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THE GIFT OF 
 
 MAY TREAT MORRISON 
 
 IN MEMORY OF 
 
 ALEXANDER F MORRISON 
 
Digitized by the Internet Archive 
 
 in 2008 with funding from 
 
 Microsoft Corporation 
 
 http://www.archive.org/details/corporationfinanOOgree 
 
Corporation Finance 
 
 A Study of the Principles and Methods of the 
 Management ^f the Finances of Corporations 
 in the United States ; with Special Reference 
 to the Valuation of Corporation Securities 
 
 by 
 THOMAS L. GREENE 
 
 ll 
 
 AUDITOR, MANHATTAN TRUST COMPANY 
 
 G. P. PU I N ^M'S -' ■ 
 
 •Michfrbocl.tr (.Irr^s 
 
 '- 17 
 
Copyright, 1897 
 
 BY 
 
 G. P. PUTNAM'S SONS 
 Entered at Stationers' Hall, London 
 
 •Cbe Tkntcfccrbochcr ipreee, HAcw JSorh 
 
< 
 
 C5 
 
 
 PREFACE. 
 
 BEFORE there can be any intelligent discussion of 
 the problems which arise in the management of 
 corporations, it is necessary that there shall be a wider 
 knowledge of the objects sought in corporation finan- 
 ciering, and of the practical reasons which have led to 
 the policy pursued in the United States, together with 
 its results. 
 
 Some suggestions have been made which mav, 1 
 £ trust, prove of service to the large class of business 
 w men and lawyers who are not infrequently called upon 
 2 to deal with the incorporation or with the administra- 
 tion of an industrial undertaking ; in the description of 
 the methods of practical finance the attempt has like- 
 O wise been made to supplement the text-books already 
 5 in the hands of educators and students. 
 § Experience has developed and brought into promi- 
 «* nence business rules and facts which will be useful to an 
 investor in estimating the value of the bonds or shares 
 of corporations in which he may lie interested, and it 
 2: has been the aim to present these rules and practi 
 2 UCh a manner as, while technical in its precision, shall 
 o also be available for the purposes of tin- general n 
 
 £ T. I,. G 
 
 a i Wall Stre< t, N< ••. Vorl City, 
 March, i 
 
 io< 
 
CONTEXTS. 
 
 
 PAGE 
 
 I.— Bonds and Stocks ... i 
 
 II.— Forms of Corporate Enterprise . 16 
 
 III.— Railway Bonds 33 
 
 IV. — Subsidiary Companies and their Se- 
 curities 63 
 
 V. -Corporation Accounting ... 80 
 
 VI.— Tin-: Examination of Railway Re- 
 ports 102 
 
 VII. — IVliJ.IC Por.lCY TOWARDS CORPORATION 
 
 PR( UMTS . . 1 i] 
 
 viii. — o >rporatlon reorganiz itions a.nd 
 
 Receiverships [46 
 
CORPORATION FINANCE 
 
 CHAPTER I 
 
 BONDS AND STOCKS 
 
 TIIK business man or firm must borrow money. 
 With the few exceptions, where firms have com- 
 mand of practically unlimited sums of their own, 
 business success is possible only through the aid of the 
 money-lender. Let US suppose for illustration that a 
 firm employs a capital of $1,000,000 in its business, one 
 half of which it borrows from the banks on its commer- 
 cial paper at six per cent, interest. We will suppose 
 also that the firm " turns its capital over " six times a 
 year, which is only another way of saving that its vol- 
 ume of annual sal<s is six times the capital. Assuming 
 
 that our firm is enabled to earn two per cent, net upon 
 its sales, the resulting profits, $120,000, amount to 
 
 twelve per cent, upon the capital employed. As under 
 our assumption the firm is paying six percent, on the 
 
 amount borrowed, or - yearly, it follows that the 
 
 ial< irninj upon the firm's own capital are $9 >,<>, «., 
 
 [ghteen per cent., a handsome return made possible 
 
 only through the borrowing of money which can be 
 
 d to extend the volume ol trade and to earn some- 
 
2 Corporation J : inance 
 
 thing for the firm over and above the percent inn of 
 interest paid, The actual, profits earned under this 
 system van- i.ii different trades, though usually the vol- 
 ume of 'nwnrs- is in inverse proportion to the percent- 
 age of profit : Cin fchfe annual sales. Whatever sum we 
 select or whatever earnings we assume, the principle 
 underlying the illustration is the same. Of course a 
 part of the capital of such firm or corporation in busi- 
 ness must be invested in credits granted to customers 
 and in some form of merchandise in stock. 
 
 The practical working out of this fact that borrowing 
 money is now essential to business success, is beneficial 
 to the customer of the firm, to the consumer, and to the 
 people at large. Competition is even more severe be- 
 tween trading firms than in the cases of large manufac- 
 turing corporations ; profits tend everywhere to a mini- 
 mum, so that in the end the percentage of earnings on 
 sales declines toward the level of existence. Slowly, 
 therefore, the possibilities of profit, under this system 
 of doubling or trebling the volume of business through 
 the borrowing of capital, are, through the pressure of 
 competition, taken from the firm and given to the pub- 
 lic in the shape of lower prices or superior service. 
 This is the universal law of trade. If we suppose, 
 under our former illustration, that in time the volume 
 of sales reaches eight times the capital employed and 
 that the percentage of profit declines from two per cent, 
 to one per cent., making a return of $80,000 annually, 
 from which as before interest on borrowed capital, 
 amounting to $30,000, is to be deducted, we see that 
 our supposed firm has toiled steadily to increase its 
 trade, has taken large commercial risks in the way of 
 bad debts, declines in the prices of commodities, etc., 
 and has, after all, made but ten per cent, upon its own 
 
Bonds and Stocks 3 
 
 capital invested and hazarded in its business ; a return 
 too small to compensate for the labor and the danger 
 of loss. Clearly, however, the addition of borrowed 
 capital and the increased volume of trade thereby 
 secured give advantages of profit, in which both firm 
 and customer are entitled to share. 
 
 Concurrently with the growth of firms and corpora- 
 tions which do a large business under these conditions, 
 there has come a large increase in the amount of money 
 waiting to be loaned, and a large advance in the meth- 
 ods by which the surplus capital of the world is col- 
 lected for loaning. Banks, insurance companies, trust 
 companies, and savings banks, in short, firms and cor- 
 porations, both large and small, formed for even' con- 
 ceivable financial purpose and of every conceivable 
 kind, now stand ready to lend to the deserving bor- 
 rower. The more depressed the times, the more easily 
 and cheaply can the safe borrower secure needed' 
 money. But the greater part of these increasing sums 
 of money is for loan only upon some sort of security. 
 The lenders who are willing to take some risk are lew: 
 those who wish to be certain of the return of their 
 money are many. To secure this safety, the owners 
 
 of this surplus capita] are willing to lend it at a low 
 
 rate of interest. The unwillingness of the average 
 
 investor, individual or institutional, to put his money 
 
 at any business hazard, is one of the main causes lor 
 the continued fill in tli oi interest. 
 
 Capital competes with capital for safe investment. 
 
 Tli'- demand for security in loans gives the husiuess 
 firm or corporation its opportunity, [f perfectly sound 
 in condition and management, it can borrow its outside 
 capital at a low rate, and so increase its own profits. 
 The machinery for gathi ring mom j and loaning it has 
 
4 Corporation Finance 
 
 been so perfected, and the knowledge of the conditions 
 of safety in business has become so extended, that the 
 proportion of borrowings to a firm's entire capital has 
 been much increased. Formerly it was with hesitancy 
 that a bank would lend a firm one quarter of its 
 required capital ; now, there is a temptation for a 
 writer to say that a quarter of the firm's own money, 
 with three quarters of borrowings, would be nearer the 
 usual proportion. To borrow one half of one's neces- 
 sary capital, in money or goods, is common. The 
 comparative ease of obtaining credit, the fall in the 
 average rate of profit made possible by this increase in 
 capital, and the resulting heavy increase in the output 
 and in the volume of trading throughout the world, 
 made necessary in order to earn a fair return under the 
 diminishing ratio of profit, are the forces under which 
 we are witnessing prosperity and depression in almost 
 regular cycles. To take advantage of these trade 
 forces, and at the same time to check the excesses due 
 to them, constitute the great industrial problem of our 
 time. 
 
 These conditions of safe lending and mercantile 
 borrowing have drawn a sharp line of distinction in 
 industrial finance. The lenders of money to firms or 
 corporations are creditors, the stockholders are part- 
 ners in the enterprise. As creditors are willing to 
 furnish capital up to the line of safety, it has become a 
 common saying that the bonds of a corporation ought 
 to cover the minimum value of the property or fran- 
 chise, leaving the fluctuating or uncertain part of the 
 enterprise to be represented by the shares. This is a 
 good rule, but one which differs in its application to 
 different cases. L,oans upon real estate in cities can be 
 made with safety up to a larger percentage of the 
 
Bonds and Stocks 5 
 
 appraised value than in towns or upon farms. So too 
 with corporations or with firms of long standing, whose 
 style of management is well known, the stability of 
 whose trade or traffic has been tested by experience, 
 and where the limits of the expected fluctuations in 
 volume of commerce can be reasonably predicted ; 
 such companies or firms can borrow capital up to a 
 high percentage of their supposed worth. The practi- 
 cal test of this limit of borrowing is found by a con- 
 sensus of opinion in answer to this question : To what 
 amount can commercial paper or bonds be floated at 
 par and at about the ruling rate of interest for such 
 borrowings? Even if the firm or company be in ex- 
 ceptionally good credit and able to borrow up to a large 
 percentage of the real capitalization (including in this 
 term the guaranties and other fixed charges not 
 covered by bonds) yet the managers should for their 
 own future safety conservatively limit their borrowings 
 to the minimum value of their property as the same 
 might he estimated in a time of possible adversity. 
 It is not good financiering to sill evidences of in- 
 debtedness at a heavy discount, even though the 
 stated rate of interest be below the usual percentage. 
 
 It is better, if possible, to arrange the rate of interest 
 so that the bonds or notes will fetch par. It occa 
 sionally happens that for sentimental reasons, or per 
 
 ha]>s to differentiate ;i later issue from former ones, a 
 
 company will knowingly offend against this rule, and 
 put out bond perh ip under a blank* t mortg 
 bearing a low rate ol inter I for less than their pai 
 value. Since the par value of tl" e bonds must i>< 
 paid at maturity, the shan hold< 1 ;, ii th< j \\i h to pro 
 ted themselves againsl the di count, m ty ai 1: that this 
 discount he prorata d ov< r the numb 1 oi y< in t" th< 
 
6 Corporation Finance 
 
 maturity of the mortgage and a proportion be deducted 
 from the net earnings each year. The tendency to 
 relieve the present by a sacrifice of the future is nat- 
 ural, but cannot be defended on abstract grounds. For 
 example, a company which might float a five per cent, 
 bond at par chooses to issue a four per cent, bond at 
 (let us say) 80. Of course, to raise a certain amount 
 of money it must then increase the issue by twenty-five 
 per cent. If a million of dollars is needed, the com- 
 pany must put out $1,250,000 of bonds at 80 to obtain 
 the required sum ; the interest to be paid annually 
 meanwhile being the same as though five per cent. 
 bonds had been issued at par. Manifestly, though, 
 such an issue requires the payment of $250,000 extra 
 principal at maturity, an amount which might be pro- 
 rated over the number of years till maturity and 
 deducted each year from income. That would at least 
 serve to remind shareholders of the real expense of 
 such a method of financiering, even when thought to 
 be made necessary by circumstances. The course of 
 the Louisville and Nashville, since 1894, ni this very 
 matter deserves commendation. One of the reasons for 
 such issues at a discount is that investors like to buy a 
 bond selling a little less than par, because it offers a 
 better chance for an increase in value than a bond sell- 
 ing at a premium. If it requires a rate of interest far 
 above the ruling market rate to enable the issue to fetch 
 par, it is a proof that the amount of principal asked for 
 is too large for the business to support. 
 • To issue bonds or commercial paper at too high a 
 rate of interest or at too great a discount from the face 
 value, except for special reasons, is a violation of the 
 principle upon which modern industrial debt financier- 
 ing is based. As we have seen, this principle is that 
 
Bonds and Stocks J 
 
 as large a part of the required capital must be borrowed 
 at as low a rate of interest as will enable the partners 
 in the enterprise to use those borrowings in their busi- 
 ness with safety and at a profit to themselves. If the 
 partners or shareholders of a new enterprise are not 
 willing to contribute the necessary money beyond this 
 secure proportion, there is something doubtful about 
 the outcome. What has been said about firms applies 
 with changed circumstances and names to corporations. 
 They, too, must borrow, though their borrowings nun- 
 take the form of a mortgage rather than that of com- 
 mercial paper. We occasionally read of a surface rail- 
 way or other company which has no bonds upon its 
 property, but only shares. If the enterprise is at the 
 beginning so doubtful that borrowed money would en- 
 danger success, the promoters do well to take all the 
 risk, providing they have faith in the outcome. But 
 in the case of a corporation starting with something 
 assured, or where experience has demonstrated that 
 there is a margin of safety, to avoid borrowing may 
 not be good financiering. A street electric railwa) 
 paying six per cent, on its stock could sell bonds up t<> 
 half of its capital on a hasis, we will say, of five per 
 cent, interest. By issuing such bonds it could, on the 
 same earnings, pay sewn per cent, instead of six per 
 cent, on its capital stock. Ever) profitable corporation, 
 if it so decides, may rightly take all the advanl 
 
 ible of these principles in the management "I its 
 finances. 
 
 The shareholders in a corporation are the parti 
 they take tin- risks of the business, and are not only 
 entitled to all profits but may rightly in 
 profits b alii- means. It is also a busin 
 
 question whether the share capital should he subdivided 
 
8 Corporatio7i Finance 
 
 into classes with a preference of one class over another. 
 In the cases of certain trading or manufacturing com- 
 panies no bonds are issued, the capital being divided 
 into one or more classes of preferred shares together 
 with common stock. The corporation of H. B. Claflin 
 Company in New York City is an instance in point. 
 This company was formed in 1890 to take over the dry- 
 goods jobbing business of H. B. Claflin & Co. It has 
 a capital of $9,000,000, divided into first preferred 
 stock, bearing cumulative dividends of five per cent., 
 second preferred stock, bearing cumulative dividends 
 of six per cent., and common shares covering nearly 
 one half of the capitalization. In such cases the higher 
 shares should have the preference not only in divid- 
 ends, but in claims upon the assets ; in return for 
 which privilege they are limited to a certain but com- 
 paratively small rate of dividend annually. Such shares 
 usually carry a cumulative claim as against the other 
 classes, which means that a dividend passed at any one 
 quarter or year must be made up from future earnings 
 before the lower shares receive any return. Under such 
 circumstances these preference stocks really take the 
 place of bonds, and are to be so considered in theory. 
 Their advantage over bonds lies in this, that in years 
 of extreme depression or of great trade losses, suspens- 
 ion of preference payments does not involve fore- 
 closure and loss to the common stock, because time is 
 allowed in which to make up such losses. In the cases 
 of corporations formed to take over trading or manu- 
 facturing concerns in whose business violent fluctu- 
 ations are possible, the issue of preference stocks 
 instead of bonds is to be commended ; but with com- 
 panies whose business may reasonably be called stable, 
 bonds are in better favor. In both instances much de- 
 
Bonds and Stocks 9 
 
 pends upon the management, but the average investor 
 seems to think himself more secure where annual pay- 
 ments of interest are obligatory ; he believes that a lit- 
 tle pressure upon the management has often a goodeffect. 
 In the United States the majority of preference shares 
 in the hands of the public represent equitable claims 
 upon future or present prosperity. They were generally 
 issued by the railways as evidences of debt which the 
 exigencies of the times required should be deferred ; 
 perhaps some peculiar obligation not then easily paid ; 
 but more probably, such preferred shares were given to 
 old bondholders who were compelled by insolvency to 
 yield something of the principal and interest of their 
 then debt. In 1888 the Chesapeake and Ohio Railway 
 was reorganized without foreclosure, the bondholders 
 consenting to readjust their claims. The " B " bonds 
 of the old company (bearing six per cent. ), dated 1878, 
 were exchanged for two thirds of their face value into 
 new five per cent, bonds, and for one third into first 
 preferred stock. The company becoming more pros- 
 perous, this first preferred stock was, in [893, ex- 
 changed two thirds into " blanket" four and a half per 
 cent, bonds, and one third into common stock. This 
 
 process relieved the needs of the company .it the time, 
 while afterwards the holders of old " B" bonds received 
 more than the value of their original investment. 
 
 The Lake Superior and Mississippi Railroad was 
 sold under foreclosure in [877 to the holders ol its 
 first mortgage bonds, who exchanged their bonds into 
 preferred shares at the rate ol of such shares for 
 
 h bond oi Jiooo. The new company, the St. Paul 
 and Duluth, thi reupon issui d a nev 
 bearing five per cent. In time a second m< 1 was 
 
 put upon the property foi extensions and impro 
 
io Coi'poratioii Finance 
 
 ments. Under this policy the necessities of the situ- 
 ation were met, and after 1883 the course of the old first 
 mortgage holders was justified by the receipt of regu- 
 lar dividends upon the preferred shares ; without such 
 concession the loss to such holders would have no 
 doubt been almost total. 
 
 Though no stronger for these reasons legally, prefer- 
 ence stocks issued to represent deferred claims embody 
 an ethically good claim upon the general or future 
 prosperity. 
 
 At other times companies having only common 
 shares may like to exchange a part in certain propor- 
 tions for preferred. In such cases the motive is often 
 sentimental ; the company may be earning a small sum 
 over fixed charges (bond interest, rentals, and taxes), 
 a sum too small for division among a large number of 
 common shares, but enough to pay, perhaps, four per 
 cent, on a small preferred capital. It is considered 
 better to pay that four per cent, if the capital is 
 arranged so as to allow of it, because such payment, or, 
 in fact, any honest payment of dividends, improves the 
 credit of the company in the eyes of the public. Senti- 
 ment is an important factor in corporation financiering, 
 one of which the good manager will make legitimate 
 use. It is, however, an abuse of sentiment where divid- 
 ends not fairly earned are paid in order that the credit 
 of the corporation may have a fictitious support. The 
 declaration of dividends on the preference bonds of the 
 Philadelphia and Reading in 1893, followed a month 
 later by the bankruptcy of the company and the placing 
 of the property in the hands of receivers, is open to the 
 above criticism. An exception to this statement should 
 be made in cases where a succession of prosperous 
 years is followed by a period of losses ; if recovery 
 
Bonds and Stocks 1 1 
 
 seems fairly in sight, it is proper to continue such divid- 
 end payments for a while rather than destroy the con- 
 tinuity of such returns to shareholders. An instance is 
 that of the Chicago, Burlington, and Ouincy, a company 
 which suffered severe losses, in 18S8, through a strike 
 among its enginemen. Though confessedly not having 
 earned it, the company paid the dividend, and was 
 under the circumstances justified in so doing. The 
 statements made regarding the stocks and bond-- of 
 railway companies are true also as to the bonds and 
 stocks of other corporations, though changes must be 
 made to meet the circumstances of each case. 
 
 In instances where large corporations have been 
 formed for the prosecution of enterprises which demand 
 large plants and extensive organizations tor the carry- 
 ing on of the business, the same remarks may be made 
 without much modification. Such extensive companies 
 formed, say, for the manufacture of certain particular 
 articles in much demand, require the expenditure of 
 large sums of money for special machinery ami for the 
 erection of buildings specially designed for the purpose 
 of the business. This plant and machinery may be 
 almost valueless for any other purpose than tor this 
 particular manufacture. Bonds issued by such a com 
 pany are, like railway mot illj dependent 
 
 upon the success of the corporation and its bus 
 since usually the amount «»i such bonds is largely in 
 
 of th value of the land and maeliimi\ if sold 
 
 for any other than the original purpose of manu 
 facturing. The difference between the valuation of 
 the plant at fol and the am mnl foi whi< li it is 
 
 the good will of the business, whethei 
 it is so stated in the company's accounts or not. It 
 
 DOl alter the case to Sa5 that t lie amount ol the 
 
i 2 Corpoi'ation Finance 
 
 bonded indebtedness (or preferred stock) has really 
 been expended by the company upon its property. The 
 lien is not so much upon the property itself as upon the 
 business success of the company. Yet that success may 
 be so reasonably sure that it may properly form the 
 basis for borrowing at a low rate of interest. Those 
 who have knowledge of the particular line of manu- 
 facturing which the new company is to pursue, may be 
 clear in their judgment that the success of the com- 
 pany will be beyond a peradventure. Yet for the in- 
 vestor or for the banks or for the capitalist generally, 
 nothing can take the place of experience as the basis 
 of a judgment as to corporation values. When a com- 
 pany has been running long enough to enable the or- 
 dinary lender of money to form such a judgment, he 
 is usually willing to grant the company a larger pro- 
 portion of credit than was at first obtainable. 
 
 The fact, however, that at first only a comparatively 
 small proportion of the required capital could be bor- 
 rowed at ordinary rates of interest may have led the 
 promoters of such enterprises to try* to borrow a still 
 larger sum, with the result that the extra risk as esti- 
 mated by the banking houses is paid for during the 
 whole life of the bonds by an unusually high rate of 
 interest, or, which is the same thing, by a heavy dis- 
 count from the par value of the bonds issued. An 
 instance of such a discount is afforded by a prominent 
 railroad company. This company issued ten-forty ad- 
 justment bonds, bearing six per cent. These bonds 
 were so named because they could be called in by the 
 company at no and cancelled ten years from date, be- 
 coming due in forty years. These bonds, after first 
 being offered to the shareholders, were sold at 57^4 with 
 a bonus of stock at 22 14 . In other words, for $800 in cash 
 
Bonds and Stocks 1 3 
 
 the purchaser received one $1000 adjustment bond and 
 $1000 in stock at par. Thus the bonds practically cost 
 the purchaser about $350 each. The then managers, 
 representing foreign stockholders, finding the company 
 pressed for ready money to take up called loans (tem- 
 porarily, as it turned out), thought themselves com- 
 pelled to offer such severe terms ; the situation hav- 
 ing become acute through mistakes in financial policy 
 in previous years. The credit of the company having 
 meanwhile greatly improved, these bonds were paid in 
 10 years. The conversion of the Atchison incomes into 
 " A " and " B " bonds in [892 is an illustration of the 
 mortgaging of future prosperity to relieve present needs 
 for money. Such extra interest or discount is a meas- 
 ure of the badness of the financiering or of the pressure 
 of necessity, and in times of depression may even cause 
 such a financial pressure of annual charges as in effect 
 to be a reason for bankruptcy. When we hear it 
 stated, as we sometimes do, that a particular business 
 cannot bear the high rates of interest which it is directlj 
 or indirectly paying, we may rightly assume, in the 
 absence of some other oppressing cause, that the reason 
 for the present distress goes back to the time when the 
 promoters of the enterprise or the organizers of the 
 newly incorporated company formed to take over an 
 old business, were unwilling to accept tin- estimat 
 experienced money-lenders upon the uco s ol the 
 company. Either by advancing their own money or 
 by inducing others to become partners in the . nt< r 
 prise, they ought to have obtained slum- capital enough 
 irted the enterprise con ervativel) ; "i" 
 important element oi this conservatism being tli.it 
 only so much money should be borrowed as could be 
 obtained on favorable terms. 
 
14 Corporation Finance 
 
 In the cases of comparatively small corporations 
 formed for trading purposes or tc prosecute a business 
 comparatively small in volume, care must be exercised 
 by both organizers and lenders of money. The bonds 
 of such corporations are not eagerly sought for from 
 the nature of the case. Sometimes, as has been already 
 remarked, the financiering of such corporations is 
 accomplished by the issuing of preferred stocks instead 
 of bonds. So far as the general public is concerned, 
 the borrowing of money on the part of such small com- 
 panies does not differ greatly from the procedure 
 observed in the borrowing of money on commercial 
 paper by partners. But few of the bonds of these small 
 companies reach the public ; the principal source of 
 supply for borrowings being the banks. The banks 
 in lending money to these small corporations require 
 statements from them the same as in the cases of firms ; 
 but because of the difference in responsibility between 
 partners and corporations, lending institutions, in addi- 
 tion to the claim upon the assets of the company, usu- 
 ally demand the personal endorsement of the officers, 
 thus in effect securing from such small companies the 
 personal liability of the managers precisely as though 
 the business were the property of an individual or a 
 firm. 
 
 Municipal bonds form an exception to the rules of 
 borrowing according to the probability of successful 
 business. A municipality is any territorial subdivision 
 of a country, city, county, village, or township, which 
 may wish to borrow money for any improvement allowed 
 by law. The security for such borrowings does not rest 
 primarily upon business profits but upon the property 
 embraced, though in the long run property valuations 
 in any city or county must depend upon the prosperity 
 
Bonds and Stocks 15 
 
 of the community. Usually the power to bond the 
 town is limited by law to an amount covering so small 
 a percentage of the town values that the question of 
 the security of such bonds, from the point of view of 
 the sufficiency of the property pledged, does not often 
 arise. 
 
 On this account municipal bonds, when they arc 
 good, are very good indeed, and command high prices 
 at the hands of a special class of investors, such as sav- 
 ings banks and insurance companies. The dangers of 
 municipal bonds arise from another quarter. The ques- 
 tions of legality of issue are so complex, and, as even 
 after able legal opinions, unexpected difficulties may be 
 encountered, their purchase becomes a matter of some 
 risk, including perhaps a long-contested lawsuit, in 
 cases where counties and towns may fir any reason 
 desire to repudiate their obligations. For these reas >ns, 
 cities enjoying good credit can sell their bonds at the 
 lowest rate of interest known in financial circles ; while 
 as for the bonds of other less known municipal divis- 
 ions, only such institutions as have unlimited resotu 
 for investigation and for the enforcement of the pay- 
 ment, if found necessary, become the purchasers. In 
 general, municipal bonds are not favorite forms of in- 
 vestment with the average capitalist. 
 
CHAPTER II 
 
 FORMS OF CORPORATE ENTERPRISE 
 
 WHEN a firm, established long enough to give its 
 returns some stability, desires to sell its busi- 
 ness, it soon finds that the easiest way to accomplish 
 this result is by incorporation. When the company is 
 decided upon or formed, the bonds or shares become 
 available for public sale or subscription in any desired 
 amounts. In this way a large business with its plant 
 can be sold by piecemeal, as it were, at a total valu- 
 ation which could not be obtained in any other way. 
 The larger the business the more difficult is it to find 
 partnership purchasers. 
 
 The usual course in such matters is to consult some 
 banking or promoting house which can be induced to 
 finance the project (i. e., to furnish any money required 
 during the transfer), and which has facilities for dis- 
 posing of the new bonds or shares to its customers and 
 the public. It is a tendency of the times to give the 
 sale of public securities into the hands of those whose 
 profession is that of judging of the values of the securi- 
 ties to be offered. The majority of the investors have 
 their own concerns to look after, and in any case are 
 not good judges of bonds or shares or of the prospects 
 of success of special enterprises. Such persons in the 
 end take the advice of trusted banking houses. Since 
 the reputation of such houses is very important to 
 
 16 
 
Forms of Corporate Enterprise i 7 
 
 them, they take pains not to recommend purchases 
 which may involve their customers in losses. Con- 
 versely their recommendation is much sought after for 
 new enterprises, and to pay their charges is the cheap- 
 est way in the long run to " float " a public corpora- 
 tion. These remarks, of course, do not apply to cases 
 where all of the new capital is retained by the old 
 partners. 
 
 Where such houses are consulted by the would-be 
 incorporators there is usually a difference as to the 
 value to be put upon the enterprise ; the owners are 
 perhaps over-sanguine ; the banking house, if conserv- 
 ative, goes through the submitted facts and figures in 
 cold blood. It knows, too, approximately, what the 
 public will be willing to pay. The capitalization is 
 then fixed at a sum which it is supposed will allow of a 
 small distribution of profits even in poor years. 
 
 There is first the division of the capital into bonds 
 (or preferred stock ) and common shares. In order that 
 money may be borrowed at the lowesl rate of interest, 
 and thus every possible profit be reserved for the com- 
 mon stock, it is necessary that bonds should he issued 
 only to the minimum value of the property. Winn 
 preferred stock has a preference not only as to divid- 
 ends but also as to assets in cases of failure, it t al 
 the place of bonds and should be regarded in the li 
 Of a debt. What this minimum value IS, is not an i 
 
 question to d termine. Sometimes it is takm to 
 include the values of the buildings, machinery (or 
 other contents), and the raw material on hand or in 
 process of manufacture. Whether this is 5 ife d< p< nds 
 in part upon the nature of the business Sometimes 
 real I to apprais the plant 
 
 basis for bonds; l>nt her* hould be taken 
 
1 8 Corporation Fina?ice 
 
 the instructions given to such appraisers. If they are 
 required to give an opinion on the value of the ground, 
 buildings, etc., for the use of that particular business, 
 they may honestly put their appraisal at figures far 
 above anything which could be obtained at forced sale 
 in case of insolvency, and security in such an event is 
 the very thing sought for by the bondholder. In the 
 same way and under similar instructions an extrava- 
 gant valuation may be put upon the machinery, which 
 may not be new, and indeed may already be in process 
 of supersedure as to kind in other and competing estab- 
 lishments. The raw or half- worked up material should 
 be also computed at prices which allow for possible 
 fluctuations because of changes in fashions or by reason 
 of any circumstances which may affect the particular 
 business under consideration. Yet bonds aggregating 
 a larger sum than the valuation of the plant at forced 
 sale may be legitimate and safe because of the stable 
 nature of the manufacturing or trading to be taken 
 over by the new company. But in such cases it should 
 be distinctly understood that a part of such bonded 
 debt rests for security upon success rather than upon 
 real-estate values, i. e., upon the " good-will." 
 
 The amount of common stock to be issued does not 
 occasion so much trouble. Allowing for the tips and 
 downs of business, the common capital should fairly 
 represent the fluctuating possibilities of the new con- 
 cern. To estimate this future properly, the number of 
 common shares should be conservatively small ; but the 
 difficulty here, as everywhere else in corporation finan- 
 ciering, is the dislike of the public to the payment by a 
 corporation of dividends higher than the normal rate of 
 interest. It is better financiering to pay good returns 
 in good years, thus allowing for a decline in periods of 
 
Forms of Corporate Enterprise 19 
 
 depression, than to capitalize the company up to the 
 highest point with the possible result of making the 
 whole common issue of little or no value in poor years 
 — and worthless shares are always a menace to honest 
 business. 
 
 In asking for subscriptions to bonds or shares in a 
 new corporation formed to take over a manufacturing 
 or trading business, it is usual to employ reputable 
 public accountants who are required to make a report 
 stating what the profits have been for a number of 
 years. These accountants' certificates have had great 
 weight with purchasers, but recent events have limited 
 their importance. Too much meaning was ion ml in 
 such certificates by small capitalists ; they were con- 
 strued practically to guarantee the whole corporation 
 and its future. As a matter of fact, those certificates 
 were valuable as giving an expert statement of the 
 books of the old partnership as they stood ; but they 
 were not intended to explain or to sit in judgment upon 
 the commercial facts which lay behind those books. 
 Being employed by the old partnership or by the pro. 
 moting house, such accountants may have examined 
 only such accounts as they were requested to, made 
 statements in the form desir< d, or omitted items which 
 
 they were not paid to investigate. A firm of account- 
 ants might certify that the average annual profits for 
 
 three years were a given sum, and stop 1 1 1 « i 1 report at 
 
 that point. If the partners had a year previously 
 formed the resolution to incorporate, they mi 'lit 
 swell their revenues greatly during the 1 Tin 
 
 •-amy would be detected if the earning • were 
 given for ea< b yeai eparatel bul doI it' an a' 
 alone were itated Again, the form of uch a certificate 
 might be that the accounts and bills receivabl 
 
20 CorporatioJi Finance 
 
 ceeded those payable by a given sum which might be 
 added to the assets to be covered by the proposed share 
 capital ; and such a statement, while true, might be 
 misleading. The accounts receivable might be such as 
 were always outstanding, for which working capital 
 should be provided in the plan of capitalization. If so, 
 and every business needs more or less of such working 
 sums of money, simply to offset them by bills payable 
 — meaning money borrowed from the banks — is, under 
 the circumstances, manifestly improper. Borrowed 
 money is a debt, and the plan of incorporation under 
 discussion assumes that the bonds or preferred stock 
 covers the whole of that debt. This particular error in 
 incorporating is sometimes ventured upon in order to 
 give to the old partners all the money subscribed by 
 the public for the bonds and common stock, but it con- 
 ceals the real status of the finances and leaves un- 
 guarded a possible danger. Moreover, bills payable 
 must be met in full while the running accounts of cus- 
 tomers may not be worth their face, leaving a deficiency 
 not covered by such a plan of incorporation. The rise 
 and fall of the Thurber- Why land Company in New 
 York City furnishes an example. 
 
 It may be that the certificate unintentionally mis- 
 leads in another way. The books may be exact in 
 giving the earnings and expenses for the previous 
 year, and yet the resulting profits may not be a proper 
 basis for corporate capitalization ; for the reason that 
 selling prices may have been exceptionally high or the 
 cost of raw material or of some important item of ex- 
 pense exceptionally low, so that the year's profits may 
 be too good for an estimate of the future. The case of 
 the Allsopp Brewery in England is an illustration. 
 For these reasons, the course for those proposing to 
 
Forms of Corporate Enterprise 2 1 
 
 incorporate themselves, or to promote such incorpora- 
 tion, or to purchase the bonds and shares in the new 
 company, is to supplement the information furnished by 
 the accountant with other expert knowledge regarding 
 the circumstances and conditions under which the par- 
 ticular business has been and is likely to be carried 
 on. 
 
 A matter which should be considered is that of man- 
 agement. Practiced experience, as well as the best 
 economic theory, lays emphasis upon the importance of 
 an able manager. Nothing can take his plao : and 
 his rewards in the shape of salary or returns upon his 
 shares, must be commensurate with his importance. 
 In building up a business the personal element is a 
 great factor. In railways there has been developed in 
 the process of time a body of specialists who are trained 
 in their work of superintending and managing railroad 
 operations, and from whom men may always be had by 
 any company to take control. This same thing will in 
 time be true of all corporation work which concerns 
 the production or distribution of staple goods or neces- 
 saries, and, indeed, this is true already of certain lines 
 of w<>rk ; but it is a point to be considered bj all in 
 
 terested in new corporations whether expert manage- 
 ment can be had, particularly if those who broughl th< 
 old firm up to its place of importance an- soon to drop 
 out of control through age 01- lack ol interest. When 
 our important corporations have passed theii experi 
 mental stage, proper management will be largely a 
 question of proper payment. 
 
 Aside from the advantages which th- corporati form 
 offers for th- gathering of capital in small sums foi 
 soiii enterpi i ■ . for tin- m oi m< n and 
 
 ma' hinery at some proper spot, and foi the 1 ondui I ol 
 
22 Corporation Finance 
 
 a large business at a small expense per unit of output, 
 there are benefits to other and smaller concerns by the 
 transfer into corporations. It often happens that part- 
 nerships are turned into companies without intention 
 to become public concerns. Perhaps a number of per- 
 sons acquire an interest in a business established and 
 built up by a father and uncle, a business which it is 
 intended to keep in the family. But the multiplication 
 of owners occasions much difficult)', while another 
 death or two may put the whole enterprise in peril, 
 perhaps require a selling out to other parties in order 
 to determine the value which would then require to be 
 divided. These perils lying in the path of firms hav- 
 ing many partners, some minors, some women, are well 
 understood. Some of them may be guarded against by 
 such devices as insuring the lives of the managing part- 
 ners ; but many of such instances are best solved by 
 organizing a corporation to carry on the business ; in 
 this way the proportion of each partner or heir can be 
 set aside in shares, which can be transferred or sold in 
 any proportion or at any price without affecting the 
 business itself. Nor will death destroy the living of 
 the remaining owners ; for corporations do not die with 
 the death of shareholders. One of the arguments 
 against trading coporations is that the new company 
 may lose the advantage of the zeal and ability of the 
 manager who has brought the business up to its present 
 state of profitableness, but who having now no such 
 interest in the result will drop out altogether, or will 
 not give it the old and close attention. In scattered 
 instances this may be a good objection, for we should 
 not omit the personal equation from our calculations. 
 To supply a class of managing specialists in trading or 
 manufacturing is a work of time ; but if a particular 
 
Forms of Corporate Enterprise 23 
 
 line of trading or manufacturing- is large enough to 
 demand expert management and to give remunerative 
 employment to those who will study the business, such 
 a class will surely arise to meet that demand. The 
 only danger is that until a good manager is born and 
 made, the business ma}' suffer to a certain extent. It 
 is proper to take the contingency into account in esti- 
 mating on the probable future values of the bonds and 
 shares of a corporation if offered for public subscription 
 or sale. In some cases the contingency may be provided 
 for by arranging to have the old managers retain a 
 large interest for a certain number of years, or in any 
 way which will make future success an advantage to 
 the old partners. 
 
