular service, and its use avoids the handicap which historical cost places upon the more recently built plant in a developed territory: the cost of the more recent properties is generally far greater than the older, and hence a scale of rates yielding a fair return upon the historical cost of the older would be quite inadequate for the newer. It also recognizes value increments and decrements 2 in the public utility field, just as those elements are recognized in the general field of property. And, finally, the employment of this principle places the burden of excessive cost upon the shoulders of inefficient or dishonest management and fully rewards the efficient and honest builder. To offset these advantages, however, there are certain definite objections which have been urged against all types of costof-reproduction as a basis of valuation. The acceptance of such a principle will, in any progressive society, mean increasing capital value and, in consequence, increasing service costs. In the second place, cost-of-reproduction is a matter; of estimate, and actual experience shows that the estimates placed upon a given property by different valuation experts have often varied so widely as to arouse serious doubt as to the fundamental soundness of the principle. The acceptance of this basis may also, unless great care is exercised by regulative bodies, result in giving to the holder of utility shares a double return: he may receive not merely a reasonable return upon his actual sacrifice in the form of dividends, but also an additional return through an increase in capital value. A final criticism of the method rests upon the wide fluctuation of cost figures from time to

time: a valuation as of January 1, 1915, during a period of low commodity prices, would compare strangely with the valuation of the same property, with no additions or betterments, as of January 1, 1920, a date which fell within the recent period of peak prices. This difficulty has been partially met, however, by the use of the "unit price," the average cost of materials and labor during a period of years being used instead of the price figure for a particular date. Yet even here difficulty arises, since the length of the period covered in computing the average is highly significant in determining results.

One other difficulty, or matter of dispute, relative to finding the cost-of-reproduction of railway properties has arisen in the selection of the type of such cost to be used. Railway management insists that, if the property has been maintained in such condition as to make it possible to operate with 100% efficiency, depreciation should not be deducted. Although this matter has not been finally determined by the courts, it seems probable that they will hold an old property incapable of rendering the same period of service to the public as a new one, thereby justifying depreciation. Nevertheless, the fact that the railway properties of the United States are in such condition as to average between 80 and 85% of cost-of-reproduction-new indicates that depreciation is an important item. Therefore, its deduction to arrive at a proper rate base will be bitterly contested by the carriers and defeat admitted only at the hands of the highest

court.

NOTE: Because of the close relationship between the subject-matter of this chapter and the one following, references covering the field of both are combined on pages 499-500.

XXI

SECURITY REGULATION

Sound public policy concerning valuation Need of authoritative findings. Watered stock: meaning and tests. Reasons for stock-watering. Conditions promoting stock-watering: market manipulation; the "construction company"; stock dividends and "rights"; reorganization. Morality of financial practices. Demand for the regulation of railway security issues. Control by the states. Movement toward federal regulation. Action by Congress. Gains of security regulation.

DURING the past 20 years commissions and courts have been forced to deal with the problem of valuation frequently and under widely varying conditions. Strange to say, however, as a result of those years of experience, no definite and explicit principles to govern the determination of the worth of a property can be set forth. Only in general terms have the pronouncements of commissions and courts been phrased. Yet a survey of the ruling decisions indicates that, as a working basis in the determination of capital value, administrative bodies and the courts use cost-of-reproduction-new-less-depreciation as a cornerstone. This figure seems to be modified often by a consideration of historical cost, however, and even of earning capacity to the extent that earnings reflect the efficiency of management or intelligence of location where several routes were available.

To say that such is the present fundamental basis of determining the value of public utility property is one thing; to contend that such a basis will be permanently accepted is another. Indeed, it appears that, as conditions become more certain and methods of regulation, as well as the principles upon which such regulation rests, become more definite, historical cost will gain increasing acceptance. Today, however, the more theoretical basis must be regarded as fundamental and in the determination of the figure to which the

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paper worth ought measurably to correspond, this principle will serve for many years as a guide to commission and court alike. Yet the precise weight given it in fixing a final figure has not been indicated by a single body or individual and much less has any general agreement been secured. Indeed, agreement is unlikely to be reached at any time on such a matter.

NEED OF AUTHORITATIVE FINDINGS

The demand for the determination of the worth of railway properties has received impetus from two directions. Legislative bodies have been desirous of having a sum fixed upon which a reasonable return should be paid, as an aid in the determination of rates; without such figure it is difficult to chart a safe course between confiscation and extortion. The second purpose which a valuation of railway properties should serve, and one which was perhaps first to appear as a motivating factor, is the protection of the investor. For many successive decades railway securities afforded the American people their one great investment and speculative opportunity, but, because of the uncontrolled issuance of securities and the involved systems of accounting, it was difficult for the possessor of capital to know at a particular time the true status of the security, bond or stock, in which he was interested as an investor, or to be assured of its position even in the immediate future. In consequence of this complete absence of control, the deceits and frauds perpetrated by promoter and by corporate organization upon the investing public during more than a halfcentury of railway history were many and gross; indeed, the overcapitalization of certain railway properties became so notorious that the situation acquired political as well as economic significance. No small measure of public antagonism during the past 40 years has been the outgrowth of these very excesses.