elements named. To say just how much allowance should be made, and for how long a period, requires the exercise of a careful, conservative, and discriminating judgment. If allowance be sought on account of this element of original risk, we think it will be permissible at the same time to inquire to what extent the company has already received income at rates in excess of what would otherwise be reasonable, and thus has already received compensation for this risk.

§ 796. Standard of present risk for new enterprise.

(2) Rate of return adequate to induce investment in a new enterprise at the present time. This is the rate that prevails in competitive industry. The rate of return is practically governed by the return at which there will be a free flow of capital into the business. If the rate is higher, excess capital will be attracted and through competition the average rate of profit will be reduced to the normal rate. If the average rate of return is too low, capital will cease to flow into the business until through exhaustion of existing capital or a demand for increased capital the rate of return is increased to the normal rate. The same test may with considerable reason be applied to the determination of a fair rate of return for public service corporations. This is not because it is desirable to induce competition in the supplying of public services, for that theory has been generally abandoned. It is based rather on considerations of justice and public policy. While the state has no desire to induce another gas company to compete with an existing gas company it is desirous of securing a free flow of capital into the gas industry for the improvement and extension of existing plants and the construction of plants in new communities. There is considerable force in the argument that the best way to do this is to permit the capital at present in the business to earn the rate of return that is deemed adequate to induce such new investment.

§ 797. New enterprise standard-Approval by commissions and courts.

This seems to be the standard that finds most favor with the state regulatory commissions. It is indicated in the opinion of the Wisconsin Railroad Commission in State Journal Printing Company v. Madison Gas and Electric Company quoted in § 791; in the opinion of the Interstate Commerce Commission, in Spokane v. Northern Pacific Railway Co. quoted in § 753; in the opinion of the Nebraska State Railway Commission in Lincoln Traction Company case, quoted in § 765; and is expressed as follows by Commissioner Maltbie in the decision of the New York Public Service Commission for the First District In re Queens Borough Gas and Electric Company, 2 P. S. C. 1st D. (N. Y.) —, decided June 23, 1911:

Various standards have been suggested for determining the fair rate of return. The one which in our opinion is properly applicable to this case is that the rate should be such that investors would be induced to provide the funds with which to construct and extend a gas and an electric plant within the area in question. If the state were to fix a rate below this standard, capital could not be secured. If investment were made before the state acted, the original capital might be forced to remain, but additional capital could not be secured unless necessary to protect the first outlay.

On the other hand the courts have usually adopted a rate of return lower than that which would be produced by the application of the above standard. In Columbus Railway and Light Company v. City of Columbus, quoted in § 743, the special master refers to this as the administrative standard but holds that the judicial standard for testing the constitutionality of an ordinance must be based on the narrower grounds of prevention of actual confiscation. On the contrary the Appellate Division of the New York Supreme Court in the Saratoga Springs Gas

Rate Case (quoted above, § 745) apparently approves this standard.

§ 798. Present market rate standard.

(3) The market rate indicated by the income basis on which the securities of the company are bought and sold. This corresponds to the rate of return that would make the market value of the securities substantially equal to the actual investment. It is the rate of return that would make the market value of the property substantially equal to the fair value of the same for rate purposes. The question is what return do actual investors at present demand when purchasing the stocks and bonds of the company. If the total capitalization is made up of one-third stock and two-thirds bonds and the bonds can be sold on a 5% return basis and the stock on an 8% return basis, the average for both stocks and bonds is 6%. If the company were allowed 6% as a fair return it would be enabled to pay 5% on the two-thirds of its valuation represented by bonds and 8% on the remaining one-third represented by stock. The market value of its securities would accordingly be maintained at the same total as the fair value of its property for rate purposes. This method of determining a fair rate of return is applied by Circuit Judge Grosscup in Chicago Union Traction Company v. State Board of Equalization, quoted in § 735. This was a tax case and is therefore of value as illustrating the method rather than as establishing a precedent. There is no direct judicial precedent for the use of this method in a rate case. It seems probable, however, that some such mental process as this has influenced the numerous decisions of the courts holding 5% or 6% a fair return or at least as a non-confiscatory return. This seems to be the underlying thought of Judge Hough and Justice Peckham in their opinions in the Consolidated Gas Case (see §§ 750,

751). Although not followed in later decisions (see § 791) the above standard for determining a fair return is clearly stated by the Wisconsin Railroad Commission in Buell v. Chicago, Milwaukee and St. Paul Railway Company, 1 W. R. C. R. 324, decided February 16, 1907. The Commission said (at page 477):

It has been quite generally held that a fair rate of interest is a rate which, other things being equal, corresponds to the current market rates on money. This is a position with which it is not easy to take issue, for it is quite clear that whatever rate money brings in the market is a safe index to what it is generally worth for investment purposes. It may also be said, and with a great deal of force, that a fair rate of interest for any particular road is the rate of income which its securities bring on their market value. The market rate includes the ordinary risks, as it is usually considerably higher than the rate which is obtained on government and other securities where substantially no risks at all are involved.

$799. Conclusion.

It seems probable that in determining the fair rate of return each of the above three standards may be used for different cases, but that most cases will require the application of a composite standard. A first essential to clear thinking on this matter is the recognition of the fact that the fair rate of return depends very largely on the method adopted for the treatment of the cost of establishing the business and the franchise. If the cost of establishing the business has been capitalized and added to the fair value for rate purposes there will of course be no necessity for again allowing for the same thing in the rate of return. The prospect of early losses is one of the important risks of the original investor but if considered as a risk in determining the fair rate of return it can not also be capitalized as cost of establishing the business as that results in double pay. The franchise secures to the investor the

chance to a certain permanency in the enjoyment of returns commensurate with the original risks of the undertaking. If this right to such larger returns is capitalized and added to the fair value for rate purposes, the fair rate of return on such increased valuation will be based on present risks rather than original risks. The franchise value will in this case represent a capitalization of the difference between a fair return based on present risk and a fair return based on original risk. The original risk, having thus been allowed for in the value of the franchise, should not be doubly paid by including it in the fair rate of return. If we assume as seems more appropriate that neither the cost of establishing the business nor the franchise will be capitalized and included in a valuation for rate purposes, the following considerations will be important in determining the fair rate of return. The original investor is entitled to a return commensurate with the risks of the initial enterprise. This higher rate of return should continue for a reasonable period; which period, however, may be reduced by reason of actual excess profits sufficient to compensate for such nitial risk and including as a part thereof the cost of establishing the business. Public utility enterprises are, however, built up piecemeal, and upon the actual risk incurred in each successive improvement or extension depends the fair rate of return that should be earned for a reasonable period upon each particular increment of the investment. It may be said that in a well established and successful enterprise all the capital needed for improvements and extensions can be obtained at a low rate of interest. This is true. The investor will buy the bonds of such an enterprise on a basis which shows that he considers the risk slight or negligible. But nevertheless extensions and improvements cannot usually be made without risk to the existing profits of the enterprise. The new extension