 But to partners who form a company for family 
 reasons, these possible objections do not apply. The 
 status of such companies is directly affected by the fact 
 that no bonds or shares are to be sold to the public ; 
 therefore the public are concerned with the success or 
 failnre of such a family company only so far as that 
 company may wish to borrow money from the hanks 
 or ask for credit on goods purchased. In such cases 
 equity requires a complete exhibit of their affairs t<> 
 who have a right to that information. Forthe 
 public at large, and for the information of the state 
 which granted the charier of incorporation, a statement 
 of tin- assets and liabilities in brief form i^ pri 
 
 demanded. The profits of a family company is not a 
 matter with which the state need concern itself. The 
 limits of liability under a corporate form ate w< 11 under 
 
 stood, and it liability is limited, so also is the credit : 
 
 no undue advantage is taken of anybody by incorpora 
 tion. Bank officers when asked foi loans will either 
 
 I tin- signature of the company through its prop r 
 
24 Corporation Finance 
 
 representative, or will demand the personal endorse- 
 ment of some individuals ; the matter of credit in 
 family corporations regulates itself. 
 
 A defect in our general laws touching corporations 
 is often the neglect to distinguish between those com- 
 panies which are public in their nature and those which 
 are private. A company whose bonds or shares are 
 held by the public and which depends upon public sup- 
 port for its financiering, ought to be compelled (if it 
 does not agree of its own motion) to give out its busi- 
 ness accounts in such detail that the holders of its bonds 
 or preferred or common stocks can form a clear idea of 
 the profitableness, of the financial standing, and of the 
 managerial success of their company. But private or 
 family companies are under no obligations to the pub- 
 lic as to their affairs except as already noted, and should 
 not be required to make returns in detail. The distinc- 
 tion between public and private corporations would at 
 times be difficult to draw ; no rule could be made which 
 would not sometimes err. Perhaps a limit to the num- 
 ber of stockholders would furnish a practical test under 
 which such a distinction could be made. 
 
 It is sometimes thought that the legal restrictions 
 imposed upon corporations and the state oversight to 
 which they are subjected, are such drawbacks to the 
 corporate form as to balance the advantages already 
 referred to. Such restriction and such oversight will 
 probably never be withdrawn ; indeed, the tendency 
 of the times — as evidenced as much in economic discus- 
 sion as in actual legislation — is toward further restraint. 
 The matter of stock or bond watering often has busi- 
 ness effects which a prolonged strike or some other 
 commercial event can alone make clear ; the whole 
 discussion as to " monopoly," though somewhat crude 
 
Forms of Cor par ale Enterprise 25 
 
 as yet, may, as regards future legislation, turn in the 
 end upon the question whether the profits arising from 
 combination or from huge corporations have been equi- 
 tably divided between the three parties in interest ; the 
 company itself, the consuming public, and the em- 
 ployees. To answer such a question, the widest in- 
 formation will be necessary. Corporations, therefore, 
 should not look forward to any general reduction in 
 the amount of state regulation. 
 
 But while this seems to be true generally, it by no 
 means follows that corporations will find that form of 
 doing business less favorable than before. If we keep 
 in mind the fact that a corporation — a public company 
 — implies a well-established business on a scale so great 
 as to require large capital and a large and well equipped 
 plant, it will be seen that the best success cannot come 
 from the partnership form. If we accept a large out- 
 put or traffic and a correspondingly low cost per unit 
 of production as the criterion of a well-managed com 
 pany, we necessarily imply a large business enjoying 
 good credit and with years of experience behind it. 
 things which are not so hopefully to In- ex] rom 
 
 a firm. Such a company must, in tin- nature of tin- 
 case, have an element in its business which, from want 
 of a better word, may be called monopolistic ; if that 
 advantage is used for the public good tli< re should be 
 no complaint ; it is an advantage in the'hai l.il 
 
 ful manager for which the company may well paj by 
 
 ing publicity to its affairs. Nor should it be i<" 
 ten that in such cases publicity docs not have tin- draw 
 backs m mall trading companies tint it invi 
 
 competition, [four supposed company is well man 
 d and is doing business .-it ,-i low ratio oi profit, 
 publication of its affairs rather repel competition 
 
26 Corporation Finance 
 
 by showing the hopelessness of success to a new 
 company. 
 
 Precisely because a large volume of transporting or 
 manufacturing is essential to the stability and long- 
 continued success of an ideal corporation, so such cor- 
 porations tend gradually to absorb the production of 
 such articles as can be carried or manufactured in 
 large quantities, and, of course, consumed by the pub- 
 lic in like amounts. Generally such articles are the 
 nceessaries of life, or if not strictly speaking neces- 
 saries, then those with which the consuming public are 
 especially concerned. From this point of view also we 
 must expect in the future additional legislation. The 
 best defence of corporations against unduly severe laws 
 is full publicity. The history of a company, its early 
 losses and struggles, the prices of the commodity when 
 the business was begun compared with prices now, the 
 cost of production per pound or gallon or barrel, show- 
 ing the reduction, and in view of such facts the moderate 
 profits of to-day — statements such as these will prove to 
 be the best defence against drastic legislation before the 
 bar of public opinion. But a company relying upon such 
 a defence must be sure that its course as regards prices 
 and policy is one which cannot be fairly attacked. 
 For these reasons, while the restrictions imposed by 
 the state are sometimes onerous and often foolish, yet 
 the advantages of the corporate form for the prosecu- 
 tion of a large and stable business must outweigh the 
 disadvantages. Probably the question of taxation is a 
 serious one for most corporations. Their form and 
 their business seem to invite taxation. It may be that 
 for a time corporations will be obliged to carry more 
 than their proportionate share of the common burden 
 in this respect. In the end this question will run into 
 
Forms of Corporate Enterprise 2 7 
 
 the more general one of the rightful profits to be mack- ; 
 but meanwhile taxes are things for which incorpora- 
 tions must be prepared. 
 
 Corporations formed to carry- on a business semi- 
 public in its nature, like that of supplying water and 
 gas to the citizens of cities and towns, do not need 
 extended discussion. So far as the arrangement of 
 their finances is concerned, it should not depart greatly 
 from the principles already laid down for the formation 
 of manufacturing companies. Into the matter of gov- 
 ernmental ownership it is not purposed to enter here ; 
 but regarded from the financial point of view the 
 amount of bonded indebtedness should not exceed the 
 safe value of the property conservatively estimated. 
 Gas and water companies do not indeed often offend in 
 these particulars, since in successful cases the shares 
 have so increased in value as to leave no doubt of the 
 conservatism of the original financial plan. The 
 investor should look into the probability of losses by 
 reason of a change in policy on the part <>i the com- 
 munity, or because of the beginning of the enterprise 
 on a scale of expenditure not warranted by the prob- 
 abilities. Yet water and gas are modern necessaries 
 of life, and the supplying of these necessaries, when 
 done by private companies under .1 conservative plan, 
 is a proper and safe business for the investment of 
 money. 
 
 Another form of industrial enterprise destined to 
 assume an important position in investment Qnac 
 that of supplying street transportation to the inhabit 
 ants of cities and towns. The rapid growth in the 
 1 trical power lias carried the matt 1 
 
 railways in and between cities and villages I" B 
 
 tion of great importance \ orming the basis for the 
 
28 Corporation Finance. 
 
 investment of capital there can be nothing better than 
 the street traffic of our cities. Experience has demon- 
 strated that such traffic is even more constant and 
 stable than that of steam railroads, and is capable of 
 yet greater development, as surface car lines are ex- 
 tended to meet the demands of a spreading population 
 and as travel increases in proportion as the facilities 
 of easy and rapid transit are increased. 
 
 But while the safety of street travel as a basis for 
 the investment of capital cannot be disputed, there 
 may remain questions about the values of the bonds 
 and shares of individual street railway companies for 
 whose settlement further time is required. Some six 
 or eight years ago the motive power of street lines 
 was the horse ; but electricity, it was soon found, 
 upset all the old calculations of receipts and expenses. 
 The capitalization of the company was increased by 
 the cost of the new power but so was the volume of 
 travel, so that great profits were shown to have been 
 earned. 
 
 The demand for electric equipment led to its manu- 
 facture in such quantities and under such uniformity 
 of detail that the prices of new motors and the like fell 
 to one half the old figures. Stud)' and experience 
 found ways of keeping rolling stock and motors in 
 repair at a cost formerly believed impossible ; and 
 meanwhile the traffic receipts continued to increase 
 steadily and regularly as the public came to realize 
 the improvements in street conveyance and to take 
 increasing advantage of them. 
 
 In the cases of companies freshly established and 
 operating in large cities, it may be assumed, for the pur- 
 poses of a rough calculation, that the roadbed will re- 
 
Forms of Corporate Enterprise 29 
 
 quire a complete renewal in ten or twelve years, the 
 overhead construction (if the trolley is used) within fif- 
 teen years, the electric station and buildings in from 
 twenty-five to fifty years, the car bodies in twelve or 
 fifteen years, and the motor trucks in ten or twelve 
 years, with the steam machinery in fifteen years. 
 These averages of life should, of course, be extended in 
 cases where circumstances would make such a test too 
 severe, as, for instance, in interurban lines using the 
 turnpikes. When, however, fair averages can be ob- 
 tained and the cost of such renewals estimated, it will 
 be possible for those interested in a new road to make 
 a hypothetical calculation of the average annual earn- 
 ings for the future, leaving the expected increase in 
 traffic as an offset to any possible error in the calcu- 
 lation. 
 
 We are now accumulating a mass of experiences and 
 figures about street railway companies which will place 
 the bonds and shares of those companies on as sure a 
 basis as those of steam railroads and as fully entitled to 
 the good opinion of the investing public. Meanwhile, 
 an approximate result can be obtained by any <>ne who 
 will take the time and trouble to make a thorough 
 
 analysis <>f the condition and circumstances in any 
 
 ] .articular rase. 
 
 A matter to be considered also is tin- life of tin char- 
 
 of the street companies and the rights to the use 
 
 of the highway. Generally speaking, the American 
 
 public .-in- not disposed to lie unfair, and ;i practical 
 
 railway property by a forfi iture of the 
 
 irter or by a refusal to rene^ th< 1 me without com 
 
 pensation is not to \>< expected. On the other hand, 
 
 it is often a matter of importance how i.n th>- company 
 
$o Corporation Finance 
 
 is protected against competition perhaps on adjoining 
 streets. It is well also to examine the provisions of the 
 charter to sec whether they contain requirements which 
 may prove onerous in the future. 
 
 Throughout this book the form of corporation dis- 
 cussed is that of the company whose capitalization rests 
 directly upon the property, and whose shares are owned 
 by individuals. There is, however, a company of an- 
 other sort formed under the laws of certain States, par- 
 ticularly New Jersey, which permit corporations to hold 
 the shares of other corporations. In such instances the 
 company does not itself hold property or manage a busi- 
 ness, but issues its bonds or shares upon the bonds or 
 shares of other and operating companies held in its 
 treasury ; it is, in short, a corporation of corporations. 
 
 In certain lines of business such financing companies 
 are the logical result of the movement toward consolid- 
 ation, of which the simple company was the first out- 
 come. In some cases no other method of concentration 
 seems possible. Perhaps the production of some article 
 requires that the various processes shall be conducted 
 in as many different States whose laws demand that the 
 business within that State shall be conducted by a com- 
 pany incorporated by that State. If all these sub- 
 sidiary companies are to work in harmony there must 
 be some method of uniform management, brought 
 about most easily by a common ownership of the differ- 
 ent shares. Economically speaking, such financing 
 companies are to be judged by their results, precisely 
 as in the case of simple corporations. 
 
 Companies are sometimes formed to hold the shares 
 of other companies, principally to prevent competition 
 and to stop the reduction in prices that perhaps previ- 
 ously to such common ownership was bringing disaster 
 
Forms of Corporate Enterprise 3 1 
 
 upon all concerned. Financial insolvency is a thing to 
 be dreaded for its own sake ; and when it would ap- 
 parently lead to no better conditions than before, it con- 
 fers no benefit upon the community. Such companies 
 are, as before, judged by their ultimate results, society 
 at large being adverse to such combinations only as 
 they may prevent genuine progress through the forma- 
 tion of still larger single companies able to reduce costs 
 to themselves and prices to the consumer. Such com- 
 binations are sometimes made through Trust agree- 
 ments, which purport to give to the old proprietors in 
 lieu of their old title, a trustee's certificate stating that 
 they are entitled to such a proportion in the equity of 
 all the combined businesses as their original property 
 bore to the whole, these various values being previ- 
 ously fixed by negotiations between those concerned. 
 The public at large are hostile to such Trusts, believing 
 them to be secret agreements in restraint of trade and 
 against the interests of the community. Moreover, 
 they appear to be unnecessary, since all the essential 
 advantages of a Trust can be secured under the form 
 of a lawful corporation either simple or compound. 
 
 Where the properties sought to be combined have 
 been owned by firms or individuals, it Iris often been 
 found expedient to transfer the title of such properties, 
 perhaps lying in different States, directly to the coin 
 bining company in return for the issue of bonds and 
 shins of the new company in agreed proportions. In 
 such cases the possible advantages are that it may give 
 to the new company the knowledge and skill possessed 
 in different d ind about differenl parts of the pro 
 
 by the old proprietors, for common use ; that it 
 may prevent frauds in weighl and quality which the 
 previous extreme competition may havi broughl about ; 
 
32 Corpora Hon Finance 
 
 and that it may allow a concentration of buying and 
 selling at the least expense and with better results. If 
 a reasonable sbare of these advantages is given to the 
 public in one form or another, the new company has a 
 strong argument for its existence. 
 
 As to the finances of such huge corporations, or of 
 companies holding the shares of other companies, they 
 do not differ in principle from the rules already quoted 
 regarding simple corporations. The bonds issued (in- 
 cluding the underlying liens, if any) should not exceed 
 in amount the minimum worth of the property, and the 
 shares should fairly represent the fluctuating values 
 remaining. The bonds and shares of such great com- 
 bining corporations, generally speaking, are not quoted 
 on the exchanges at as high a range as those of rail- 
 ways. This may be due partly to the fact that the 
 business of the company may be, from the nature of 
 the case, highly speculative in character, and therefore 
 uncertain as to results in any particular year ; or its 
 affairs may be in the hands of men perhaps experienced 
 in that particular line of business, but who have not 
 yet acquired a reputation with the investing public ; or 
 perhaps there may be on its board of directors or among 
 its officers no one in whom capitalists have confidence 
 as experienced in financial management, for the depart- 
 ment of the finances in corporation affairs requires 
 special care and ability just as does the manufacturing 
 or trading. Time will be required to bring about a 
 settled public opinion as to the degree of value which 
 can safely be put upon the businesses of huge industrial 
 combinations or corporations. 
 
CHAPTER III 
 
 RAILWAY BONDS 
 
 WHEN the owner of a dwelling-house executes a 
 mortgage upon his property up to a certain 
 percentage of its assumed value, the transaction, so far 
 as the financiering is concerned, is not different in 
 theory from similar transactions when entered into on 
 a larger scale by corporations. The lender of the 
 money first inquires into the safety of his loan. He 
 does not wish to become in effect a partner with the 
 mortgageor by making himself dependent even to a 
 small extent upon the suecess of the borrower in busi- 
 He loans the borrower a sum of money equal to 
 one half or two thirds of the appraised value of the 
 dwelling-house, considering this proportion of that 
 value as secure even under a forced sale. Practically, 
 therefore, the mortgageor, as in the case of corporations, 
 borrows money at a comparatively low rate <>f interest 
 upon the minimum value of his property, [f the sum 
 asked for is in excess <>l these percentages "t tin- value 
 tin- loan is refused, or if accepted is taken at a corre 
 spondingly high rat' of interest, thus violating the 
 principle of debt finam ilready discussed. 
 
 Mori upon dwelling-houses differ, however, in 
 
 some important points from the debts due by corpora 
 tions. Tin- lender <>f mom 5 upon ordinary real estate 
 does not rely lor security upon tin- success of the boi 
 3 
 
34 Corporation Finance 
 
 rower in business, — that has already been stated ; but 
 neither does the lender rely upon the profitableness of 
 the profession or trade in which the mortgageor is 
 engaged. The reliance is rather upon the business 
 success of all citizens, with allowances, of course, for 
 advances or reductions in values of real estate which 
 may come from the shiftings of population or the 
 caprices of fashion. If the mortgageor should be unable 
 to pay the interest on his mortgage when due, and the 
 property should be offered for sale under foreclosure 
 proceedings, any man in any line of business may 
 become the purchaser. In short, the property and its 
 value is not dependent upon any one man or any one 
 trade, but upon the prosperity of the whole community. 
 This is not generally the case with large corpora- 
 tions. The railway lines in the United States, for 
 example, vary in cost from $15,000 to $200,000 per 
 mile, with an average of about $50,000. They are 
 bonded for an average of $32,000 per mile. Railway 
 lines are expensive to construct. A roadbed must be 
 built up and made fit to bear the running of trains ; 
 the erection of costly bridges and other works must be 
 undertaken ; rails and ties must be bought, so that the 
 railroad properties as they exist to-day could not be 
 duplicated for the amount of their bonded debt ; yet if 
 the trains were to stop running, the rails and ties would 
 be worthless except for old iron and wood, while the 
 right of way could be sold to the neighboring farmers 
 only at a low valuation per acre. The whole property 
 of a railroad company, considered simply as real estate 
 and old material, is worth but a small fraction of the 
 amount for which it is mortgaged. The creditors of 
 the company depend for the security of their money 
 not upon the property considered as such, but upon the 
 
Railway Bonds 3 c; 
 
 business for which the company was organized ; that is„ 
 upon the transportation of passengers and goods. If that 
 transportation yields a profit, the bonds are safe, other- 
 wise not. The bondholders cannot, as in the case of a 
 dwelling-house, hope to sell the property to any com- 
 panies except those engaged in transportation. The 
 American law and the wording of American railway 
 mortgages state the lien to be upon the property ; but, 
 commercially speaking, this is not correct ; the mort- 
 gage is really upon the company's revenues. But rail- 
 way trains must continue to be run. Not only is there 
 a public duty involved which forbids the State to allow 
 the stoppage of railway working except in extreme 
 cases, but, since the value of the bonds depends upon 
 income, the operations which produce that income 
 must be continued even though the result be in part 
 unfavorable ; otherwise the loss would be total. But 
 since railways must be worked, the expenses of work- 
 ing must be paid. Sufficient material and supplies 
 must be bought, the claims of employees for wages 
 must be met, and everything reasonably necessary for 
 the proper operation of the railway must be paid from 
 current revenues. It is seen, therefore, that the Lien 
 
 of a railway bond is finally shifted from the real estate 
 to the gross earnings and then to the net earnings oi 
 the company. 
 
 The statement that the real lien of a railway bond is 
 upon the commen ■ the company asacarriei 
 
 <>t ti plains some of the anomalies oi corporation 
 
 practice. The railway mo peats in the strong- 
 
 est legal phrases the supposed fad that, if interesl 01 
 principal is not paid when due, or if any othi 1 pro 
 vision is not complied with, thi □ the mi shall be 
 
 ! and the property sold to the high 1 bidder. 
 
36 Corporation Finance 
 
 Tli is is a legal fiction. Although the terms are the 
 same in railway mortgages as in those on dwelling- 
 houses, the commercial facts just mentioned forbid 
 compliance with them. In the great majority of cases 
 the selling of a railway at forced sale, even to another 
 company, is out of the question except as the result of 
 reorganization. Partly to give the appearance of living 
 up to the terms of the mortgage and partly to prevent 
 those terms from being literally carried out, the courts 
 appoint receivers for railway properties in bankruptcy 
 or about to become so. Out of this contradiction 
 between the too strong language of our railway mort- 
 gages and the commercial facts which control, has 
 arisen the American custom of appointing railway 
 receivers, a custom which is in the course of evolution, 
 both as to the law and as to the practice under that 
 law. The English " debenture " expresses the real 
 situation more clearly than the American bond. The 
 former by its language limits its lien to the earning 
 capacity of the company, though the real liens are the 
 same in both cases. Probably the American custom 
 of putting into the railway mortgage terms which are 
 stronger than the commercial facts warrant was due to 
 the feeling, at one time prevalent, that the granting by 
 the company of a number of legal rights (such as fore- 
 closure) supposed to be absolute, added to the value of 
 the security. Something of this feeling remains with 
 us yet, for in the United States the debenture bond, 
 except when issued by companies of unusual credit, 
 like the New York Central, is not classed as high as 
 bonds drawn in the American fashion. 
 
 The principal use of the right of foreclosure in rail- 
 way bonds is to convey title to a reorganization com- 
 mittee in case of insolvency. The courts are always 
 
Railway Bonds $7 
 
 careful to insist upon the carrying out of the forms and 
 remedies provided for in the mortgage, when cases of 
 this sort are brought before them. Yet so well under- 
 stood is the real situation that the same courts will ask 
 the creditors of a bankrupt company to be speedy in 
 coming to some agreement in order that the receivers 
 may be discharged ; implying that the receivers are 
 operating the property in order to keep the road run- 
 ning and to prevent disintegration of the system as a 
 temporary' expedient, until some readjustment of the 
 obligations can be made ; and such indeed is the actual 
 practice. The Richmond and West Point Terminal 
 Railway and Warehouse Company, a financing corporat- 
 ion formed to control other companies, became bankrupt 
 in 1892. An elaborate plan of reorganization embrac- 
 ing the subsidiary companies was promulgated in 1894 
 under the name of the Southern Railway Company. 
 To bring the different properties under one company, 
 foreclosure proceedings were begun and carried out 
 tinstthe Richmond and Danville Railroad Company, 
 under its consolidated mortgage of [886, and against 
 the East Tennessee, Virginia Mini Georgia Railway Com- 
 pany, under its equipment and improvement mortgage 
 of [888 and its general mortgage of [890. Those and 
 other properties embraced under the Wesl Point Com 
 pany were, under these foreclosures, bid in by the 
 
 Southern Railway Company, subject to underlying 
 
 liens. J',-.., hange of bonds and shares of these lot.' 
 
 ed companies for those ol the new company v. 
 
 proceeded with at cording to thepli 1 reorganization, 
 
 the suits for fore< losure b in;.' carried out without oppo 
 sit i on to tran \< r the title. 
 
 But since railways fill so Larg< -i pari in our modern 
 industrial life and since we can safe!) aj that there 
 
 432i»><» 
 
38 Corporation Finance 
 
 must be carriers of traffic so long as civilization en- 
 dures, it is apparent that that traffic can be made the 
 security for the borrowing of money as safely and 
 legitimately as can a dwelling-house ; provided always 
 that those rules of financiering are observed which 
 require only that the minimum value of the property 
 be represented by such funded debts. The investor, 
 therefore, need not fear to put his money into railway 
 bonds or debentures because of the commercial condi- 
 tions under which railways are operated ; but those 
 commercial conditions require that he should, if he 
 seek safety for his investment, consider the bearing of 
 these facts upon the particular road in which he is 
 interested. If the earning capacity of that company 
 becomes for any reason impaired, the strong legal lan- 
 guage of the mortgage will not save the holder of the 
 company's bonds from loss. In the end he must accept 
 as a basis for revaluation of his securities the earning 
 power of the company as a carrier of traffic. 
 
 When money is loaned upon a dwelling-house the 
 mortgage is made to cover the real estate as security, 
 the bond which usually accompanies the mortgage 
 being a contract under which the mortgagor pledges 
 all his property for the repayment of the loan. The 
 terms have a slightly different meaning, however, 
 when applied to corporations. The mortgage is the 
 indenture issued by the company to trustees who may 
 be trust companies or individuals. The preference for 
 trust companies as trustees under these mortgages 
 arises from the fact that their existence is continuous, 
 that they have all the machinery for properly execut- 
 ing large transactions, and because their names are 
 known to all investors. 
 
 The mortgage made to trustees contains the terms 
 
Railway Bonds 39 
 
 under which the money is borrowed. Under this mort- 
 gage and governed by its terms the Company issues 
 bonds of the denomination stated in the instrument, 
 usually $1000, which bonds may be registered with the 
 interest payable by check, or may be coupon bonds 
 accompanied with sheets of coupons that when cut off 
 on the respective interest dates are payable to bearer as 
 drafts upon the company and so easily collectible. 
 The one form of bond or the other is preferred accord- 
 ing as the holder wishes to make a permanent invest- 
 ment secured against theft or destruction, though the 
 sale of a registered bond is a matter requiring some 
 little time and trouble — or prefers a form which, in the 
 language of Wall Street, is a "good delivery" for 
 instant sale at any time. 
 
 The railway mortgage usually begins by giving the 
 name of the company with the particulars of its incor- 
 poration ; then follows an exhaustive list of the prop- 
 erty to be mortgaged. If there are prior liens upon the 
 property or on any part of it, these exceptions are 
 stated. Then the amount for which the mortgage is 
 to be issued is stated, and tin purposes for which the 
 money is to be used should be given in detail. Then 
 may be stated thi proi 1 dure under which the trustee is 
 allowed to certify bonds for sale to the public. The 
 
 object of appointing a trustee is to see that the legal 
 formalities embodied in the mortgage are strictly car- 
 ried out, and that there is no ovi r issue. The mort- 
 ften contains a provision exempting the trustee 
 from all liability under any circumstances. Sometimes 
 the bonds are to be o rtified by the tra timi to 
 
 time merely on the n olution of the Board of Direcl 
 ors : but the more modern m deny this power 
 
 me until certain form d. For instance, 
 
40 Corporation Finance 
 
 in the case of bonds on a road under construction it is 
 often provided that no new bond shall be issued until 
 a certificate is filed with the trustee, signed by the 
 president and chief engineer, certifying that the 
 stated number of miles of road have been completed 
 and turned over to the operating department. 
 
 In cases where there are existing underlying liens it 
 is sometimes provided in the mortgage that these 
 underlying bonds shall be paid off as they mature and 
 not extended ; this is done in order to insure to the 
 issuing bonds a first lien at the maturity of the under- 
 lying mortgages. In late mortgages, some sections 
 relating to reorganization in case of insolvency have 
 been inserted. The sections referring to the foreclosure 
 of the mortgage are usually very carefully considered. 
 A common arrangement is that in case of non-payment 
 of interest, when such a default continues for six 
 months, at the request of a certain small proportion of 
 the bondholders, the trustee may begin foreclosure pro- 
 ceedings or enter upon the possession of the property ; 
 or in case of a demand by a considerable percentage of 
 the bondholders, shall do so. In that way practical 
 control of the foreclosure proceedings is given to a cer- 
 tain proportion of the holders of the bonds outstanding. 
 A few of the older mortgages give this power of control- 
 ling foreclosures to a small proportion (the old general 
 mortgage of the Philadelphia and Reading granted the 
 privilege to ten per cent, of the outstanding bonds), 
 but the later mortgages require a larger percentage. 
 Another interesting feature in modern mortgages, 
 inserted because of certain experience in that direction, 
 allows the trustees under certain circumstances to with- 
 draw the proceedings for foreclosure, if such have been 
 begun, where a more favorable outcome would be had 
 
Railway Bonds 41 
 
 by compromise, or where a technical default should not 
 allow the company to pay off an established and secure 
 mortgage not yet due, for the sake of refunding the 
 loan, in that compulsory fashion, at a lower rate of 
 interest. It is also well to give to the majority of the 
 bonds outstanding — say three fourths — the power to 
 direct a trustee to buy in the property at foreclosure in 
 accordance with any plan or reorganization which may 
 be adopted, and also under certain circumstances to 
 authorize the creation of new mortgages prior to the 
 one under consideration. These latter features are in 
 the mortgage of the Southern Railway Company. 
 
 Since the provisions of the mortgage govern the whole 
 transaction, and since a mistake here may have disas- 
 trous consequences, it is the usual custom to employ 
 good corporation lawyers, so that the terms of the 
 mortgage may be formulated in strict accordance with 
 the equities of the ease. On the one side the stock- 
 holders, as well as the company itself, desire that the 
 conditions of the mortgage shall be as little onerous as 
 possible; on the other hand, the lenders wish the mort- 
 gage drawn so as to give them the 1" -1 security. Just 
 where the line of compromise shall fall depends to a 
 certain extent upon the reputation of the company and 
 its general credit, < >n the other hand, where pro- 
 visions of the mortgage are too loosely drawn, they 
 may dele it their own purpose in not allowing money 
 to be borrowed by the corporation at the most favor 
 able rates and under the most favorable conditions. 
 
 M01 ' ire divided into 1 lasses and call< d bj 
 
 various natm ding as their claim upon the prop 
 
 erty is direel or indirect Prior lien bonds need no 
 particular discussion. Our | railway systems 
 
 have been foi tned in tn< 1 I oul oi a numbei 1 »t 
 
4 j ( orporation Finance 
 
 existing roads. In a great many instances these older 
 and smaller companies have issued bonds which are 
 necessarily the first mortgage upon their respective 
 portions. These senior bonds, as they are sometimes 
 called, may be liens upon old roads which are now 
 parts of the new main line and worth many times the 
 original mortgage. Such underlying bonds, having 
 been issued years ago, often bear six per cent, or seven 
 per cent, interest, and being considered thoroughly 
 secure, sell on the exchanges at such prices as yield 
 the investor but a small return. Upon the system as a 
 whole there may be a first mortgage, so called because 
 it is the first mortgage of the consolidated company, 
 although the prior lien bonds just mentioned of course 
 take precedence of it. After the first mortgage other 
 bonds may come. A form of bond which was at one 
 time popular but afterwards fell into partial disrepute, 
 is the income or preference bond. The bond is so 
 called because it attempts to combine the lien of a mort- 
 gage with contingency of interest. The mortgage in 
 due form declares the principal to be a claim upon the 
 property, but follows this statement with another, that 
 no interest shall be paid unless it has been earned. In 
 most cases the question whether there .shall be any net 
 earnings applicable to this interest in any given year is 
 left absolutely to the discretion of the Board of Direct- 
 ors. A fatal objection to the income or preference 
 bond is that it is an attempt to combine two contra- 
 dictory commercial principles. As we have already 
 seen, the lender of money to a corporation does not 
 wish to participate either in the profits or the losses 
 arising from the success or failure of the company, but 
 simply intends to loan his money on what he thinks is 
 sufficient security, so that he may receive the interest 
 
Railway Bonds 43 
 
 on the same and the principal when due. To the 
 stockholders who manage the company are left the 
 profits or losses over and above this charge upon the 
 minimum value of the property, whichever these may 
 be. It will be noticed that security for both interest 
 and principal is the essence of the creditor's position, 
 while contingency depending upon success is the 
 essence of the stockholder's position. We might, 
 therefore, expect that a so-called bond which attempts 
 to combine security with contingency would prove dis- 
 appointing to all concerned, and so it has turned out. 
 In some cases income bonds have been given to old 
 security holders in part payment for sacrifices which 
 they were asked to make because of former insolvency. 
 In such cases it would have been better had these old 
 holders accepted their changed position from creditors 
 to partners and received preferred stock for their de- 
 ferred claims. The income bonds of the Atchison, 
 Topeka and Santa Fe, issued after the reorganization of 
 and the preference bonds of the Philadelphia and 
 Reading, issued after the reorganization of [886, are 
 instances of such bonds. A practical objection often 
 raised to income bonds by British and German holders 
 of such bonds, is that the Board "i" Directors represent- 
 ing the shareholders may in years of good earnings put 
 into the property the surplus revenues which might 
 have gone toward paying interest on the income bonds, 
 and continue such a policy until such time as the earn- 
 ings of thi company justify paying interest to the 
 income holders and at the sam< time a dividend on 
 Againsl such appropriation of the earnings, 
 when equitably due to them, the income holders have 
 usually no remedy. Sometimes thi power of voting 
 has been given to such bonds in ord rd against 
 
44 Corporation Finance 
 
 such a possible abuse ; but preferred stock is a better 
 tiling to issue and to hold under these circumstances 
 than the miscalled income bond. 
 
 In our corporation history there have been instances 
 of preference bonds, like those of the Philadelphia and 
 Reading, with the definition of net earnings applicable 
 to their payment drawn in the mortgage of 1888 in 
 such severe terms that there seemed no loophole of 
 escape. Nevertheless charges have in such cases been 
 ingeniously put ahead of such bonds. It may happen, 
 too, that the very severity of the language which is in- 
 tended to compel the payment to the preferred holder . 
 of all earnings over and above certain specified and 
 fixed charges, by defeating other borrowings or by 
 depriving the company of improvement moneys, may 
 so embarrass the managers of the company as to cause 
 the preference bonds themselves to fall in value. 
 
 Another form of corporation borrowing of which we 
 have seen instances in late years, is that of collateral 
 bonds or trust notes. Collateral bonds are obligations 
 issued by a company with a lieu upon the real estate 
 junior to that of other mortgages. To give these col- 
 lateral bonds value in the eyes of investors they are 
 made a first lien upon various bonds and stocks, usu- 
 ally of auxiliary companies, which are taken from the 
 treasury of the system and deposited with some trust 
 company as trustee under the terms of the collateral 
 mortgage. As the name implies, such a mortgage is 
 really a borrowing upon the collateral owned by the 
 company, and differs from the borrowing of money from 
 the banks through the hypothecation of the securities 
 in the company's treasury, only by arranging for a loan 
 for a term of years and at a fixed rate under certain 
 specified conditions. 
 
Railway Bonds 45 
 
 A large system which has been formed by the con- 
 solidation from time to time with it of various other and 
 smaller corporations usually finds that it has collected 
 in its treasury a considerable number of bonds or 
 shares which represent to it its investments for control. 
 These bonds or shares are those of railroad companies 
 whose corporate existence may still be kept up, but 
 which form nevertheless an integral part of the present 
 system ; or they may be the bonds or shares of ter- 
 minal companies, or warehouse or elevator companies, 
 or of some water transportation company which pro- 
 vides by river or lake an important connection with 
 the present company ; or, of companies which furnish 
 much traffic to the railroads, and whose securities 
 were bought in order that that traffic may be held 
 for the system beyond a doubt. In all these cases 
 it is assumed that the continuance of the control of the 
 parent company over the various enterprises whose 
 bonds and shares it holds is necessary to the preserva- 
 tion of the system and to the securing to the system of 
 the traffic represented. To pledge these various shares 
 and bonds tor a new loan is regarded as legitimate 
 financiering because it grants to the holders of the col 
 lateral bonds a claim upon the assets of the company, a 
 claim which often in effect, though not in name, is 
 equal to that of regular mortgage bonds. 
 
 An illustration of such mortgages by a strong com 
 
 pany is that of tin- four percent, extension bonds of the 
 
 Chicago and Northwestern Railwaj Company, issued 
 in [886, upon the bonds of tin- branch road, tin- Pre 
 mont, Elkhorn, ami Missouri Valley, deposited with the 
 trustee as collateral. In like manner the Illinois Cen 
 tral Railroad Company in 1 d collateral bonds 
 
 based upon the deposit with th< trustee ol various 
 
46 Corporation Finance 
 
 bonds of subsidiary roads important to the system. 
 The uncertainty of the value of a claim upon collateral 
 in cases of insolvency is illustrated by the history of 
 the collateral trust bonds of the Oregon Short Line and 
 Utah Northern Company. This company, under the 
 control of the Union Pacific, purchased more than half 
 the stock of the Oregon Railway and Navigation Com- 
 pany (a connecting road), and, depositing the same 
 with the trustee, issued thereon its collateral trust 
 bonds. Pending the reorganization of the Union 
 Pacific and because of a decline in the earnings of the 
 Oregon Railway and Navigation Company, the value of 
 these collateral trust bonds became but nominal. In 
 1883 the Wabash, St. Louis, and Pacific issued $6, 000, 000 
 of collateral trust bonds bearing six per cent, interest 
 and sold them to the public at 90. Under the reor- 
 ganization of this company into the Wabash Railroad 
 Company (dating from July, 1889) these collateral trust 
 bonds were exchanged into debenture " B " bonds of 
 the new company, the latter being quoted at less than 
 one third of the price at which the collateral trust 
 bonds were originally issued and sold. 
 
 The difficulty which experience has found with col- 
 lateral bonds lies in the fluctuating value of the securi- 
 ties pledged under them. The collateral bond held by 
 the public is a mortgage upon certain other mortgages, 
 and if foreclosed by reason of insolvency the purchasers 
 legally come into possession, not of the real estate of 
 the company, but of certain other bonds, which in turn 
 may have to be foreclosed separately, necessitating a 
 large number of distinct actions. The loss is the same 
 whether these separate transactions are actually carried 
 out or an equivalent reduction made in the quoted 
 values of the bonds. Not only is the expense of the 
 
Railway Bonds 47 
 
 transaction and the ultimate outcome made doubtful by 
 these facts, but in securing the absolute property delays 
 which may occur under these circumstances may cause 
 further losses ; for it is plain that the value of the sub- 
 sidiary properties whose bonds and shares are pledged 
 as collateral may depend, in cases where the mortgag- 
 ing company becomes bankrupt, largely upon the 
 quickness with which they may be seized upon and 
 handled with vigor by their new owners. In a devel- 
 oping country new discoveries in mining may be made, 
 or new centres for trade distribution or manufacturing 
 may be formed, which may change the value to the 
 system of a branch line or auxiliary company so materi- 
 ally and so rapidly, that holders of a funded obligation 
 resting for security upon these subsidiary properties 
 may find their real security slipping away from them 
 while they are yet helpless. For these reasons a collat- 
 eral bond usually ranks in quotations below that of 
 other mortgages of the same company covering specific 
 portions of its property. 
 
 But while these remarks are true in many cases there 
 are instances, like those of the Chicago and Northwest- 
 ern and Illinois Central, to which they do Q01 practi 
 1 ally apply. There an- railways which have been in 
 operation for many years and whose traffic not only as 
 to volume but as to source has laconic well established. 
 Fluctuations in the value of the properties directly 
 owned by such companies are so little likely to occur 
 that collateral bonds issued upon the stocks and bonds 
 of such subsidiary proper! i comparatively safe 
 
 investment. Thi re i i 00 hard and fa I rule foi judging 
 of the lien iu these cases. Each company and each 
 collateral morl tnusl be valued l>\ the merits in 
 
 h particular case. Thi general reputation and 
 
48 Corporation Finance 
 
 credit of the mortgaging company should also be taken 
 into consideration. 
 
 The objections raised to collateral bonds before 
 spoken of have led to variations in the form intended 
 to meet these difficulties. Such a variation is that of 
 collateral trust notes. Like collateral bonds these notes 
 are an obligation of the issuing company and are made 
 a first lien upon certain shares and bonds of properties 
 important to the system, which are given to some trust 
 company to be held as collateral for the notes. With 
 this difference, however, that the mortgage gives the 
 control of the hypothecated bonds and shares to a par- 
 ticular trust company or to a committee of financiers, 
 who have the power to dispose of these hypothecated 
 bonds and shares under circumstances which are care- 
 fully stated in the mortgage. Sometimes authority is 
 given to this committee to sell these hypothecated 
 securities at certain stipulated prices or at their discre- 
 tion, the proceeds of the sale being used to redeem the 
 collateral notes ; or else the committee are empowered 
 to make such sales either of all or of part of the securi- 
 ties as they may deem best, in case of a forfeiture of 
 interest payments by the obligating company. These 
 provisions, with others of the same tenor, are inserted 
 in the collateral trust mortgage in order to do away 
 with the objections of investors and by making the 
 transaction more nearly like the ordinary borrowings 
 of money at the banks, to command a higher price for 
 these notes than would otherwise be obtainable. Exam- 
 lilts may be found in the issues of collateral trust notes 
 by the Union Pacific and Northern Pacific Companies 
 in 1S91 and 1X93. 
 
 Railway systems which have attained their present 
 magnitude either through the consolidation of parts of 
 
Railway Bonds 49 
 
 their road at different times or through the amalgama- 
 tion at one time of a number of smaller companies, 
 often find themselves obliged to provide new capital in 
 order to arrange for improvements necessary for hand- 
 ling a larger amount of business, improvements which 
 are required in order to introduce the very economies in 
 operating for which the combination may have been 
 formed. In a developing country like the United 
 States the demand for railway capital, except in periods 
 of depression, is continuous. As traffic grows so must 
 facilities increase. And since it has heretofore been 
 our experience that an increase in the number of pas- 
 sengers and tons of freight is accompanied by a de- 
 crease in the amount received per passenger or per ton, 
 an American road should be considered well managed 
 if the net earnings, legitimately arrived at, increase a 
 little faster than the fixed charges. Such a result, if 
 fairly obtained, proves that the additional capital spent 
 upon the property from year to year has been product- 
 ive. Acknowledging that systems require the expend- 
 iture of money, it often becomes a problem upon what 
 special security this money should be raised. One 
 method is that of issuing "blanket" mortgages, as 
 they are called, a Wall Street term which means merely 
 that the system which already has prior mortgages 
 upon different parts <>f it, now issues bonds which cover 
 the system as a whole, subject, of course, to the undi r 
 lying encumbrances upon the property. 
 
 In the minds of financial men some of these blanket 
 
 mo;' , not hold a fust class position : the feeling 
 
 inst them may be summed up thus : blanket bonds 
 
 not first mo:' fact which everyone must 
 
 admit. Yet if it is tin.- that systems must grow, just 
 
 as parts of the same system in while inde- 
 
50 Corporation Finance 
 
 pendent, there is much to be said in justification of 
 obtaining capital by bonding the system as a whole. 
 The majority of the things needed by the system are 
 such as are chargeable upon the separate parts only 
 proportionately. Equipment which is bought for the 
 benefit of the system should not be paid for by the fur- 
 ther issue of divisional bonds, even where such addi- 
 tional issues are provided for in the divisional mortgage. 
 So, too, bonds sold for the acquisition of freight yards 
 are intended to facilitate the handling of traffic over the 
 whole system. In the approaching days when the use 
 of air-brakes for freight trains and of one pattern of 
 freight-car coupler will increase the number of trains 
 which may be moved rapidly and safely over any par- 
 ticular piece of road, the capacity of the terminals rather 
 than that of the track will even more than at present 
 prove the standard by which the limit to the volume 
 of traffic will be measured. It would be unjust under 
 these present or supposed future circumstances to 
 charge the cost of such terminals to that part of the 
 whole system upon which they may happen to be 
 located. There is no way of meeting these demands 
 so equitably as by the issue of system bonds for system 
 improvements. Blanket mortgages have been issued by 
 the Chicago, Milwaukee, and St. Paul and the Louis- 
 ville, and Nashville Railway Companies, among others. 
 If these blanket mortgages are carefully drawn with 
 provisions compelling the retirement of the prior liens 
 as such mature, they will in time become first mort- 
 gages themselves. Some modern blanket mortgages 
 also contain sections limiting the amount of bonds 
 which may be issued for improvement in any one year, 
 the intention being to prevent the forcing upon the 
 market of such an issue of bonds as to cause a decline 
 
Railway Bonds 5 1 
 
 in price, and also to check a yearly issue in excess 
 of reasonable requirements. An example of such a 
 guarded mortgage covering an issue of blanket or sys- 
 tem bonds is that of the Cleveland, Cincinnati, Chi- 
 cago, and St. Louis general mortgage of 1893. 
 
 If corporations become insolvent it is expected that 
 such blanket or general bonds will be the first to be 
 seriously affected. The Wabash, St. Louis, and Pacific 
 Company in 18S0 issued and sold $16,000,000 of its 
 six percent. " general " or system bonds at 95. Be- 
 coming bankrupt, a new corporation, the Wabash Rail- 
 road Company, was formed in 1889. The general 
 bonds of the old company were converted into deben- 
 ture "B" bonds of the new company, these being 
 quoted at less than one third of the price at which the 
 generals were originally sold. 
 
 There is no doubt that blanket mortgages may lend 
 themselves to over-colored notions of future possible 
 traffic sometimes field by optimistic managers. The 
 with which such bonds may be issued to the large 
 amounts for which the mortgages are made sometimes 
 proves too tempting to railway officers who, through 
 good motives or bad, venture upon extravaganl calcu 
 lations of tfie growth in business for the future. In 
 such cases blanket bonds are not regarded much more 
 highly than would be tin- same amount oi pre P rred 
 stock. While tfiis, however, is a dang< r, it is not a 
 ■ 1 argument against system bonds when legitimate lj 
 led. Blanket bonds should be judged, therefore 
 by that principle in general debt financiering which 
 requires tin- amounl ol borrowed money i" be well 
 within tin- minimum value ol the propert} . When this 
 requirement i-- kepi in view, and when tfi'- companj 
 ha l' ■ □ op rating it 1 line of railway long 1 nougb t<» 
 
52 Corpora tio?i Finance 
 
 allow a fair estimate as to the stability of the traffic, 
 the issue of blanket or system bonds is proper and safe. 
 One form of railway mortgages differing somewhat 
 from those which have just been considered, is that of 
 terminal bonds. Mortgages upon terminal properties 
 which are indispensable to the successful operation of 
 railways are generally well regarded by investors. 
 Proper terminals are more and more essential to our 
 railways as the commercial development of the country 
 proceeds. Passenger stations in important cities, with 
 the land necessary for approaching tracks, are neces- 
 sary if a company is to continue in business and not to 
 yield its traffic to some rival ; and mortgages upon such 
 properties are well thought of. Mortgages upon some 
 railway terminals at Chicago and New York are exam- 
 ples. There are other terminal bonds, however, which 
 cover cases not precisely similar to the one just men- 
 tioned. Terminal properties which are used or may be 
 used by two, three, or more railroads sometimes depend 
 for their immediate value upon the question whether 
 their facilities are, or in the near future can be, fully 
 utilized ; or whether one or more of the occupying 
 companies may not transfer their favors to some other 
 terminal property more accessible to their lines. These 
 inquiries embrace also another set of facts ; whether 
 the properties covered by the mortgage under consid- 
 eration are the best that can be had and whether they 
 are therefore from that point of view also sure of con- 
 tinued occupancy. The case of the Chicago and North- 
 ern Pacific Company is an illustration. This company 
 acquired lands, tracks, and other terminal properties in 
 the city of Chicago, and in 1890 authorized an issue of 
 $30,000,000 five per cent, bonds. It was admitted that 
 the properties covered by the mortgage were of great 
 
Railway Bonds 53 
 
 value of themselves, but because of lack of tenants fully 
 to utilize their facilities, on the appointment of receivers 
 for the Northern Pacific and Wisconsin Central Com- 
 panies in 1893 (companies which had practically guar- 
 anteed bond interest), the Chicago and Northern Pacific 
 was likewise placed in the hands of receivers, its bonds 
 falling in price to one half their former quotations. 
 
 In other cases railway companies have themselves 
 issued terminal bonds which they make a first lien on 
 certain specific terminal properties of their own. In 
 such instances the value of the grounds and buildings 
 in cities must be judged according to the hints already 
 given. If such bonds, however, cover terminals in 
 towns or villages remote from cities or away from 
 places which from the traffic point of view may be 
 called strategic, the question may arise whether the 
 land thus set apart for country terminals has any 
 special value for railroad purposes. If the company 
 could easily put down elsewhere tracks and buildings 
 suitable for their purpose, then their so-called tennin.il 
 bonds are dependent for their value not so much on th< 
 property mortgaged as upon the general success of the 
 company as a carrier of traffic. 
 
 Some of the older of our railway mortgages provid< 
 for a sinking fund. The sections relating to such funds 
 
 usually provide that a certain sum shall he set apart 
 annually and paid to the mot TIh s, 
 
 sums arc to be inv<-st<-d in tin- company's bonds of tin 
 issue to he thus retired, either by purchase in the open 
 market or more commonly at a price fixed in tin- morl 
 ga^e. the particular bonds required being drawn by lot 
 and the result I in the dailj pap is. The 
 
 bonds tliM i chosen cease drawing public interest. It is 
 usually also provided in such cas s that the bonds pui 
 
54 Corporation Finance 
 
 chased by lot shall not be cancelled but remain alive 
 (that is, remain in all their original force against the 
 company) in the hands of the mortgage trustee, the 
 interest on them being added to the sinking fund and 
 used in the purchase of further outstanding bonds. 
 By this method it is not difficult to calculate the exact 
 annual payments by the company which will be neces- 
 sary in order that the mortgage trustee at the maturity 
 of the mortgage may have on hand the amount of 
 money required to pay all interest and principal and 
 thus cancel the whole issue. 
 
 It is sometimes provided that the money contributed 
 by the company to form a sinking fund maj- be used to 
 purchase other bonds of the same system in case the 
 bonds in question cannot be had at a named price ; or 
 perhaps the whole matter is left to the discretion of the 
 trustee or of the company's directors. It usually hap- 
 pens that the quotations of such sinking-fund bonds are 
 higher than the purchase price named in the sinking- 
 fund sections of the mortgage, and hence the invest- 
 ment of the fund in other securities is necessary. 
 
 The course followed in such cases is to buy such 
 other bonds, perhaps of subsidiary roads, as will indeed 
 make up the par value required at maturity, but whose 
 value depends upon the fact that they are obligations 
 of the selfsame system. Such bonds — or indeed any 
 bonds other than the issues originally intended to be 
 extinguished by the sinking fund — could not be sold to 
 the public without increasing the interest charges pay- 
 able to the public by the amount of the interest on the 
 old bonds. In this way the owners of the old bonds 
 indeed receive their principal and interest, but the fixed 
 charges of the system are not in any wise reduced by 
 the transaction. Sometimes it is thought desirable for 
 
Railway Bonds 55 
 
 the company to take over into the treasury all these 
 securities held in the funds, the maturing issues being 
 meanwhile met by sales of other bonds of the same 
 company which bear a lower rate of interest or are part 
 of a larger mortgage and already sure of a market. In 
 such cases the labor of keeping up the sinking fund is 
 thrown away, because usually the exchange of the new 
 bond for the old could have been easily accomplished 
 without that machinery. 
 
 When railway companies are in good credit, or when 
 the mortgage containing sinking-fund clauses covers 
 property conceded to be worth more than the bonds, 
 the establishment of such funds is a financial mistake. 
 If the bonds are to be compulsorily retired so many 
 each year by lot at say 1 10 per cent, of their par value, 
 that fact immediately decreases their value as invest- 
 ments. Xo investor likes to buy bonds which, how- 
 ever good or whatever the premium he may have paid 
 for them, he may have to give up a short time after 
 purchasing. If a bond is really good, the longer the 
 time it has to run the better the bond-buyers like it. 
 Another practical objection is that no one wishes to be 
 on the lookout for advertisements which he may or 
 may not chance to see, but which are legal notices 
 binding on the bondholder that interest on the 
 
 bonds named by their numbers ceases on a certain 
 
 On the other hand, tin- companies would rightly 
 object to a sinking-fund system which should require 
 them to contribute certain sums yearlj to be used in 
 buying that particular issue of bonds in tin- open mar 
 kit. Such ;i provision would soon create an artificial 
 ■< itv in those boi I ba1 the price quotations 
 
 would l»c above the normal. 'To pur< h 1 e :;t ■! high 
 
56 Corporation Finance 
 
 premium bonds which at maturity the company could 
 pay at par would be poor financiering, and a use of the 
 current revenues of the company to which the share- 
 holders could properly object. The form of sinking 
 fund which allows of the investment of the funds in 
 securities other than those intended to be retired, is of 
 little practical value to the bondholders in question. 
 Their mortgage is upon a certain piece of property, and 
 that is still their main hope. It usually happens that 
 the securities purchased by such a fund are those of the 
 same system, and thus at maturity it is often found that 
 to pay off one obligation there is nothing in the fund but 
 another obligation of the same company ; and if the 
 first is not itself good, the other is not likely to be 
 worth much. Investments of sinking funds in bonds 
 of other enterprises are not favored for obvious reasons, 
 while purchases of such undoubted securities as govern- 
 ment bonds at high premiums would cost the company 
 and the bond- and shareholders more than the accruing 
 benefits. For these reasons, sinking-fund requirements 
 have been left out of most of our modern railway mort- 
 gages. As to companies in poor credit, whose bonds 
 rule very low in price, there is not much to be said. 
 Corporation financiering requires that debts shall be 
 only of such a proportion to the real value as will bring 
 the highest returns to the company with the lowest rate 
 of interest. Sinking funds do not need discussion 
 where different conditions prevail. As such funds can 
 be accumulated from but one source — the revenues of 
 the company, and as under our present supposition, 
 those reserves are not enough to sustain the bond 
 credit, it is practically useless to rely upon them for the 
 formation of any such thing as a sinking fund. Com- 
 panies in distress will always use current revenues to 
 
Railway Bo?ids 57 
 
 pay pressing needs regardless of sinking-fund clauses 
 in their mortgages. 
 
 Since under practical conditions sinking funds in 
 the mortgages of railways having good credit are not 
 favored, we may next inquire as to the public aspect of 
 the matter. In national finance it is now understood 
 that sinking funds for the payment of government 
 bonds can be established only from governmental rev- 
 enues ; in short, from taxes. If, therefore, it be the 
 opinion that the government should not remain always 
 in debt, but arrange to pay off its borrowings by de- 
 grees, the funds must be supplied from taxes. The 
 government is not in business and has no business rev- 
 enues. But corporations which, so far as we now see, 
 must continue to earn money through their services to 
 the public indefinitely, occupy a different place. The 
 rules covering public debt financiering do not now 
 apply. Rather do we see the opposite, where borrow- 
 ing is not only a necessity, but often the only road to 
 success. The revenues of such corporations do not 
 come from taxes, but from moneys given to them in 
 return for services rendered in a business way to those 
 concerned. Such services must in sonic form be con- 
 tinuous, and the benefits paid for continuously on a 
 business basis. Moreover, through competition or in 
 other ways, the profits of such companies tend toward 
 smaller margins, these being usually only enough to 
 pay a fair return to the capital invested. Since the 
 only way to pay off debts is from revenue, it follows 
 that the retirement of bonds at maturity by cash pay- 
 menl (except, of course, through the sale of other 
 bonds) could be< ff! 1 1< d only by increasing the revi nues 
 through advancement of the prices charged to pa: »en 
 gers and shippers, or by the shareholders (or perhaps 
 
58 Corporation Finance 
 
 the bondholders themselves) foregoing their returns for 
 years. As a practical matter either way is unadvisable 
 or impossible. Unlike taxes, rates or prices could not 
 be advanced so largely as to pay off bonded debts. 
 Railway charges, for example, could not be increased 
 to that extent in the face of an adverse public opinion. 
 On the other hand, to stop dividends for such a pur- 
 chase would prove equally unpopular, and would also 
 result in a decay of public progress in our industries ; 
 for no one would undertake a new enterprise if he were 
 not permitted to reap the annual fruits of his ability 
 and labor. 
 
 For these reasons the payment of corporation debts 
 from corporation revenues is, generally speaking, im- 
 possible in practice. Hence it is assumed— by large 
 railway systems, for illustration— that when an existing 
 mortgage matures the company will be able to borrow 
 new money to pay off the old, and perhaps at a lower 
 rate of interest. Sinking funds for such a purpose are 
 unnecessary, though, as a matter of formal obligation, 
 they may be kept up by companies in good credit, like 
 the Chicago, Burlington, and Quincy or Chicago and 
 Northwestern. But reference has been made to corpo- 
 rations which it is assumed will go on doing a stable 
 business indefinitely. Other companies may be subject 
 to extreme fluctuations in profits, or, like mining cor- 
 porations, may have a certain number of years to run 
 when their business opportunities will be exhausted. 
 In such cases sinking funds fulfil a proper purpose- 
 that of guarding the interests of the mortgagees, and 
 should be insisted upon ; such funds may be established 
 either by way of deposit with trustees of moneys to 
 purchase bonds or be held in trust, or by writing off the 
 values of the plant before paying dividends and holding 
 
Railway Bonds 59 
 
 such moneys in a sort of depreciation account, or by a 
 combination of both methods. There is no real con- 
 fusion between indefinite and short-lived companies, for 
 by a commercial law the short-lived corporation nun- 
 retain a rate of profit on its transactions high enough, 
 if well managed, for all sinking-fund purposes, and 
 higher than anything which the stable corporation may 
 hope to gain. A business which bears no evidence of 
 stability and endurance, or whose life, if it is to be 
 short, cannot be calculated and provided for, should 
 not become incorporated. The partnership form is best 
 adapted to enterprises which are largely speculative in 
 character. 
 
 In order to draw capital from all sources, corporation 
 mortgages are made to trustees who certify to certain 
 bonds of small denominations. In this way the bor- 
 rowings of corporations, amounting in some cases to 
 more than a hundred million dollars at a time, are 
 divided into small sums within the reach of the humble 
 investor. Of late years the trust companies in the 
 
 tern cities have been selected as trustees instead of 
 
 individuals whenever the law of the State where the 
 property was situated allowed of such selection. Trust 
 companies have manifold advantages over individuals 
 in such a relationship ; they do nol die ; the Lai 
 amount of financial business which the) dailj transact 
 provides them with the machinery for such purposes; 
 while their well known names stand as evidence to the 
 purchasing public thai a1 leasl the accessary formal- 
 have been complied with. Beyond thai responsi- 
 bility the trustees of corporation moil usually 
 assume none. 
 
 In recet I he trust 1 ompanii have shown a 
 
 tendency, when a< tin 
 
60 Corporation Finance 
 
 nize a greater moral responsibility than they at first 
 were willing to bear. Trust companies did not, of 
 course, intend to appear as in any way guaranteeing 
 the bonds to which they certified, though that seems 
 often to have been the erroneous opinion of the un- 
 thinking ; but trustees now acknowledge themselves 
 bound within the limits of the mortgage to use their 
 influence to protect the interests of the bondholders. 
 A trust company which should now allow the issue of 
 unsecured bonds because of some glaring defect in the 
 language of the mortgage, would no longer be morally 
 excused by financial opinion, though perhaps held 
 technically innocent. 
 
 One way in which this sentiment attributing some 
 sort of ethical responsibility to trustees of corporation 
 mortgages manifests itself is through slight alterations 
 in the wording of the mortgage itself. The old lan- 
 guage was that the trustee was to be held harmless 
 under all circumstances. Now the trustee is often 
 found willing to assume responsibility at least for gross 
 negligence or for the negligence of servants or clerks 
 not carefully selected. If to some such phrases be 
 added a more careful drawing of the mortgage as to its 
 provisions against unauthorized issues of bonds, a bet- 
 ter compliance with the ethics of the situation would be 
 had ; for it is undeniable that a part of the public com- 
 plaint against the fraudulent issue of bonds should be 
 directed against the inadequate safeguards imposed in 
 the mortgage rather than against the trustee. 
 
 As an example of what is meant may be taken a 
 mortgage which we will say may be issued for the 
 purpose of improving a railroad, though the proceeds 
 of the bond when sold may be devoted toward an 
 entirely different object, one, we will say, tainted with 
 
Railway Bonds 6 r 
 
 fraud. Such a fraudulent misuse of company borrow- 
 ings would be checked at the outset if the mortgage 
 had contained sections limiting the amount of money 
 which should be expended in any one year, and pro- 
 viding that the trustees should not certify to any of 
 the bonds until a certificate had been filed with the 
 trust company, signed by the chief eugineer, stating 
 that a certain amount of work had been done or a 
 certain number of miles of new road or new track con- 
 structed. This statement of the chief engineer could 
 have been accompanied by an affidavit, signed by the 
 president and treasurer of the company, to the effect 
 that the allegations of the chief engineer were true. 
 Provisions of this character, varied according to the 
 circumstances of each case, but to the same intent, 
 should be inserted in every mortgage which contem- 
 plates the spending of new money for corporation uses. 
 Restrictions such as these would protect the trustee ; 
 while at the same time rendering the officers clearly 
 responsible to the public and to the Law for any lapse 
 of corporation duty as to any issue of bonds whenever 
 a fraudulent or unauthorized use of the money w;is 
 thus guarded against. The two ideas of better care on 
 the part of the trustees of corporation mortgages, and 
 of better definition of the terms and conditions under 
 which the money is to be borrowed and used, go to 
 
 ther. Both are essential unless we are willing to 
 entrust the whole matter to the good faith and to the 
 interpretation put upon responsibility by those run 
 
 tied. The necessit} of granting to the direct' 
 chosen by the st< the properl 5 , at 
 
 least a proper amount of liberty in thai management 
 is obvious : but that i the shareholders, nol the 
 
 creditors. Good corporation financiering requires that 
 
62 Corporation Finance 
 
 money be borrowed on the best possible terms. Since 
 bondholders do not wish to concern themselves with 
 questions of success or failure in management, they are 
 best pleased with investments which are surrounded 
 with all possible money safeguards. Cheap borrowing 
 demands that the prejudices of capitalists be, within all 
 reasonable limits, regarded. 
 
 The listing of bonds and shares on the exchanges is 
 of benefit to both corporations and investors. A wider 
 market is thus made for those who wish to buy or to 
 sell. One of the advantages of corporation securities, 
 and one which gives to them a higher range of values 
 than they otherwise would obtain, is the ease and 
 rapidity with which sales can be made. Real estate, 
 for instance, with all its good points, has the drawback 
 that it cannot be quickly turned into cash at need. In 
 like manner a mortgage on country property cannot be 
 used at the banks as collateral for loans, nor can a 
 mortgage on good city property always be easily dis- 
 posed of. Bonds and shares of corporations which can 
 be listed on the exchanges have at once a standing (not 
 value) which gives them a market at some price always. 
 Corporations which issue bonds and shares intended 
 for public purchase, should list such issues whenever 
 possible. 
 
CHAPTER IV. 
 
 SUBSIDIARY COMPANIES AND THEIR SECURITIES. 
 
 OUR American systems of railways are matters of 
 growth. They usually consist of a number of 
 smaller roads once independent which have been joined 
 together by purchase or by consolidation. Where these 
 lines are continuous their status does not need discus- 
 sion. The original bonds of such lines are recognized 
 as having a prior lien which cannot be disputed, and as 
 such they command very high quotations on the stock 
 exchanges; but in addition to old roads winch now 
 form a part of the existing main line, nearly all our 
 systems have branch roads, which a1 greater or less 
 length read] from the main line into some agricultural 
 section or to mines or to cities. In this way facilities of 
 transportation are afforded to the sections thus reached, 
 while the main line traffic is increased. It isonly lately 
 that the importance of well located branch lines to the 
 
 main .stem lias been appreciated in the public mind. 
 
 The capacity of the main line of a railway for carrying 
 a large quantity of traffic it. b< ing practi 
 
 cally limited only by the amplitude of the terminals. 
 Every additional car which may be add< d to trains that 
 must be run in an fain to the company ; 
 
 in like manner the r< i eipl - froi idditional fa i 
 
 train whii h the road ma; i up to the limil ol its 
 
 after deduct i ng the train 
 6.1 
 
64 Corporation Finance 
 
 or ' ' movement ' ' expenses ; for while the latter may be 
 roughly estimated at forty cents a train mile, the aver- 
 age gross earnings of such a train in the United States 
 are about $1.60 per mile run. The increasing profit- 
 ableness and necessity of additional traffic explains why 
 the railways in the United States, and particularly 
 those doing a small business west of the Mississippi 
 River, have been led either to build branch roads into 
 all sections where extra traffic might profitably be 
 secured or to support directly or indirectly so many 
 auxiliary businesses, farming or stock-raising enter- 
 prises, which might add to the volume of traffic. So 
 clear has the necessity of branch lines seemed to the 
 managers of the railways in our newer States that the 
 company which did not build or purchase subsidiary 
 enterprises might not expect to develop traffic in the 
 parts of the country near their lines ; indeed, could not 
 hope to hold their shipments against the competing rail- 
 ways which were active in following out the policy of 
 building such lines. 
 
 The profit accruing to the main lines from the traffic 
 which they interchanged with the branch railroads was 
 great in any case, and became all the more conspicu- 
 ously so when, as usually happened, the main line was 
 benefited by the long haul of hundreds of miles upon 
 this branch-line business. Sometimes these branch 
 railroads proved very expensive to build, ' as, for ex- 
 ample, in attempts to reach some mountain mining 
 camp ; and whether expensive or not, the money for 
 their construction was usually obtained by the issue of 
 branch-line bonds, which may have been guaranteed 
 directly by the parent company or were made salable 
 to the public by a lease or other contract, setting forth 
 in some form the obligation of the large road to its 
 
Subsidiary Companies : their Securities 65 
 
 dependency. The majority of the branch roads in the 
 old Northern Pacific system, for illustration, were oper- 
 ated under leases which specified that the earnings of 
 the branch, even though prorated mile for mile, should 
 always be equal to the annual sums required for bond 
 interest and sinking funds. 
 
 Where such branch lines were built with reasonable 
 judgment and care there seems no doubt that their 
 building was justified. Under the circumstances a 
 division of the joint earnings on the basis of mile for 
 mile of the whole distance carried would be, as a cri- 
 terion of its real value, manifestly unfair to the sub- 
 sidiary road. It has been determined by railroad 
 custom for many years that the division of joint earn- 
 ings between two companies should be on equal terms 
 only when the circumstances were equal. But when 
 the little road is the originator of the traffic, receiving 
 that traffic from different stations in small lots and 
 delivering it at the junction point in train Loads to the 
 main line, it is well settled that the conditions are not 
 equal, and that the branch line is commercially entitled 
 to more than its mileage proportion of the throu 
 With a few of its branches jusl mentioned, the North- 
 ern Pacific arranged to allow ion of two miles 
 on the branch for every mile actually travelled. In 
 som< of short branch lines these have b 
 allowed to charge arbitraries, as they are called, i. < .. 
 fixed sums regardless of the through rate, sums u 
 high enough to ; ; Id the auxiliary road fair earnin 
 In other cases these bran h 3 have been allow.'. 1 " con 
 structive " mileage, through either an agreed percent 
 of the whole rate or a proportion based upon two 
 or three tim< tu igth of the haul upon the 
 
 branch line. As an illustration of the division 1 
 
 5 
 
66 Corporation Finance 
 
 ings by fixed percentages, the case of the lines of the 
 Atchison, Topeka, and Santa Fe system in California 
 may be taken. At the time of the Atchison receiver- 
 ship in December, 1893, on shipments of freight from 
 Los Angeles, California, to Kansas City, Missouri, five 
 cents per hundred pounds were allowed as a terminal 
 charge in Los Angeles ; the California lines were 
 (after deducting the terminal charge) then credited 
 with nineteen per cent, of the through revenue. The 
 remainder of the through charge was then divided on a 
 mileage basis between the other roads in the system 
 carrying the traffic. On a mile-for-mile basis the Cali- 
 fornia lines would have received but about eight per 
 cent, of the total charge. An example of purely con- 
 structive mileage is that of the allowance by the Union 
 Pacific main line to the Oregon Short Line (a part of 
 the Union Pacific system) of 1^ miles for each one 
 mile of actual haul. To show the results of construct- 
 ive mileage in practice a supposititious case may be 
 taken. If a branch road is one hundred miles long and 
 the freight which it originates is hauled a distance of 
 five hundred miles on the main line (the freight 
 charges being based in the first place upon the com- 
 mercial conditions), strict mileage proportion would 
 require that the branch road should receive one sixth 
 of the total charges. If the constructive mileage of two 
 miles for one were allowed to the auxiliary roads its 
 haul would be considered as two hundred miles for the 
 purpose of the calculations, the main line having the 
 same mileage as before, five hundred miles ; this would 
 give the little road two sevenths of the same total 
 receipts. Out of joint earnings, amounting to $1000, 
 the former method would give the branch $166.67, 
 while constructive mileage of two for one would yield 
 
Subsidiary Companies : their Securities 67 
 
 $285.71, the difference, $119.04, being a net increase — 
 that is, an increase of earnings without an increase of 
 expenses. Sometimes three miles for one are allowed 
 the auxiliary company. But few branches have so long 
 a proportionate haul as one hundred miles. In cases 
 where the distance to the junction of the main line is 
 very short, the branch is allowed in the calculations a 
 minimum distance of say fifty miles. It occasionally 
 happens that roads having a long mileage are by reason 
 of their circumstances really to be considered in the 
 light of branches and entitled to more than a strict 
 mileage proportion of the revenues received from the 
 traffic carried over their own and other lines on a 
 through rate. The case of the Oregon Short Line, just 
 cited, is an example. What proportions are equitable 
 in any particular case can only be determined by a 
 careful study of all the circumstances, and by consult- 
 ing the judgment of those who by long experien< 
 familiar with the customs of the railways in these 
 respects. 
 
 When the Chicago, Burlington, and Quincy Railroad 
 was built west of the Mississippi River, the Nebraska 
 
 Hi-, ived half of tlie through rat'- for the ai 
 haul of [35 miles, as against the oth( 1 li ill' n C< ived bj 
 the old main line for its haul of |.86 miles. [llustra 
 
 tions of this sort abound in our railroad history. N01 
 are they new. A dozen years ago the legislature <>i 
 Illinois investigated the practice of the Illinois On 
 tr.d Railroad in allowing constructive mileage to its 
 branches, on complaint that the State, which w.r 
 entitli d to 1 y. a per 1 ent. of thi ol that 
 
 company, was by this policj 1" ing tin- sums due to it. 
 The committee r< porti d that thi mrag 
 
 ing the building of branches bj the Illinoi Central 
 
68 Corporation Finance 
 
 really increased the revenues of the main line and 
 therefore of the State. The case is even stronger than 
 this. It was estimated by the United States Pacific 
 Railway Commission in 1887 that, on the traffic inter- 
 changed by the Union Pacific Railway with its branches, 
 the profit to the main line was in the aggregate nearly 
 twice as much as that derived from the business origi- 
 nating on its own main lines. The testimony before 
 that Commission was to the effect that without its sys- 
 tem of branches the Union Pacific would have been 
 then bankrupt. 
 
 Since the large systems were under the necessity of 
 building or acquiring branch lines in order that their 
 main lines might have a volume of traffic sufficient to 
 make its carriage a financial success, it was soon seen 
 that the position of these branches as regards the main 
 steins must be defined commercially before the money 
 for their building could be obtained. Theowmerofa 
 branch-line bond was quick to see that he was depend- 
 ent for the value of his property upon the main line ; 
 for while the branch company held a contract of some 
 sort with the parent company, the obligation of that 
 contract came after the mortgages which had been or 
 might be put upon the main lines, and hence might be 
 disavowed in time of financial distress. Such a breach 
 of contract would leave the branch-line holder without 
 an adequate commercial remedy. In this way the 
 necessity of putting a constructive valuation upon aux- 
 iliary properties, joined with the acknowledged business 
 equities of the subject, led to the granting of a more or 
 less defined position to subsidiary companies wdiich 
 could be sustained before the courts. Thus the holder 
 of the bonds or other obligations of auxiliary companies 
 was assured of a financial value to his holdings equiva- 
 
Subsidiary Companies : their Securities 69 
 
 lent to their commercial value as ascertained by a 
 consensus of railway opinion. This valuation being 
 somewhat indefinite, the market quotations for the 
 bonds of branch railway lines are influenced in part by 
 the known advantages of the branch line in question, 
 and in part by the general opinion as to the honor of 
 the system managers and the ability of the company to 
 earn the required revenues. 
 
 The necessity of branches, particularly in the de- 
 veloping sections of the country, being admitted, it 
 follows that the values of those branches and the bonds 
 upon them are not to be determined by the form of con- 
 tract under which they arc- operated. In a large number 
 of instances the exact commercial worth of each sub- 
 sidiary company is not statistically worked out by the 
 controlling system. It is often considered sufficient if 
 a lease is made under which it is mutually agreed that 
 the earnings of the branch shall always be equal to 
 annual interest on the bonds. Then the joint earnings 
 may be divided as may be most convenient foi th< 
 bookkeeping, usually on a " straight mileage " basis, 
 mile for mile. Under such accounting the branch line 
 would show each year a deficit in earnings under fixed 
 charges which under its lease the main company would 
 take from its general treasury. Obviously such book 
 ping, though not intended to mislead, would not 
 
 be a proper basis for estimating thecommi rcial valu< oi 
 
 the branch prop rt \ or of its bond- Alb in is a sl0V 
 
 enly way of accounting. Usually it is adopted merel> 
 to save the trouble of obtainin ' opinion as to tin 
 
 true division of joint earning >, The I ks and statis 
 
 of largi companii . railway or manufacturing; 
 
 in to be so kepi and the public reports so mad' . .>• 
 
 to six ,v as exactly a po ible the real earning* 01 
 
jo Corporation Finance 
 
 losses of the system as a whole and of each particular 
 branch line or subsidiary property not merged into 
 the old company. 
 
 The inadequacy of this old style of accounting be- 
 comes of practical importance in cases of insolvency or 
 where through the expiration of a lease a readjustment 
 is to be made. The Board of Directors in the latter case 
 may seek to compel the branch bondholders to accept a 
 reduction in the interest rate to correspond with the 
 earnings of the branch road as shown on the system's 
 books. Or when a reorganization is necessary and the 
 capitalization of the whole system must be reduced, the 
 problem of dividing that reduction among all the 
 obligations of the system becomes very complicated. 
 If the real earnings of the different parts of the system 
 are to be taken as the basis for the new capitalization, 
 the holders of bonds of branch lines which show de- 
 ficits may be asked to submit to many sacrifices of 
 principal and interest. A case in point is that of the 
 Atchison, Topeka, and Santa Fe system before referred 
 to. It will be remembered that the lines in California 
 were allowed a fixed percentage — nineteen per cent. — 
 of the through charge on shipments between Los Ange- 
 les, California, and Kansas City, Missouri, and that the 
 remainder of the through charge was divided between 
 the other carrying companies mile for mile. These 
 other lines between the points named consisted of the 
 Atlantic and Pacific from Barstow, California, to Albu- 
 querque, New Mexico, about 747 miles, and the Atchi- 
 son main line thence to Kansas City, about 920 miles. 
 To secure the connecting line, the Atlantic and Pacific, 
 the Atchison Company, jointly with another company, 
 had guaranteed interest on the Atlantic bonds ; a 
 necessary measure, for under the mile-for-mile con- 
 
Subsidiary Companies : their Securities 71 
 
 tract and because of light local traffic and heavy operat- 
 ing expenses, this connecting line up to the date of 
 the receivership had shown large deficits under fixed 
 charges which were made good by the guarantors. 
 When reorganization became necessary in 1895, the 
 bondholders of the Atlantic and Pacific were unwilling 
 to accept the deficits under the bookkeeping as prov- 
 ing the small value of their property, claiming that the 
 commercial and fair worth had never been properly de- 
 termined by the Atchison system when solvent. In 
 such cases the only sure ground for determining the 
 values of auxiliary properties or for refusing acquies- 
 cence in a new lease or in a reorganization plan, is the 
 real commercial earning power or importance of the 
 property in dispute. If such power has never been 
 ascertained in the manner already indicated, the 
 holders of bonds need not consent to a reduction until 
 such appraisement has been made by competent author- 
 ities. There is every chance for fierce disputes at just 
 this point ; for in cases of bankruptcy the own 
 roads on the main lines naturally look upon their lien 
 as paramount to obligations of any kind due to sub 
 sidiary companies ; and technically they are of course 
 right. But the question at once arises ; whence comes 
 the traffic which, moving over the main lines, yields 
 th • train on whicb the senior tnortgagi has tin- 
 first claim ? If from the Stations Oil the main lines - 
 
 if it is strictly " local " the branch holders may be 
 told to " take tluir road." Bui if, as often happens, 
 tht figures prove thai an important part of this traffic 
 is interchanged with branch roads, as in the ca 1 oi 
 the Union Pacifii befon mentioned, then those branch 
 
 ntitled to an equitable share in th 
 ity of the system wl that may be ; a share to be 
 
7 2 Corporation Finance 
 
 decided by the proportion which branch-line earnings 
 properly determined bear to the whole. For these 
 reasons the real value of branch lines and branch-line 
 bonds, when not settled until insolvency or termination 
 of a lease, give rise to endless controversies. And yet 
 the obligations of subsidiary companies when based 
 upon values which by custom have come to have a 
 substantial basis, are safe investments ; though those 
 values ought to be established through accurate stat- 
 istics from the very beginning. 
 
 It thus appears that branch lines are necessary to 
 the development of the railway systems of our newer 
 States and equally a necessity to the growth in wealth 
 of the sections of the country traversed by them. It 
 also appears that certain of these branches may have 
 shown a yearly deficit under their own fixed charges, 
 although the indirect benefits to the main lines may 
 have been greater than the deficits paid from the com- 
 pany's treasury. In such case, however the accounts 
 may be kept, the total result is a gain to the system. 
 The question now arises, how should these deficits be 
 treated in the company's books ? In some instances 
 railways have preferred that the gross earnings should 
 at first be reported as favorably to the main lines as 
 possible in order that these might make a better show- 
 ing. Sometimes controlling companies in making up 
 their accounts for the year omitted those branch-line 
 losses from their income statements, charging them 
 instead as "loans" to subsidiary companies or as 
 " investments " in branch-line bonds and stocks. 
 
 It would not be equitable to condemn every instance 
 of this kind. If a reasonable expectation existed that 
 the increase of traffic upon a new branch would in a 
 year or two be such that the owning company would be 
 
Subsidiary Companies : their Securities */$ 
 
 reimbursed for such branch-line advances, the policy 
 of carrying such deficits as loans for a short time might 
 properly be followed. Instances may be found in the 
 history of the Louisville and Nashville Railroad where 
 some branch lines wisely projected but which did not 
 yield in the first year or two direct income sufficient to 
 pay the accruing bond interest, soon developed traffic 
 enough to pay back to the parent company the full 
 amount of all fixed charges from the beginning. 
 
 But railway managers are perforce optimistic, and 
 share owners are naturally desirous of the best possible 
 returns from their holdings ; so managers were led to 
 continue the practice once begun of charging branch- 
 line losses to capital instead of deducting them from 
 income. So dividends, or perhaps bond interests, were 
 paid year by year on alleged earnings of the main line, 
 when in fact such earnings were annually overstated. 
 The Louisville and Nashville Railroad just mentioned 
 is an instance of this latter policy also : for in [894 it 
 began for the first time to deduct from its profit-and- 
 loss statements the losses on one of it- main branches 
 which it had for years tx 1 \ dug as " assets " 
 
 in an optimistic hope that the amounts "advanced" 
 to the branch would be mad'- up from increased earn 
 ings. In that same year, 1894, the New York, Lake 
 Brie, and Western beg in also for the fust tim< to de 
 duct thi : its auxiliary companies from its main 
 
 line income account. The policy of carrying branch 
 line deficits as assets in thi gent ral balance sheet was 
 carried out systematically by the Richmond and \\ 
 Point Terminal Railway and \\ Company. 
 
 Those who widi to follow the matter further will find 
 
 abundant illustration in th( and rep 
 
 that company and of the railways embraced in its 
 
74 Corporation Finance 
 
 control. In this way "investments" in branch-line 
 roads or other subsidiary property were increased on 
 one side of the ledger, to be balanced by an equal 
 increase of funded, floating, or current debts on the 
 other. It was inevitable under such a system of 
 accounting and of dividend paying that the real weak- 
 ness of a system should be revealed at the first touch 
 of adversity. It usually happens that the limit of credit 
 to such a company comes at the very time when good 
 credit is essential in order to tide affairs over a tempo- 
 rary decline in profits. No more money can be bor- 
 rowed, for the borrowing powers have been exhausted 
 in order to collect funds for past payments to bond- or 
 stockholders ; a receivership then becomes unavoidable 
 and the true state of things becomes publicly known. 
 
 A few systems, some only when really insolvent and 
 some while solvent, have adopted the policy of charg- 
 ing off against surplus income the losses of auxiliary 
 companies which had been accumulating perhaps for 
 many years. Such housecleaning should be general. 
 A healthy financial opinion regarding the wisdom of 
 conservatism in estimating profits, is not the least of 
 the good effects of business depression. Among sys- 
 tems which have pursued a rash course so long that 
 the holdings of shares are endangered, it is useless to 
 hold the accounting department responsible. As re- 
 marked, the process of debiting or crediting items to 
 certain accounts on certain ledgers, is simple ; the real 
 difficulty lies in putting a correct opinion upon the 
 items themselves and in formulating a clear mercantile 
 theory about them and that which they represent. 
 
 In a large number of cases the parent company, in 
 order to create a market for branch-line bonds or to 
 buy the control of certain independent roads, has guar- 
 
Subsidiary Companies : their Securities 75 
 
 anteed the payment of interest on these bonds as well 
 as payment of the principal at maturity. In our corpo- 
 ration history there have been instances of the repudia- 
 tion of such guaranties, and the question of their com- 
 mercial value is raised in the reorganization of nearly 
 every large system. The forms of words which contain 
 this guaranty are many. "For value received" is 
 perhaps the most common, the usual meaning of that 
 phrase being that the traffic connection gives to the 
 guaranteeing company an equivalent for its obligation. 
 In certain cases the language means merely that the 
 parent company agrees that the interest shall be paid 
 to the bondholders : it then sometimes happens that 
 the obligating company purchases the coupons without 
 cancelling them. By this method the lien of interest 
 would not lie discharged but kept alive : and at the 
 maturity of the mortgage these purchased coupons are 
 legally entitled to rank with the bonds in claiming part 
 of the property. An instance may be found in the his- 
 tory of the consolidation of the former roads into the 
 Pittsburgh, Cincinnati, Chicago, and St. Louis Railway 
 Company in 1890. The practical effectofsuch purchas- 
 ing is to weaken the value of the bonds to that « stent. 
 The guaranteeing company, however, cannot " pur- 
 chase" coupons, but must pay and cancel them unless 
 s authority for the former course. 
 
 ( nh'T forms of guaranty rtain specific 
 
 sid< rations or refer back to certain conditions nol given 
 in the endorsement on the bond but contained in the 
 
 olutions of the Board of I and not easily 
 
 accessible to the public. If the matti r is of importance, 
 it is advisable for all holders of guaranteed bonds to 
 consider the form of guaranty carefully and to obtain 
 and read the proceedings of the different board 
 
7 6 Corporation Finance 
 
 directors or officers or committees which have dealt 
 with the subject. In this way a clear idea may be 
 obtained of the nature of the obligation and of the con- 
 sideration which has been given for that obligation. 
 
 The courts have always upheld and enforced the 
 guaranties of railway companies whenever that was 
 legally possible ; still, if a company resolves to repudi- 
 ate its obligations, it will often find a legal reason for 
 so doing. The laws governing such transaction in the 
 several States are sometimes conflicting, and the ques- 
 tion of the applicability of this or that statute or section 
 of the constitution to a particular case is often so much 
 in doubt that the question of lack of power to make 
 such a contract or to enter into such a guaranty is 
 easily raised if a company needs to do so ; and it is 
 often hard to settle. The innocent holder of repudiated 
 bonds is entitled to the benefit of every doubt and usu- 
 ally gets that benefit ; but, as before stated, if a com- 
 pany decides to dishonor its promises, the legal points 
 it ma} 7 raise are many, and the result not always clear. 
 The repudiation by the Evansville and Terre Haute 
 Company in 1894 of its guaranty on Evansville and 
 Richmond bonds is in point. In estimating the value 
 of guaranteed bonds, therefore, the holder must take 
 into consideration the general reputation for good faith 
 and solvency which the company bears in the opinion 
 of the financial public. 
 
 There have been instances in our corporation experi- 
 ence in which companies have justified their repudiation 
 of guaranties by a general argument. That argument 
 usually runs thus : " A company has guaranteed the 
 almost perpetual payment of certain interest. At the 
 time such an agreement was made the circumstances 
 justified the bargain ; the branch taken over was worth 
 
Subsidiary Companies: their Securities ~j 
 
 to the main company all that was annually to be paid 
 for it. But in a lew years business changed greatly ; 
 another road was built into the branch's territory, or 
 the mine or manufacturing, for which the branch was 
 projected, gave out. In fine, the yearly result to the 
 guaranteeing company is now a heavy deficit under the 
 agreed rental. Should the company be kept to the 
 letter of its contract no matter what happens, or should 
 the branch share in the common loss ? The equity of 
 a continuing contract is a thing yet commercially unde- 
 termined. In business affairs most continuing contracts 
 which involve loss upon either party are settled either 
 by a compromise or by the insolvency of the losing 
 party. In trade the instances are very few indeed 
 where such losses are paid regularly year by year 
 indefinitely. It is true that for obvious reasons the 
 courts always insist upon the letter of a contract because 
 the sacredness of contracts is vital to business ; yet the 
 statement that no machinery exists for determining 
 such questions does not alter the fact that the common- 
 sense of mankind is against the enforcement <>f such 
 unfair contracts running indefinitely. The principle is 
 the same as that which allows a debtor to escape his 
 
 debts under certain conditions, because it would be 
 
 hopeless and cruel to keep a man in jail or even in debt 
 for his whole life. Th il no such rule exists lor corpo- 
 rations merely shows that corporation law has nol 
 that far: meanwhile suffering companies try to reach 
 
 precisely that end through legal quibbles and consider 
 them I i i ommi rcially entitled I rythi ir pur] 
 
 out if pi 
 
 uments like these have - om in. \ thinkers, 
 
 and in con • quen< e pro] tim< hi aid 
 
 that continuing guaranties should be made adjustable 
 
yS Corporation Finance 
 
 as to percentage of returns every ten or twenty years. 
 The lease of the Central Pacific to the Southern 
 Pacific was so drawn. The argument of a defaulting 
 corporation is, however, usually weakened by the facts 
 of the case. A company wishes at the time to build a 
 new line or buy control of one already existing. The 
 situation is carefully considered by the officers and 
 directors and the degree of necessity decided upon. 
 That company must pay for that line, and must agree 
 with the money-lenders or the owners as to terms. If 
 it could borrow money on its guaranty at five per cent., 
 let us say, but could not induce the capitalists to build 
 the line and take their chances without a guaranty at 
 less that ten per cent., let us suppose, then clearly 
 enough the five per cent, saved annually by guarantee- 
 ing the bonds is a part of the consideration though it 
 ma}' not be mentioned in the documents ; the saving is 
 of the nature of an insurance given by managers who 
 ought to know what they are doing. If now the expect- 
 ations of these managers be not realized, it is not sim- 
 ple equity to demand a readjustment. If that had been 
 the idea originally, the investors would have demanded 
 much higher returns at the start. Readjustments have 
 never been in commercial favor even when provided for 
 in contracts. The statistics are in the hands of one of 
 the parties, the other being able to get but slight 
 knowledge of the real facts. For these reasons capital- 
 ists have been unwilling to accept adjustable guaran- 
 ties, considering them not so much inequitable as 
 uncertain and indefinite. 
 
 It follows from what has been said that guaranteed 
 bonds are often safe but sometimes not. It is a mistake 
 for investors to buy bonds merely because they are 
 guaranteed, and oftentimes a mistake in financiering 
 
Subsidiary Companies : their Securities 79 
 
 for companies to issue them expecting them to find 
 favor on that ground alone. The terms and conditions 
 under which the guaranty was given, the form in which 
 the obligation is set forth, the good faith of the guar- 
 anteeing company, are all to be carefully considered. 
 In some cases the replies to these questions will be so 
 satisfactory that no further investigation need be made, 
 especially if we believe the revenues of the company to 
 be equal to the fixed charges and something more ; for 
 the ability of a company to earn its interest is as im- 
 portant as its intention to pay if earned. 
 
 In a large number of cases it is well for the investor 
 to look a little further and for the company to ask him to 
 do so. The question in such an investigation is: Does 
 the guaranty represent the commercial situation ? Does 
 the branch line really earn the interest on its bonds? 
 Is it as it stands worth to the guaranteeing company 
 all that it o>sts that company annually in interest and 
 expenses? II" so, the bonds are, for the time at least, 
 ire. This question is in a great many cases very 
 hard to determine. The same neglect which has been 
 discussed in previous pages of tin's chapter regarding 
 branch lines whose bonds are not guaranteed, follows 
 these guaranteed roads also. Man} companies haw- 
 not kept these accounts so as to show whence their 
 revenues are really derived ; such companies oughl to 
 suffer in credit for their carelessness. The financial 
 position of branch line bonds, whether dependent upon 
 tli'- traffic of the roads covered or upon the guaranty 
 of the main line, should be clearly d< lined. An opinion 
 as to the -.iluc of such branch line bond gu irant ed 
 or not, is then possible. The mot.- favorable that 
 opinion, the bettei i- it for tin- company which is 
 responsible for them. 
 
CHAPTER V 
 
 CORPORATION ACCOUNTING 
 
 EVOLUTION in accounting is to be expected the 
 same as in the methods of conducting business. 
 As the transactions become numerous and increase in 
 complexity, a corresponding change in the style of keep- 
 ing the books is demanded. The principles of book- 
 keeping are simple, and the various kinds of entries are 
 easy of general comprehension. The practical difficulty 
 lies in making the books set forth the real facts ; for it 
 is in judging of the true meaning of those facts that the 
 statistician's art consists, the process of recording the 
 figures, once the facts are agreed upon, being compara- 
 tively easy. Moreover, truth is many-sided ; a business 
 optimist will see things favorably and make up his fig- 
 ures accordingly, while an ultra-conservative merchant 
 will seek to have the position of his affairs set forth in 
 the most unfavorable light. There is the more excuse 
 for optimism in corporation matters, for corporations 
 live on, and having more extended credit, often live 
 down losses which would wreck partnerships ; thus 
 it sometimes happens that for his own reputation's 
 sake and because of that good credit, the manager of 
 a large corporation will give to his statements the 
 brightest colors that the circumstances permit. For 
 these reasons criticisms upon corporation reports are so 
 often unfavorable ; not because of malice on the part of 
 
Corporation Accounting 81 
 
 the critic, so much as of abounding optimism on the 
 part of the usual corporation manager. The excuse for 
 such optimism should fairly be taken into account : 
 that there is no hard-and-fast line between fact and 
 credit ; that many a railway (for illustration) is helped 
 over a bad place by its credit, and helped safely, 
 whereas if the exact truth were known, that credit 
 might be destroyed and with it perhaps the whole 
 capitalization. A little unwilling forbearance on the 
 part of creditors may bring everything around right 
 and cause no loss. 
 
 Every corporation must adopt such forms of accounts 
 as suit its particular business. They should embrace 
 such a number of separate books as will enable the 
 management to know exactly what is being done in 
 every department and in every detail and at what cost. 
 Tlie collection of statistics costs money, but modern 
 experience is showing that only by accurate statistical 
 knowledge can modern business be successfully carried 
 • m. There are good systems containing elaborate pro- 
 visions for ascertaining the various costs in manufactur- 
 ing. A corporation should be more, rather than less, 
 exact than a firm. The sources of profit down to the 
 minutest detail should he carefully inquired into ; in 
 no other way can the manager know which class of 
 
 work to encourage, or which to study with a view <>t 
 improving tin- process of production. 
 
 In large companies the main account is that ot the 
 i. in which arc regularly stated 
 the otinr accounts such as surplus income or profit 
 and loss. Tims the balance-sheet reflects merel) the 
 changi - in the g( n> ral condition during the year, not 
 the amount of profit. This table or si itement is the 
 oni upon which the lend r of money or the investor 
 
82 Corporation Finance 
 
 should bestow his careful scrutiny, because on the 
 interpretation of the items depends one's judgment as 
 to the solvency of the company. The income table is 
 simply an account of the earnings and expenses in 
 totals, together with the proper deductions from the net 
 revenue for the year. Accompanying the income 
 account should be tables explaining in full detail the 
 items there given in gross. There may be a difference 
 of opinion between the managment and the bond- or 
 shareholders as to the proper disposal of certain items 
 of expenditure made during the year. There may be 
 a legitimate question whether such items are properly 
 chargeable to income or not ; such questions are not 
 only theoretical but very practical, because on their 
 answer often depends whether a dividend is paid or not. 
 For such reasons the report which every corporation 
 ought to make to its shareholders and the public (if the 
 public holds the shares) should contain statements in 
 sufficient detail of every transaction during the year, 
 whether included in the income account or not, in order 
 that every one may form his own judgment on the wis- 
 dom of the management and the safety of his invest- 
 ment. 
 
 In cases where the charging of items of expenditure 
 to the income account may be a doubtful policy, or 
 where, from the nature of the case, it is difficult to 
 decide such questions, since the answer may depend 
 upon one's opinions as to the business prospects for the 
 future, the profit and loss account offers an easy com- 
 promise. To this profit and loss account may be cred- 
 ited annually all the surplus earnings of the corporation 
 over and above fixed charges and dividends, or fixed 
 charges only, leaving dividends for the profit and loss 
 table. Against these surpluses may be charged from 
 
Corporation Accounting 83 
 
 time to time the cost of unproductive improvements ; 
 the deficits of subsidiary companies, which for the time 
 must be met from the revenues of the owning corpora- 
 tion ; sums which have been included in the earnings 
 of previous years and which have now proved uncollect- 
 ible, and in general all items which, in the judgment 
 of the management, should not be deducted from the 
 income of the year, but which good financiering re- 
 quires should be treated in the accounts in some way as 
 debits, even if temporarily, in order that no inflation in 
 the assets may occur. Such a profit and loss account^ 
 if carefully and fully kept, will prove a better test of 
 the earning capacity of the company than the income 
 account, which shows the profits in any one year, for 
 the reason that the former table gives an average of 
 results extending over a number of years. The annual 
 reports of the Denver and Rio Grande Railway are 
 worthy of study in this particular. 
 
 One of the perplexing things in the financial man- 
 agement of a large manufacturing or trading company, 
 is the treatment of the expenditures for the care of the 
 plant. A depreciation account in some shape must be 
 kept by every company or firm in business. The real 
 estate may decline in value, and in any case, in an\ 
 
 progressing concern, money will he required to he 
 spent each year to adjust the buildings more perfectly 
 to the requirements of the business, and yet these ad- 
 justments may not a. Id anything to the salable value 
 of the property, and should not, therefore, be added 
 in tip- accounts to the company's investment in real 
 In like manner, machinery will wear out, and 
 ilwavs subject to the danger of new inventions, 
 which m.r. n rider the old machinery practically worth 
 
 It is not easy to f! h<n a new outfit will 
 
84 Corporation Finance 
 
 be in part or in whole required, though experience 
 soon places a limit to the number of years in which a 
 given set of machinery may be useful. The proper 
 course in these cases is always the conservative one. 
 The corporation should estimate the probabilities of 
 depreciation always against itself, and set aside yearly 
 such sums from its profits as will suffice to renew so 
 much of the plant as may be expected to wear out or 
 to become useless in a given time. Unless this depreci- 
 ation fund is carefully thought out and its separation 
 from profits rigidly insisted upon, the shareholders of 
 the corporation and perhaps the bondholders may in 
 the course of years find that their securities cover a 
 property of little or no business value. If certain sums 
 are not set aside to meet this depreciation, and if for 
 this reason dividends are paid larger than would other- 
 wise be the case, to the extent to which this is carried 
 the returns received by the shareholders are not 
 dividends but their capital returned to them in piece- 
 meal. These depreciation sums should be real and not 
 merely bookkeeping liabilities of the company to itself. 
 Modern corporation accounting requires that in the- 
 ory a sharp line of distinction should be drawn between 
 outlays which may be considered a part of the regular 
 working expenses, and those which are chargeable to 
 an increased investment in the business. In theory the 
 former should be deducted from the gross earnings 
 before the net revenue is determined, while the latter 
 may be met by an increased issue of bonds or shares. 
 There is no doubt of the correctness of this principle in 
 general, but in its practical application it is subject to 
 great modification. English shareholders in American 
 corporations usually insist upon such a system of ac- 
 counting as divides the expenditures strictly according 
 
Corporation Accounting 85 
 
 to this rule ; and such indeed is the general practice in 
 Great Britain. By charging to capital every item small 
 and large which could hy any possibility be construed 
 to be a betterment, the British railways have increased 
 their capitalization until they are dependent for a con- 
 tinuance of interest payments on good traffics year by 
 year. Thus far no harm has come to these railways 
 from this policy, because the fluctuations in the vol- 
 ume of their traffics have been comparatively slight. 
 
 But in the United States more caution must be 
 observed in this matter. From the very nature of the 
 case, business of all kinds in a developing country must 
 be more subject to changes in profitableness than in 
 older countries. The very character of the American 
 people, energetic and progressive, makes business all 
 the more liable to such fluctuations. Bad years follow 
 good years in every line of American industry, although 
 differences are less violent in those trades which are 
 the longest established and among those companies 
 which have been in operation long enough to render 
 their business comparatively stable. The principle, 
 therefore, of charging all so-called betterments to cap- 
 ital and meeting the cost from the sale of bonds or 
 shares, requires modification according to the circum- 
 stances of each particular company. The more fluctu- 
 ating the volume of business lias been or is likely to be 
 the more important is it that in one form or another a 
 part <»f the profits in prosperous years should be with 
 held from tli- shareholders and pul into the property or 
 
 iside for its renewal. To those who wish a working 
 
 principle to distinguish the propel items to be charged 
 to capital accounl in the actual tnanagemenl of Ameri 
 
 ad other, the follow ill'.', 
 
 1 : Xo additions to the propei I \ 
 
86 Corporation Finance 
 
 either to the real estate or to the machinery (if a manu- 
 facturing company), or to the roadbed and track (if a 
 railway company), should be considered betterments 
 and charged to capital, unless they increase the pro- 
 ductivity or earning capacity of the plant. Under this 
 rule the purchase of additional equipment for a railway 
 would be an expenditure which could conservatively be 
 met by the issue of bonds or equipment notes, because 
 such purchases would enable a larger volume of traffic 
 to be handled ; on the other hand, the replacement of a 
 wooden bridge by an iron one would not be a proper 
 charge to capital, under our definition, unless it was 
 one of a series of expenditures deliberately resolved 
 upon in order that heavier trains could be run and a, 
 larger volume of traffic handled, thus increasing the 
 revenues of the company — an increase which our theory 
 demands should be clearly seen to be possible after the 
 various amounts of capital set aside for this purpose 
 had been spent. The same rule might be applied to 
 corporations other than railways ; the safe course is to 
 charge against revenues (possibly through the profit- 
 and-loss account) the cost of all additions to the prop- 
 erty which do not increase the output or decrease the 
 cost of production. Yet any rule or any principle in so 
 delicate a matter can properly be applied in each case 
 only after a careful study of all the circumstances, 
 including the business of past years and the prospect 
 for the future. With railroad laws in nearly every 
 State permitting unrestricted building, American rail- 
 roads are constantly liable to attack by competing lines 
 projected for legitimate or speculative purposes. In 
 England companies are not chartered unless a public 
 necessity for the proposed line is shown. In the United 
 States the only safe course for the old roads is to make 
 
Corporation Accounting 87 
 
 themselves strong by using a part of their earnings for 
 betterments, thus keeping down the capital accounts. 
 The Pennsylvania Railroad has pursued this policy for 
 forty years, having in that time, according to its re- 
 ports, paid eighty millions of dollars for betterments 
 out of profits. The foreign shareholders have fre- 
 quently complained of this policy, though experience 
 has shown it to be an essential element in the present 
 strength of that company. 
 
 On railways the working officers prefer to have 
 included in the operating expenses only such sums as 
 may rightly be grouped under that title. This is a 
 proper request on the part of the superintendents, 
 because the}- naturally wish that their administration 
 of the affairs of the company should be shown to be 
 conservative and careful. There is another reason 
 also for keeping operating expenses distinct, in that it 
 enables the managers to compare the same items of 
 expenses year by year. If these items are varied by 
 the inclusion or exclusion at times of sums whose 
 proper accountings may be in doubt, the comparison of 
 
 ts from year to year is vitiated and a valuable test 
 of the efficiency of the operating officers is lost. To 
 meet this requirement certain corporations deduct the 
 
 ■ 3 of Mich bettermi nts as one it' m from the net rev- 
 enue often in the income statement. The objection to 
 this course lies in the fact that the sums thus expended 
 lost si.^ht of; and to the extent to which those 
 items are hidden, the real amount of money spent upon 
 
 the plant is understated. This i^ not ;i mere hook 
 
 ping objection. The railways have found that the 
 
 real cosl of their property is a factoi in dealing with 
 
 ■■• < . Laws may be pa < d in order b 1 reduce 
 
 freight rates and passengi r fares t<> a point which shall 
 
88 Corporation Finance 
 
 yield the companies a return "on cost." The same 
 point may arise at any moment with companies other 
 than railways. Every corporation should therefore so 
 keep its accounts as to show the amounts expended to 
 improve the plant year after year from earnings. A 
 common custom is to apply the annual surplus directly 
 to the construction charges for the year, bonds being 
 issued for the amount of the capital account after thus 
 deducting the surplus. That custom practically adds 
 the surpluses spent for betterments to the capitaliza- 
 tion ; yet it is a question whether it would not be better 
 to open a comprehensive profit-and-loss account, in 
 which the cost of betterments, as well as other indirect 
 but necessary expenditures, could be included. 
 
 Corporations small in capitalization but public in 
 their nature and in their stock holdings, often conduct 
 businesses which do not require an elaborate system of 
 accounting. Such companies are often managed by 
 men who are themselves large owners in the property 
 and at the same time skilled in that particular trade. 
 Such men, for their own use or for that of the few other 
 shareholders, need only the simplest statements of the 
 business. It is customary in these small companies to 
 unite the general balance-sheet with the income ac- 
 count, and in their cases this custom leaves no diffi- 
 culty. On the one side are stated the items of cost of 
 property, the valuation of the tools and machinery, the 
 cash in the bank, perhaps the amount of interest 
 charges and dividends paid during the year, and the 
 working expenses. On the other side of the account, 
 the revenues of the year, the bonded debt, and the 
 current debt. Such simple statements are well enough 
 for those who understand the business thoroughly, 
 while the changes in the items from year to year allow 
 
Corporation Accounting 89 
 
 of the working out of the various principles which 
 have just been discussed but about which no such 
 sharp distinction need be drawn as in the case of large 
 manufacturing companies. The original cost of the 
 property can be written off from time to time by adding 
 to the cash on hand a yearly sum before dividing 
 profits ; a method of keeping a depreciation account 
 which meets the peculiar requirements of such com- 
 panies as have only a limited existence, such, for 
 instance, as those which operate a mine where the 
 amount of coal or ore can be estimated within reason- 
 able limits. This sum of money in the bank is then 
 applicable to the extinguishment of the bonded or 
 share capital at the proper time, or may be used for 
 heavy improvements to the property if such should be 
 decided upon. Small corporations which have been 
 formed for family reasons, and whose shares are held 
 by the former partners and not sold to the public, 
 require no special discussion. Their affairs are man- 
 1 very much the same as under the former partner- 
 ship. 
 
 The formation and increasing numbers <>f corpora- 
 tions whose shares are held by the public and whose 
 business is trading, have led to a more rigid system of 
 
 imating mercantile credits and of inspecting the 
 
 items upon which that credit is based. The evolution 
 
 ■i] .oration (or partnership 1 credit is one which must 
 
 work for the good of all concerned. Such companies 
 
 I 1 increasing opportunities for the investment of 
 
 small sums, and while tlin g ithi ring tOg< th( I the little 
 
 rivulets of capital, their managers should themselves 
 
 In- under a moral responsibility to take all the more 
 
 of other people's money. It is well therefore that 
 
 the affairs of trading companies should he subjected to 
 
90 Corporation Finance 
 
 such analyses as will indicate their solvency. Prepar- 
 ing statements that will stand examination is one of the 
 best tests to which corporation managers submit as 
 tending to bring the real position clearly before their 
 own eyes and making them conservative in conducting 
 the business and in estimating profits for the share- 
 holders. Following this thought further, below will be 
 found the statement of a non-existing trading com- 
 pany, whose assets and liabilities may be commented 
 upon without reserve. The figures chosen for the pur- 
 pose are intentionally doubtful and do not, of course, 
 reflect the real position of our small corporations. They 
 have been compiled in this form arbitrarily and for the 
 sake of comment. 
 
 "The Blank Trading Company" we will suppose 
 was incorporated for the purpose of importing and sell- 
 ing fancy goods. The statement below is assumed to 
 have been made December 31st and the inventory to 
 have been taken on the same day. The head office is 
 in New York City, with branches in Boston and Chi- 
 cago. The president of the company is interested in a 
 retail store in Chicago, to whom the company sells 
 goods. The statement of assets and liabilities of the 
 company is as follows: 
 
 THE BLANK TRADING CO. 
 ASSETS 
 
 A. Cash on baud $ 600 
 
 B. Cash in Consolidated and other banks 4 000 
 
 C. Bills receivable (due from customers) 7 000 
 
 D. " " (due from branches) 10 000 
 
 E. Accounts receivable (due from customers) 63 000 
 
 G. Merchandise (valued at cost) 170 000 
 
 H. Real estate 27000 
 
 J. Machinery and fixtures 800 
 
 K. Merchandise in bonded warehouses 37 600 
 
 $320 000 
 
Corporation Accounting 91 
 
 LIABILITIES 
 
 P. Capital stock {Preferred £50 coo 
 
 r (. common 50 000 
 
 Q. Bills payable for merchandise 47 000 
 
 R. " to banks 15 000 
 
 S. " " for commercial notes sold 10 000 
 
 T. Open accounts 109 000 
 
 V. Deposits of employees 4 500 
 
 X. Profit and loss 34 500 
 
 f32o 000 
 
 Some additional facts are assumed. A portion of the 
 merchandise in warehouses is subject to " trust re- 
 ceipts." There is a contingent liability (not shown in 
 the statement) of $20,000 for endorsed bills receivable 
 outstanding. About $12,000 of accounts and bills 
 receivable is acknowledged to be past due. Sales the 
 preceding year amounted to $350,000. Expenses of 
 conducting the business were $60,000, and dividends 
 of eight per cent, upon preferred and twelve per cent, 
 upon common shares, calling for $10,000, were paid 
 during the year. 
 
 First as to the items of the statement. Item A. cash 
 on hand, needs no particular comment. It represents 
 actual money in the hands of the company. In a few 
 instances where deliberate fraud was intended this item 
 
 has been manipulated. Sometimes the words •• and 
 
 cash items" have beet] added so thai uncollectible 
 
 bills or things of that character could, by a stretch of 
 language, be included. In one instance, where a pay- 
 ment was -0011 to he made to creditors, a sum of money 
 was borrowed from the bank and called " on hand," 
 
 though tin- 1, : m k by understanding did not allow the 
 
 • :n it DO ' ion, retaining it at interest 
 
 ■ statement day. But such cases are rare. "Cash" 
 has :i recognized meaning, and is correct!} accounted 
 
92 Corporation Finance 
 
 for by the vast majority of companies and firms. Item 
 B, cash in bank, also means what it says, being funds 
 of the company on deposit and subject to cheque ; as 
 our company is a reputable one, there is nothing to 
 cause doubt as to these items of cash, A and B. 
 
 Item C, customers' bills receivable is a small one. 
 If it were necessary to examine into it closely, one ought 
 to know something about the customers whose bills are 
 held and the character of the obligation. Business 
 methods have changed in recent years. It was at one 
 time the general custom to settle all accounts by giving 
 bills. Now, with the exception of a few trades, it is 
 customary to keep running accounts, so that the jobber 
 does not have his customers' due bills as evidences of 
 money owing to him as much as formerly. Of course, an 
 obligation signed by two known firms, though one be 
 small, is better than single-name paper ; but such paper 
 is no longer obtainable in quantities. In the present 
 case the item is considered a good asset. 
 
 Item D, covering bills receivable due from branches, 
 must be thrown out. Since the branches are parts of 
 the main house their obligations are also obligations of 
 the main house, and cannot in any w r ay be called assets. 
 The confusion sometimes brought into the matter of 
 the relations between parent houses and their branches, 
 or between the home office of a corporation and its sub- 
 sidiary offices, is cleared up when we remember that for 
 the general purpose of estimating upon the financial 
 value of shares and bonds, the branches and the head 
 office constitute but one concern. If juggling with 
 figures or technical book keeping operations is indulged 
 in, it is usually done to conceal annual losses or de- 
 preciation or else to make the reported condition seem 
 better than the reality. In small trading companies 
 
Corporation Accoimting 93 
 
 the matter is usually more simple. Instances have 
 been known where the head office, ignoring the real 
 position of its branches, has asked for bills payable to 
 cover only the book keeping debts due to the parent 
 company. These bills in the names of the branch were 
 endorsed by the manager and discounted at the bank, 
 the proceeds, of course, making a surprisingly excellent 
 showing in the annual statement. The indorsed bills 
 were not included among the liabilities because not 
 considered "direct" obligations. Of course, the ex- 
 hibit thus made was not a correct statement of the 
 company's real condition. Many trading firms and 
 corporations habitually exclude from their public an- 
 nouncement all indirect obligations of endorsement on 
 the ground that they become a proper charge only 
 when not paid by the maker. This is true so far as 
 the sheet itself is concerned, but the share- or bond- 
 holder who wishes to learn all the facts should know by 
 a separate statement how large these indirect endorsed 
 obligations are. If out of proportion, it then becomes 
 important to inquire why they exist, and how far the 
 makers are financially responsible. The matter of 
 indirect debts winch may become direct, is one which 
 should have careful consideration in all corporation 
 management. A manager willing to take advantage 
 of book keeping technicalities may not speak of con 
 tracts which he has made for the purchase of supplies 
 or machinery because dated ahead, and therefore not 
 yet direel itions ; but all such prospective debts 
 
 must be known if a < le ir view of the future is desired. 
 The Blank Trading Company acknowledge thai tin \ 
 b 1 contingenl liability amountin ..mm,. 
 
 I ' ■-:• : . 1 .1 mo I important 
 
 on'- in a trading company's stati tnent, and one equally 
 
94 Corporation Finance 
 
 hard to value. Book accounts and merchandise are 
 the main assets of firms and corporations doing a trad- 
 ing business. If, upon investigation, it is found that 
 these two items can be considered really good assets, 
 the company is justified in expecting credit. The first 
 question to ask concerning accounts receivable is : Are 
 they in proportion to the amount of business done and 
 not in excess of the proportion of the same item among 
 other houses in the same trade ? In some trades these 
 book accounts run fairly uniform throughout the year. 
 In others they vary so as to show large amounts at one 
 season with small sums at another ; in the latter case 
 one may judge of the item partly by the date of the 
 statement. In the particular line of trade which has 
 been chosen for our illustration the amount of accounts 
 receivable on the last day of the calendar year ought to 
 be quite small, increasing in amount from the first of 
 the year until the conditions are reversed by spring or 
 early summer. Perhaps ten per cent, of the gross 
 aggregate sales would be a fair proportion to expect for 
 this item in the statement under our assumed condi- 
 tions. It will be noticed that this item is, therefore, 
 about twice what it ought to be. This fact of itself 
 furnishes a reason for further investigation. It is, 
 of course, possible, that these accounts are all good 
 — possible, but not probable. One might inquire 
 how much of these book accounts is over-due and is 
 carried along by the company. If the proportion 
 of over-due accounts in this item is at all heavy, it is 
 an indication either that goods have been too freely 
 sold to irresponsible parties on credit, or else that some 
 misfortune, such as the loss of a staple crop, has fallen 
 upon a certain section of the community in which a 
 large quantity of The Blank Trading Company's goods 
 
Corporation Accounting 95 
 
 have been sold ; a possibility always to be borne in 
 mind when inquiring whether the credit risks are scat- 
 tered or practically confined to one or two sections of 
 the country ; to be sure not to be caught by any tech- 
 nical differences, one should ask how many of these 
 accounts have been extended when due, which, of 
 course, is another way of carrying them. If the com- 
 pany will make up a statement of the customers who 
 arc indebted, one may obtain their rating from a mer- 
 cantile agency and see what the proportion is between 
 their capitals as thus reported and the obligations in 
 question. If a large part of these obligations figure 
 out to be more than twenty-five per cent, of the capital 
 of these customers, one may distrust the value of their 
 accounts. In the present case, it is slated that the 
 president of the company is interested in a retail store 
 to whom the company sells goods. Technically we 
 may expect that the company would not consider the 
 account of this retail store as over-due, and yet it is 
 possible that the swelling of this item beyond the limits 
 customary in that particular line of trade may be owing 
 to the credits granted to this particular store. Perhaps 
 it is found that suspicions are in part confirmed, and 
 that the excess of hook accounts over the normal 
 amount is really (had wood carried by the company. 
 
 therefore, in his estimate of values, may put down 
 this item at atx >u1 % $< i,co >. 
 
 Item O, merchandise. It is so easy to accumulate 
 
 old and unsalable merchandise thai nothing but eternal 
 
 ilance can keep a firm free from that error. It is 
 
 difficult for the ordinary investigator to make up 
 his mind r< yarding this item in the company's state 
 ments ; so much depends upon the business instinct 
 with which the goods arc selected and the judgment 
 
96 Corporation Finance 
 
 with which the future of the particular trade is fore- 
 casted. Another matter that one should know is, on 
 what basis the value of the goods has been arrived at. 
 In our table it is stated that the merchandise is ' ' val- 
 ued at cost," meaning cost to The Blank Trading 
 Company. In these figures, therefore, is included the 
 manufacturer's profit, which again is affected by the 
 credit of the purchasing company. The open accounts 
 due by this corporation are fairly heavy, and one may 
 reasonably conclude that the merchandise has not been 
 reduced in cost by any discounts for cash. In short, it 
 is proper to refuse to accept this item at its face value 
 in estimation on the solvency of the company. 
 
 In judging of a firm's or corporation's solvency the 
 character of the goods dealt in must always be borne in 
 mind. The difference between staple and fancy goods 
 is one which not only distinguishes one trade from an- 
 other but is an important distinction many times to be 
 drawn between a certain set of articles and another in 
 the same store. Groceries may be accepted at almost 
 full value even under the hammer, while silks and rib- 
 bons are dependent upon the caprices of fashion from 
 one season to another. In like manner hardware can 
 be taken at a close estimate nearer to its inventory 
 value than can boots and shoes. Wool is a more stable 
 article than woollens ; and so we might go through the 
 list. In the present instance it is proper to say that 
 fancy goods are of uncertain value, yet one may assume 
 that The Blank Trading Company deals in the more 
 stable kinds. Nevertheless, it is clear that one cannot 
 assume the full value for the stock of merchandise in 
 question if sold at auction. Balancing all these proba- 
 bilities, the value of this item may be fixed at $100,000. 
 
 The proper valuation to be put upon book accounts 
 
Co7'poration Accounting 97 
 
 and merchandise in cases of insolvency are constant 
 subjects of study among those whose business it is to 
 loan money to firms or companies either by direct dis- 
 count or through purchase of commercial paper. Below 
 is a table of liquidating values for five trades, compiled 
 by a banker of experience : 
 
 Trades 
 
 Accounts Receivable 
 percentage good 
 
 Merchandise 
 percentage good 
 
 Hardware 
 
 72 
 
 80 
 
 Dry Goods 
 
 67 
 
 70 
 
 Boots and Shoes 
 
 80 
 
 65 
 
 Furniture 
 
 70 
 
 68 
 
 Groceries 
 
 40 
 
 95 
 
 The experience of different bankers and of different 
 trading firms and companies may be more favorable or 
 unfavorable than this table indicates regarding the 
 realizable value of book accounts and stocks of mer- 
 chandise. It should, therefore, be modified in accord- 
 ance with tlie business reputation of the men in charge, 
 or of the traders in tile particular section to whom the 
 goods have- been sold on credit. 
 
 Item II, real estate, S-?7,ooo. This value seems a 
 little high for the- comparatively small amount ofbusi- 
 ;;• done, and should have further investigation. 
 Some small companies, sometimes through carelessness 
 rather than actual error, add the cost of improvements 
 ■ to the value oi their real estate 
 
 until this item comes to stand on their books at an 
 amount much in excess <>t its actual selling worth. In 
 
 the present instance it is assumed that this has been 
 md thai the actual value of the property 
 by apprais il i- >i s.ooo. 
 
 It'-in J, machinery and fixtures, is a small one in 
 
98 Corporation Finance 
 
 ain- case and need not be commented upon. If it were 
 an important item, one should inquire as to the de- 
 preciation. 
 
 Item K, merchandise in bonded warehouses, $37,600, 
 is subject to the same criticism as regards its real value 
 as that already passed upon the merchandise in stock ; 
 that is, for the purpose of questioning the solvency of 
 the company or of putting a value upon its preferred or 
 common shares the figures named in the statement are 
 too high. In addition to this, it is noted in the business 
 statement that a part of this bonded merchandise is 
 subject to trust receipts. 
 
 It is a common practice for firms doing an importing 
 business to have the foreign goods consigned to a New 
 York City banking house, upon whom also the foreign 
 bills are drawn payable in a certain number of days, 
 varying according to the customs of the different coun- 
 tries. It frequently happens that these goods reach 
 their destination before the bills drawn against them 
 are due. In order that the merchandise may be sold 
 by the importing firm .soon after arrival, an arrange- 
 ment to this effect is made through trust receipts. 
 One form of such receipts gives the importing house 
 possession of the goods, but without title, the house or 
 corporation guaranteeing to hand the proceeds of the 
 sale over to the banking house. Another form permits 
 the putting of the goods in store under warehouse 
 receipts. These forms are varied according to the cir- 
 cumstances of the case and the credit and standing of 
 the importing company ; but in whatever way the busi- 
 ness is transacted, the meaning is that the merchandise 
 affected is not the property of the importing house, 
 and cannot, therefore, be included in its list of assets. . 
 In the present case, something must be deducted from 
 
Corporation Accounting 99 
 
 this face value on this account also. It will be dealing 
 generously with this item if it is put down at $20,000. 
 
 By adding up the assets as re-valued, we find the 
 total to be $177,400. A glance at the table of liabil- 
 ities shows a total of $320,000. If from this one deducts 
 for his own purpose capital stock and the profit and 
 loss — the latter item being simply to balance accounts, 
 — he finds the actual debts for money to amount to 
 
 s.ooo, or about $8000 more than the assets as valued 
 in our examination. This means, in effect, that if the 
 company should be wound up, the holders of both pre- 
 ferred and common stock would lose their whole invest- 
 ment and very likely some of the creditors also would 
 not be paid in full. Although according to the state- 
 ments this trading company paid dividends last year 
 amounting to eight per cent, upon the preferred and 
 twelve per cent, upon the common shares, yet it is 
 clear that no dividends ought to have been distributed 
 until a fund had been accumulated which would bal- 
 ance tlie possible bad debts and depreciation of mer- 
 chandise of which we have spoken. 
 
 'I'll- sales are stated to have amounted the preceding 
 
 ' to $350,000. This, it will be noted, is only y/ 2 
 times the capital. There has been some gross misman- 
 
 mi nt o\ the business because modern conditions 
 demand that the capital should be tinned over many 
 
 more times than this during tin- year. This impression 
 
 onfirmed when we loot at the amount of business 
 
 i,OCK >. Taking the expenses and dividends 
 
 ther, it will he noticed that it required twenty per 
 
 cent, profits on the small amount of sales t<> meet them. 
 
 F hou esin tl of sharp competition 
 
 • .hi in- assured of the continuance of so large an aver 
 
 rofit as that at wholesale. There is clearly 
 
ioo Corporation Finance 
 
 something the matter with the affairs of the company. 
 It is possible that some of the excess in accounts receiv- 
 able already spoken of represents bad debts contracted 
 by the company in order to cover so large an amount 
 of business expenses. To secure so large a percentage 
 of profit they have been willing to sell goods to retail 
 houses with indifferent credit. If these bad debts had 
 been charged off there would have been no dividends 
 and it might have been found that expenses had not 
 been earned. 
 
 Although the valuation put on the assets shows that 
 at forced sale they would only realize enough to pay 
 the creditors, it does not follow that the affairs of the 
 company cannot be retrieved. There is a foundation 
 here for better business. If energy and ability can be 
 secured, in the management, the amount of sales can 
 be doubled and expenses reduced so as to show a great 
 change in the proportion to the volume of trade. If for 
 a while the profits thus realized could be applied to the 
 reduction of the uncertain items among the assets, it is 
 possible that in a few years the aspect of things could 
 be so completely changed as to show that the company 
 was again in a sound condition. 
 
 Complete change in the modern methods of supply- 
 ing mercantile credits makes it necessary for the lender 
 of money whether on commercial paper or in the form 
 of bonds or of preferred shares, to rely upon the general 
 solvency of the firm or corporation. This of itself 
 makes needful a more or less thorough investigation 
 into the whole affairs of the borrowing houses. Very 
 likely in this matter as in other lines of business there 
 will arise banks and banking houses which will make 
 a specialty of such loans. 
 
 The same set of facts puts a new responsibility upon 
 
Corporation Accounting 101 
 
 the firms and companies which ask for credit. These 
 requests for loans involve' two things : firs;, that the 
 borrowers are honest and mean to pay- — which, in the 
 majority of cases, is taken foi g&Sntgcl, --^iiid .'second, 
 that there is a reasonable hope of their ability to pay. 
 This latter point does not concern the honesty of the 
 managers, but depends for its answer upon a wide esti- 
 mate of business facts. It is, therefore, no reflection 
 upon a borrowing firm or company to have the investor 
 or lender ask for such a statement of their affairs as 
 shall enable him to form a business judgment upon 
 their condition. The asking for investment money on 
 mercantile loans from banker or investor implies, there- 
 fore, that such a statement shall be forthcoming. 
 
 The habit of making such statements for more or less 
 public examination will cause the managers to give 
 even closer attention to the meaning of various items 
 which they are earning upon their books. In this way 
 conservatism is increased by the conditions of doing 
 business, which now demand, on the one side, large 
 loans of capital, and, on the other, business ability and 
 honesty without sentimentalism. 
 
CHAPTER VI 
 
 THE EXAMINATION OP RAILWAY REPORTS 
 
 THE bonds and shares of the railways of the United 
 States form the most available investments or 
 instruments of speculation for the people. The general 
 knowledge about railways is greater and the industry 
 itself more firmly established than is the case with 
 other large enterprises. The securities of these rail- 
 ways are the ones most prominently dealt in upon our 
 exchanges, thus giving to holders the important advan- 
 tages of easy and quick purchases or sales. For these 
 reasons it is advisable that the items which are con- 
 tained in the usual annual reports should be analyzed 
 at length and in detail, in order that any purchaser or 
 holder may be able to form for himself a general idea 
 of the meaning of railway statistics and of the import- 
 ance of the differences appearing in those reports from 
 year to year. 
 
 The Great Eastern Railway is a supposititious road in 
 the United States east of the Missouri River. Having 
 no actual existence, its supposed records can, without 
 invidious comparisons, be made the text of an examin- 
 ation into the meaning of railway statistics, and the 
 relation of one item to another in such tables as are 
 usually printed in railway annual reports. 
 
 Although paying four per cent, dividends, it is 
 assumed that the stock of the Great Eastern Railway 
 
The Examination of Railway Reports 103 
 
 is not quoted at very high prices on the exchanges. A 
 company which is really earning four per cent., and 
 which seems likely to continue earning and paying 
 that dividend, usually finds its stock well thought of in 
 financial circles. Contrary to this rule, a holder of 
 Great Eastern shares sees his stock declining under 
 daily sales presumably by " insiders." Naturally his 
 attention is aroused ; he asks himself why the prices 
 of his shares should fall ; in search of information 
 which should satisfy his questionings, he first takes up 
 the annual report of his railway and looks over the 
 figures given therein. On the first pages he finds an 
 income account for the last fiscal year, containing 
 nothing which on the face of it could be construed 
 unfavorably. The statement of the result of the year 
 is as follows : 
 
 GREAT EASTERN railway : INCOME ACCOUNT 
 
 TO JUNE 30 
 
 Gross earnings : passenger £1,080 000 
 
 freight. 5,600 000 
 
 mail and express 120 OOO 
 
 Total 6,800 000 
 
 Operating expenses (62 pei cent.) 4,200 000 
 
 2,600 OOO 
 
 Add interest on bonds owned 250 000 
 
 2,850 000 
 
 \ 
 
 bond interest. . .. 1,300000 [,400000 
 
 income [,450 000 
 
 at [,200 000 
 
 Surplus for thi tried to profit and loss 250 000 
 
104 Corporation Finance 
 
 On succeeding pages of the annual report are given 
 the results for the year of the Rich Valley Railroad, a 
 branch or feeding line, owned by the Great Eastern 
 Company, but operated independently : 
 
 Gross earnings $1,500 ooo 
 
 Operating expenses 1,400 000 
 
 Net earnings 100 000 
 
 Guaranteed bond interest paid 700 000 
 
 Deficit for the year 600 000 
 
 There is nothing which necessarily shows bad man- 
 agement in the fact that a ' ' feeder ' ' is not self-sup- 
 porting. The Rich Valley, as its name implies, may 
 be a short line running through a rich agricultural 
 and manufacturing district, the greater part of whose 
 traffic is carried by the parent road to the great mar- 
 kets. Were it not for this branch the traffic would 
 seek a rival road. Hence in this case the profits result- 
 ing from the carriage of this extra business are worth 
 to the Great Eastern Railway, it is assumed, a great 
 deal more than the $600,000 which it loses through its 
 guaranty of Rich Valley bonds. The policy of build- 
 ing or purchasing branch lines which are run at a loss 
 may, of course, be carried to such an extreme as to 
 involve the guaranteeing company ; particularly when 
 the real effect of such annual losses is concealed by the 
 method of book-keeping adopted in this case. Clearly 
 the Great Eastern Company must pay this deficit of 
 $600,000 ; but from what fund ? Since the gross and 
 net earnings of the main line receive all the benefit of 
 the traffic turned over to it by the branch, and since, as 
 we have assumed, this benefit is great, it follows that 
 the cost of procuring that extra traffic is a proper 
 
The Examination of Railway Reports 105 
 
 charge against the income helped thereby. In other 
 words, the annual loss of $600,000 on the branch line, 
 unless clearly but a temporary deficit, ought to be 
 deducted from the gross income of the Great Eastern 
 Railway before a dividend is declared. If this is not 
 done — and a glance back at the income account pre- 
 sented shows no mention of the item, — the real earning 
 power of the company is to that extent overstated and 
 the dividend unjustifiable. 
 
 How, then, is the deficit of the Rich Valley branch 
 carried ? To answer this question the general balance- 
 sheets for two years must be examined. These gen- 
 eral balances show on the one side the assets of the 
 company and on the other the liabilities. The different 
 amounts are stated at their face and not at their intrin- 
 sic values. Ordinarily it is useless labor to go through 
 >mpany's general balances for the sake of getting at 
 the actual worth of the properties. Hence, for the 
 information of ordinary shareholders, the most import- 
 ant object in having general balance accounts is the 
 opportunity afforded for annual comparison. II we 
 note- the changes in the items from one year to another, 
 we can often get valuable hints about the real pros- 
 perity of the company, because the facts thus revealed 
 may not be mentioned in the text of the annual report. 
 
 t, then, should be stated the balance-sheet for two 
 
 rs : 
 
io6 
 
 Corporation Finance 
 
 GREAT EASTERN RAILWAY 
 GENERAL ISALANCE-SHEET, JUNE 30, PREVIOUS YEAR 
 
 Assets 
 
 Liabilities 
 
 Cost of road 
 
 |45,ooo 
 
 000 
 
 Capital stock 
 
 $30,000 000 
 
 Cost of equipment 
 
 10,000 
 
 000 
 
 Funded debt (5 %), 
 
 25,000 000 
 
 Stocks owned, 
 
 
 
 Interest accrued. . 
 
 500 000 
 
 Rich Valley Co. 
 
 1,000 
 
 000 
 
 Due connecting 
 
 
 Five per cent. 
 
 
 
 
 600 000 
 
 bonds of Rich 
 
 
 
 Due for wages. . . . 
 
 500 000 
 
 Valley branch 
 
 
 
 Supply accounts 
 
 
 
 5,000 
 
 000 
 
 payable 
 
 100 000 
 
 Advances to Rich. 
 
 
 
 Claim vouchers 
 
 
 Valley 
 
 400 
 
 000 
 
 
 100 000 
 
 Due from connect- 
 
 
 
 Profit and loss. . . . 
 
 5,500 000 
 
 
 250 
 
 000 
 
 
 
 Materials on hand, 
 
 200 
 
 000 
 
 
 
 Accounts receiv- 
 
 
 
 
 
 able 
 
 100 
 
 000 
 
 
 
 Suspense accounts 
 
 100 
 
 000 
 
 
 
 Cash on hand. . . . 
 
 250 
 
 000 
 
 
 
 
 $62,300 
 
 000 
 
 $62,300 000 
 
 GREAT EASTERN RAILWAY 
 
 GENERAL BALANCE-SHEET JUNE 30, PRESENT FISCAL YEAR 
 
 (Corresponding to the income account given above.) 
 
 Cost of road 
 
 $48,000 
 
 000 
 
 
 $30,000 000 
 
 Cost of equipment 
 
 11,000 
 
 000 
 
 Funded debt (5 ',;). 
 
 27,000 000 
 
 Stocks owned, 
 
 
 
 Interest accrued . . 
 
 700 000 
 
 Rich Valley 
 
 
 
 Due connecting 
 
 
 
 5,000 
 
 000 
 
 roads 
 
 1,000 000 
 
 Advances to Rich 
 
 
 
 Due for wages . . . 
 
 700 000 
 
 Valley 
 
 i,ooo 
 
 000 
 
 Accounts payable, 
 
 300 000 
 
 Due from connect- 
 
 
 
 Bills payable 
 
 1,000 000 
 
 ing roads 
 
 200 
 
 000 
 
 Supply accounts 
 
 
 Materials on hand 
 
 150 
 
 000 
 
 pavable 
 
 300 000 
 
 Accounts receiv- 
 
 
 
 Claim vouchers 
 
 
 able 
 
 300 
 
 00c 
 
 
 200 000 
 
 Suspense accounts 
 
 200 
 
 000 
 
 Profit and loss. . . . 
 
 5,750 000 
 
 Cash and cash 
 
 
 
 
 
 items 
 
 100 
 
 000 
 
 
 
 
 $66,950 
 
 000 
 
 $66,950 000 
 
The Examination of Railway Reports 107 
 
 A brief explanation of the items first may be desir- 
 able. The costs of road and equipment are approxi- 
 mate statements of the amount of money spent for these 
 objects, though they contain items which are only in- 
 directly a charge against cost. For example, in those 
 balance-sheets will be noticed an increase of bonds from 
 S-.S. 000,000 to $27,000,000 during the year. If these 
 bonds were sold at a discount, .say twenty per cent., 
 the amount so deducted from their face value, $400,000, 
 would not represent money put into the road directly 
 or physically, though the whole increase, $2,000,000, it 
 will be noticed, is added to cost of road in another way, 
 /. 1 ., in its lack of credit. Sometimes this item of bond 
 discount does not arise from lack of credit but from an 
 attempt to issue bonds at a rate of interest so low, com- 
 pared with the ruling rate in the money market, that 
 par cannot be obtained for the bonds. In such cases, 
 since the income account presumably is benefited by 
 the small animal interest charges, that same income 
 account should be debited each year with a proportion 
 of the loss by the discount. The item profit and loss 
 has misled many. If the assets foot Up more than the 
 
 liabilities (and every road tries to have it so, even as a 
 matter of b< 'hie,, for appearance's sake), the 
 
 item appears on the liability of the account. It will 
 
 thu to be what it really is, merely the balance 
 
 between the 1 liabilities in the genera] balani 1 
 
 sheet represt nting the supposed excess of property over 
 the capitalization and debts. It is nol money in hand : 
 it usually a tnei annual surpluses which may 
 
 long ago have b< ' for equipment or on road, or 
 
 invested in th< materials carried in the storehouses and 
 not yet put into the property, n a road has cash 
 or salable securities in unusual measure, these will 
 
10S Corporation Finance 
 
 be found on the opposite side of the accounts as 
 assets. 
 
 Another item is the interest accrued but not due. 
 Such accrued interest should always be put down as a 
 liability in balance-sheets, otherwise an unreal pros- 
 perity would be shown at one time or an unreal depres- 
 sion at another, according as the bond interest becomes 
 payable. In all railway tables there are found items 
 of current accounts with connecting roads both debit 
 and credit, cost of materials and supplies purchased 
 but not yet used or charged to the respective operating 
 departments, and the like, being things for which 
 working capital must be provided. Two further items 
 in our statements merit notice. Supply bills payable 
 is one. Every report should be examined to see 
 whether this liability is included. It is the custom for 
 all large companies to buy their fuel, rails, ties, etc., 
 on time. Hence every company on any particular date 
 has a large amount of obligations out, which are not yet 
 due and for which no notes have been issued. Tech- 
 nically these may not be considered in the balance- 
 sheets until due, but since they are sure to become due 
 shortly, there can be no true statement of the com- 
 pany's condition made without including them. Some- 
 times when engines and cars have just been purchased, 
 these unrecorded obligations may be very heavy. 
 Again, when in straits for money, railway companies 
 do not hesitate to pigeon-hole the bills for supplies sent 
 them until the accumulated debts become large ; and, 
 if not stated in the balance-sheets, an untrue appear- 
 ance of ease in money matters is given. 
 
 Audited vouchers often form a growing obligation 
 when traffic is depressed. Claims for losses of goods 
 and rebates (not always unfair) are common ; in spite 
 
The Examination of Railway Reports 109 
 
 of care, overcharges in the freight bills rendered con- 
 signees will be made through the errors of clerks ; 
 wrecks may destroy much property for which the com- 
 pany is responsible ; cattle may be hurt by trains ; and, 
 worst of all, accidents may kill or maim passengers. 
 The claims thus presented to the company are often 
 very large in amount. After investigation a certain 
 portion are pronounced true claims and marked for 
 payment. Such items are called " audited claims or 
 vouchers" and should find a place in every balance- 
 sheet. The still larger amounts of claims for losses, 
 overcharges, or rebates not yet passed upon cannot well 
 be stated in the balance-sheet, because their amount is 
 uncertain, yet when "cut rates" are freely given the 
 aggregate of claims and rebates which must presum- 
 ably one day be paid may be so great that the amount, 
 if known, would make a serious impression. Yet, on 
 the other hand, where the sum of such unaudited 
 claims stays approximately the same from year to year, 
 no real harm is done by not attempting to include them 
 in the company's tables. 
 
 Among the ;isM-t> the items " accounts receivable " 
 
 and " suspec ounts " require little explanation. 
 
 These are claims carried by tin- company against other 
 rinst merchants. They may he good or 
 they may not. Every company should have a separate 
 table of" Profit and Loss," to which all such doubtful 
 lits should he charged. It may be technically cor- 
 ■ mi' "11. 1 1 ibl< a< counts stand- 
 ing among the assi ts of tin- general balance sheet, but 
 do matter how the rules of boob keeping treatises may 
 of all corporation accounting is to 
 ■ the commercial 1 
 Companies which hesitate to deduct losses (branch- 
 
iio Corporation Finance 
 
 line losses included) from their income account and yet 
 shrink from actually calling such losses " assets " should 
 charge such deferred claims to " Profit and Loss," 
 crediting that account with the annual surpluses from 
 operation. The difference would then show the real 
 earnings. If at any time such old claims should be- 
 come collectible, the same account could be credited 
 with the sums thus recovered. 
 
 The array of figures in our general balance-sheets 
 looks a little bewildering ; so to make the matter 
 clearer, we will tabulate the changes during the year : 
 
 EXPENDITURES : 
 FOR WHAT PURPOSE INCURRED 
 
 Increase in cost of road $ 3,000 000 
 
 " " cost of equipment 1,000 000 
 
 " " advances to Rich Valley * 600 000 
 
 " " accounts receivable 200 000 
 
 " " suspense accounts 100 000 
 
 $4,900 000 
 RESOURCES : 
 WHENCE DERIVED 
 
 Decrease in amounts due from connecting roads. .. 50 000 
 
 " " material on band 50000 
 
 " " casb and casb items 150 000 
 
 Increase in funded debt 2,000 000 
 
 " " interest due 200 000 
 
 " " amounts due connecting roads 400 000 
 
 " " wages due 200 000 
 
 " " unadjusted accounts 300 000 
 
 " " bills payable 1,000000 
 
 " " supply accounts due 200 000 
 
 " " vouchers audited 100 000 
 
 " " profit and loss 250000 
 
 $4,900 000 
 
The Examination of Railway Reports 1 1 I 
 
 This summary of changes in the position of the 
 company during the year is worth study. The words 
 ' ' expenditures ' ' and ' ' resources ' ' are used in their 
 book-keeping sense : a decrease in the amount due 
 from other roads and an increase in the amount due to 
 other roads being both alike resources for our present 
 purpose. The statement shows an increase in invest- 
 ment in road and equipment amounting to $4,000,000, 
 of which more hereafter. The deficit of the Rich Val- 
 ley branch is seen to have been carried in the accounts 
 also as an increase in value of plant, offset on the other 
 side of the account by money newly borrowed. We 
 are assuming that this is not a correct principle and 
 that the value of the property has not been advanced a 
 penny through the Rich Valley, since all the profit for 
 the branch for the year has already been included in 
 Gi at Eastern earnings. This system of disposing of 
 branch-line losses in the accounts is resorted to mainly 
 to allow of borrowing money to meet the deficiency. 
 Carrying subsidiary losses as assets and borrowing 
 money or issuing bonds therefor, has been a common 
 practice. The combination of many small roads into a 
 e system permits such accounting, either through 
 mistakes, optimism, or for purposi • of deception, with- 
 out danger of detection by superficial examination. 
 
 Sometimes this way of concealing deficits is practised 
 for a year or two during hard times, the officers intend 
 ing to apply the surplus revenues of succeeding pros- 
 iward wiping out all these imaginary 
 ad the debts contracted to pay for them. Such 
 a policy should be leniently judged, if honestly held. 
 Of course it is also proper to treat in tins way a genu- 
 ine loan when repayment is reasonably certain. The 
 balance sheets further show that the only bonds owned 
 
1 1 2 Corporation Finance 
 
 by the Great Eastern Railway are those of the Rich 
 Valley branch. A glance at the income account 
 shows $250,000 received from this source. It thus 
 appears that in order to show that dividends had been 
 earned, the directors of the Great Eastern Company 
 did not charge up the losses of the Rich Valley branch 
 as they should have done, but did take credit to them- 
 selves for $250,000 unearned interest on their own 
 guaranteed bonds. 
 
 We now begin to grow suspicious and scrutinize the 
 items more closely. The bonded debt and the bills 
 payable amount to $28,000,000, for which interest at 
 but five per cent, on the total (and money is not 
 always borrowed "in the street " at as low a rate as 
 that) would amount to $1,400,000 per year, whereas 
 but $1,300,000 is allowed in the income account. This 
 may be an accurate statement for that particular table, 
 since the bonds may not have been issued for the 
 whole } r ear and hence a year's interest may not yet be 
 due ; still our comparison shows that at least $100,000 
 must be added in our calculations to the requirements 
 for another year. 
 
 The expeditures in the table show $3,000,000 spent 
 upon the property and $1,000,000 upon equipment 
 during the year ; the other items make up a total ex- 
 penditure of $4,900,000. Let us now see how this sum 
 was obtained. Allowing for the discount, $2,000,000 
 was raised from the sale of bonds and $1,000,000 was 
 borrowed on call (i. e. , can be demanded by the lender 
 at any time), or for a definite (though short) period. 
 The remaining $1,900,000 was gathered by piecemeal. 
 Debts due the company were more closely collected, 
 and on debts due by the company, it will be seen, pay- 
 ments were deferred. Wages are running farther in 
 
The Examination of Railway Reports i 13 
 
 arrears and $200,000 more of bond interest was not 
 paid. There is a new item " unadjusted accounts," 
 which in this table undoubtedly is simply another 
 name for more floating debt. Money due for supplies 
 and for acknowledged claims has been held back. 
 There has been further economy in the already too 
 small stock of materials on hand. Cash is dwindling ; 
 let the reader note the significant change in the word- 
 ing of this item. A year ago it was " cash," now it 
 is "cash and cash items." While "cash" has a 
 definite meaning in Wall Street, the phrase " cash 
 items" may cover a lot of rubbish which cannot be 
 turned into cash at all — notes of bankrupts, disputed 
 balances, and the like. It is not a harsh judgment 
 which in this case assumes the amount of actual money 
 on hand to be very small. Then the two offsets, ac- 
 counts receivable and suspense accounts, down in the 
 table as new assets worth $300,000, may fairly be re- 
 jected as assets altogether. A company in the position 
 of the Great Eastern would not allow such accounts to 
 be so much increased ; for being in stress for money it 
 presumably would have collected them if they had 
 
 been good. 
 
 The table of changes certainly wears a very unfavor- 
 able aspect : yet one purpose of the managers has been 
 omplished, to cover iu> anion- a number of items a 
 part of the money they have spent. Reliance is put on 
 the tact that stockholders will not figure through the 
 rats. 
 
 Xow as to the $4,000,000 increase in cost of road and 
 equipment. Every report should contain a table giv- 
 ing in detail the items charged to construction or cap 
 ital account. There is su< h a field foi a or foi 
 
 equally ruinous bad judgment in construction statistics 
 
ii4 
 
 Corporation Finance 
 
 that the utmost publicity should be insisted upon. The 
 toll owing construction account is divided (arbitrarily as 
 to these figures) into columns of proper and improper 
 charges to capital. 
 
 CONSTRUCTION ACCOUNT 
 
 CHARGED TO CAPITA!. 
 
 Properly. Improperly. 
 
 Road, for new rails $400 000 
 
 for damages from wrecks by ac- 
 cidents 
 
 for renewals of ties 
 
 for double track 700 000 
 
 for new bridges 100 000 
 
 for real estate bought 750 000 
 
 for new stations 150 000 
 
 Total charged to road, $3,000 000. 
 Equipment, for 15 replaced engines... 
 
 for 15 new engines 150 000 
 
 for 500 replaced freight 
 
 cars 
 
 for 500 new freight 250 000 
 
 for 25 replaced passenger 
 
 coaches 
 
 for 25 new passenger 
 
 coaches 100 000 
 
 Total equipment, $1,000 000. 
 
 $2,600 000 
 
 $350 000 
 150 000 
 
 150 000 
 
 250 000 
 
 $1,000 000 
 
 Every active concern must in some shape keep a 
 depreciation account, to which shall be charged certain 
 sums for renewal of machinery, etc., before profits are 
 divided. If this is not done, the company will at the 
 end find itself without plant and without money. In 
 
The Examination of Railway Reports 1 15 
 
 railway matters this is best accomplished simply by 
 replacing cars and locomotives as they become worn 
 out, and charging directly to operating expenses the 
 cost of such new cars as do not add to the number of 
 cars in use. In this way the quantity and quality of 
 equipment or buildings or track are kept up at the 
 expense of the annual earnings. In the construction 
 account just given, $1,000,000 is improperly charged to 
 capital and paid for by bonds, because the items cover 
 depreciation and should have been included in the 
 operating expenses. The test to be applied for the 
 ascertainment of wrong charges to capital on equip- 
 ment account is that of comparison. Every railway 
 report gives, or should give, a list of the number of 
 engines, passenger and freight cars in service at the 
 close of the fiscal year. It is an easy matter to calcur 
 late the increases from year to year. For the reason 
 that variations may at times occur, it is better to take 
 a period of years. If the increases in the lists for, say, 
 five years, multiplied by a fair valuation for each class, 
 equal approximately the sums of the amounts charged 
 tn capital for new equipment during that period, then 
 no wrong charms on this account have been made.. 
 In the case before us, we will compare the lists on two 
 successive years. 
 
 STATEMENT m BQUIPMBNT 
 
 
 i't- r edlng 
 year. 
 
 ■ lit 
 year, 
 
 In. aw 
 
 No. of lo. otnoti 
 
 [85 
 
 20O 
 
 •5 
 
 " " passenger <-ars 
 " " freight 1 
 
 375 
 29, 5" > 
 
 400 
 
 ,V>,rxx> 
 
 25 
 
 500 
 
 This statemenl of equipmenl explains why, in tin- 
 table of construction jusl given, $500,000 charged t<>i 
 
i 1 6 Corporation Finance 
 
 replaced engines and cars is marked as improperly 
 debited to that account. The actual increase in the 
 list during the year is but half that carried in the com- 
 pany's balance-sheet as cost of plant. Other items 
 included in the construction table as improperly 
 charged, are payments for train accidents and for 
 replaced ties. These, of course, should go into operat- 
 ing expenses. Payments for wrecks may, however, be 
 concealed under ' ' double-track ' ' or similar items if a 
 company is determined to deceive. As to ties, it is 
 fair to assume that these last about seven years, de- 
 pending, of course, on the climate and the kind of 
 wood used. If we estimate 2800 ties to the mile of 
 single track as about the average requirement, we 
 have as an estimate of yearly renewals 400 ties per 
 mile. Here, again, a number of years should be taken 
 to obtain a fair average ; but, in the long run, if a 
 road's renewals of ties fall on the average much below 
 400 ties per mile per year, inquiry should be made as 
 to the reason. 
 
 As to rails : the life of a steel rail is not yet definitely 
 ascertained ; perhaps twenty or twenty-five years may 
 be taken in order not to be unfair to the company 
 under examination. Estimating the weight of steel 
 rails at seventy pounds per yard, the required weight 
 per mile of single track is one hundred and ten tons. 
 This would assume an average renewal of five or six 
 tons per mile per year. A calculation spread over a 
 number of years would show how far short of such an 
 average a particular company had fallen. If its rails 
 are new, or nearly so, such a calculation would be of 
 value only as approximating the amount which will be 
 required for that purpose in the future. 
 
 By our analysis of the Great Eastern's construction 
 
The Examination of Railway Reports i i 7 
 
 account we have ascertained the amount which should 
 have been charged to operating expenses, to have been 
 $1,000,000. This added to the $600,000 loss on the 
 branch line, makes $1,600,000 which should have been 
 deducted from' income. As the sum applicable to divid- 
 ends in the income account was $1,500,000, we reach 
 the conclusion that the dividend was not really earned 
 and should not have been declared. 
 
 It will be remembered that the road was operated for 
 sixty-two per cent. The percentage of expenses to 
 earnings is of little use except as a guide for further 
 examination. Of itself it is only the percentage re- 
 lation between two sets of independent figures. If a 
 railway earns one dollar and spends fifty cents, it is 
 operated for fifty per cent. ; but if from any cause — 
 water competition, let us say — it can get but seventy- 
 five cents for the same unit of service, and if its ex- 
 penses per unit stay at fifty cents, then it is operated 
 for 66 ■' s per cent. Usually the volume of units of 
 traffic increases as the charge per unit falls, so that 
 the road makes as much gross profit from the larger as 
 from the smaller receipts per unit ; but manifestly we 
 must go into details of the operating expenses if we 
 would form a judgment upon the management. Here 
 are four statistical tables of the Gri il Eastern Railway : 
 
 OPERATING EXPENSES 
 
 Maintenance <if way and structures $ 420 000 
 
 Maintenance <>( equipment : 
 
 1 i can $100 000 
 
 Freight <.-irs 300 000 
 
 in< 60000 460000 
 
 ransportation 2,320 000 
 
 General^ i,oo<><«' 
 
 $4, 200 000 
 
ii8 Corporation Finance 
 
 STATISTICS OF OPERATIONS 
 
 MILES OF RAILWAY OPERATED 8oO 
 
 Passenger-train mileage 1,800 ooo 
 
 Freight-train mileage 3,200 000 
 
 Switching, etc., mileage 1,000 000 
 
 Total engine mileage 6,000 000 
 
 Number of passengers 800 000 
 
 " " " 1 mile 36,000000 
 
 Tons of freight 3, 000 000 
 
 " " " 1 mile 700,000000 
 
 Rate of fare per mile, in cents .03 
 
 Rate of freight per ton per mile, in cents .008 
 
 Mileage of passenger and baggage cars 9,000 000 
 
 Mileage of freight cars 96,000 000 
 
 GENERAL ITEMS 
 
 Maintenance of way per mile $525 
 
 Average number of passengers to each train mile 20 
 
 Average number of tons to each freight train mile 220 
 
 Average number of passenger cars to each train 5 
 
 Number of freight cars to each train 30 
 
 Average mileage of each freight car per day 10 
 
 Average earnings per mile : 
 
 each passenger train $0.60 
 
 each freight train 1.75 
 
 Cost of motive power per engine mile : 
 
 Repair of engines $0.01 
 
 fuel 05 
 
 Engineers and firemen 07 
 
 Oil and waste 01 $0.14 
 
 Railway reports do not always give just these statist- 
 ics, but usually the information we need can be ob- 
 tained by a little figuring. The cost of maintenance 
 of way per mile is easily ascertained by dividing the 
 average number of miles operated into the total pay- 
 
The Examination of Railway Reports 1 1 9 
 
 ments for that account. The average number of pas- 
 sengers or of tons of freight to each train is found by 
 dividing the train mileage into the number of miles 
 travelled by passengers or the tons one mile, respect- 
 ively. The results are, therefore, somewhat in the ab- 
 stract, but they afford the best comparison regarding 
 the economy of the train service, one of the most im- 
 portant things to be considered in judging railway 
 properties. It is necessary to know the number of 
 miles run annually by cars, freight cars especially, in 
 order that we may check the construction account and 
 judge of the general efficiency of the company's manage- 
 ment. 
 
 The amount allowed for maintenance of way is too 
 small for the volume of traffic and number of trains. 
 The sum varies from $2000 per mile in the case of our 
 principal roads, downwards. Generally this item is 
 best judged by comparing the amounts spent per year 
 for a number of years with those spent by neighboring 
 companies similarly situated. On many railroads the 
 average annual cost of necessary repairs and renewals 
 IS $500 on each passenger coach. s|<> each for freight 
 cars, and $1000 each for engines. Multiplying these 
 averages into the list of equipment given above, we find 
 that there should be an addition of over a million dol- 
 lars to the sum allowed in the operating expenses for 
 repairs and replacement of equipment. This, oi course, 
 would increase the total expenses by that amount and 
 correspondingly decreas thi net income. A.sweknow 
 that the Greal Eastern Railway (or any railway) can 
 notion- be run without making the repairs and renew 
 als its neighbors find necessary, we are forced to the 
 conclusion that if money enough to < ire rightlj for the 
 property has been expended and charged to current 
 
120 Corporation Finance 
 
 working expenses, the fixed charges might not have 
 been earned. Bankruptcy, therefore, awaits the com- 
 pany, unless heroic measures are taken to remedy 
 defects in management and save the property. The 
 decline in the market prices of the stock was more 
 than warranted. Our inquiring stockholder would do 
 well to dispose of his holdings at once at whatever 
 price he can get ; unless his ownership is so large and 
 his knowledge of railway operation so good as to 
 enable him to ascertain and himself apply the proper 
 remedy. 
 
 We have not yet exhausted comment on these tables. 
 The cost of fuel (five cents per engine mile) is not 
 high ; and if we add two or three cents to the cost of 
 repairs for locomotives, the cost of motive power, per 
 mile run, is low, — a point much in the company's favor. 
 The rate received per ton per mile is not high, and 
 perhaps a careful examination of the commercial condi- 
 tions of the country through which the road runs would 
 show where improvement is possible. The passenger 
 department is grossly mismanaged. So many trains 
 are run that the average number of passengers is only 
 twenty per train mile. The average for the whole 
 United States is about forty-five, and to carry less than 
 thirty-five passengers per average mile is hardly profit- 
 able. Trains should at once be withdrawn until only 
 the reasonable demands of the public are met. Since 
 only half the present number of passenger cars is really 
 needed, it was a gross abuse of power for the manage- 
 ment to purchase more coaches, as the construction 
 account shows they did. There is no particular fault 
 to be found with the lading of the average freight train 
 or with the earnings per freight train mile ; they are 
 up to the average, if not beyond it. But to what use 
 
The Examination of Railway Reports 121 
 
 so many freight cars can be put is a mystery. It ap- 
 pears that the average mileage of the freight cars is but 
 ten miles per day ; it should be at least three times 
 that number to be profitable. The daily mileage of 
 each freight car on the average is found by dividing 
 the total freight-car mileage hy the number of cars. 
 Nine or ten thousand miles per year is the expected 
 work of each freight car on the average on a successful 
 road. Very likelv more than half of the large number 
 of cars owned (large in proportion to traffic carried) 
 are standing idle on side tracks. The construction 
 account showed 1000 cars bought at an expense of 
 $500,000. Not a single car should have been added to 
 the list, since under good management one third the 
 number already owned should carry the stated volume 
 of business. The extra number of cars should be 
 reduced or loaned out to other roads, to be paid for at 
 the standard rate for use of foreign cars, about three 
 fourths of a cent per mile run. It sometimes happens 
 that an unscrupulous company will charge renewals of 
 equipment to capital and conceal the fact by adding 
 the new cars to the old list of a year ago, even though 
 it may not have in service the number of locomotives 
 and cars certified to in the report ; such unjustifiable 
 additions are called " vacant numbers." Vacant num- 
 bers sometimes arise from the destruction of worthless 
 cars which should be replaced from operating expenses 
 but temporarily are not, because of hard times. Tins 
 is a legitimate economy if so stated in the report ; 
 though it is better to chai insl income the 
 
 [mated co I of filling the vacanl numbers. If the 
 mileage of freighl cars is stated in the report, thi 
 
 with equipment, when at all serious, can be 
 
 detected, it the company is really short of cars the 
 
122 Corp07-ation Fi7iance 
 
 cost of hiring equipment (itemized in the detailed table 
 of operating expenses) will be a large and increasing 
 sum. If more cars are, for the purposes of deception, 
 kept in the lists than are actually running, either be- 
 cause old cars have been broken up and not replaced or 
 are allowed to stand in the yards though worthless, the 
 fact will be revealed by dividing the number of cars 
 into the total mileage. If this total mileage includes 
 foreign cars, such foreign mileage must be deducted 
 and the mileage of home cars on foreign roads added. 
 If, as in the Great Eastern case, the whole freight 
 equipment ran an average of but 3200 miles during the 
 year, when the average should have been 9000 miles or 
 more, there is serious mismanagement or fraud. There 
 has therefore been gross mismanagement or fraud also 
 in locking up capital by the purchase of unnecessary 
 equipment, which when bought must be kept in repair 
 though perhaps falling to pieces through lack of use. 
 In view of these latter criticisms it is probable that all 
 the items in the construction account should receive 
 careful investigation. The amount allotted to general 
 expenses on a road carrying a fair amount of traffic 
 should be not much over ten per cent, of the total ex- 
 penses. Judged by this test the Great Eastern man- 
 agers may be wasting about $500,000 a year. In 
 short, the directors of this company are either ' ' work- 
 ing ' ' the road for their own benefit, or are culpably 
 negligent of their duties as trustees for the stockholders. 
 It is often of importance to find out whether a com- 
 pany has much ready cash or is likely to be obliged to 
 borrow for interest or dividends. An estimate upon 
 this point is possible. Taking the balance-sheet given 
 for the last fiscal year of the Great Eastern Railway on 
 a former page, we find the cash items as follows : 
 
TJic Examination of Railway Reports 
 
 \2X 
 
 Quick assets. 
 
 Due from connect- 
 ing roads 
 
 Accounts receiv- 
 able 
 
 Suspense accounts 
 
 Cash and cash 
 items 
 
 Excess of debts . . . . 
 
 $200 000 
 
 300 000 
 200 000 
 
 100 000 
 
 |8oo 000 
 2,700 000 
 
 Quick liabilities. 
 
 Due connecting 
 
 roads $1,000 000 
 
 Due for wages. . . . 700 000 
 
 Unadjusted accts.. 300 000 
 
 Bills payable 1,000 000 
 
 Supply accts 300 000 
 
 Vouchers 200 000 
 
 $3,500 000 
 
 Very likely the true state is a little worse than this, 
 for while "unadjusted" or "suspense" debts must 
 usually be paid in full at some time, accounts receiv- 
 able or in suspense often cover items carried along in 
 this way from year to year, and in part at least worth- 
 less or unavailable. The real cash resources as indi- 
 cated in the above statement may be fairly set down as 
 not more than half the sum stated, or S4<x>,ooo. The 
 item of accrued interest ought also to be included in 
 the pressing debts, if the actual day of payment is near 
 at hand — as, for example, July est, when the fiscal 
 year closes June 30th. Materials and supplies, prop 
 erly carried in the balance-sheet as assets since the 
 ipany's working capital is invested therein, an- not 
 available for the payment of current debt and are there- 
 fore excluded from our table. A glance ;it tin- balance- 
 t shows that the only treasury assets which can be 
 sold are the bonds of the Rich Valley branch. amount- 
 It is doubtful under our showing 
 
 whether these bonds could be sold al a heavy sacrifice, 
 if at all : for an investigation would reveal the fact that 
 the bonds wen- really dependenl foi their value upon 
 th' of tl ace the branch line itself 
 
i 24 Corporation Finance 
 
 is not earning the interest. A proper inquiry at this 
 point would be whether the Rich Valley is commer- 
 cially entitled to a larger proportion of the combined 
 earnings ; if so, its bonds would be enhanced in value, 
 though the enhancement would be at the expense of 
 the earnings of the main line. 
 
 Of course, the selling of Rich Valley bonds in the 
 Great Eastern treasury would only exchange one form 
 of debt for another, and would not therefore relieve the 
 real situation. The company's affairs require thorough 
 overhauling. Yet the fact that a company in tempo- 
 rary difficulties has in its treasury bonds available for 
 sale, is often important. The obligation is changed 
 from a floating to a funded debt, and therefore relieves 
 the company from the fear of a receivership. Yet such 
 a change really avails nothing in the long run unless 
 the business or the management changes with it in 
 such a way as to insure a greater success. The affairs 
 of the company look desperate ; it is doubtful whether 
 such an entanglement could be straightened out with- 
 out a receivership for a few years, long enough to 
 enable the pressing debts to be liquidated without too 
 much sacrifice of the company's assets. Nevertheless, 
 we see that in spite of gross mismanagement there is a 
 good traffic, which in capable hands could be made to 
 earn a fair revenue. We will, therefore, assume that 
 indignant shareholders turn out the board of directors 
 and discharge the officers, substituting capable and 
 honest men. Let us suppose new directors and officers 
 in charge. Of course the payment of dividends is sus- 
 pended and all energies are devoted to saving the prop- 
 erty from foreclosure. In such large affairs, all that is 
 wrong cannot be righted at once. Corporate salvation 
 is a work of time. In the present case we will assume 
 
The Examination of Railway Reports i 2 5 
 
 that money could be borrowed to meet pressing needs, 
 that two or three years' hard work has had its results, 
 and that the income of the road is now meeting in 
 full all proper operating expenses and fixed charges. 
 Under these conditions the income account would be 
 as follows : 
 
 Gross earnings : passenger $ 2,000 000 
 
 freight 7.°°° °°° 
 
 mail, express, and miscellaneous. 600 000 
 
 Total earnings 9,600 000 
 
 Operating expenses (70 per cent.) 6.745 000 
 
 Total income 2,855 °°o 
 
 Fixed charges : taxes $150 000 
 
 bond interest 1,500000 1,650000 
 
 Net income 1.205 000 
 
 Deduct loss on Rich Valley bonds 
 
 outstanding $35° ooo 
 
 Deduct amounts set aside to pay interest 
 
 and principal of old floating debts. . . 350 000 700 000 
 
 Surplus for year, devoted to improvements and 
 
 betterments $505 000 
 
 This is very satisfactory. Passenger earnings have 
 increase] by the judicious issue- of commutation and 
 ursion tickets, though the fare received on the 
 has fallen from three cents to two cents per 
 mile. In the intervening years the new officers have 
 increased the volume of traffic, 'faxes and bond inter- 
 est have increa ted, and the losses on the Rich Valley 
 branch are now properly charged. Evidently also the 
 new management lias adopted the policy of paying off 
 old debts b] - b< ing a I aside for that 
 
 purpose. There still remains a surplus of $500,000, 
 which is to be spent for improvements on the property. 
 
126 Corporation Finance 
 
 Altogether there is a fair prospect of resuming divid- 
 ends, so that those who purchased the stock when at 
 its lowest point will very likely make large profits. 
 
 For the sake of contrast, the details of the operating 
 expenses are given : 
 
 Maintenance of way $r,ooo coo 
 
 Maintenance of equipment : 
 
 400 passenger cars at $500. . . $200 000 
 
 15,000 freight cars at $50 750 000 
 
 200 engines at $1000 200 000 1,150 000 
 
 Conducting transportation 4,095 000 
 
 General expenses 500 000 
 
 $6,745 000 
 
 STATISTICS 
 
 Miles of railway operated, 800. 
 
 Passenger-train mileage 2,500 000 
 
 Freight-train " ' 3,600000 
 
 Switching " 1,200 oco 
 
 7,300 000 
 
 No. of passengers, one mile 100,000 000 
 
 Tons of freight, one mile 900,000 000 
 
 Rate of fare in cents per mile .02 
 
 " " freight " " " .008 
 
 Mileage of passenger and baggage cars 12,000 000 
 
 " " freight cars 150,000 000 
 
 No. of passengers to each train 40 
 
 No. of tons of freight to each train 250 
 
 A generous amount is allowed for maintenance ; 
 when the plant is once in excellent condition, it can be 
 maintained at a less cost than that here given. The 
 expense for trains earning revenue (this phrase ex- 
 cludes switching mileage and the like) is about $1 per 
 train mile. In actual operation, this expense runs from 
 eighty cents upwards per mile run, varying according 
 
The Examination of Railway Reports 127 
 
 to conditions, particularly the relative cheapness or 
 clearness of coal, which forms a large item in all rail- 
 road expenses. As we have assumed that the Great 
 Eastern Railway obtains its fuel cheaply, the assumed 
 cost per train mile is fair, indicating reasonably high 
 expenses for improving the property if the management 
 is good, or a waste of money if the management is bad. 
 Under the old state of affairs on this railway, the 
 expense per train mile was about eighty cents. Our 
 examination of details showed that this old appearance 
 of cheapness was deceptive. Whether the new cost of 
 about $1 per train mile is due to a generous care of the 
 property or to greater waste, can be told only by fur- 
 ther scrutiny into the accounts. 
 
 The table of statistics enables us to judge of the new 
 management, and by contrast with the old figures 
 shows important differences. The number of locomo- 
 tives and passenger cars is the same as before. These 
 have been presumably kept in good condition, the 
 amounts allowed in the new operating estimates being 
 fairly large. Freight cars have been reduced one half, 
 partly by sale and partly by the breaking up of old 
 and small cars which were uneconomical to use. The 
 
 new management had to do the best they could with 
 
 the property as they found it when coming into power. 
 The number of passengers per train lias doubled, show- 
 ing more careful study of that part of the corporation 
 problem. Nothing has been added to capital account, 
 but the policy has been inaugurated of setting aside 
 ■ tin -.inn t >r the payment of outstanding unfunded 
 debts. The old traffic of the company was large 
 enough to furnish a good basis for the presenl better 
 condition ; the question was cue of management ex- 
 clusively. 
 
128 Corporation Finance 
 
 The management of American railways is better than 
 it used to be — better as to operation and more exact as 
 to the accounts. Nevertheless, while some railways 
 furnish model specimens of book-keeping in their re- 
 ports, others, weighed down in some cases by tradi- 
 tional policy in their accounting, publish statements of 
 their finances which are misleading. For example, the 
 practice of carrying branch-line losses as assets, wrong 
 as the policy seems when stated in those words, never- 
 theless can in some cases be justified from a book- 
 keeper's standpoint. Yet it is clear that a railway 
 company might continue to call such deficiencies ' ' in- 
 vestments in subsidiary roads, " and continue to issue 
 bonds to cover the actual cash required, until at last a 
 poor year might not yield earnings enough to pay 
 interest on the overloaded debt. If, at the same time, 
 owing to the state of the money market and the spread- 
 ing knowledge of the road's real condition, no one 
 would lend it any more money, a crisis would be im- 
 pending, with a certain loss to the holder of the com- 
 pany's bonds and perhaps an assessment on the stock. 
 It has been assumed that the Rich Valley, though not 
 itself earning interest, was valuable to the Great East- 
 ern because of the interchanged traffic. In some cases 
 these branch lines may not be worth much to the parent 
 road, and may, indeed, have been ' ' unloaded ' ' on the 
 old road by unscrupulous insiders. In judging of such 
 cases, the ordinary stockholder must rely upon the 
 character of the men in control. Full knowledge of 
 such details is not usually possible to him. 
 
 But while every particular concerning a road cannot 
 be and need not be known, it has been the purpose of 
 this chapter to show that any one with a fair know- 
 ledge of railroad operations can find out for himself the 
 
The Examination of Railway Reports 129 
 
 broad facts concerning any company, provided suffi- 
 cient details are given in the annual reports, and pro- 
 vided he will take the trouble to examine them closely. 
 It is a mistake to suppose that nothing can be ascer- 
 tained from the annual reports of railways ; the main 
 facts can be. It is often thought that the figures can 
 be manipulated, and so made worse than useless ; this 
 is true, but only to a certain degree. The items in a 
 railway report are interdependent in a way often un- 
 suspected. For example, if bonds have been issued or 
 bills payable contracted, some item or items on the 
 other side of the balance-sheet must be increased also. 
 The inquirer should then proceed to look into such 
 items of assets with a view to finding out whether such 
 increases are legitimate, and if so, whether they com- 
 mend themselves to his judgment. Charges to capital 
 should be scrutinized carefully, with a glance at the 
 items allowed for maintaining roadbed, track, and 
 equipment to see whether these have been neglected. 
 Comparison should always be taken with a road simi- 
 larly situated, and more than one year's work should 
 be tabulated. 
 
 The lading of the trains can easily be ascertained, 
 while a little study will show that the number of tons 
 carried one mile, the rate per ton mile, the number of 
 train miles run, the cost of the same, and the net earn- 
 ings of the company, arc all related to each other. 
 
 In order that the general fads regarding a railway's 
 op-ration and financial management may be open to 
 investigation, public opinion should require that the 
 
 annual reports of all railways Should contain si 
 
 ments in detail of every item of income and expense, 
 
 including statistics of trains. By following and com 
 
 paring these statistics from year to year and studying 
 
130 Corporation Finance 
 
 them in connection with the statements of similar rail- 
 roads, an investor or stockholder, after the manner 
 herein set forth, can form a fair judgment as to the 
 main facts which affect the value of the company's 
 bonds or stock. 
 
CHAPTER VII 
 
 PUBLIC POLICY TOWARD CORPORATION PROFITS 
 
 IF we assume that advancement in material civiliza- 
 tion is made possible chiefly through a cheapening 
 of the cost of production for staple articles, and if we 
 believe that true progress can be made only as both 
 labor and capital receive their due rewards, we state 
 the conditions of an industrial problem which point 
 directly toward more effective organization. Cheaper 
 cost, higher wages, and better profits form a union of 
 blessings which can be realized, if realized at all, in no 
 other way than through combinations of capital, larger 
 in the aggregate, though divided into small owner- 
 ships, together with the best mechanical resources, a 
 massing of employees, and an efficient oversight of the 
 whole. Following industrial precedents, we may ex 
 that time will be required before the greater part 
 <>t our commerce in staples will lie carried on by such 
 large organizations, yet the evolution, though slow, is 
 unmistakably in that direction. 
 Such organizations, so far as we can now see, can he 
 irranged through corporations. Just as the State 
 may p^iss laws regulating the business and credil <>i pari 
 nershi] I may give charters \>> companies and 
 
 ena< t i hi ir i ights and re ponsibilities. 
 
 Limited liability is th< i ofthi corporation idea ; 
 
 i ■ 
 
1^2 Corporation Finance 
 
 combining the possibility of gathering large amounts 
 of capital in the forms of bonds and shares, with easy 
 and legal ways of dividing that capital into proportions, 
 minute yet distinct. The corporation, assured of a 
 continued existence though its officers or shareholders 
 may die, offers on the one side a well-understood 
 chance to investors with risks small as compared to a 
 partnership, and on the other an unequalled oppor- 
 tunity to men of first-rate administrative ability. 
 
 The relation of such trade bodies to the State and to 
 the public may give rise to problems with which suc- 
 ceeding generations must deal. In the development 
 of large corporations three parties should be benefited : 
 the capitalist, the consumer, and the laboring man. 
 But before the political or social economist may prop- 
 erly discuss the rights of the latter two as to their fair 
 share of the larger profits which the corporate form 
 renders attainable, there must be an acknowledgment 
 of the fairness of good returns to the capitalist. With- 
 out a prospect of profit no capital could be obtained for 
 investment in land, buildings, or machinery, and with- 
 out this first venture of capital, few laborers could find 
 employment. This is particularly true at the forma- 
 tion of the corporation, and for a reasonable number of 
 years thereafter. With the question of the fairness of 
 large corporation profits long continued, we are not 
 now concerned. So far as experience goes, we may 
 believe that commercial forces, in the majority of cases, 
 are effective for a reduction of the profits of long-estab- 
 lished corporations to a normal basis. 
 
 It often happens that this privilege of making money 
 is granted by public opinion to firms and individuals, 
 but denied to incorporated companies. It is forgotten 
 that a corporation, particularly at the beginning, is a 
 
Public Policy 133 
 
 business enterprise as purely as a partnership. Pur- 
 chasers of its bonds or shares weigh the chances of 
 success, and usually demand concessions in some way 
 commensurate with the supposed risks, before buying. 
 In the case of a partnership, this practical demand for 
 a profit in proportion to the danger of loss and the 
 resulting uncertainty, is admitted to be equitable. It 
 is no less so where the same business is undertaken by 
 a company. The owner of a dwelling-house which has 
 doubled in value collects his rent 011 the advanced val- 
 uation ; and no objection is made. If the house should 
 be owned by a stock company, the doubling of the 
 annual returns on the shares would in the minds of 
 man}- be an economic offense. At the beginning the 
 enterprise of building a costly line of elevated railway 
 in New York City was thought to be a doubtful one. 
 The original projector was able to secure capital 
 enough to build an experimental piece of mad, but not 
 to demonstrate the success of the plan commercially 
 and financially. The capitalists, who secured control 
 and proceeded with the work of extending the lines, 
 believed in the enterprise and hacked their belief with 
 their money ; yet many people thought failure would 
 be the result. When afterwards success was seen to be 
 assured, the payment of good returns in sonic form 
 on the sums originally invested was believed by tin 
 capitalists who hazarded their money to be their com 
 mercial ri 
 
 Public opinion seems, indeed, to be confused between 
 the question of the fairness ol corporation dividends in 
 ordinal*} nd the larger and more diffii ull ques- 
 
 tion of the equity of high profits when earned by linv.t 
 corporations long established and monopolistic in their 
 nature. Vet even in these lattei \ ■ uch com- 
 
i 34 Corporal ion Finance 
 
 panics are monopolies at the start ; the}- usually begin 
 business under doubts as to their financial success, just 
 as other companies do ; their development into grasp- 
 ing concerns belongs rather to the second stage of the 
 corporation problem at which the United States (speak- 
 ing broadly) has hardly yet arrived. 
 
 If, then, corporations are primarily business enter- 
 prises under a new form, and if they are in consequence 
 entitled to business profits the same as partnerships, it 
 becomes proper to consider the tests to which the fair- 
 ness of such business profits may be rightly subjected. 
 The prevailing ideas on this subject as regards corpo- 
 rations are clearly inequitable, and this injustice is in 
 great part responsible for stock-watering and other ills 
 with which corporation finance is afflicted. Public 
 opinion still insists that the rates of dividends paid In- 
 corporations shall be measured, as to their fairness, by 
 the ruling rate of interest on borrowed money. It is 
 constantly said that five or six per cent, annual returns 
 on the share capital of a company is all that should be 
 paid, since about that percentage is the normal yield 
 on bonds or commercial paper or paid on notes dis- 
 counted at the banks. It is overlooked that the 
 standard thus set is the rate on money loaned on good 
 collateral, and considered secure both as to interest and 
 principal. The comparison may be proper as between 
 the prevailing rate of interest and that paid by the 
 company on its bonds ; but manifestly the returns on 
 that part of the capital hazarded by the shareholders 
 should not be so judged. If that rule were really car- 
 ried out, if public opinion had been able to limit 
 returns even in hazardous enterprises to a bare inter- 
 est rate, the community would be the worst sufferer 
 from the lack of facilities in transportation, in maim- 
 
Public Policy 135 
 
 facturing, and in trading which it now enjoys. The 
 only result of this ill-defined but commercially errone- 
 ous opinion about the rate of dividends has been to 
 complicate the whole subject of corporation investment 
 and regulation with a series of false issues. We are 
 treated to long discussions and severe statutes upon 
 the subject of " water " in the stocks and bonds of rail- 
 ways and other corporations ; while the real point has 
 usually been the commercial justice of returns larger 
 than the rate of interest on borrowed money when paid 
 to shareholders in companies formed and managed sim- 
 ply as business enterprises. 
 
 The experience of all civilized countries has shown 
 the uselessness of all direct attempts to limit profits by 
 legislation. Such attempts merely compel concealment 
 in si mic way, or dull the edge of enterprise. For exam- 
 ple, the charter of the Boston and Worcester Railroad 
 (now a part of the Boston and Albany), granted by 
 ichusetts in 1831, has this section : 
 ' Toll is granted as may be agreed upon by the 
 directors provided that if, at the expiration of ten 
 rs, the net income from tolls and other profits shall 
 have amounted to more thai] ten per cent, per annum 
 upon the cost of the road, the legislature may take 
 measures t « » reduce the tolls in such a manner as to 
 off the surplus." 
 
 It i that the railroad in question has paid 
 
 mm h more than tin- ten per cent, yearly allowed, dur- 
 ing the last sixty years. Then- is no known insta 
 
 uch a limitation of dividends being practically en- 
 for< ■ • ommercial profits justified a higher rate. 
 
 The onl; lation which, under present conditions, 
 
 has much chance of practical effect, is that of which 
 some London (England) gas charters furnish an illus- 
 
3 
 
 6 Corporation Finance 
 
 tration. By Act of Parliament certain of these gas 
 companies must sell the gas at 2> s - gd. per 1000 feet. 
 For every penny taken off this price to consumers the 
 company is allowed to increase the dividend one fourth 
 of one per cent. ; for every increase in the price, there 
 must be a corresponding dividend reduction. Of course 
 such legislation is crude, for there can be no arithmetical 
 ratio between the prices of the goods sold and the 
 annual dividends on the shares ; but it embodies a 
 principle, which indeed usually works itself out in 
 rough fashion, that there must be a division of the 
 benefits of the corporate form between the parties con- 
 cerned. It would be inequitable if a corporation 
 should keep all the profits for its shareholders ; and 
 equally unjust if it could so keep none of them. 
 
 It is not necessary to prove that values have increased 
 in the United States ; figures, such as those of the cen- 
 sus, showing such increases between 1880 and 1890, are 
 available for those wishing to follow the subject far- 
 ther. It is also a matter of common knowledge that, 
 while certain individuals and firms have failed, others 
 have amassed large fortunes. A number of firms 
 have taken the corporate form and have offered their 
 shares to the public. In no one of these cases of incor- 
 poration of old partnerships was the original amount 
 invested in the business by the partners stated ; the 
 public, it is held, has no right to that information. 
 The prospectuses of the Proctor & Gamble Co., The 
 H. B. Claflin Co., or of the larger corporations, like 
 the American Sugar Refining Co., may be searched in 
 vain for such information. The present status of the 
 new company and its probable future, based upon the 
 profits for several years past, are, however, always set 
 forth in the prospectus, and these facts and estimates 
 
Public Policy 1 3 7 
 
 really form the basis upon which the amount of capital- 
 ization the new company can bear is arrived at. What 
 percentage upon the original investment the yearly 
 profits to the old partners have been, is not thought to 
 have any bearing upon the value of the business at the 
 time of incorporation. The capitalization is fixed at 
 such an amount as will in the judgment of the promoters 
 allow the shares to be sold to the public at about their 
 par value. If the profits are legitimate, the business 
 stable, and the financial condition honestly set forth, 
 the arrangement is proper. If the enterprise had been 
 started originally as a corporation, it is to be feared 
 that the large profits annually earned would have been 
 considered as commercial wrongs to the community. 
 But whether these profits are fairly earned or not, is a 
 question which cannot be determined by the percent- 
 age of such profits to the original investment. Their 
 fairness is not alone to be judged by the rate of returns, 
 nor by the fact that those returns are divided among 
 partners or paid to shareholders by an incorporated 
 company. 
 
 Com, ding that in fairness tin- value and profits of a 
 corporation should vary with the degree of success, and 
 be allowed to grow with the growth of business gen 
 erally, the question aris-s : How should that incr< 
 be r< I ? Real estate finds purchasers at pri 
 
 which show the successive changes in values. The 
 property ot >mpanies cannot be so treated. A 
 
 merchant talc s an inventory on a certain day, and so 
 can close his boohs for the year with exactness. Nol 
 so a railway imple, whose balance sheet musl 
 
 continue on the same nominal basis of values from y< ai 
 to year in order to preserve tin , ontinuit} "I the com 
 pany. Such corporations can show the daily 01 
 
J 
 
 S Corporation Finance 
 
 fluctuations in the value of their assets, and in the value 
 of their stocks and bonds based upon those assets, only 
 by changes in the market prices. This occasions no 
 trouble in the case of industrial corporations whose 
 stock is in few hands ; but in the case of companies 
 whose shares are owned largely by persons exercising 
 no direct control over its affairs — by investors, in short 
 — other questions arise ; when increased profits are to 
 be divided higher dividends must be paid or additional 
 stock issued. Usually the stock is " watered " to make 
 the capitalization conform in a rough way to the value 
 of the property as determined by its probable earning 
 capacity. During the flush times following the resump- 
 tion of specie payments in 1879, the railways, particu- 
 larly those west of Chicago, felt the full effects of the 
 improved conditions and good crops. They made 
 money rapidly. The Chicago, Rock Island, and Pacific 
 Railway Company, for illustration, paid 9^ per cent, 
 dividends on its then capital stock in the fiscal year 
 ending March 31, 1879, and ten per cent, in 1880. 
 Finding its profits still increasing, the company, in 
 June, 1880, doubled its capital stock, giving to the 
 holders two shares for one. The prognostications of 
 its officers were for the moment justified, for the com- 
 pany on its doubled shares paid 6^> per cent, in divi- 
 dends in 1 88 1, and seven per cent, in 1882. 
 
 Stock-watering in this, its innocent form, is not an 
 attempt to cover up extortion, so much as to solve a 
 commercial question. It is not a cause of an increase 
 in profits, but rather an effect of such increase, 
 whose fairness toward customers should be judged in 
 other ways and by other means. The prejudice in the 
 public mind against the distribution of dividends In- 
 corporations at a percentage higher than the usual 
 
Public Policy 139 
 
 interest upon loans, makes the public itself in a meas- 
 ure responsible for such shares of unpaid stocks as are 
 issued to conceal the fact that the earnings are larger 
 than the usual borrowing rate. 
 
 The remedy for stock- watering, therefore, even in its 
 innocent form, is not additional law but a change in 
 public opinion, which shall allow the payment of ten, 
 twelve, or fifteen per cent., if legitimately earned, to 
 the shareholders of corporations organized for business 
 purposes. It would certainly be a gain in honesty if 
 the capital of a company could openly he stated at a 
 Mini no larger than the amount actually invested. 
 This would be the result much oftener than now if such 
 returns as are above suggested could, without protest 
 — because of thai fact, — be paid if earned. But this is 
 not all. The community by its feeling against high 
 corporation dividends deprives itself of a certain natural 
 protection against unfair earnings ; because if such 
 were openly paid competition would be oftener at- 
 tracted. The tendency of an open return would be 
 toward a lower return. In the case of the Chicago, 
 Rock Island, and Pacific Company just mentioned, the 
 extreme profitableness of traffic-carrying in the years 
 following [880 was found not to he lasting. After pa\ 
 
 at. in dividends upon the doubled stock 
 
 rly, from [882 to [887, the company distributed hut 
 
 four per cent, in tin- years from [88g to [893, thus 
 
 bringing the real returns to about tin- same rat. 
 
 ruled before the watering. II id thi original capital 
 
 not been doubled this latter return w.ndd not seem so 
 
 small. What the community has lost in freights and 
 lities, through th oi the managers to p ;i \ 
 
 dividend-, on doubled capital at a rate which should 
 nominally be as high as the usual int. resl on borrowed 
 money, can only he a mat' 
 
140 Corporation Finance 
 
 The tendency of corporation managers, under the 
 pressure of public protest against high dividends, to 
 water the capital has been much accelerated by the 
 financial law that stock-watering actually increases 
 market values. If a company is paying ten per cent, 
 annually in dividends, its shares will be quoted, let us 
 say, at 175. If now the company doubles the number 
 of its shares and continues to pay five per cent., its 
 new stock will be quoted at about par. The original 
 holder, w 7 hile receiving the same aggregate dividends 
 as before, finds his principal increased in value. The 
 same law holds good when shares are below par. If a 
 company's stock is quoted at sixty, and a stock divid- 
 end of fifty per cent, be declared, the quotations will 
 not fall to forty as they ought. This fact, probably 
 explainable on the previously mentioned theory that 
 share values are in part based on the interest rate, has 
 always been a strong incentive to stock-watering. 
 
 Another objection to stock- watering is that while it 
 provides a method by which capitalization and profits 
 may correspondingly increase, it affords no means of 
 registering a decline in those profits, for shares once 
 issued cannot readily be found and called in. In spec- 
 ulative America fluctuations in business profits are to 
 be expected, and one of the embarrassing things in 
 Wall Street is the presence there of shares having little 
 or no intrinsic value but which may be used by unscru- 
 pulous and sometimes almost penniless adventurers to 
 obtain possession of a railway or other company. The 
 temptation in such cases is great for the men thus 
 placed in control to recoup themselves in some way for 
 the cost of purchasing that control. Low-priced stocks 
 cannot, of course, be avoided, but their number might 
 be largely decreased if we could remove from the 
 
Public Policy 141 
 
 exchanges those shares which represent ' ' water ' ' 
 principally, and which have fallen below the expect- 
 ations of optimistic stock-waterers. The well-known 
 early history of the Erie Railway furnishes a good 
 illustration. Yet here, as before, we must first remove 
 the cause of the trouble ; namely, the public feeling 
 against good corporation profits based upon the origi- 
 nal investment. The argument of the stock-waterer 
 always is, that in no other way can he secure profits 
 commensurate with his risks, even if fairly earned ; 
 and it is an argument which has its force. 
 
 While the amount of capitalization has little effect 
 upon the rates charged by the railways — for it is in 
 reference to railways that the question has been most 
 discussed — the indirect results of excessive capitaliza- 
 tion are evil. If a company's capital stock has been 
 doubled and the shares now receive (let us say) five 
 per cent., these shares are sold to innocent holders 
 On the basis of a five per cent, return. If, for any 
 ■in, tin- dividend should be reduced to four per cent, 
 there are immediate protests from the then share- 
 holders, for the reason that the apparent returns are 
 below the nominal rates of interest. But if, on the 
 other hand, the company hail been allowed to continue 
 
 payments of ten per cent, upon the original number of 
 shares, thai percentage of payment lor good commercial 
 
 • ms could I"- reduced to < ighl \»r cent, without so 
 much complaint the reduction in the actual earnings 
 of the company being the same in both cases. It is 
 
 use of this that, when a decline in profit comes, 
 stock watering ha- a direel effect. Tin- managers 
 knowing that a reduction in the dividend rate from 
 four to five per cent, will be very unpopular, strive in 
 every way legitimately and illegitimately to continue 
 
142 Corporation Finance 
 
 the old payments. They will withdraw trains, will 
 discharge employees, will buy less supplies, and in 
 even- way will endeavor to increase their net earnings 
 up to the former amount, with the result that the 
 public are deprived of facilities to which they are en- 
 titled and which they might otherwise obtain ; while 
 at the same time the industrial depression is aggra- 
 vated by the larger number of men thrown out of work 
 directly through the action of the company in their 
 discharge and indirectly in the refusal to purchase the 
 usual amount of material and supplies. Here, again, 
 the condemnation goes farther than complaints against 
 the existing management and touches the source of 
 the trouble, viz., the attempts of the company, per- 
 haps years before, to placate public opinion while at 
 the same time paying the high dividends to which 
 its shareholders considered themselves entitled. There 
 is reason for thinking that the former lack of train 
 sendee on the New York City Elevated and the de- 
 ficiency in other facilities (such as the proper lighting 
 of the cars), of which loud and frequent complaints 
 were made, can be traced back to the time when the 
 owners, finding their projected profits more than five 
 or six per cent, on the original cost, issued the watered 
 stock of the Manhattan Company to correspond with 
 the expected increase in dividends. Had public opin- 
 ion allowed the payment of ten or twelve or fifteen per 
 cent, on the original capitalization, it is possible that 
 better service would have aftenvards been given, even 
 though the dividends had then been reduced to eight 
 per cent. Public opinion against high corporation 
 returns is thus responsible indirectly for the later pub- 
 lic complaints of overcrowding and other ills. 
 
 What has been considered may be called the inno- 
 
Public Policy 143 
 
 cent form of stock- watering. But all stock- watering is 
 not innocent. An unreal prosperity may be brought 
 about through an illegitimate curtailing of expenses 
 and in other ways, so that an extra issue of stock may 
 falsely be made to seem justifiable on grounds of large 
 but fair profits. Or honest prosperity may come up 
 quickly, to fall away as quickly. In either case, whether 
 through fraud or error, the increase of capital stock 
 may be commercially unwarranted and a source of loss 
 to innocent investors. Again, parties in control of a 
 railroad or other large corporation owning compara- 
 tively few shares, may decide suddenly to distribute 
 new shares free : and, by taking advantage of their ex- 
 clusive information, may, if unrestrained, make large 
 sums of money for themselves. Or, further, a com- 
 pany's directors, to perpetuate their control, may issue 
 new shares to themselves at merely the cost and trouble 
 
 mying old shares on a margin. This may result in 
 giving over to men not equitably the real owners, the 
 management of an important property. Such control 
 is not likely to be exercised for the public good, but 
 rather for speculative purposes. Such stock -watering 
 
 ■ bis is an abuse of the principles of good corporation 
 
 finance, against which it is the right of the State to 
 
 protect itself by all legitimate means. Vet, until high 
 
 :riis are freely allowed, the distinction between the 
 
 right and the wrong of the practice is one always to be 
 borne in mind. The laws of New York State regard- 
 ing railways try to meel this difficulty. Its statutes 
 
 provide that no in. 1, ipital stock shall Ik- valid 
 
 unless approved by a two thiols vote of the share 
 
 holders at a inciting called for tli.it purpose after 
 
 notice to each stockholder, and unless 
 also approved by the Board of Railroad Commissioners. 
 
144 Corporation Finance 
 
 A further amendment, passed in 1890, adds that no 
 stock shall be issued except for money, labor, or prop- 
 erty. In passing upon applications for increase, the 
 Board since 1883 has wisely interpreted the statute as 
 not condemning such issues where cause is shown. 
 The Board consents to an increase when the new stock 
 is to be sold and the proceeds spent upon the property ; 
 but if the stock is to be distributed free, then the total 
 capitalization (bonds and stock) must not exceed the 
 cost of the property. It is the custom to include in the 
 term cost, all improvements paid out for revenue. 
 Practically, therefore, when such an unpaid issue seems 
 expedient for sound commercial reasons, but little 
 stands in the way of the Board's approval ; for ex- 
 penditures on the property above cost of mere mainten- 
 ance from year to year can usually be shown by all 
 prosperous roads ; yet it would be better to increase 
 dividends than to increase the capitalization. On the 
 other hand, the New York statutes have apparently 
 stopped, or at least rendered very difficult, the fraud- 
 ulent cases of stock issue just referred to. The neces- 
 sary vote of so large a proportion of stockholders after 
 a three-weeks notice of the reason for calling them 
 together, renders the action of a minority-holding Board 
 of Directors practically impossible should such a board 
 attempt to give money or control to themselves by a 
 sudden issue. The real owners must first approve of 
 the plan. Then the public stockholders' meeting and 
 the public argument before, and investigation by, the 
 Board of Railroad Commissioners take-so much time 
 that all concerned have an opportunity in which to 
 arrange their holdings for the change. There is, of 
 course, the further objection to any issue of share 
 capital without full payment, however justified by 
 
Public Policy 1 45 
 
 trade circumstances, that it really gives to a holder at 
 once and at a particular time that increase in value 
 which may have been accruing for years. But by such 
 laws as these of New York, the State, until public 
 opinion as to corporation profits changes, has gone as 
 far as it rightfully can to protect all interests. No 
 statute can give exact justice, to every complainant. 
 To stop all free issues of stock, even the innocent, would, 
 in the present state of opinion upon the unfairness of 
 high corporate dividends, put a check upon corporate 
 enterprise which would work injury to the public as a 
 whole. The State selfishly wishes its capitalists to 
 realize enough returns from incorporated capital so 
 that as many railroads as are needed may be built, 
 the public thus getting facilities in transportation not 
 otherwise attainable. The State of Massachusetts in 
 \ enacted amendments to its railroad laws, which 
 forbid the free issue of stock under any circumstances ; 
 issues of shares are lawful only after approval by the 
 Board of Railroad Commissioners and for the purposes 
 < ertified to, and must be sold to shareholders at auction 
 at not less than par, or at the market value if more 
 than par. Such absolute prohibition of stock watering 
 is economically justifiable only where 110 limit is put 
 
 upon corporation dividends either in public opinion or 
 indirectly through legislation intended arbitrarily to 
 reduce charges. 
 
CHAPTER VIII 
 
 CORPORATION REORGANIZATIONS AND RECEIVER- 
 SHIPS 
 
 ALTHOUGH as has already been stated, the corpo- 
 ration form is best adapted for those businesses 
 which meet a public demand, whose volume of trading 
 or traffic or manufacture is apparently steady, and 
 whose profits under good management may be ex- 
 pected to be reasonably uniform, and although under 
 such conditions insolvency should be rare, yet incorpo- 
 rated companies at times become bankrupt — that is, 
 are unable to pay their floating or funded debts. If 
 such corporate insolvencies in any line of business con- 
 stitute a larger percentage than is shown by the gen- 
 eral average throughout the United States, a percentage 
 larger either in the proportion of bankrupts to the whole 
 or in the proportion of assets to liabilities, then it is 
 important for the welfare both of investors and of 
 the public that careful investigation should be made 
 to ascertain the causes of such undue percentages. 
 Perhaps the reasons for such large proportion of 
 bankrupts may lie in the fact that the earnings of 
 the company from some cause have been reduced 
 so fast that the expenses could not correspondingly 
 be cut down ; or it may be that the capitalization 
 of the company was in the first place arranged on a 
 false basis; or perhaps the failure may have come from 
 
 146 
 
Reorganisations and Receiverships 1 47 
 
 a combination of these causes. Sometimes, also, wide- 
 spread commercial disasters, such as the failures of 
 crops over a large section of the country, may account 
 for the temporary embarrassment ; although even in 
 such a case the possibility, in a concern whose finances 
 have been conservatively managed, ought long ago to 
 have been taken into account. 
 
 But from whatever cause arising or whatever the per- 
 centage may be of those companies which have failed 
 to have achieved success, the fact of the inability of 
 any company to pay its debts brings up at once a large 
 number of financial problems of extreme difficulty and 
 delicacy. The affairs of the simple trading company, 
 when forced to sneenmb, may prove comparatively easy 
 of adjustment , but not so with large companies. Our 
 great railway systems, for example, have grown to 
 their present size by degrees through the construction 
 or absorption into the system of lines or branches once 
 independent, or which may yet be nominally considered 
 The credit ofsucb ;i huge railway system is also :i 
 matter of growth; but a good credit once attained docs 
 not yield easily to tin- first rumor of disaster. The 
 managers, properly careful for the interest of the share- 
 holders, put the best face upon tin- declining revenues 
 in tin- hope that the deficit may be but temporary and 
 indeed by helping to tid< period of embarrass 
 
 ment through the means of old established credit, the 
 managers of such a system have in many instances 
 really saved the property lor the shareholders. In 
 otic • however, where the evil was too de< p 
 
 : or where the < mbarrassment con 
 tinued thai it could be no longer ignored, 
 
 the on of insolvency has found the affairs of the 
 
 ■any in a most unfortunate shape. 
 
148 Corporation Finance 
 
 The receivers, upon appointment, have been ordered 
 by the court to pay off those back debts which properly 
 should have been discharged at the time of their incur- 
 ring from current revenues, but which were allowed to 
 accumulate in order to enable the managers to maintain 
 the appearance of solvency. As these claims are made 
 a first lien upon the property either with or without the 
 issue of receivers' certificates, usually the property 
 must remain in receivers' hands at least as long as it 
 may be necessary to accumulate from the revenues 
 sums sufficient to provide for these prior claims. If, 
 after a time, it is found that the payment of these 
 claims from revenues is impossible, or where receivers' 
 certificates have been issued for this very purpose and 
 are now outstanding, then these sums must be taken 
 into account by the reorganizes of the company as so 
 much which must be raised by the owners of the prop- 
 erty before it can be turned over to them. 
 
 In addition to the sums of money thus directly re- 
 quired, it is almost always found that other cash amounts 
 are also necessary. Since a railway system does not 
 plunge at once into insolvency, it usually finds itself 
 tending in that direction for a longer or shorter time 
 previous to the final confession, and it commonly hap- 
 pens during these months or years when the stress of 
 the circumstances began to bear hard upon them, that 
 the managers have omitted to do many things which 
 the business of the company really required. In the 
 case of railways the roadbed may have been long neg- 
 lected without absolutely going below the standard of 
 safety. Repairs to wooden bridges or trestles have 
 been delayed and renewals of rails and ties have been 
 put off, so that the real requirements of the property 
 are not revealed until a receivership makes conceal- 
 
Reorganizations and Receiverships 149 
 
 ment no longer advisable. When that receivership 
 comes and before reorganization plans can be drawn 
 up, the amount of money necessary to be spent in order 
 to make good all depreciation and to render the plant 
 capable of the most economic working must be de- 
 finitely known. This is the time, too, for an outlook 
 into the future when the possible changes in transport- 
 ation rates or in the services demanded should be met 
 by some arrangement for granting to the reorganized 
 company certain sums of money year by year for this 
 future use. Altogether the cash requirements for the 
 present and for the future constitute sums which must 
 be raised in reorganization either by assessments upon 
 the shares and bonds or — what amounts to the same 
 thing — by some arrangement which will allow of a 
 prior mortgage upon the property sufficient to accom- 
 plish these results. Usually, also, it is necessary that 
 the accounts of the defaulting company should be gone 
 over carefully in order that tin- real earnings of the 
 property, unadulterated through bookkeeping assets or 
 suspense accounts or padding of any kind, should be 
 ■ tained. 
 With these figures before them and with the outlook 
 for business in general and in tin- section ofthecountry 
 immediately concerned in particular, the banking firm 
 or committee are able to determine within reasonable 
 
 limits what the earning power of tin- company after 
 
 ■ '.ani/ation will be. Here, then, arc tin- elements 
 of tin- problem at tin- beginning. A certain amount of 
 
 1 must be rai ,■ -l to pay oil debts and to make good 
 the il'ii* i' :i< i' in ih- d< pr< 1 iation accounl ; allowance 
 must be made for the cash requiremi tits of the future ; 
 and finally all the fixed charges of the reorganized 
 company must be brought so far below the assumed 
 
150 Corporation Finance 
 
 earnings as to give to the new bonded capital a good 
 standing and credit at once upon all the exchanges. 
 
 It having been determined to what extent the present 
 bond- and shareholders must suffer loss in order to 
 bring the capital of the new company within the earn- 
 ing limits at the time of reorganization, the next prob- 
 lem is the division of this loss among the old security 
 holders. This is a task demanding the widest know- 
 ledge combined with the best financial judgment. 
 Under our assumption the railway system, now insolv- 
 ent, is composed of many different parts, each having 
 upon it bonds varying in value, in interest charges, 
 and in length of time to maturity, whose liens upon the 
 various properties may also be so interlaced as to make 
 their disentanglement a very difficult thing indeed. 
 Very likely there are prior lien mortgages upon the 
 older parts of the road on which the interest charges 
 have unquestionably been earned. Where such is clearly 
 the case, such bonds should not be asked to surrender 
 any part of their principal or interest. A fundamental 
 axiom in corporation financiering is that bonds which 
 are unquestionably good should unquestionably be 
 paid. Nothing tends to throw discredit upon corpora- 
 tion securities so much as a lack of discrimination in 
 cases of insolvency between bonds which are good and 
 those which are not. 
 
 Perhaps there is also a first mortgage upon the entire 
 system whose interest has been earned ; if so, the loss 
 should fall upon the junior securities ; or perhaps one 
 of the difficulties of reorganization begins at this point. 
 It may be that the main line has earned the interest on 
 these first-mortgage bonds, to judge from the state- 
 ments prepared in the auditor's office ; but it is im- 
 portant to inquire whence comes the traffic whose 
 
Reorganizations and Receiverships 1 5 1 
 
 carriage has yielded this profit ? There may be branch 
 lines which give to the system so much of its volume 
 of business that without them interest on the first-mort- 
 gage bonds would not have been earned ; it may be 
 that valuable terminals in the large cities are occupied 
 by the company subject to mortgages of their own ; or, 
 again, perhaps contracts of various kinds have been 
 entered into with connecting roads which on their face 
 are unprofitable, and yet if those contracts were an- 
 nulled the resulting indirect loss to the company might 
 seriously imperil the interest on the first mortgage 
 which we are considering. Manifestly, in the face of 
 such complications, it will not do to say that interest on 
 these first-mortgage bonds has been earned and should 
 be paid, while at the same time no allowance is made 
 for interest upon the terminal bonds or branch-line 
 obligations or contracts with connecting lines. If it is a 
 question of division of the losses between them, the 
 exact proportion which each should suffer can only be 
 determined after a careful search into the whole mat- 
 ter and after a full investigation into the claims of each 
 one of these from a transportation point of view. 
 
 It is, in a majority of cases, useless for the holders 
 
 Of bonds having a lien upon a specific piece of road to 
 
 think of foreclosing their mortgage and taking the 
 pr, ,■ rvered by it out of the system to make it 
 
 independent. An exception, of course, must be made 
 in the casi s of property such as a terminal in a large 
 city, which may be essential to tin- business of the de- 
 faulting company and yet which may be s,, situated as 
 to be easily turned ov< r to and used by some other 
 company. In such cases, of course, then- is no alter 
 native but ' mch terminals in the system by 
 
 ing interest upon the bonds ; usually the COUltS are 
 
i 5 2 Corporation Finance 
 
 quick to recognize the exigencies of the situation and 
 to authorize the receivers to pay such interest even at 
 the expense of the remaining parts of the trust estate. 
 Usually, however, a piece of property, even though 
 covered by a separate mortgage, finds its chief value as 
 a component part of the system as a whole. The 
 reason for the amalgamation of separate railways into 
 one system is that the business as a whole may be 
 administered to the best advantage of all. Under 
 these conditions the individuality of any one part of 
 the system is in time lost and cannot be easily regained 
 even under a separate ownership through foreclosure 
 of that particular mortgage. There is something, 
 therefore, beyond mere words in the disinclination so 
 often stated by the courts to allow any ' ' disintegration 
 of the system," and there is likewise good reason for 
 the further order that at any sale for the purposes of re- 
 organization the whole shall be offered as one parcel. 
 This is the true policy, not only from the point of view 
 of the investor which we have just been considering, 
 but also from that of the public whose facilities for 
 quick and cheap transportation would be seriously inter- 
 fered with, were an old system allowed to be broken 
 into its separate parts by reason of differences of opin- 
 ion between the bondholders as to the values of their 
 respective mortgages. The same reasoning with modi- 
 fications suited to the circumstances applies to corpora- 
 tions other than railways which have been conducting 
 large business operations. 
 
 Stockholders to whom belong all the profits of the 
 enterprise should under ordinary circumstances be will- 
 ing to bear the losses. It is upon this principle that 
 the cash requirements of an insolvent company, which 
 have just been referred to, are usually made up by an 
 
Reorganizations and Receiverships 153 
 
 assessment upon the shares. But this principle is it- 
 self limited by expediency. If, under the influence of 
 impending trouble and actual insolvency, the quota- 
 tions for the shares on the exchanges have fallen to 
 very low figures, a large assessment levied upon each 
 share might indeed, if carried out, result in the wiping 
 out of such stock under a reorganization, but would not 
 bring into the treasury of the new company any cash ; 
 the old shareholders would prefer to lose their holdings 
 rather than to pay the assessment demanded, unless 
 they were convinced that the prices of the new shares 
 upon the exchanges after reorganization would at least 
 be higher than the amount of the assessment. If the 
 shares alone are asked to furnish the money for the 
 cash requirements and at the same time to stand the 
 brunt of the reorganization generally, the new stock 
 to be given in exchange for the assessment might be 
 of little value. From the nature of the case the 
 equities of a reorganization cannot be proved like a 
 mathematical problem, but are matters of individual 
 judgment ; hence able lawyers employed by aggrieved 
 shareholders arc often able to bring forward facts and 
 arguments to such an extent as to make doubtful or 
 delay tin- carrying out of any plan of reorganization to 
 which their clients arc unanimously opposed. More 
 than that, the m( under whose terms the bond- 
 
 holders must act in foreclosing, often contain sections 
 who 1 meaning perhaps is doubtful, or whose 
 
 provisions cannot he quickly carried out, offering 
 chano 9 for long legal delays. It is sometimes possible 
 
 for the shareholders to oppose the foreclosure of a 
 
 tnorl ilfully as to make tin- carrying out a 
 
 matter ol For all these reasons it is customary 
 
 in drawing up plans of reorganization to consult the 
 
154 Corporation Finance 
 
 so-called ' ' rights ' ' of the stockholder to as great a 
 degree as is consistent with justice to all concerned. 
 
 The practical effect of this small deference to the 
 shareholder is to put a part of the losses under reorgan- 
 ization upon the junior securities ; that is, upon those 
 mortgages which of course come ahead of the stock, 
 but whose lien upon the property is subsequent to the 
 older bonds. Perhaps the cash requirements already 
 spoken of may be arranged for by an assessment of 
 several dollars upon each share of stock and also upon 
 the junior bonds. Sometimes when the future looks 
 hopeful, the holders of the senior bonds may be asked 
 to forego their interest for a while or to refund their 
 coupons into a separate loan for which they may re- 
 ceive other securities under the plan. 
 
 In the history of American railway reorganizations, 
 it has been a common thing to find certain bonds or 
 shares given to the old holders, to represent the cash 
 assessments which they were asked to pay, or the 
 losses in principal or interest to which they were 
 asked to submit. Such a course is justified by business 
 conditions in the United States. In America values 
 are largely determined by reference to the future. 
 Quotations of the corporation stocks or bonds upon 
 the exchanges are governed by two considerations — the 
 present earnings and the expectation for the future. 
 Such a method of estimating values is to be expected 
 in a large country not yet fully developed, whose agri- 
 cultural and mineral possibilities are great, and which 
 on the average is increasing in wealth and in the 
 volume of business year by year. The very pace by 
 which industry usually advances leaves the way open 
 for temporary depreciations, and these for a time may 
 curtail business to such an extent as to leave a railway 
 
Reorganizations and Receiverships 155 
 
 or other corporation unable to meet its obligations. If, 
 under these circumstances reorganization becomes 
 necessary, it is not forgotten that the future may have 
 in store for the company greater earnings than are now 
 annually being obtained. Hence it is in accordance 
 with business facts that the holders of bonds or shares 
 which, under the stress of present necessity, must sac- 
 rifice something, should ask that some evidence of 
 their former claims against the company be granted 
 them. They ask for this evidence so that if the com- 
 pany in future years should earn as much as in times 
 of former prosperity or indeed anything at all beyond 
 the present standard, these old postponed claims may 
 then become alive again and be worth something to 
 their holders. Nearly all railway reorganizations re- 
 cognize the justice of this position, and the plans are 
 arranged accordingly. 
 
 Another reason why the method of giving some evi- 
 dences of indebtedness in exchange for assessments or 
 bond losses is popular, lies in the fact that investment 
 sentiment seems better satisfied where paper of some 
 kind is given to bondholders in return for their sacri- 
 fices, than where such sacrifices are demanded without 
 
 it. This is true even in cases where tile intrinsic values 
 
 of the two pieces of paper are no larger than thatof 
 
 alone would he. lint even where intrinsically the 
 
 same, it i- a common experience that the quotations i<>r 
 the two are larger than would be that for one alone. 
 The great majority <>f mankind are optimists and deal 
 with corporations' shares ami securities optimistically. 
 natural Ik. pes ( ,f inv ore, serve to give 
 
 tn an income bond or a share of stock dependenl upon 
 future earnings, a quotable value which through senti- 
 ,t may be considerably higher than that justified by 
 the present position of the company. 
 
156 Corporatio7i Finance 
 
 For these reasons it may be possible in an easily ar- 
 ranged plan of reorganization to give to the holder of a 
 discredited bond a new bond for a part of his claims, 
 and in addition an income bond or shares of preferred 
 stock, in such proportion that by selling both new issues 
 the old bondholder may be able to get back his entire 
 investment and really lose nothing. Such a proced- 
 ure, however, is oftentimes possible only when the 
 capitalization of the new company is largely increased. 
 If regard is had to the present time only and to the 
 demands of the present holders of the bonds of the 
 defaulting company, such a reorganization will be con- 
 sidered a success ; and it is not to be denied that the 
 wish to satisfy present demands is legitimate so far as 
 it may be proper. But if we regard the day of reckon- 
 ing, such a reorganization may not be defensible. The 
 new capitalization may indeed be made to mature long 
 years hence, but when that maturity arrives and the 
 increased principal must be met, the wrongfulness of a 
 plan which increases the capitalization, even though 
 without an increase of obligatory charges at the mo- 
 ment, becomes apparent. And if, meanwhile other 
 disasters should overtake the corporation, the old in- 
 judicious arrangement of increased capitalization will 
 make it all the more difficult to secure to the company 
 such new money or such concessions as it may need. 
 
 When the holders of discredited bonds are asked to 
 surrender a part of their principal and to accept a 
 smaller rate of interest, an income bond to represent 
 the losses may be offered to them. To satisfy the con- 
 ditions of the problem, this bond must be of such a' 
 character as to be quoted in the Street at such a figure 
 as will reimburse the old holders for their sacrifices ; 
 at the same time, of course, the object of the reorgani- 
 
Reorganizations and Receivers kips. i 5 7 
 
 zation must be kept in view — that is, to reduce the fixed 
 charges. To satisfy both these conditions, the income 
 bond must be made contingent upon earnings on the 
 one hand, and on the other must have also such obliga- 
 tory features as will commend it to investors. Al- 
 though these two features are contradictory, such a 
 bond has, in a number of cases, been arranged for in 
 American reorganizations. Experience has shown 
 what, indeed, might have been expected, that such a 
 form of corporation capital works out no better in prac- 
 tice than in theory. On the one side, the holders of 
 such income or preference bonds are continually claim- 
 ing that certain profits earned by the railway company 
 should be paid over to them. On the other hand, the 
 principal being an obligation, these income or preference 
 bonds often stand in the way of proper management of 
 the finances of the company. As every growing system 
 has increasing needs, the managers find easy opportuni- 
 ties where the expenditure of a few thousands of dollars 
 would bring a large return in the way of increased 
 traffic or profit ; yet they are debarred from borrowing 
 money because the income mortgages deny them that 
 privilege. The result of this curious position is that 
 tin- com]) my does not progress as it ought, the acuteness 
 the managers being meanwhile exercised to devise 
 means whereby the too stringent terms of the in- 
 come m may be made practically of no effect, 
 illustration, m company may need larger terminals, 
 and these terminals may Ik- the means of increasing the 
 profits which should go toward i ». 1 \ in;.-, something upon 
 the income bond-.. Being, however, unable in its own 
 name to borrow the mon< •. \<> pay for the-- terminals 
 the new moi innol b pul ahi .id of the 
 income bond . the company may arrange to have them 
 
i 5 8 Corporation Finance 
 
 held in another name, meanwhile entering into a con- 
 tract with the terminal company to pay over to the 
 latter certain sums for the nse of the supposed ter- 
 minals. Such a terminal charge per passenger and 
 per ton is agreed upon as will be enough to meet the 
 interest on the new terminal bonds ; such terminal 
 charges being meanwhile added to the working ex- 
 penses of the system. In this way practically the 
 interest on the terminal bonds is paid for by the parent 
 company, although the terms of the income or preferred 
 mortgage would forbid such a thing if attempted 
 directly. All these considerations being taken into 
 account, the quotations for these income bonds often 
 rule so low upon the stock exchanges as to make a 
 large issue necessary if the original losses of the bond- 
 holders under reorganization are to be thus made up. 
 As a consequence, the capitalization of the new corn- 
 pan}- is much larger than that of the old. 
 
 Preferred stocks given in exchange for the sacrifices 
 of the old bondholders are much better than income 
 bonds from the point of view of good corporation finan- 
 ciering. Preferred shares may thus properly represent 
 deferred claims. There is no peremptory obligation 
 resting upon the company to pay an annual dividend 
 upon these shares, particularly if they are made non- 
 cumulative. To make dividends on preferred shares 
 cumulative is not good policy except in extreme cases, 
 because it lays the shares open in modified degree to 
 the reasoning which has just been applied to the 
 income bonds. Preferred shares, too, have voting 
 power, and their holders, even though small in num- 
 ber, are thus put in the way of defending their own 
 interests in the Board of Directors or before it. More- 
 over, while an excessive capitalization represented by 
 
Reorganizations and Receiverships. 1 59 
 
 shares is an evil and gives rise to some objectionable con- 
 ditions in our corporation finance, yet it is by no means 
 so dangerous as excessive capital represented by bonds. 
 Altogether, therefore, preferred shares represent de- 
 ferred claims under reorganization much better than 
 can income or preference bonds, and in all cases of 
 reorganization should be issued for such purposes 
 where the laws of the state will allow of such issue. 
 The issue of preferred shares in exchange for assess- 
 ments paid by the common-stock holders is often made 
 expedient by the sentimental wish of the assessed 
 shareholder to have some special piece of paper to 
 represent his payments. 
 
 Legally the owner of a single bond is entitled to all 
 the rights and advantages which the terms of the mort- 
 gage may give. It is becoming more common, however, 
 to limit the rights of a small minority by modifying 
 somewhat the extreme language of the mortgage. Rail- 
 way mortgages now usually provide that the trustees 
 shall take legal proceedings, shall declare the principal 
 due and shall proceed to foreclose, only when a certain 
 percentage of the bondholders request itsotoact. Cus- 
 tom yet gives to one half of the bonds outstanding, or 
 sometimes to a smaller pert entage, the right to demand 
 the satisfai tion of their mortgage through the truster. 
 But the Legal right of fori is our thing and the 
 
 commercial expediencj is often quite another. A sys 
 tern with a number of different 1 Lasses of bonds upon it 
 being in difficulties, the holders of some of the junior 
 issues may he unwilling I to any plan of reor 
 
 ganization whatever, or may find fault with the pro 
 portion of new securities to ; '.hem under the 
 
 advertised plan. In eith< 1 If or more oi the 
 
 bondholders have the powei to compel the tru 
 
160 Corporation Finance 
 
 begin foreclosure proceedings. If these proceedings 
 are carried through, these same bondholders must be 
 prepared to bid in the property in order to secure their 
 debt. This, in turn, involves "financing" the new 
 company. They must often be prepared to furnish 
 money enough at the sale to pay all the floating and 
 current indebtedness, and if they would make a success 
 of their new company, they must also be ready to 
 furnish the capital which under our assumed con- 
 ditions the system needs in order to be put in good 
 condition and ready for economical working. These 
 two requirements may call for so much money that the 
 bondholders may well hesitate before they enter upon 
 such an undertaking. Holders of corporation securi- 
 ties are scattered throughout the country, and perhaps 
 many of the bonds are held in Europe. A scattered 
 majority stands rather helpless before such a problem ; 
 the trustee will not act unless expenses are guaranteed 
 to it, while no banking house will undertake the forma- 
 tion of a new company unless it sees clearly that the 
 conditions favor success, and unless, too, it has the 
 support of a majority of the mortgage issues. It is 
 customary now for committees to be formed to protect 
 the interests of the various securities involved in the 
 insolvency. If such committee succeed in getting the 
 greater part of the securities deposited with it, it be- 
 comes a factor in the reorganization ; yet even when 
 this is the case, such committee may not be willing to 
 furnish the large sums necessary to finance the new 
 company in a manner favorable to the particular bonds 
 held by them. 
 
 It will thus be seen that it is better for the bond- 
 holders of a bankrupt railway system to accept a plan 
 of reorganization, if found equitable, rather than to 
 
Reorganizations and Receiverships 161 
 
 attempt to buy in the property for themselves. If the 
 proposed plan of rehabilitation is believed by a majority 
 of all bondholders to be unfair, it will usually fall to 
 the ground through lack of support ; that is, a plan, to 
 be carried out successfully, must have the active as- 
 sistance of a majority of the bondholders given to it 
 through a deposit of bonds of those holders who assent 
 to the plan. No matter how strong the language of 
 the mortgage, the bonds issued under it are worth only 
 what the commercial conditions of the company allow ; 
 hence it is better for the holders of defaulted bonds to 
 accept a plan when found upon examination to be 
 equitable, than to insist upon their legal rights ; for 
 their bonds are worth only what their proportion of the 
 total value of the company's property comes to ; they 
 could not get any more than that proportion even 
 though they insisted upon the full terms of the mort- 
 gage. Corporation reorganizations resolve themselves 
 into commercial problems rather than legal. 
 
 As business conditions change rapidly in a develop- 
 in- country, it frequently happens that a company 
 when insolvent and about to be reorganized wishes to 
 get rid of certain branches, guaranties, leases, or other 
 
 contracts which in the course of time may have proven 
 
 themselves very unprofitable. So long as the corpora 
 tion is solvent, the question of the justi( e of Living up 
 to its contracts does not arise. When, however, it eon 
 • is unable to paj its debts, then its financial 
 rehabilitation becomi tion ol i omm< r< ial value, 
 
 and in this light it is deemed proper for a reorganization 
 committee to plan for a cutting off of those branches, 
 or other contracts whi< h are n cognized as bui 
 densome upon the i ompany. Sometimes a company is 
 rehabilitated without a sale ol itspropertj al foreclos 
 
1 62 Corporation Finance 
 
 ure. In such happy cases it has been found possible to 
 make such an arrangement among all the bond- and 
 stockholders as enables the old company to rearrange 
 its mortgages and shares and go on with its business 
 under the existing charter. In cases, however, where 
 unprofitable branch lines have had to be supported or 
 onerous contracts carried out, the determination to 
 relieve the company from these burdens proves a 
 stumbling-block to the easy form of rehabilitation just 
 referred to ; for whenever a company is rehabilitated 
 by a change in its financial arrangements and proceeds 
 with its business under its old charter, all the contracts, 
 guaranties, and leases which it may once have entered 
 into are kept alive and become claims against the com- 
 pany. The only method of getting rid of such burden- 
 some guaranties or leases is through the foreclosure of 
 some one of the mortgages and a sale of the property 
 and franchises to another company. If there is a char- 
 ter in existence whose privileges are such as to meet 
 the conditions of the insolvent company, then the prop- 
 erty may be sold and conveyed to a company organized 
 under it. If this is not possible, then a new charter 
 must be obtained in the state or states concerned. 
 
 It is at this point that new difficulties arise. In 
 many cases the charters under which the insolvent 
 systems are now operating were granted many years 
 ago and contain privileges which could not now be 
 obtained from any legislature or from congress. It 
 may be that the state which originally gave the fran- 
 chise has, since granting that charter, enacted new 
 laws which forbid perhaps the very things that the old 
 charter permits. Under these circumstances the fore- 
 closure of one of the mortgages on the system and the 
 sale of the property to a company formed under a new 
 
Reorganizations and Receiverships 163 
 
 charter might involve the surrender of so much of the 
 old commercial rights as would render the success of 
 the enterprise doubtful. Here, again, it may be expedi- 
 ent for the holders of a senior or a junior mortgage 
 to make some concessions which will allow of a restora- 
 tion of the plant into the hands of the original com- 
 pany, rather than to insist upon the carrying out of 
 the provisions of the mortgage, which, though legally 
 clear, are impossible of fulfilment except at the ex- 
 pense of the holders of the bonds themselves. When 
 systems having old and valuable state or federal char- 
 ters have also burdensome leases or contracts, the 
 adjustment becomes one of great difficulty. If the 
 present charter be retained, the onerous contract is still 
 in force even though temporarily disowned by the 
 receivers ; if it is sought to throw off these contracts by 
 a sale to a company newly organized under present 
 laws, an equally large or even larger loss may be 
 lied. [f neither party will yield something under 
 these conditions, the property may stay in the hands of 
 receivers much longer than would be otherwise neces 
 sary, and longer too than the courts prefer to keep the 
 control in their possession. If at last neither will yield, 
 it becomes a 1 hoice of evils. It may be that during the 
 period of embarrassment the general business of the 
 ' ompany has suffer '1 to such an extent that the senior 
 bonds are affe< ted. It then 1" comes a question whether 
 :iior bonds will foreclose their mortgage and Let 
 
 go for what it will brim', : in such cases 
 
 the breaking up of large and importanl systems is .-1 
 thing to be lamented in th<- interest of the public no 
 than that of the creditors themselves, 
 ire insolvenl companie und< 1 ■ tnization 
 
 there is usually a period of receivership. The practice 
 
164 Corporation Finance 
 
 of operating insolvent railways through court officers 
 appointed for the purpose is not yet definitely settled 
 either as to the methods of working or as to the legal 
 doctrines involved, the whole matter being yet in a 
 state of evolution. It is the boast of our law that it 
 changes to meet the changing demands of commerce as 
 business becomes more complex and the rules govern- 
 ing it necessarily more involved ; so as regards railway 
 receiverships our present situation is the result of a 
 compromise between the terms of railway mortgages 
 and the commercial conditions under which railway 
 operations are carried on. 
 
 The original idea of appointing a receiver to take 
 charge of the property of a firm or individual was that 
 the business might be wound up with as little delay as 
 possible and the assets sold and distributed to the cred- 
 itors in some equitable proportion. As corporations 
 became more common, taking the place of firms and 
 individuals, the same idea was applied to them when 
 insolvent. They were placed in the hands of receivers 
 in order that their affairs might be closed up with the 
 least possible delay by dividing the assets among the 
 creditors in the proportion to which it was shown they 
 were entitled. It was inevitable that the question of 
 the proper method of treating insolvency among rail- 
 way companies should arise. From small beginnings 
 the number of miles of railway in the United States 
 increased rapidly until now, judged by the magnitude 
 of the property invested and the amount of business 
 done, the railways form perhaps our largest industry, 
 certainly one of the most complex. Through one 
 cause or another it was inevitable that bankruptcy 
 should increase among these rail carriers as their mile- 
 age increased ; and in such cases also it was natural, 
 
Reorganizations and Receiverships 165 
 
 as in the cases of firms or small corporations, that 
 receivers should be appointed pending a settlement of 
 the insolvent debtor's affairs. But here a new quest- 
 ion arose. A trading firm or corporation unable to 
 pay its debts could be wound up and its assets dis- 
 tributed to*its creditors without loss to the community. 
 Other traders could take their places and business 
 would go on as before ; but it was otherwise with the 
 railways. It was quickly seen that great states and 
 sections of states depended upon the continued opera- 
 tion of these railways for the transaction of their every- 
 day business, for supplies of clothing and manufactured 
 goods, and even for meat and bread. Whatever the 
 outcome, the trains must be kept running. Since, in 
 the course of time, local railways have grown into sys- 
 tems, it was found that the interests involved in these 
 systems were so enormous that their combined assets 
 could not be easily sold as one parcel to any one person 
 or company, or sold separately without breaking up 
 the systems. Hence, until the serious questions of 
 reorganization or sale were settled, the receivers of 
 these systems must continue to run the trains in the 
 interest of tin- public. As these necessary adjustments 
 wen- often found very complicated, requiring a long 
 time for negotiations and final agreement, the receivers 
 appointed by the courts w< re placed for the time being 
 in the position of railway managers. They wen con 
 fronted with technical problems of much practical im 
 portani e. Thej wi re required to become familiar with 
 di puted questions concerning reasonable rates and 
 tlnir ramifications. The conflicting claims of eities 
 and towns as t<> 1 hargi 9 which should be relatively fail 
 1 upon their attention. In shoi I 
 it was required that 1 ihould be able to form 
 
1 66 Corporation Finance 
 
 ulate for the operation of the properties in their charge 
 a policy which should be equitable to the capitalists 
 whose monej' was invested in the road, to all the sec- 
 tions served by the railway, and to the general travel- 
 ling and shipping public. Needless to say, the success 
 of such a task required men of administrative ability, 
 with the further result that the courts through their 
 appointed officers were obliged to decide upon the 
 details of administration. 
 
 It was the practice at first for receivers to be asked 
 for solely by certain creditors of the company in 
 order that their property might be held together and 
 protected against the seizure of certain parts of the 
 system by other creditors which might destroy the 
 value of the property as a whole. Usually the corpor- 
 ation appeared before the court in opposition to the 
 motion, so that, if receivers were appointed at all, the 
 court acted upon information brought to its knowledge 
 after a severe legal struggle. The idea that the corpor- 
 ation itself could ask for an appointment of a receiver 
 for its own property originated with the late Jay Gould, 
 whose contention in the Wabash cases in this respect 
 was afterwards affirmed by the Supreme Court of the 
 United States, which held that a company could itself 
 ask for the protection of the court if such was for the 
 best interest of all concerned. Under this doctrine few 
 of our large railway systems are now placed in any but 
 "friendly" hands. In such cases the matter is all 
 planned out beforehand and the men chosen. Any 
 creditor of the company, friendly to the administration, 
 may allege that the corporation owes him money that 
 it cannot pay, and as every going concern has plenty 
 of creditors in the ordinary course of business, such a 
 convenient creditor is usually not hard to find. To this 
 
Reorganizations and Receiverships 167 
 
 complaint, usually prepared in secret, some one of the 
 company's officers arranges a reply confessing the truth 
 of the charge. All parties concerned, each with the 
 respective documents, and without notice to the other 
 creditors or to the public, apply to the judge, perhaps 
 at night, who forthwith grants the application and ap- 
 points the receivers already arranged for. That this 
 procedure opens the door to the possibility of great 
 abuse of corporate interests needs no argument. That 
 on the whole the plan has worked fairly well is ow- 
 ing to the high character of our judiciary and also 
 of the officers in charge of our great corporations. Yet 
 it is not reassuring to holders of stocks, bonds, or float- 
 ing debt to know that a conspiracy between any small 
 creditor and any one of the principal officers of a cor- 
 poration may throw the control of the whole property 
 of the company into the hands of the court. Unques- 
 tionably, the appointment of former officers of the com- 
 pany as receivers leads to the charge at times that those 
 who had wrecked the company are still left in power. 
 Moreover, the door is open to abuses, such as the diffi- 
 culty easily thrown in the way of a thorough investiga- 
 tion into the company's condition, which it may be the 
 wish of the old managers to thwart, but which may be 
 an equitable plan of reorganization 
 
 can be evolved. Vet the affairs of our large corpora- 
 tions ha 1 implicated that only those long 
 familiar with them arc capable of administering them 
 
 without losses both to owners of the road and to ship- 
 
 This business fad has so far controlled the 
 
 <w of the courts in the appointing of old officers of 
 
 the insolvent corporation as receivers, though usually 
 
 other nun not previously connected with the company, 
 
 but ■ iting important interests as w( II as the s< c 
 
1 68 Corporation Finance 
 
 tions through which the road runs, are chosen to serve 
 with them. L,aws have been introduced in various 
 states to check the abuses to which the methods of 
 receiverships have given rise, but while these statutes 
 have done good as to certain matters of detail, the com- 
 mercial facts of which we have spoken have been strong 
 enough thus far to prevent any material modification 
 of the policy. 
 
 The immediate cause of a railway receivership is 
 usually the floating debt. Strictly speaking, the ex- 
 pression ' ' floating debt ' ' means the money borrowed 
 by a company on collateral and made payable on 
 demand or within a short time. The term, however, 
 is sometimes used to cover other debts of the corpora- 
 tion, such as for supplies which have been bought but 
 not paid for. A railway which is fairly prosperous can 
 arrange to pay its bond interest in a period of depres- 
 sion without showing signs of distress. Every large 
 business concern, such as a manufactory, must arrange 
 for a depreciation of plant and machinery before setting 
 aside earnings applicable to interest or dividends. The 
 reason for this is that, were a contrary course to be pur- 
 sued, the stock- or bondholders would very shortly find 
 themselves in possession of a worthless property. In 
 factories the expected losses from depreciation are usu- 
 ally arranged for by setting aside a certain sum of 
 money from the earnings yearly, but the practice of 
 railways is different. It is the custom with them to 
 renew or replace roadbed, track, and equipment from 
 year to year as fast as these deteroriate or become worn 
 out, charging the cost directly to working expenses. 
 By these means the whole plant is kept up to its stand- 
 ard at the expense of the earnings, the effect being the 
 same as though specific sums had ' been set aside from 
 
Reorganizations and Receivers flips 169 
 
 income each year. This method of arranging for de- 
 preciation allows the railways to vary the amount of 
 replacement from year to year according as the seasons 
 are prosperous or the reverse. In a good year more 
 may be spent upon the roadbed and the track and for 
 the purchase of new equipment to replace the old at 
 the cost of working expenses, than perhaps was pro- 
 portionately required. Then, in poor years, not so 
 much of this sort of work may be done, allowing a 
 larger proportion of gross income to be payable to bond- 
 and stockholders. This saving in the working expenses 
 by a stoppage of repairs to the plant is usually the first 
 resort of the railway manager when pressed for im- 
 mediate money to pay bond interest. Then there are 
 always demands for new capital for improvements 
 necessary to be made by every railway as its traffic 
 increases. Ordinarily bonds are sold to meet these 
 capital charges. If, because of a lack of confidence on 
 the part of the investing public, or a lack of credit as 
 ards this particular company, such bonds cannot be 
 sold, exc pt perhaps at a great sacrifice, then the 
 management proceed to borrow the necessary money 
 for these capital improvements and perhaps for the 
 then due bond interest. Usually the company must 
 
 hypothecate with the bankers from whom the money is 
 borrowed bonds either of the company itself or such .-is 
 are held in its treasury and controlling subsidiary lines 
 important to the integrity of the system, so that the 
 banker's loan may be fully secured. If matters go 
 from had to worse, if it appear to the lender thai the 
 situation of the company is becoming more and more 
 ii al, so thai h inning to di >ub1 1 he real value 
 
 of the collaterals held by him, he then calls for his 
 money, ii it is loaned on d< tnand, or gives notice that 
 
i yo Corporal ion Finance 
 
 he will ask for it when the same shortly matures. If 
 the company cannot arrange to borrow the amount 
 from some one else, and if it is confronted with the sale 
 of all its securities at bankrupt prices, the managers 
 may resolve to confess their own insolvency before a 
 public confession is made by the sale of the securities 
 held by the banker. Perhaps, just at this moment, a 
 large amount of interest is due to bondholders. In 
 such a case the railway managers may choose to 
 default on the bond interest and take the money for 
 payment to the floating-debt holders, in order to save 
 for the company the collateral which the bankers may 
 hold, and which may be essential to the control of parts 
 of the system, but which would very likely go for a 
 song if pressed for immediate sale. While, therefore, 
 floating debts do not differ from other obligations of 
 the company except in form, they have come to be 
 recognized in Wall Street as a source of great danger 
 in any period of business depression or lack of credit. 
 If this money borrowed on demand or on short notice 
 can be funded into bonds having years to run, the com- 
 pany cannot suffer through a demand upon it for the 
 principal, but it is safe so long as the interest is 
 promptly paid. This reasoning has led railway com- 
 panies at times to adopt the plan of selling long-time 
 bonds in order to pay off the floating debt, even though 
 the price received should be far below par. But such a 
 course compels the company to pay a very high rate of 
 interest during the whole life of the bonds and is con- 
 sidered such bad financiering that such sales are taken 
 in Wall Street as an acknowledgment that the company 
 is hard pressed — with results to the credit of the cor- 
 poration almost as bad as though the distress had been 
 openly acknowledged. Under these circumstances, 
 
Reorganizations and Receiverships i 71 
 
 ' ' friendly ' ' receivers are often asked for so that inter- 
 est may be withheld from the bondholders and used to 
 take up the obligations of the company immediately 
 pressing, particularly in cases where a failure to meet 
 those obligations would entail severe losses upon the 
 system for all time. 
 
 The court appointing receivers thus asked for usu- 
 ally stipulates that debts incurred in the operation of a 
 road for several months shall be paid by the receivers. 
 At first blush it would appear that such an order entails 
 hardship upon the creditors of the company, yet upon 
 examination it will be found to be equitable. Trans- 
 portation is conducted as a cash business. Travellers 
 and shippers are required to pay their money down 
 before taking their journey or receiving their property. 
 Since a railway must be run in the interest of the gen- 
 eral public, and since this involves the theory that its 
 working expenses must be paid, it is clear that the 
 expenses of to-day are properly chargeable to the gross 
 receipts of to-day paid in cash by the patrons of the 
 road. But, as we have seen, in periods of distress, the 
 managers in order to postpone a confession of bank- 
 ruptcy in the hopes that the temporary trouble may be 
 tided over, begin to put off payments for wages or for 
 
 coal, rails, ties, and supplies of all descriptions which 
 
 they may continue to buy, because necessary lot- the 
 continued operation of the trains, in this way, at the 
 date of appointment 1 every bankrupt road 
 
 li 1 3 lai - and accounts to be made up. 
 
 A realy chargeable to 
 
 the receipts of the several months past, and as these 
 ;;>ts have been taken to pay bond interest or for 
 other purposes in the interest of the bondholders, it is 
 proper that the prior i should 
 
i 72 Corporation Finance 
 
 be made up from the first receipts of the road under the 
 receivership. If there is any complaint to be made on 
 the part of the bondholders, it is that the knowledge of 
 these facts has not been brought to their attention ; 
 but usually in such a matter the managers of the road 
 act in good faith, in the hopes that better times may 
 enable them to pay up the back debts and save the 
 indirect losses to the bondholders, which a public con- 
 fession of the real situation would at that time have 
 caused. 
 
 The heavy expenses confronting the receivers at the 
 time of their appointment are met partly from defaulted 
 bond interest and perhaps from receivers' certificates. 
 At first these certificates, generally made a first lien on 
 the property, were authorized very sparingly by the 
 courts and only in cases shown beyond dispute to be 
 necessary. Gradually such issues were extended, until 
 the present practice is for authorization of certificates 
 for any purpose which the court may be led to believe 
 is for the ultimate benefit of the road. In this way an- 
 other mortgage is put ahead of the regular mortgage 
 whose bonds, held by the public, have been supposed 
 and declared to be a prior lien upon the road. The 
 force of circumstances often thus impairs the rights of 
 existing mortgages though these be drawn in strong 
 legal language. The right to issue receivers' certifi- 
 cates has been, and may be, greatly abused. In one 
 case the expense of operating greatly exceeded the re- 
 ceipts. The property and franchises should have been 
 sold at once so that the first-mortgage bondholders 
 might at least have received the value of the rails and 
 equipment ; but the court allowed the receivers to go 
 on running the road until the certificates issued to 
 make up the losses amounted to more than the value 
 
Reorganizations and Receiverships. i ,$ 
 
 of the property, the bondholders not getting a cent. 
 Receivers' certificates should be authorized only when 
 a careful judgment tempered by conservatism justi- 
 fies their issue. As just said, the directors, at the first 
 appearance of a decline in profits, economize in de- 
 preciation expenses, hoping for better times. If the 
 decline continues and a receivership ensues, the pass- 
 ing of the property into the hands of the court is 
 an acknowledgment of facts regarding impairment of 
 income which are true though not before generally 
 known. Hence the issue of receivers' certificates 
 commercially represents the impairment of income just 
 referred to, but which at the time was not enforced 
 against the bondholders. Railway mortgages are not 
 sacred because of the strong legal terms in which they 
 are drawn, but are dependent upon success in the busi- 
 ness of transportation, differing in this respect from 
 real-estate mortgages which rely more upon the pros- 
 perity of the whole community. The legal doctrine 
 of certificates is in a state of evolution, with a tendency 
 to approximate its working to the business circum- 
 stances. Our practice of railway receiverships is thus 
 a development of our own circumstances and a sort of 
 compromise between the too strong language of our 
 
 moil ad tin- actual conditions of the business of 
 
 transportation. 
 
 A receiver may decline to pay the rentals dm- to 
 leased Lines or the interest owing on guaranteed bonds 
 if these lines are .it the time of tli' receivership unpro 
 Stable, no matter how necessarj t<> the parent company 
 th'-.- branches may once have been. Bui the old con 
 tracts are still legally in force againsl the company, and 
 thrown off only 1>\ a sale of the franchise and 
 property t<» a new corporation. Such a sale sometimes 
 
i 74 Corporation Finance 
 
 would involve a forfeiture of valuable charter rights 
 besides a long legal struggle ; and in such reorganiza- 
 tions committees usually try to formulate some plan 
 which shall bring the fixed charges below the mini- 
 mum profits by allotting the necessary losses among all 
 classes of securities in proportion to their respective 
 values to the s)'Stem as a whole — a process which does 
 not regard the liens of the mortgages so much as the 
 worth of the lines they cover. But with plans of reor- 
 ganization, the receiver properly should have nothing 
 to do. 
 
 The legal doctrine and the practice regarding receiv- 
 erships and receivership problems have, in the United 
 States, been developed thus far largely in the affairs of 
 railways. Railways so clearly have public duties to 
 perform that it was inevitable that questions regarding 
 their continued operation should require settlement. 
 This point once settled, matters of detail about the 
 proper working would naturally come up for adjust- 
 ment in the order of their commercial evolution. 
 
 For these reasons we find the custom regarding rail- 
 way receiverships much in advance of those concerning 
 other corporations. But though these latter lag be- 
 hind, there are not wanting signs that some of the 
 problems of this character which we are trying to solve 
 in transportation, are in the future to demand consider- 
 ation in manufacturing. When factories were numer- 
 ous but small and easily managed by an individual or 
 by a firm composed of but few persons, it was not a 
 matter of great public moment whether one or two 
 firms failed. The demand could be easily supplied by 
 the manufacturers still in business and perhaps the 
 factory itself, belonging to the insolvent partners, 
 would be re-opened and run by another firm. The 
 
Reorganizations and Receiverships. • 175 
 
 case is altered already, if we have in mind the large 
 corporations formed to do certain manufacturing on an 
 extensive scale, and the point is likely to demand more 
 attention in the future, when, in the probable evolution 
 of things, the greater part of our manufactured output 
 may be produced by a comparatively few companies 
 having large capital, extensive plants, and the best of 
 appliances — for to such a state of production are we 
 slowly tending. 
 
 Already cases of the insolvency of large manufactur- 
 ing companies have been before the courts. In appoint- 
 ing receivers, it is now customary in such instances to 
 allow these officers of the courts to continue the busi- 
 ness. Like railways, these large corporations cannot 
 very well stop working. Not only are large bodies of 
 laboring men dependent for bread upon this continued 
 operation, but concerns throughout the country would 
 be embarrassed if their orders, perhaps half executed, 
 should not be completed at the appointed time. 
 
 Under our assumptions, it might not be possible for 
 the customers of the corporation to obtain the required 
 artich-s from any olln-r source of supply, and certainly 
 not in time to go ahead with their own plans, — plans 
 
 which if not carried out mighl cause financial embar- 
 
 •neiit to them also and to others. In short, the 
 
 larger the company, the more complete the producing 
 
 nization, the more important to the community is 
 
 its continued operation. We have heard complaints 
 
 from solvent companies or firms thai the competition of 
 
 irii - in the hand ivers was unfair to them, 
 
 of railways; but the growing 
 
 interdependence of trade and commero leaves no other 
 
 alternative. 
 
 This being so, the discussion just had on the com 
 
1 76 Corporation Finance 
 
 mercial facts underlying railway receiverships has a 
 bearing upon the immediate and future problems of 
 manufacturing or trading corporations. This is all the 
 more true because these latter are now issuing mort- 
 gages after the manner of transportation companies. 
 In the present customs about railway receiverships and 
 their rapid evolution under the stress of actual condi- 
 tions, and in the philosophy which seems to underlie 
 those customs, we may catch glimpses of the probable 
 experience awaiting the community if large business 
 corporations are to do the most of our manufacturing, 
 and if the managers of those companies should repeat 
 the financial blunders or frauds which appear in our 
 past railway history, or if commercial disaster should 
 compel a readjustment of capital. 
 
INDEX. 
 
 Accountants, public, 19 ; judg- 
 ing of business, 20 
 
 mling with branch lines, 
 69 ; losses of branch lines, 72- 
 74 ; charging off old deficits, 
 74 ; difficulty in setting forth 
 facts, "o ; excuse for optimism, 
 80: truth might destroy credit 
 and chance for recover) 
 general balance-sheets, 81; 
 old show full details, Ji, 
 - -• ; profit and 1' i^s account, 82 ; 
 tment of depreciation, 83, 
 84 ; charging to income or 
 capital, 82—84 ; betterments on 
 British railways, 85 ; better- 
 ments on American railway-, 
 85, 86 ; operating exp< 1 
 87 ; importance of knowing 
 ■ of plant, 88 ; for small 
 
 -, 88 
 niing for mercantili 
 
 h, mean- 
 ing of, 01 ; bills 
 . indirei 1 obliga- 
 
 'HlltS, 
 
 <) 1 ; mer< handi e, ■)-" . 1 h 
 
 ■f goo'K deal) in, 96 ; table 
 of liquidation valui 
 
 ; mi' hinery anil fix- 
 in of profit 
 
 1 liabilities 
 ■ ']<•' '1. '(0, 
 1 ondition 
 
 [01 
 
 Accounting of railways, 102 ; i:i- 
 comeaccount, 103; general bal- 
 ance-sheet, 106, 137 ; capital 
 losses through lack of credit. 
 107; explanation of assets, 107; 
 explanation of liabilities, 108 ; 
 bills payable for supplies, to8 
 169; accrued interest. 108; 
 audited vouchers, 10S ; rebati :s 
 and cut-rates, 109 ; profit and 
 loss, 1 01) ; details of general 
 balance-sheet, IO7-IO9; tabu- 
 lated changes in general bal- 
 ance-sheets, no; expenditures 
 anil resources in yearly state- 
 ments, III J losses of subsidi- 
 ary companies as assets, 1 1 1 ; 
 expenditures for capital, how 
 
 gathered. 112, 113 ; lncri ase in 
 
 I andequipment, r 13— 
 statement ol equipment , 
 . life of rails, ti6; percent- 
 operating expensi 
 < arnings, 117; examples of 
 ■ rises, 117, i t - : 
 main f way, 119, 169 ; 
 
 • quipment, 
 1 1 'i, 1 '.■ , ; a\ erage numbei oi 
 
 1 - to train. [20 ; 
 
 of fuel, 1 ..1 motive 
 
 power, 1 2" ; freight train lad- 
 
 [20 : freight > ars and 
 1 
 geni ral expenses, 122 ; table of 
 qui< I et o.d liabil 
 
 ; bonds in treasury, 
 1 2 1 ; s.i\ in^ a railw a) , 121. 
 
 77 
 
178 
 
 Index 
 
 V counting of railways. — Con. 
 of management, 125 ; operat- 
 ing expenses under change of 
 management, I2<> ; average 
 cost of a train mile, 127 ; re- 
 ports may give investor the 
 broad facts, 129 ; floating 
 debts, 168, 169, 171 ; see also 
 Great Eastern Railway 
 
 Alsopp Brewery, 20 
 
 American Sugar Refining Com- 
 pany, 136 
 
 Atchison, Topeka and Santa Fe, 
 13, 66, 70 
 
 Atlantic and Pacific, 70, 71 
 
 Blank Trading Company, 90 ; 
 estimate of financial position, 
 
 99 
 Bonds, should fetch par, 5 ; if 
 issued at a discount, 5 ; good 
 effect of issue to reasonable 
 amount, 7 ; of manufacturing 
 companies, 11 ; experience 
 necessary to establish values, 
 12; risk paid for by high in- 
 terest, 12 ; municipal, 14 ; of 
 railways dependent on success 
 of company, 34 ; of railway, 
 a lien really upon net earnings, 
 35 ; debentures, 36 ; foreclos- 
 ure of mortgage to convey title 
 in reorganization, 36 ; prior 
 lien, 41, 42 ; first mortgage, 
 42, 1 50 ; income or preference, 
 42-44, 156-15S ; the position 
 of holders of, 43 ; collateral 
 trust, 44, 45 ; collateral trust 
 notes, 4 s ; "blanket" or sys- 
 tem, 49 ; terminal, 52 ; funded 
 debts of railways generally can- 
 not be paid off, 58 ; listing on 
 the exchanges, 62 ; of branch 
 lines, 68-72, 151, 163; of sub- 
 sidiary companies, guaranteed, 
 75, 76, 163; argument for re- 
 pudiation of guaranties, 76, 
 77 ; adjustable branch line 
 
 guaranties, 7S ; argument 
 against adjustable guaranties, 
 78 ; guaranteeing, questions to 
 be asked about, 71; ; prim- Hen, 
 
 150 ; foreclosing on specific 
 piece of road, 151 ; terminal, 
 
 151 ; junior mortgages some- 
 times assessed under reorgani- 
 zations, 154 ; given for assess- 
 ments, 156 ; under reorganiza- 
 tion, 159-161, 172 ; selling of, 
 to provide for floating debts, 
 
 I7 " 
 Borrowing money, necessary for 
 
 business man or firm, 1 ; ex- 
 ample of result, 1 ; beneficial 
 to all concerned, 2 ; effect 
 upon prices and profits, 2 ; 
 methods of collecting capital, 
 3 ; such funds not to be put at 
 hazard, 3 ; should be only to 
 minimum value of property, 
 4, 5 ; if at too high a cost, 7 ; 
 necessity of a sufficiency of 
 capital, 13 ; by small corpora- 
 tions from banks, 14, 23 ; mini- 
 mum value of industrial com- 
 pany, 17 ; by railways in times 
 of stress, 170 ; see also Bonds, 
 Capital, Mortgages 
 Boston and Albany Railroad, 135 
 Branch lines, their advantages to 
 parent company, 63, 64 ; divis- 
 ion of earnings with parent 
 company, 65 ; allowances of 
 constructive mileage, 66-68 ; 
 commercial value of, 68, 69 ; 
 how determined in reorganiza- 
 tion, 71; under reorganization, 
 70 ; their deficits, how carried 
 in accounts, 72-74 ; under re- 
 organizations, 163 ; receivers of 
 parent company may decline 
 to pay rentals of, 173 
 
 C 
 
 Capitalization, see Bonds, Ac- 
 counting, Corporations 
 
Index 
 
 179 
 
 Central Pacific, 78 
 Chesapeake and Ohio, 9 
 Chicago, Burlington and Quincv, 
 
 5S. 
 
 Chicago, Milwaukee and St. 
 Paul, 
 
 Chicago. Rock Island and Paci- 
 fic. 13S, 139 
 
 Chicago ami Northwestern, 45, 
 
 47- 
 Chicago and Northern Pacific, 52 
 
 Claflin, II. : -, 136 
 
 Cleveland, Cincinnati, Chicago 
 and St. Louis, 5 I 
 
 Companies, gas, 27 ; water, 27 ; 
 
 Companies, street railway, their 
 traffic stable, 27 ; electricity 
 changes old conditions, 28 ; in- 
 crease of travel, 28 ; reduction 
 in cost of equipment and re- 
 pairs, 2s ; when freshly estab- 
 lished. 2s ; charters, 20 
 
 rations, distinction between 
 public and private, 24 ; state 
 regulation of, 24 ; widest infor- 
 mation required concerning, 
 25 , publicity, a safeguard 
 
 inst restrictions, 25. 
 taxation of, 26 ; owning shares 
 of other corporati 
 
 f';M: 
 
 plants, 31 ; trusts, 31 ; possible 
 advantages of combinatii ■ 
 their finani es, 32 ; mining and 
 other short - lived compi 
 
 ■uiiing of, 80 ; evolu- 
 tion toward, 1 |i : limited lia- 
 bilil ' 131; three 
 
 ^r;r is often denied 
 
 1 mop- 
 
 ■ 'i us, 131; 
 
 I I . 
 
 ipts to limit 
 
 ■ om- 
 
 . divi- 
 
 I 
 
 136 ; registering an increase in 
 value of plant, 137, 13S ; water 
 in stocks or bonds, 135, 138 ; 
 stock- watering, remedy for, 
 
 139 ; gain in honesty if actual 
 capital could be stated, 
 stock- watering increases! | u 
 values of shares, 140 ; low- 
 priced shares not desirable, 
 
 140 ; amount of capital little 
 effect upon rates, 141 ; reduc- 
 tion of dividend easier on non- 
 watered stock, 141 ; effects of 
 stock-watering on service, 141, 
 142 ; paying high di\ idem 
 elevated railroad, 142 ; illegiti- 
 mate stock -watering, 143: laws 
 of New York about increasing 
 capitalization, 144 ; laws of 
 Massachusetts about increas- 
 ing capitalization, 145 ; absol- 
 ute prohibition of stock-water- 
 ing, 145 ; may become bank- 
 rupt, 146 ; good credit 
 affected easily, 1 17 ; may owe 
 luge sums "ii insolvency, [48, 
 17;; not broken u] 1 bet ause "l 
 
 • nets 
 
 of, 1 " friendly " 
 
 1 1 eivers for, c66, [67; floating 
 debts, t68, [69, 1 3 1 : paj men! 
 <pf floating debts required in 
 insolvent y, 169, 171 ; old 
 
 • in insolvency 
 until reorganization, 173; valu- 
 able charters in insolvencj . 
 171; (••nit inuing operation un- 
 dei 1 : ; . industrial. 
 
 und 1 hips, 17 = . 1 
 
 up 1 
 
 ounting ; railway, account- 
 ing of, \.c( ounting 
 
 nil . Corporal n 1 
 ( orporation 
 
 D 
 I lividends, im] 1 
 
i So 
 
 Index 
 
 Dividends. — Con. 
 
 when not earned, n ; see also 
 Corporations 
 
 Elevated Railroad in New York, 
 
 133, 142 
 Erie Railroad, 73, 141 
 Evansville and Richmond, 76 
 
 G 
 
 Great Eastern Railway, 102 ; in- 
 come account, 103 ; Rich Val- 
 ley branch, 104 ; deficits of 
 branch, 104 ; general balance- 
 sheets, 106 ; general balance- 
 sheets analyzed, no; construct- 
 ion account, 114; statement 
 of equipment, 115; statements 
 of operating expenses, 117, 
 11S ; table of quick assets and 
 quick liabilities, 123 ; income 
 account under new manage- 
 ment, 125 ; operating expenses 
 under new management, 126 
 
 I 
 
 Incorporation of firms, 16 ; bank- 
 ing houses in connection there- 
 with, 17; advantages of, for 
 family concern, 22 ; not for un- 
 stable businesses, 59; profits set 
 down in prospectus, 136 ; origi- 
 nal cost of plant not stated, 
 136 
 
 Illinois Central, 45, 47, 67 
 
 Louisville and Nashville, 6, 50, 
 73 
 
 M 
 
 Management, importance of, in 
 corporate affairs, 21 ; of Ameri- 
 can railways, 128 
 
 Mortgages on dwelling houses, 
 33 ; not dependent on business 
 success of borrower, 33 ; rail- 
 way, wording about lien not to 
 be construed too literally, 35 ; 
 railway, description of, 39-41 ; 
 more careful drawing discussed, 
 60, 61 ; foreclosure under re- 
 organization, 159, 160; affected 
 by commercial conditions, 161; 
 development of receiverships 
 under, 173; see also Bonds, 
 Corporations, Reorganizations 
 
 X 
 
 New York Central and Hudson 
 
 River, 36 
 Northern Pacific, 48, 53, 65 
 
 
 
 Oregon Railway and Navigation, 
 
 46 
 Oregon Short Line, 46, 66, 67 
 
 Pennsylvania Railroad, S7 
 Philadelphia and Reading, 10, 
 
 44 
 Pittsburgh, Cincinnati, Chicago 
 
 and St. Louis, 75 
 Proctor & Gamble Co. , 1 36 
 
 R 
 
 Receivers, to operate railway 
 pending plan of reorganiza- 
 tion, 37 ; must pay certain 
 debts, 148, 171 ; authorized to 
 pay certain interest, 152 ; legal 
 practice of, not settled, 164 ; 
 original theory of appointment, 
 164; of railways, problems con- 
 fronting, 165, 166, 174; of trad- 
 ing firms, 165, 175; "friendly," 
 
Index 
 
 1S1 
 
 166, 167; certificates of, T72, 
 173; may decline to pay under 
 old contracts, 173 ; practice 
 under, a compromise, 1 73 ; 
 probabilities regarding, as to 
 industrial companies, 174; see 
 also Reorganization-. 
 Reorganizations, affecting branch 
 lines, 70-72 ; large amounts of 
 money must often be raised in, 
 i-P, 149; earning power of 
 company must be ascertained, 
 
 149 ; division of losses among 
 security-holders, 150 ; good 
 bonds should be undisturbed, 
 
 150 ; various m mder, 
 150, 151 ; courts do not favor 
 disintegration of systems, 152 ; 
 losses of shareholders, 152 ; 
 assessments, 153 ; so-called 
 " rights " of shareholders, 1 53, 
 [54 , position of junior secur- 
 ities, 1 54 ; bonds or shares 
 given foi u nts, 154 ; 
 equity of giving evidem 
 future claims for a 
 
 or 1 ; work 
 
 of committees, 149, 160, 161 ; 
 reasing capitalization under, 
 1 capitalization 
 . bonds «.r ■ 
 . ; not hindered by lang 
 of mortgages, 161 ; 
 ial problem 
 Richmond and West I 
 pany, 37, 73 
 
 Shareholders are partners in the 
 enterprise, 7 ; position of, un- 
 der reorganization, 152-154 
 
 Sinking funds, 53-58 
 
 Southern Railway, 37, 41 
 
 Stock, common, when exchanged 
 into preferred, 10 ; amount to 
 be issued at incorporation, iS 
 
 Stock, preferred, should have 
 preference upon assets, 8 ; when 
 more advisable than bonds, 8 ; 
 often represents old debts 
 scaled down, 9 ; ethical claims 
 when so issued, 10 ; given for 
 assessments, 156 ; under reor- 
 ganizations, 15(1, [58; cumulat- 
 ive dividends under reorganiz- 
 ation, 1 58 
 
 Stock watering, see Corporations 
 
 St. Paul and Duluth, 9 
 
 Trustees under mortgages usually 
 trust companies, 38 ; their rc- 
 sponsibilii 
 
 U 
 Union Pacific, i v , 66, 68, 71 
 
 W 
 
 Wal ,51 
 
 in < Central, 53 
 
UNIVERSITY OF CALIFORNIA LIBRARY 
 
 Los Angeles 
 
 This book is DUE on the last date stamped below. 
 
 R 1 4 1953 
 
 Form L9-25m-9,'47(A5618)444 
 
 LOS ANGEL Fe 
 
4026 C orporation 
 J83c finance. 
 
 . 
 
 4026 
 G83o 
 
 AA 000 593 520 o